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12 UNIT EIGHT: BUSINESS ORGANIZATIONS
FINDING INFORMATION ON INCORPORATION REQUIREMENTS
Nearly every state has a Web site at which you can find the individual state’s requirements for
INCORPORATING ONLINE
If you wish to incorporate via an online incorporation service, all you need to do is fill out a form online.
For example, if you fill out the incorporation forms at the TCC Web site, TCC will then file the forms with the
appropriate state office and obtain a certificate of incorporation (corporate charter) for you. You can also
arrange for the online incorporation service to perform other services such as acting as registered agent for
your corporation, obtaining a tax identification number, and registering a domain name for your business.
CHECKLIST OF FACTORS TO CONSIDER WHEN INCORPORATING ONLINE OR OFFLINE
1. Compare taxes that would be owed. Also, determine the impact that double taxation would have on your
potential income.
2. Find out not only the initial cost of incorporation but also any continuing costs, such as annual fees and
possible fees for attorneys and accountants.
D. IMPROPER INCORPORATION
If the procedures for incorporation are not followed precisely, others may be able to challenge the exis-
CHAPTER 39: CORPORATE FORMATION AND FINANCING 13
1. De Jure Corporations
2. De Facto Corporations
Some states do not apply this doctrine. But in those that do, the existence of a corporation cannot
3. Corporation by Estoppel
A corporation that holds itself out as being a corporation, even when it is not, will be estopped from
E. CORPORATE POWERS
1. Express Powers
The express powers of a corporation are found in its articles of incorporation, in the law of the state
of incorporation, and in state and federal constitutions. The order of priority when conflicts arise
among these documents is—
• The U.S. Constitution.
• State constitutions.
2. Implied Powers
A corporation has the implied power to perform all acts reasonably appropriate and necessary to
3. Ultra Vires Doctrine
4. Remedies for Ultra Vires Acts
Injunction, dissolution, and damages are among the remedies available for ultra vires acts.
III. Piercing the Corporate Veil
14 UNIT EIGHT: BUSINESS ORGANIZATIONS
When a corporate owners use the entity to perpetuate a fraud, circumvent the law, or in some other way
accomplish an illegitimate objective, a court will pierce the corporate veil, exposing shareholders to personal
liability.
A. FACTORS THAT LEAD COURTS TO PIERCE THE CORPORATE VEIL
Situations that may cause a court to disregard the corporate veil include—
• A party is tricked or misled into dealing with the corporation rather than the individual.
• The corporation is set up never to make a profit or always to be insolvent, or it is too thinly
CASE SYNOPSIS—
Case 39.3: Dog House Investments, LLC v. Teal Properties, Inc.
Dog House Investments, LLC, operated a dog “camp” facility on property in Nashville, Tennessee, leased
from Teal Properties, Inc., which was owned by its sole shareholder Jerry Teal. Following a flood, Dog House
notified Jerry that the property was “untenantable.” Jerry assured Dog House that the damage was covered
by insurance but took no steps to restore the property. Dog House spent $39,000 to repair the damage and
..................................................................................................................................................
Notes and Questions
What is the standard for an award of punitive damages for a contract breach? Was the standard
met in this case? An award of punitive damages on a breach of contract requires a finding of fraud. And yes,
this standard was met in this case.
In the words of the appellate court, “clear and convincing evidence supports a finding in this case that Mr.
Teal's fraudulent actions were intentional and knowing. * * * The record in this case demonstrates that the
CHAPTER 39: CORPORATE FORMATION AND FINANCING 15
How might this suit have been avoided altogether? The obvious answer is that to avoid legal prob-
Is it common for courts to disregard the corporate form of business organization and impose
Was Jerry’s disregard for the corporate form unethical? Why or why not? Schultz’s conduct was
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Piercing the Corporate Veil
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.
B. A POTENTIAL PROBLEM FOR CLOSE CORPORATIONS
The potential for corporate formalities to be overlooked, or for other circumstances to occur that may
C. THE ALTER EGO THEORY
A court may pierce the corporate veil on the later ego theory—that the corporation was not operated as a
separate entity from the person or group who dominated and controlled it—to avoid injustice or fraud.
IV. Corporate Financing
16 UNIT EIGHT: BUSINESS ORGANIZATIONS
The principal method of corporate financing is the issuance of bonds (debt) and stocks (equity).
A. BONDS
Bonds (debentures) represent the borrowing of money by firms. Bonds almost always have a des-
B. STOCKS
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
number issued.
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
C. VENTURE CAPITAL AND PRIVATE EQUITY CAPITAL
1. Venture Capital
Start-up businesses and high-risk enterprises may obtain venture capital financing (capital from
2. Private Equity Capital
Private equity investors pool their funds to buy an existing corporation to reorganize or sell.
D. CROWDFUNDING
Crowdfunding—persons networking to pool funds and other resources via the Internet—can be used to
attract investors.
TEACHING SUGGESTIONS
1. Ask students to discuss when a promoter’s liability for acts done on behalf of the corporation should ter-
minate in the absence of an express release by the corporation. What should a promoter do if the
CHAPTER 39: CORPORATE FORMATION AND FINANCING 17
2. Ask students to discuss the situations in which the corporate entity should be disregarded and to describe
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
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
2. Does a corporation have a right to freedom of speech? The First Amendment gives corporations—similar to
individuals—the freedom of speech. In addition to freedom of commercial speech, corporations may express their
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
4. How does a court decide whether it may exercise jurisdiction over a foreign or alien corporation? The
court will examine the activities of the corporation to see whether the company has sufficient contacts with the state.
18 UNIT EIGHT: BUSINESS ORGANIZATIONS
5. What is an eleemosynary corporation? An eleemosynary corporation is a charitable corporation formed
without a profit-making purpose. Such corporations are usually private and can be used in conjunction with ordinary
6. What is the major advantage of an S corporation? Corporate profits received by S corporations are not
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
8. What is the doctrine of ultra vires? The term ultra vires means “beyond the powers” and refers to acts by a
corporation that are not within the scope of its corporate powers. Although corporations used to be sued fairly
9. What is the difference between common stock and preferred stock? Common stock provides the share-
holder with a proportionate interest in the corporation with regard to (1) control, (2) earning capacity, and (3) net
10. Under what circumstances might an employee’s supervisor, or even a corporate officer or director, be
held liable for the employee’s crime? A supervisor, or a corporate officer or director, could be held liable for an
employee’s crime if the corporate official ordered or otherwise authorized the crime. Directing an employee to dispose
CHAPTER 39: CORPORATE FORMATION AND FINANCING 19
ACTIVITY AND RESEARCH ASSIGNMENT
Ask each student to obtain an annual report of a major corporation and to summarize the results of the report in
an oral report to the class. The students should discuss the financial state of the company, new product lines, major
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 1: Mark Bloom formed North Hills L.P. as a stock investment fund and raised nearly $30 million
In Belmont v. MB Investment Partners, Inc., the U.S. Court of Appeals for the Third Circuit reversed and
remanded. The fraud of a corporate officer can be imputed to the corporation when it occurs (1) in the course of the
employment and (2) for the benefit of the corporation, even if the officer's conduct was unauthorized, effected for his
or her own benefit but “clothed” with the apparent authority of the corporation, or contrary to instructions.
Why is the liability of a corporation limited with respect to its agents’ and officers’ torts to those
committed within the course and scope of employment? The liability is limited to encourage business activity. If a
corporation was liable for its agents’ and officers’ torts whether or not the corporation participated in, authorized, or
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,
Footnote 5: John Murray, Stephen Hopkins, and Paul Ryan, are officers, directors, employees, and the
controlling shareholders of Olympic Adhesives, Inc. Merek Rubin is a minority shareholder. Murray, Hopkins, and
Ryan were paid salaries. Under Olympic’s profit-sharing plan, one-third of its net operating income was paid into a
20 UNIT EIGHT: BUSINESS ORGANIZATIONS
fund that was distributed to employees, including Murray, Hopkins, and Ryan. Twice a year, Murray, Hopkins, and
Ryan also paid themselves additional compensation—a percentage of the net profits after profit sharing, allocated
In Rubin v. Murray, 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 also affect the amount of compensation. In this case, the trial judge found that a reasonable amount
of compensation for each officer would be 4 percent to 7 percent of net sales, plus a “success premium” related to
individual contributions, for a total of 10 percent of Olympic’s average annual net sales. This amount compared to the
average compensation for officers in similar firms.
The defendants were in effect taking disguised dividends from Olympic to avoid paying taxes. The
remedy—repaying Olympic a portion of its net profits to be distributed among its shareholders—resulted in
tax consequences for the company and the shareholders. Should the court have taken this outcome into
consideration in fashioning the remedy? Courts have considerable discretion in fashioning remedies for breaches
of fiduciary duty in a close corporation. But most cases involve a shareholder’s derivative suit brought on behalf of the
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
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
Footnote 11: Brothers Owen, James, and Theodore Brennan were the shareholders of Brennan’s, Inc.,
which operated Brennan’s Restaurant in New Orleans. Their cousin Richard planned to open Dickie Brennan's
In Brennan’s, Inc. v. Colbert, a state intermediate appellate court affirmed. Corporate shareholders are not
personally liable for the debts of a corporation, except in certain instances of fraud or other wrongdoing, unless they
agree otherwise. Here, the brothers did not agree to bind themselves personally for any debt incurred in connection
CHAPTER 39: CORPORATE FORMATION AND FINANCING 21
with the services provided by the Kenyon firm to Brennan’s, Inc. And the brothers did not perpetrate a fraud on the
firm—the client was Brennan’s, Inc., and the Kenyon firm was aware of this.
Could an agreement between the corporation and the shareholders, or the shareholders and third
parties, reduce or eliminate the limits to the liability of shareholders for corporate debts? The answer to this
Should the Brennans 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,
