CHAPTER 4: CORPORATE FORMATION AND FINANCING 11
In Rench v. Leihser, 139 Ill.App.3d 889 (1986), the Appellate Court of Illinois reversed the decision of the
trial court, finding that the conduct of Leihser and Rench after their purchase of Mullen’s stock terminated the
agreement in 1961. Although agreements imposing transfer restrictions on the stock of close
corporations are valid and may be enforced by specific performance, the validity of the agreements depends
on their continuing to be followed by the parties. As the agreement had been disregarded, it was no longer in
force. In the absence of an agreement, the court could not grant specific performance. Consequently, Mrs.
whole or in part.
allocated according to their stock ownership. Over a fifteen–year period, the percentage grew from 75 percent
appealed.
A state intermediate appellate court affirmed. A salary should reasonably relate to a corporate officer’s
ability and the quantity and quality of rendered services. Profits resulting from an officer’s performance may
to individual contributions, for a total of 10 percent of Olympic’s average annual net sales. This amount
12 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
remedies for breaches of fiduciary duty in a close corporation. But most cases involve a shareholder’s
derivative suit brought on behalf of the corporation, as in this case. An order for direct relief—paying some
amount directly to the shareholder—would not be appropriate for the wrong done to the corporation. Such an
order might have different tax consequences for all of the parties, but defendants who, to avoid paying taxes,
drain off a corporation’s earnings for themselves have little to complain about if, due to their improper actions,
they have to refund the earnings and the taxes must be paid.
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?”
QUESTION IN CASE 4.2
Suppose that Murray could have pinpointed a job–related basis for determining the distribution of
the net profits among the defendants. Would the result have been different? Explain. The result in this
case might have been different if Murray had pinpointed a job-related basis for the distribution of the net
profits among the defendants. The court found it significant that Murray was vague in identifying a basis and
that the amounts paid seemed to correspond to the percentage of the individual defendants’ stock ownership.
If instead the amounts had correlated to the quantity and quality of the individuals’ services, for example, the
court might have been persuaded that the compensation had a reasonable basis.
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 4.2
What are the tax consequences of passing corporate profits on to the shareholders as dividends?
Whether a corporation retains its profits or passes them on to the shareholders as dividends, the profits are
subject to income taxes. In fact, the profits can be subject to double taxation. The company pays taxes on its
profits, and then if the profits are passed on to the shareholders as dividends, the shareholders must also pay
income tax on them. If the profits are passed on to the officers as compensation, however, the corporation
avoids paying additional taxes on them.
The requirements for S corporation status and its benefits include—
• The corporation must be a domestic corporation.
• The corporation must not be a member of an affiliated group of corporations.
• The shareholders must be individuals, estates, or certain trusts—not partnerships and
whole or in part.
In general, the law governing the professional corporations is similar to the law governing ordinary
business corporations. There is an important difference, however: despite the otherwise limited
liability of a corporation, a shareholder in a professional corporation may be liable for the
malpractice of another member. Shareholders are protected, however, from tort liability, other than
malpractice, imposed by the acts of other members.
Promoters take the preliminary steps of organizing a corporation: issuing a prospectus and securing a
charter. A promoter is personally liable on preincorporation contracts, even after incorporation unless the
third party releases the promoter or the corporation assumes the contract by novation.
B. INCORPORATION PROCEDURES
2. Secure the Corporate Name
All state require that a name include Corporation, Incorporated, Limited, Company, or and
abbreviation of one of these terms.
a. First Check Available Domain Names
The articles serve as a primary source of authority for the corporation’s future organization and
business functions, and include basic information about the corporation—
• The name of the corporation.
• The number of shares the corporation is authorized to issue.
a. Shares of the Corporation
c. Incorporators
Incorporators (some states require only one) must sign the articles when they are submitted to
the state. Often this is their only duty, and they need have no other interest in the corporation.
4. File the Articles with the State
The articles are sent to the appropriate state official (usually the secretary of state). Many states
issue a certificate of incorporation authorizing the corporation to do business.
whole or in part.
whole or in part.
18 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
12 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
remedies for breaches of fiduciary duty in a close corporation. But most cases involve a shareholder’s
derivative suit brought on behalf of the corporation, as in this case. An order for direct relief—paying some
amount directly to the shareholder—would not be appropriate for the wrong done to the corporation. Such an
order might have different tax consequences for all of the parties, but defendants who, to avoid paying taxes,
drain off a corporation’s earnings for themselves have little to complain about if, due to their improper actions,
they have to refund the earnings and the taxes must be paid.
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?”
QUESTION IN CASE 4.2
Suppose that Murray could have pinpointed a job–related basis for determining the distribution of
the net profits among the defendants. Would the result have been different? Explain. The result in this
case might have been different if Murray had pinpointed a job-related basis for the distribution of the net
profits among the defendants. The court found it significant that Murray was vague in identifying a basis and
that the amounts paid seemed to correspond to the percentage of the individual defendants’ stock ownership.
If instead the amounts had correlated to the quantity and quality of the individuals’ services, for example, the
court might have been persuaded that the compensation had a reasonable basis.
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 4.2
What are the tax consequences of passing corporate profits on to the shareholders as dividends?
Whether a corporation retains its profits or passes them on to the shareholders as dividends, the profits are
subject to income taxes. In fact, the profits can be subject to double taxation. The company pays taxes on its
profits, and then if the profits are passed on to the shareholders as dividends, the shareholders must also pay
income tax on them. If the profits are passed on to the officers as compensation, however, the corporation
avoids paying additional taxes on them.
The requirements for S corporation status and its benefits include—
• The corporation must be a domestic corporation.
• The corporation must not be a member of an affiliated group of corporations.
• The shareholders must be individuals, estates, or certain trusts—not partnerships and
whole or in part.
In general, the law governing the professional corporations is similar to the law governing ordinary
business corporations. There is an important difference, however: despite the otherwise limited
liability of a corporation, a shareholder in a professional corporation may be liable for the
malpractice of another member. Shareholders are protected, however, from tort liability, other than
malpractice, imposed by the acts of other members.
Promoters take the preliminary steps of organizing a corporation: issuing a prospectus and securing a
charter. A promoter is personally liable on preincorporation contracts, even after incorporation unless the
third party releases the promoter or the corporation assumes the contract by novation.
B. INCORPORATION PROCEDURES
2. Secure the Corporate Name
All state require that a name include Corporation, Incorporated, Limited, Company, or and
abbreviation of one of these terms.
a. First Check Available Domain Names
The articles serve as a primary source of authority for the corporation’s future organization and
business functions, and include basic information about the corporation—
• The name of the corporation.
• The number of shares the corporation is authorized to issue.
a. Shares of the Corporation
c. Incorporators
Incorporators (some states require only one) must sign the articles when they are submitted to
the state. Often this is their only duty, and they need have no other interest in the corporation.
4. File the Articles with the State
The articles are sent to the appropriate state official (usually the secretary of state). Many states
issue a certificate of incorporation authorizing the corporation to do business.
whole or in part.
whole or in part.
18 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS