Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
whole or in part.
2 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
CHAPTER 4: CORPORATE FORMATION AND FINANCING 3
whole or in part.
Since the advent of the Internet, governments at the state and federal levels have debated the following
question: Should state governments be able to collect sales taxes on goods sold via the Internet? Many state
governments claim that sales taxes should be imposed on such transactions. They argue that their inability to
tax online sales of goods to in-state customers by out-of-state corporations has caused them to suffer
significant losses in sales tax revenues. Opponents of Internet taxation argue that taxing online sales will
impede the growth of e-commerce. They also claim that because online sellers do not benefit from the state
services that are typically paid for by tax revenues (such as fire departments and road construction), they
should not be required to collect sales taxes.
THE SUPREME COURT’S APPROACH
According to a United States Supreme Court ruling in 1992, no individual state can compel an out-of-state
business that lacks a substantial physical presence within that state to collect and remit state taxes.a If the
corporation has a warehouse, office, or retail store within the state, though, the state can compel the
collection of state taxes. Nevertheless, as the Court recognized in that ruling, Congress has the power to pass
legislation requiring out-of-state corporations to collect and remit state sales taxes. Congress so far has
chosen not to tax Internet transactions.
A STATE COURT’S DECISION
The issue of Internet taxation came before a Tennessee appellate court in Prodigy Services Corp. v.
Johnson.b Prodigy, a Delaware corporation with its principal place of business in New York, is an Internet
service provider (ISP) that offers two software programs for purchase online. A Tennessee statute imposes
an obligation to collect sales taxes on anyone supplying "telecommunication services" to state residents. The
Tennessee Department of Revenue determined that Prodigy’s services constituted telecommunication
services and assessed sales taxes. Prodigy appealed this tax assessment.
Ultimately, the state appellate court held that Prodigy did not have to charge its Tennessee customers the
sales taxes. After looking closely at the wording of the statute and its legislative history, the court reasoned
that the legislature had not intended the statute to apply to ISPs. The court also concluded that even if
Prodigy had provided some telecommunication services, these services “were not the ‘true object’ of the
Prodigy sale.” The customer had to supply her or his own telephone services, and Prodigy had paid to use a
telecommunications network to connect the customer to the main computer in New York. Thus, in the court’s
opinion, Prodigy was a consumer of telecommunication services rather than a provider.
FOR CRITICAL ANALYSIS
Although most states currently do not require corporations that sell goods and services online to collect
state sales taxes, businesspersons should be aware that the law in this area is still developing. Thus,
corporations may be required to collect state taxes on Internet sales in the future. Should the fact that an
out-of-state corporation pays affiliates in a state to direct consumers to its Web site be sufficient to
require the corporation to collect taxes on Web sales to state residents? Why or why not?
a. See Quill Corp. v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992).
b. 125 S.W.3d 413 (Tenn.Ct.App. 2003).
1. Corporate Taxation
Corporate profits can be subject to “double tax.” Corporate income is taxed, and dividends are
taxable (unless they represent distributions of capital) as ordinary income to the shareholders.
whole or in part.
CHAPTER 4: CORPORATE FORMATION AND FINANCING 5
2. Holding Companies
Holding companies are often established in offshore no-tax or low-tax jurisdictions. A corporation
whose shares are held in a holding company may transfer cash and other investments to be taxed
in that jurisdiction.
D. TORT LIABILITY
A corporation is liable for the torts committed by its agents or officers within the course and scope of their
employment.
6 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
benefit of the corporation. This is true even if the officer's conduct was unauthorized, was effected for his or
her own benefit with the apparent authority of the corporation, or was contrary to instructions. The reason is
that a corporation can speak and act only through its agents and so the firm must be accountable for any acts
committed by one of its agents within their actual or apparent scope of authority and while transacting
corporate business.
This doctrine recognizes that principals generally are responsible for the acts of agents committed within
the scope of their authority. This has its basis on the public policy that a principal who has placed an agent in
a position of trust and confidence should suffer harm from the agent’s wrongful conduct, rather than an
innocent stranger. The imputation doctrine thereby creates an incentive for a principal to select and delegate
responsibility to its agents carefully.
2. What circumstances in this case suggest that MB should be held liable for Bloom’s fraud? Among
the circumstances in this case that suggest MB should be held liable for Bloom’s fraud are that MB placed
Bloom in a position of trust and confidence and permitted him to mix the operation and marketing of North
Hills with his duties at MB. Likewise, MB selected and delegated responsibility to Bloom, but arguably did not
do so carefully and responsibly. MB officers and directors knew that Bloom was running and selling North
Hills with MB’s staff and resources, and accepted his reports on the operation—reports that failed to
adequately disclose the truth.
On remand, the court will likely consider such questions as whether Bloom's fraudulent statements were
made as part of his employment with, and for the benefit of, MB. Did Bloom make it clear that he, not MB or
any of its other employees, personally managed North Hills? Did North Hills' marketing materials, tax
documents, and so on, include references to MB? Bloom marketed North Hills to MB clients—did he
represent North Hills to be an MB fund? Were investors misled to believe that North Hills was operated under
the authority of MB by Bloom’s use of MB employees and resources to conduct North Hills business? Did
Bloom's operation of North Hills benefit MB by, for example, attracting additional clients? These
circumstances could also suggest a basis for imputation.
3. What conditions did the court place on the application of the imputation doctrine in this case? The
U.S. Court of Appeals for the Third Circuit concluded that the application of the imputation doctrine might be
appropriate in the Belmont case, if the investors who brought the suit could prove that the manner in which
Bloom marketed North Hills to them while he was working for MB, and the apparent benefit of this connection
to MB, made it appear that he marketed North Hills within the scope of his authority as an officer of MB. In
other words, for the doctrine to be applied, the plaintiffs would have to prove that Bloom’s conduct occurred in
the course of his employment with MB and for the benefit of MB.
4. MB, which was already in financial distress, had to cease operations as a result of Bloom’s fraud.
How might MB have discovered the fraud before it grew so large as to have dire effects? The opinion of
the U.S. Court of Appeals for the Third Circuit in the Belmont case states that “during the period of the North
Hills fraud, MB did not have in place basic compliance procedures employed throughout the investment
advising industry to identify and prevent fraud and self-dealing by MB employees and affiliates. Compliance
weaknesses permitted Bloom to avoid required disclosures to MB about North Hills as a personal investment
vehicle. MB officers and directors failed to make basic inquiries about Bloom's operation of North Hills, and
did not collect any information on North Hills or monitor sales of investments in North Hills to MB's own
customers.”
It appears that any protocol designed to make up for these deficient procedures could have revealed
Bloom’s fraud to MB before the thievery grew so large as to lead to MB’s downfall. For example, if MB had
CHAPTER 4: CORPORATE FORMATION AND FINANCING 7
whole or in part.
simply applied the “basic compliance procedures employed throughout the investment advising industry to
identify and prevent fraud and self-dealing by * * * employees,” the company might have learned of Bloom’s
fraud much earlier.
E. CRIMINAL ACTS
A corporation may be held liable for the crimes of its agents and employees, if the punishment can be
applied to the corporation. Penalties may include fines of up to hundreds of millions of dollars, depending
on the offense, the amount of money involved, and the extent to which company officers are implicated.
ENHANCING YOUR LECTURE—
JURISDICTION OVER ALIEN CORPORATIONS
If a U.S. consumer is injured by a product manufactured by a corporation located in another country, can
the consumer sue the corporation in a U.S. state court? In other words, may a U.S. state court exercise
personal jurisdiction over an alien corporation? The answer depends on whether the defendant corporation
has sufficient “contacts” with the state where the lawsuit is filed. If the defendant corporation meets the
“minimum-contacts” requirement, then the state court can exercise jurisdiction over the corporation.
Generally, the minimum-contacts requirement is satisfied if a corporation does business in the state,
advertises or sells its products in the state, or places its goods into the “stream of commerce” with the intent
that the goods be sold in the state.
Alien corporations that are sued in U.S. courts sometimes claim that forcing them to travel to the United
States to defend against the suits is unfair because they must bear the cost of transporting witnesses,
documents, and other evidence. In response to such arguments, U.S. courts generally hold that alien
corporations, by marketing their goods in the United States, should expect to be “haled into court” in this
country. As one court stated, any such inconvenience “must be weighed against a public policy which favors
providing a forum for an injured resident to bring an action against a non-resident manufacturer.”a
FOR CRITICAL ANALYSIS
How might a foreign manufacturer that sells its products in the United States avoid being “haled
into court” in this country to defend against a product liability action?
a. Loral Fairchild Corp. v. Victor Co. of Japan, Ltd., 803 F.Supp. 626 (E.D.N.Y. 1992).
whole or in part.
individuals, though, quite a contrary situation prevailed. The corporation was private, and consequently, the
state would have had to reserve regulatory rights in the original grant of the charter for the college to be
subject to state control. In the absence of such reservations, the state of New Hampshire’s legislative acts
clearly impaired the original charter and thus violated the U.S. Constitution.
whole or in part.
