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CHAPTER 4: CORPORATE FORMATION AND FINANCING 19
whole or in part.
ANSWER TO “THE ETHICAL DIMENSION”
QUESTION IN CASE 4.3
Should the Brennan brothers be held personally liable because they misled their attorneys? Why
or why not? Kenyon & Kenyon may have felt misled because the Brennan brothers promised to pay their
legal bills. Nevertheless, the Brennan brothers did not mislead their lawyers in a way that justifies piercing the
corporate veil. Kenyon & Kenyon was not tricked or misled into dealing with Brennan’s, Inc., rather than the
Brennan brothers themselves. As lawyers, Kenyon & Kenyon should have been well aware of when the
Brennan brothers were speaking as shareholders and when they were speaking in their personal capacities.
Moreover, as legal counsel, Kenyon & Kenyon also knew which corporate formalities its client did and did not
observe.
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 4.3
Do corporations benefit from shareholders’ limited liability? If so, how? Yes. A corporation benefits
directly by the protection offered to shareholders. The limitation of liability attracts capital by attracting
investors. This also benefits society generally by funding rational risk-taking in product and service research
and development.
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Other cases in which piercing the corporate veil was based on a commingling of personal and
corporate assets or interests include the following. In these cases, the courts “reversed” the piercing of the
veil to hold the corporations liable for the personal debts of their owners.
• Litchfield Asset Management Corp. v. Howell, 70 Conn.App. 133, 799 A.2d 298 (2002) (a reverse piercing
of the corporate veil was appropriate when the owner of two limited liability companies used the funds of the
companies as if they were her own in such a way as to deprive a plaintiff of any means of collecting a
judgment against the owner).
• Acree v. McMahan, 258 Ga.App. 433, 574 S.E.2d 567 (2002) (a shareholder’s individual identity was so
enmeshed in that of the corporation that they were interchangeable and virtually indistinguishable, so that if
the shareholder was unable to pay a judgment against him, injustice to a plaintiff certainly would be prevented
by allowing recovery from the corporation).
V. Corporate Financing
The principal method of corporate financing is the issuance of bonds (debt) and stocks (equity).
A. BONDS
Stock represents the purchase of ownership in the firm.
1. Common Stock
Common stock provides an interest with regard to control, earning capacity, and net assets. A
shareholder’s interest is generally in proportion to the number of shares owned out of the total
In terms of receiving payment for their investment, holders of common stock are last.
2. Preferred Stock
Holders of preferred stock have priority as to dividends and payment on dissolution of the corpora-
tion. Preferred-stock shareholders may or may not have the right to vote. Preferred stock is similar
Start-up businesses and high-risk enterprises may obtain venture capital financing (capital from
professional investors), as well as managerial or technical expertise, in exchange for a share of
ownership in the firm or control over its decisions.
2. Private Equity Capital
whole or in part.
3. Point out that at one time, opening a small business was relatively simple in terms of the obligations to
the government. Now many businesspersons feel, however, that there is an ocean of federal, state, and local
laws that threatens to swamp even the least regulated of small businesses. For example, all states require
tests, proof of financial responsibility, and compliance with other requirements to obtain a license to engage in
particular businesses or occupations. A business that is exempt from state regulations may be required to
obtain a county or city permit or license. Every level of government also imposes taxes and penalties for not
paying them.
4. You might want to use the corporation material to illustrate how statutes are read and analyzed.
Cyberlaw Link
What effect might the fact that Internet transactions are not yet taxed by any government entity
have on the formation, financing, and conduct of business on the Web?
DISCUSSION QUESTIONS
1. How is corporate income double-taxed? Because a corporation is a separate legal entity, corporate profits
are taxed by state and federal governments. Corporations can either retain corporate profits or pass them on to
shareholders in the form of dividends. Dividends are again taxable (except when they represent distributions of
the Supreme Court has held that no such restrictions should be put on a corporation’s right of free speech.
3. What steps must a foreign corporation take to qualify to do business in a state? Because a foreign
corporation does not have an automatic right to do business in a state other than its state of incorporation, it must ob-
tain a certificate of authority in the states in which it plans to do business. Once the certificate has been issued, the
foreign corporation that has its home office within the state or has manufacturing plants in the state meets this
minimum-contacts requirement. A foreign corporation whose only contact with the state is the fact that one of its
directors resides there does not have sufficient contact with the state for the state court to exercise jurisdiction over it.
In deciding whether a company has sufficient contacts with a state, a court may consider any number of factors
including the volume of business done by the corporation in the state and the number of persons employed by the
whole or in part.
corporations to facilitate making contracts with the government. Private charities are often organized as nonprofit
the double taxation of corporate profits.
7. To what extent is a promoter liable for preincorporation contracts? As a general rule, a promoter is held
personally liable on preincorporation contracts. Courts usually hold that promoters are not agents when a corporation
has yet to come into existence. If, however, the promoter secures the contracting party’s agreement to hold only the
corporation that are not within the scope of its corporate powers. Although corporations used to be sued fairly
frequently for engaging in ultra vires acts, the significance of this concept has declined in recent years as more and
more corporations have drafted their articles of incorporation to allow the company to engage in any lawful activity.
9. What is the difference between common stock and preferred stock? Common stock provides the share-
Holders of preferred stock have priority over holders of common stock as to dividends and payment upon dissolution
of the corporation. They may or may not have the right to vote on corporate directors or proposed fundamental
changes in the corporation. Preferred shareholders receive periodic dividend payments, usually established as a fixed
percentage of the face amount of each preferred share. Preferred stock is more similar to a bond than to common
stock even though preferred stock appears in the ownership section of the firm’s balance sheet.
ACTIVITY AND RESEARCH ASSIGNMENT
Ask each student to obtain an annual report of a major corporation and to summarize the results of the report
CHAPTER 4: CORPORATE FORMATION AND FINANCING 25
whole or in part.
A. BONDS
Stock represents the purchase of ownership in the firm.
1. Common Stock
Common stock provides an interest with regard to control, earning capacity, and net assets. A
shareholder’s interest is generally in proportion to the number of shares owned out of the total
In terms of receiving payment for their investment, holders of common stock are last.
2. Preferred Stock
Holders of preferred stock have priority as to dividends and payment on dissolution of the corpora-
tion. Preferred-stock shareholders may or may not have the right to vote. Preferred stock is similar
Start-up businesses and high-risk enterprises may obtain venture capital financing (capital from
professional investors), as well as managerial or technical expertise, in exchange for a share of
ownership in the firm or control over its decisions.
2. Private Equity Capital
whole or in part.
3. Point out that at one time, opening a small business was relatively simple in terms of the obligations to
the government. Now many businesspersons feel, however, that there is an ocean of federal, state, and local
laws that threatens to swamp even the least regulated of small businesses. For example, all states require
tests, proof of financial responsibility, and compliance with other requirements to obtain a license to engage in
particular businesses or occupations. A business that is exempt from state regulations may be required to
obtain a county or city permit or license. Every level of government also imposes taxes and penalties for not
paying them.
4. You might want to use the corporation material to illustrate how statutes are read and analyzed.
Cyberlaw Link
What effect might the fact that Internet transactions are not yet taxed by any government entity
have on the formation, financing, and conduct of business on the Web?
DISCUSSION QUESTIONS
1. How is corporate income double-taxed? Because a corporation is a separate legal entity, corporate profits
are taxed by state and federal governments. Corporations can either retain corporate profits or pass them on to
shareholders in the form of dividends. Dividends are again taxable (except when they represent distributions of
the Supreme Court has held that no such restrictions should be put on a corporation’s right of free speech.
3. What steps must a foreign corporation take to qualify to do business in a state? Because a foreign
corporation does not have an automatic right to do business in a state other than its state of incorporation, it must ob-
tain a certificate of authority in the states in which it plans to do business. Once the certificate has been issued, the
foreign corporation that has its home office within the state or has manufacturing plants in the state meets this
minimum-contacts requirement. A foreign corporation whose only contact with the state is the fact that one of its
directors resides there does not have sufficient contact with the state for the state court to exercise jurisdiction over it.
In deciding whether a company has sufficient contacts with a state, a court may consider any number of factors
including the volume of business done by the corporation in the state and the number of persons employed by the
whole or in part.
corporations to facilitate making contracts with the government. Private charities are often organized as nonprofit
the double taxation of corporate profits.
7. To what extent is a promoter liable for preincorporation contracts? As a general rule, a promoter is held
personally liable on preincorporation contracts. Courts usually hold that promoters are not agents when a corporation
has yet to come into existence. If, however, the promoter secures the contracting party’s agreement to hold only the
corporation that are not within the scope of its corporate powers. Although corporations used to be sued fairly
frequently for engaging in ultra vires acts, the significance of this concept has declined in recent years as more and
more corporations have drafted their articles of incorporation to allow the company to engage in any lawful activity.
9. What is the difference between common stock and preferred stock? Common stock provides the share-
Holders of preferred stock have priority over holders of common stock as to dividends and payment upon dissolution
of the corporation. They may or may not have the right to vote on corporate directors or proposed fundamental
changes in the corporation. Preferred shareholders receive periodic dividend payments, usually established as a fixed
percentage of the face amount of each preferred share. Preferred stock is more similar to a bond than to common
stock even though preferred stock appears in the ownership section of the firm’s balance sheet.
ACTIVITY AND RESEARCH ASSIGNMENT
Ask each student to obtain an annual report of a major corporation and to summarize the results of the report
CHAPTER 4: CORPORATE FORMATION AND FINANCING 25
whole or in part.
