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Chapter 43
CORPORATION FORMATION
RESTATEMENT
A corporation is an artificial person created by statute. Corporations are created under a general corporate code
such as the Model Business Corporation Act (MBCA). Once legally incorporated, a corporation ’s certificate of
incorporation, articles of incorporation or charter receive approval from the appropriate government agency. The
types of corporations include: public, private, quasi-public, public authorities, domestic, foreign, close,
Subchapter S or S, professional and non-profit.
A corporation has the same constitutional protections as an individual with the exception of the right to claim the
fifth amendment privilege in order to avoid releasing documents.
Promoters bring together the funding and organization of a corporation. Prior to incorporations, promoters are
acting without a principal and are personally liable on the contracts. Promoters file the necessary paperwork for
incorporation which includes the following information: the name of the corporation, the number of shares the
corporation is authorized to issue, the address of the corporation ’s initial place of business and the name and
address of each incorporator. A corporation de jure is a corporation formed validly. A de facto corporation results
when the parties intended to comply with the law but failed in some procedural aspect. The law recognizes the
corporation for purposes of limiting liability of its owners. Some courts ’ interpretations of the MBCA hold that a
corporation de facto no longer exists.
A corporation is dissolved by insolvency, the forfeiture of its charter or by judicial dissolution.
Corporate powers include the right to perpetual life, making by-laws, entering into contracts, borrowing money,
transferring property, acquiring property, buying stock, doing business in another state, participating in business
enterprises, paying employee benefits and making charitable contributions. An act in excess of corporate powers
is an ultra vires act. Such an act allows the shareholders to recover for the costs of such conduct.
A consolidation is the combination of two or more corporations into a new corporation. A merger occurs when
one corporation absorbs another. Shareholders have rights to object to a merger and then obtain the value of
their shares as dissenting shareholders. Conglomerates are parent and subsidiary corporations. Where the
parent has no business activity of its own, it is referred to as a holding company.
STUDENT LEARNING OUTCOMES
LO.1: Recognize that a corporation is a separate legal entity, distinct and apart from its stockholders and that
individual shareholders are not liable for claims against the corporation.
LO.2: Explain the wide range of power given to corporations under modern corporate codes.
LO.3: Understand that the promoter is personally liable for preincorporation contracts.
LO.4: Understand that after a corporate charter has been dissolved the owners and officers may be personally
responsible for contracts made in the corporate name if they knew or should have known of the
dissolution.
LO.5: Explain a stockholder's option when he or she objects to a proposed consolidation or merger of the
corporation.
LO.6: Recognize that liabilities of predecessor corporations can be imposed on successor corporations when
the transaction is a de facto merger or a continuation of the predecessor.
INSTRUCTOR’S INSIGHTS
Break the chapter down into four components – related Learning Outcomes are indicated in ( ):
1. What is the nature of corporations and how are they classified?
Discuss the rights of the corporation as a person (LO.1)
List the classifications of corporations
2. What powers does a corporation have?
List particular powers of corporation (LO.2)
3. How are corporations created and terminated?
Define promoters and discuss their duties (LO.3)
Explain the incorporation process
4. What are consolidations, mergers, and conglomerates?
Provide definitions for consolidations, mergers and conglomerates
Discuss the legality of consolidations, mergers, and conglomerates (LO.5)
CHAPTER OUTLINE
I. What is the Nature of Corporations and How are They Classified?
A. The corporation as a person
CASE BRIEF: Crozier v. Sauers
109 A.D. 3d 507 (N.Y. App. Div. 2013)
FACTS: Crozier and Sauers entered into an oral agreement. Crozier wrote four checks to T & M
Corp. so that his friend Sauers could expand his auto glass company. Crozier sued Sauers
maintaining that Sauers was personally liable for repayment of the loan.
ISSUE: When a loan is made to a corporation, are the shareholders responsible for repayment of the
loan?
REASONING: There was no evidence that Sauers agreed to be personally responsible for the loan. The funds
were to be used for corporate purposes, were advanced to the corporation, were deposited in
the corporation’s account, and were actually used for corporate purposes.
Authors' Comment: Note that the treatment of "piercing the corporate veil" is also covered in Chapter 44, which
B. Classifications of corporations
1. Public, private, and quasi-public corporations
2. Public authorities
3. Domestic and foreign corporations – domestic in state of incorporation
C. Corporations and governments
1. Make certain that the students understand that the corporation is a separate legal entity from the
shareholders
2. Power to create
3. Power to regulate
a. Protection of the corporation as a person – United States Constitutional protection
b. Protection of the corporation as a citizen
i. Right to sue
ii. Doing business in another state – registration
II. What Powers Does a Corporation Have?
A. Particular powers
1. Perpetual life
2. Corporate name
3. Corporate seal
4. Bylaws – bylaws are subordinate to statutes and the charter
B. Ultra vires acts
1. Ultra vires acts are beyond corporate powers
2. The concept of ultra vires transactions is on the way out as a result of recent legislation in some
III. How are Corporations Created and Terminated?
A. Promoters
1. Discuss contract and tort liability problems – no principal until formation
2. Discuss fiduciary duty to the corporation and to stock subscribers – duty to them
3. Make certain that the students understand the difference between a promoter and an incorporator.
B. Incorporation
C. Application for incorporation
1. Discuss the contents of an application
2. Have the students draw up articles of incorporation for a business using the content requirements
a. Name
b. Number of shares
3. Advise the students that the name chosen for the corporation cannot be deceptively similar to that of
D. The certificate of incorporation – issued by a government official
E. Proper and defective incorporation
corporation
4. Partnership versus corporation by estoppel
F. Insolvency, bankruptcy, and reorganization
G. Forfeiture of charter
1. By state (RMBCA) if:
a. 60 days’ delinquent franchise taxes
2. If corporation exceeds its powers
H. Judicial dissolution – state statutes, management deadlocked
IV. What are Consolidations, Mergers, and Conglomerates? (See Figure 43-1 in text)
A. Definitions
1. Make sure that the students understand the difference between a merger and a consolidation. Have
2. Appraisal statutes provide protection for the minority shareholders
formed
5. Merger (See Figure 43-2 in text)
a. One absorbs the other(s)
CASE BRIEF: In re 75,629 Shares of Common Stock of Trapp Family Lodge, Inc.
725 A. 2d 927 (Vt. 1999)
FACTS: The Trapp Family Lodge (a resort complex) merged with a new corporation. The dissenting
shareholders were offered $33.84 per share and they maintained the value was $63.44 per
share. The trial court granted $63.44 and the Trapp Family Lodge appealed.
ISSUE: How is the value per share to be determined and what is it?
REASONING: The value is the proportionate interest in a going concern. It is a fact specific process that
involves appraisal and valuation.
6. Conglomerate
B. Legality – federal antitrust problems
CASE BRIEF: Marsh Advantage America v. Orleans Parish School Board
995 So. 2d 53 (La. App. 2008)
FACTS: The School Board hired consulting firm Johnson and Higgins, creating an ongoing
insurance consulting agreement between them. Pursuant to their agreement, over the next few
years, the firm prepared several requests for proposals on behalf of the School Board. The
School Board paid its fees for this consulting work without complaint. During this time, the
consulting firm merged with another company. The successor corporation, Marsh USA,
prepared two more requests for proposals. Per the terms of the agreement, the School Board
owes $75,000. The School Board asserted that Marsh USA was not a proper party to the lawsuit
and that no contract had existed with it.
ISSUE: Does the School Board have to pay a successor corporation for the work of its
predecessor corporation?
REASONING: When two corporations merge or consolidate, the new successor corporation acquires all of the
assets and rights of the former corporation. The minutes of a School Board meeting reflect the
School Board’s awareness of the merger in this case as well as its continuing contract with the
firm.
C. Liability of successor corporations
CASE BRIEF: Marks v. Minnesota Mining and Manufacturing Co.
232 Cal. Rptr. 594 (Cal. App. 1986)
FACTS: McGhan/Del., Inc. was a wholly owned subsidiary of 3M. In June of 1977, it acquired
McGhan/Cal., Inc., a manufacturer of breast implants. In April of 1977, the plaintiff, Marks, had
surgery using two McGhan implants. Marks underwent three subsequent surgeries to have
these implants replaced, eventually with another company’s implants. In 1981, McGhan/Del.,
Inc. was reorganized as a division of 3M and dissolved. The breast implants had been recalled
from the market prior to Marks’s final surgery, and Marks brought a product liability suit against
3M. 3M raised the defense that it was not liable for the actions of the predecessor corporation.
The jury awarded Marks $25,850 in compensatory damages and $75,000 in punitive damages.
The trial judge deleted the punitive damages. Both parties appealed.
ISSUE: Was the transaction between McGhan/Cal. and 3M an asset sale or was it a de facto merger?
HOLDING: A de facto merger occurred. In the merger between McGhan/Del. and McGhan/Cal.,
McGhan/Cal. shareholders received shares of 3M stock in exchange for all of the business, and
REASONING: The de facto merger doctrine developed to protect the rights of shareholders and creditors of
the corporation which liquidates in a sale of all its assets. In a conventional merger, where
stock of the acquired corporation is exchanged for either stock in the acquiring corporation or
cash, the shareholder of the acquired company is permitted to dissent to the merger and the
remedy of appraisal available. However, when the acquired company camouflages its merger
as a sale of assets, the shareholder would not have the remedy of appraisal available unless
the court steps in and declares the sale to be a de facto merger. Where a de facto merger is
deemed to occur, the acquiring corporation assumes the liabilities of the acquired corporation
as if there was a merger in the statutory form.
ANSWERS TO QUESTIONS AND CASE PROBLEMS
1. Ignoring the corporate entity. Mere ownership and operation of a corporation does not render one personally
liable for the corporation’s debts. Ellis would have to show fraud, illegality, or the need to prevent injustice to
2. Personal liability of promoter. Judgment against Watkins. No corporation existed when Watkins signed the
lease with Clinton. Consequently, Watkins was a promoter. The subsequent formation of a corporation and
3. Nature of consolidations, mergers, and conglomerates. “Consolidation” and “merger” refer to a process of
fusion by which two existing corporations become one. Usually, such a procedure is expressly authorized by
In the case of a conglomerate, each corporation in the conglomerate remains in existence and preserves its
separate identity. One corporation will own the stock of the other corporations in the conglomerate and will
As a matter of custom, the conglomerate will be an aggregate of dissimilar businesses. If all the businesses
In the case of a consolidation, the new corporation, and in the case of a merger, the surviving corporation,
will generally be liable for the debts of any corporation that disappears in the fusion process. In the case of
4. Corporate liability on promoter’s contract. No. When a corporation ratifies or adopts a contract made by a
promoter and a third person, the contract is binding on both the corporation and the third person. The fact
5. Mergers, dissenting shareholders. No, Hirschfield’s rights as a dissenting shareholder are to vote against the
6. Liability of Successor Corporations. “Successor” means a corporation surviving a merger. CloseCall (DE) is
liable to Ramlall for the bonus fee. The court pointed out that corporations are largely the molders of their
own destinies in acquisition transactions, they may buy assets without assuming liabilities, and they may
The court stated that Maryland’s legislative policy is sound. To allow successor corporations to contract
around obligations of predecessor corporations would permit corporations to use the merger statute to
7. Corporation by estoppel. Judgment for the bank. A corporation acting and carrying on its corporate business
under its corporate name for more than five years after termination of its corporate existence should be
deemed a corporation by estoppel. CYC may not have been a de jure corporation, but the court cannot
reasonably ignore the actual existence of such a corporation. CYC obtained a loan from First Community
Ct.)]
8. Promoter’s liability. As a promoter of Oahe, Emmick owed a fiduciary duty to both the corporation and its
shareholders to deal with them in good faith. Obtaining a secret profit by a promoter is a fraud on the
corporation, and the promoter may be required to account for the profit. The value of Colonial Manors, Inc.,
9. Corporate mergers. Judgment for Madison Associates. State law allows for the merger of two corporations
into a single corporation as long as certain procedures are followed, such as obtaining approval of the
merger by a two-thirds vote of shareholders. Madison met all required procedures. Even a freeze-out
10. Ultra vires acts. Judgment for the Loverings. Acts beyond the scope of a corporation ’s powers as defined by
11. Liability of corporation for promoter’s contracts. Yes. A corporation is not liable for the contracts made by its
promoters merely because it benefited either through such contracts having been performed or by using a
charter or bylaws prepared by the promoters. The corporation is not bound by the promoter ’s contract unless
12. Ignoring the corporate entity. Judgment for the New York corporation. The designation “S.p.A.” refers to the
term “Societa per Azionean.” It is defined as a stock corporation (see Genco, Dictionary of Italian Legal
13. Freeze-out mergers. Judgment for Coggins. The merger served no valid corporate purpose unrelated to the
personal interests of Sullivan. While a number of corporate purposes were listed in the proxy statement, the
LAWFLIX
Barbarians at the Gate (1996) (R)
In this movie that focuses on the law and ethics of takeovers, students can see the manipulation that occurs and
the impact greed has on the companies themselves.
To access additional videos that illustrate business law concepts, visit www.cegage.com/blaw/dvl.
management system for classroom use.