APPLICATION TO TODAY’S WORLD
This case is a landmark in corporate law because it allowed for the continued existence of private
corporations in the United States. Story’s opinion opened an avenue for the future regulation of new
corporations, while at the same time creating vested rights in private corporations. Marshall and Story both
made it clear that the United States Supreme Court would afford the property rights of private corporations the
same protection afforded to other forms of property.
a. 17 U.S. (4 Wheaton) 518, 4 L.Ed. 629 (1819).
b. The forerunner of the modern-day Democratic Party.
c. The Federalists were an early political group, or party, that advocated a strong national government.
3. Nonprofit Corporations
Corporations formed without a profit-making purpose are nonprofit corporations. Usually private,
these firms include hospitals and universities.
4. Close Corporations
A close corporation is one whose shares are held by relatively few persons (who also often are its
directors or officers). Generally, because the number of shareholders is small, there is no market
for the shares. Some states have special statutes that cover close corporations. Permitting them to
b. Transfer of Shares in Close Corporations
Shareholders may be required to offer their shares to the close corporation or the other
shareholders before selling them to outside buyers.
ADDITIONAL BACKGROUND—
Close Corporation Stock-Transfer Restrictions
In February 1955, Robert Leihser, Albert Rench, and Claude Mullen bought Loyd Trucking Corporation.
They divided the fifty corporate shares equally and signed an agreement in 1956 that should any of them die
or wish to sell his shares, the remaining shareholder or shareholders would buy the shares. A procedure was
described in the agreement for transferring the shares in that event. In 1961, Claude Mullen sold his stock,
and Leihser and Rench each bought half of Mullen’s shares. The procedural details outlined in the 1956
agreement were not followed by Mullen, however, when he sold his shares. Leihser and Rench also violated
the 1956 agreement by assigning one share of stock each to their respective spouses. Then in 1981, Rench
died. Leihser sought to buy Rench’s shares from Rench’s wife, in accordance with the shareholder
agreement. Mrs. Rench was willing to sell, but they could not agree on a price. Finally, Leihser initiated this
action to compel Mrs. Rench to sell him the shares. The trial court granted Leihser specific performance and
ordered Mrs. Rench to sell the shares to Leihser. Mrs. Rench appealed.
2 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
CHAPTER 4: CORPORATE FORMATION AND FINANCING 3
whole or in part.
Since the advent of the Internet, governments at the state and federal levels have debated the following
question: Should state governments be able to collect sales taxes on goods sold via the Internet? Many state
governments claim that sales taxes should be imposed on such transactions. They argue that their inability to
tax online sales of goods to in-state customers by out-of-state corporations has caused them to suffer
significant losses in sales tax revenues. Opponents of Internet taxation argue that taxing online sales will
impede the growth of e-commerce. They also claim that because online sellers do not benefit from the state
services that are typically paid for by tax revenues (such as fire departments and road construction), they
should not be required to collect sales taxes.
THE SUPREME COURT’S APPROACH
According to a United States Supreme Court ruling in 1992, no individual state can compel an out-of-state
business that lacks a substantial physical presence within that state to collect and remit state taxes.a If the
corporation has a warehouse, office, or retail store within the state, though, the state can compel the
collection of state taxes. Nevertheless, as the Court recognized in that ruling, Congress has the power to pass
legislation requiring out-of-state corporations to collect and remit state sales taxes. Congress so far has
chosen not to tax Internet transactions.
A STATE COURT’S DECISION
The issue of Internet taxation came before a Tennessee appellate court in Prodigy Services Corp. v.
Johnson.b Prodigy, a Delaware corporation with its principal place of business in New York, is an Internet
service provider (ISP) that offers two software programs for purchase online. A Tennessee statute imposes
an obligation to collect sales taxes on anyone supplying "telecommunication services" to state residents. The
Tennessee Department of Revenue determined that Prodigy’s services constituted telecommunication
services and assessed sales taxes. Prodigy appealed this tax assessment.
Ultimately, the state appellate court held that Prodigy did not have to charge its Tennessee customers the
sales taxes. After looking closely at the wording of the statute and its legislative history, the court reasoned
that the legislature had not intended the statute to apply to ISPs. The court also concluded that even if
Prodigy had provided some telecommunication services, these services “were not the ‘true object’ of the
Prodigy sale.” The customer had to supply her or his own telephone services, and Prodigy had paid to use a
telecommunications network to connect the customer to the main computer in New York. Thus, in the court’s
opinion, Prodigy was a consumer of telecommunication services rather than a provider.
FOR CRITICAL ANALYSIS
Although most states currently do not require corporations that sell goods and services online to collect
state sales taxes, businesspersons should be aware that the law in this area is still developing. Thus,
corporations may be required to collect state taxes on Internet sales in the future. Should the fact that an
out-of-state corporation pays affiliates in a state to direct consumers to its Web site be sufficient to
require the corporation to collect taxes on Web sales to state residents? Why or why not?
a. See Quill Corp. v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992).
b. 125 S.W.3d 413 (Tenn.Ct.App. 2003).
1. Corporate Taxation
Corporate profits can be subject to “double tax.” Corporate income is taxed, and dividends are
taxable (unless they represent distributions of capital) as ordinary income to the shareholders.
whole or in part.
CHAPTER 4: CORPORATE FORMATION AND FINANCING 5
2. Holding Companies
Holding companies are often established in offshore no-tax or low-tax jurisdictions. A corporation
whose shares are held in a holding company may transfer cash and other investments to be taxed
in that jurisdiction.
D. TORT LIABILITY
A corporation is liable for the torts committed by its agents or officers within the course and scope of their
employment.
6 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
benefit of the corporation. This is true even if the officer's conduct was unauthorized, was effected for his or
her own benefit with the apparent authority of the corporation, or was contrary to instructions. The reason is
that a corporation can speak and act only through its agents and so the firm must be accountable for any acts
committed by one of its agents within their actual or apparent scope of authority and while transacting
corporate business.
This doctrine recognizes that principals generally are responsible for the acts of agents committed within
the scope of their authority. This has its basis on the public policy that a principal who has placed an agent in
a position of trust and confidence should suffer harm from the agent’s wrongful conduct, rather than an
innocent stranger. The imputation doctrine thereby creates an incentive for a principal to select and delegate
responsibility to its agents carefully.
2. What circumstances in this case suggest that MB should be held liable for Bloom’s fraud? Among
the circumstances in this case that suggest MB should be held liable for Bloom’s fraud are that MB placed
Bloom in a position of trust and confidence and permitted him to mix the operation and marketing of North
Hills with his duties at MB. Likewise, MB selected and delegated responsibility to Bloom, but arguably did not
do so carefully and responsibly. MB officers and directors knew that Bloom was running and selling North
Hills with MB’s staff and resources, and accepted his reports on the operation—reports that failed to
adequately disclose the truth.
On remand, the court will likely consider such questions as whether Bloom's fraudulent statements were
made as part of his employment with, and for the benefit of, MB. Did Bloom make it clear that he, not MB or
any of its other employees, personally managed North Hills? Did North Hills' marketing materials, tax
documents, and so on, include references to MB? Bloom marketed North Hills to MB clients—did he
represent North Hills to be an MB fund? Were investors misled to believe that North Hills was operated under
the authority of MB by Bloom’s use of MB employees and resources to conduct North Hills business? Did
Bloom's operation of North Hills benefit MB by, for example, attracting additional clients? These
circumstances could also suggest a basis for imputation.
3. What conditions did the court place on the application of the imputation doctrine in this case? The
U.S. Court of Appeals for the Third Circuit concluded that the application of the imputation doctrine might be
appropriate in the Belmont case, if the investors who brought the suit could prove that the manner in which
Bloom marketed North Hills to them while he was working for MB, and the apparent benefit of this connection
to MB, made it appear that he marketed North Hills within the scope of his authority as an officer of MB. In
other words, for the doctrine to be applied, the plaintiffs would have to prove that Bloom’s conduct occurred in
the course of his employment with MB and for the benefit of MB.
4. MB, which was already in financial distress, had to cease operations as a result of Bloom’s fraud.
How might MB have discovered the fraud before it grew so large as to have dire effects? The opinion of
the U.S. Court of Appeals for the Third Circuit in the Belmont case states that “during the period of the North
Hills fraud, MB did not have in place basic compliance procedures employed throughout the investment
advising industry to identify and prevent fraud and self-dealing by MB employees and affiliates. Compliance
weaknesses permitted Bloom to avoid required disclosures to MB about North Hills as a personal investment
vehicle. MB officers and directors failed to make basic inquiries about Bloom's operation of North Hills, and
did not collect any information on North Hills or monitor sales of investments in North Hills to MB's own
customers.”
It appears that any protocol designed to make up for these deficient procedures could have revealed
Bloom’s fraud to MB before the thievery grew so large as to lead to MB’s downfall. For example, if MB had
CHAPTER 4: CORPORATE FORMATION AND FINANCING 7
whole or in part.
simply applied the “basic compliance procedures employed throughout the investment advising industry to
identify and prevent fraud and self-dealing by * * * employees,” the company might have learned of Bloom’s
fraud much earlier.
E. CRIMINAL ACTS
A corporation may be held liable for the crimes of its agents and employees, if the punishment can be
applied to the corporation. Penalties may include fines of up to hundreds of millions of dollars, depending
on the offense, the amount of money involved, and the extent to which company officers are implicated.
ENHANCING YOUR LECTURE—
JURISDICTION OVER ALIEN CORPORATIONS
If a U.S. consumer is injured by a product manufactured by a corporation located in another country, can
the consumer sue the corporation in a U.S. state court? In other words, may a U.S. state court exercise
personal jurisdiction over an alien corporation? The answer depends on whether the defendant corporation
has sufficient “contacts” with the state where the lawsuit is filed. If the defendant corporation meets the
“minimum-contacts” requirement, then the state court can exercise jurisdiction over the corporation.
Generally, the minimum-contacts requirement is satisfied if a corporation does business in the state,
advertises or sells its products in the state, or places its goods into the “stream of commerce” with the intent
that the goods be sold in the state.
Alien corporations that are sued in U.S. courts sometimes claim that forcing them to travel to the United
States to defend against the suits is unfair because they must bear the cost of transporting witnesses,
documents, and other evidence. In response to such arguments, U.S. courts generally hold that alien
corporations, by marketing their goods in the United States, should expect to be “haled into court” in this
country. As one court stated, any such inconvenience “must be weighed against a public policy which favors
providing a forum for an injured resident to bring an action against a non-resident manufacturer.”a
FOR CRITICAL ANALYSIS
How might a foreign manufacturer that sells its products in the United States avoid being “haled
into court” in this country to defend against a product liability action?
a. Loral Fairchild Corp. v. Victor Co. of Japan, Ltd., 803 F.Supp. 626 (E.D.N.Y. 1992).
whole or in part.
individuals, though, quite a contrary situation prevailed. The corporation was private, and consequently, the
state would have had to reserve regulatory rights in the original grant of the charter for the college to be
subject to state control. In the absence of such reservations, the state of New Hampshire’s legislative acts
clearly impaired the original charter and thus violated the U.S. Constitution.
whole or in part.
APPLICATION TO TODAY’S WORLD
This case is a landmark in corporate law because it allowed for the continued existence of private
corporations in the United States. Story’s opinion opened an avenue for the future regulation of new
corporations, while at the same time creating vested rights in private corporations. Marshall and Story both
made it clear that the United States Supreme Court would afford the property rights of private corporations the
same protection afforded to other forms of property.
a. 17 U.S. (4 Wheaton) 518, 4 L.Ed. 629 (1819).
b. The forerunner of the modern-day Democratic Party.
c. The Federalists were an early political group, or party, that advocated a strong national government.
3. Nonprofit Corporations
Corporations formed without a profit-making purpose are nonprofit corporations. Usually private,
these firms include hospitals and universities.
4. Close Corporations
A close corporation is one whose shares are held by relatively few persons (who also often are its
directors or officers). Generally, because the number of shareholders is small, there is no market
for the shares. Some states have special statutes that cover close corporations. Permitting them to
b. Transfer of Shares in Close Corporations
Shareholders may be required to offer their shares to the close corporation or the other
shareholders before selling them to outside buyers.
ADDITIONAL BACKGROUND—
Close Corporation Stock-Transfer Restrictions
In February 1955, Robert Leihser, Albert Rench, and Claude Mullen bought Loyd Trucking Corporation.
They divided the fifty corporate shares equally and signed an agreement in 1956 that should any of them die
or wish to sell his shares, the remaining shareholder or shareholders would buy the shares. A procedure was
described in the agreement for transferring the shares in that event. In 1961, Claude Mullen sold his stock,
and Leihser and Rench each bought half of Mullen’s shares. The procedural details outlined in the 1956
agreement were not followed by Mullen, however, when he sold his shares. Leihser and Rench also violated
the 1956 agreement by assigning one share of stock each to their respective spouses. Then in 1981, Rench
died. Leihser sought to buy Rench’s shares from Rench’s wife, in accordance with the shareholder
agreement. Mrs. Rench was willing to sell, but they could not agree on a price. Finally, Leihser initiated this
action to compel Mrs. Rench to sell him the shares. The trial court granted Leihser specific performance and
ordered Mrs. Rench to sell the shares to Leihser. Mrs. Rench appealed.
