958 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
E. CORPORATION BY ESTOPPEL
A corporation that holds itself out as being a corporation, even when it is not, will be estopped from denying
corporate status in a lawsuit by a third party. Corporation by estoppel is limited to a specific situation and does
not extend beyond resolution of the problem at hand.
CASE SYNOPSIS—
Case 39.2: Brown v. W.P Media, Inc.
W.P. Media, Inc., and Alabama MBA, Inc., agreed to a joint venture—Alabaster Wireless MBA, LLC—to provide
Internet services to consumers. W.P. Media was to create a wireless network and provide ongoing technical support.
Alabama MBA was to contribute capital of $79,300 and W.P. Media was to contribute “proprietary technology” in the
same amount. Hugh Brown signed the parties’ contract on Alabama MBA’s behalf as its chairman of the board. A year
later, Brown filed Alabama MBA’s articles of incorporation. Later, Brown and Alabama MBA filed a suit in an Alabama
state court, alleging that W.P. Media had breached their contract. The court issued a judgment in the defendant’s
favor. The plaintiffs appealed.
corporate status. Here, Alabama MBA was represented as “a viable, legal corporation.” The parties’ contract identified
W.P. Media did not challenge the validity of the contract until after it was sued for breaching it.
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Notes and Questions
Did Alabama MBA exist as a de facto corporation when it entered into the contract with W.P. Media? Why or why
not? No. A de facto corporation exists when an attempt has been made to create a corporation, but the effort is
somehow defective. Alabama MBA did not exist as a de facto corporation at the time the operating agreement was
signed with W.P. Media. There had not been any attempt to incorporate Alabama MBA before the execution of the
agreement.
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whether to disregard the “corporate entity” of Alabama MBA. If Brown were attempting to avoid responsibility under
the contract through the use of the firm’s corporate status, a court could circumvent the organizational structure to
hold him personally liable.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 39.2
Did Alabama MBA exist as a de jure corporation when it entered into the contract with W.P. Media? Why or why
not? No. A de jure corporation is a firm that has substantially complied with all applicable laws—particularly by filing of
articles of incorporation—and has been recognized as a corporation. Alabama MBA was not a de jure corporation at
the time the operating agreement was executed because its articles had not yet been filed.
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 39.2
had been negotiated and agreed to entirely online? Discuss. No. The method by which the parties in this case
III. Corporate Powers
A. 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.
960 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
• Bylaws.
• Resolutions of the board of directors.
B. IMPLIED POWERS
C. ULTRA VIRES DOCTRINE
Injunction, dissolution, and damages are among the remedies available for ultra vires acts. Earlier cases involved
contracts made for unauthorized purposes. Now, a declining number of cases are brought mostly against
nonprofit or municipal corporations.
IV. Piercing the Corporate Veil
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.
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 capitalized.
B. A POTENTIAL PROBLEM FOR CLOSELY HELD CORPORATIONS
The potential for corporate formalities to be overlooked, or for other circumstances to occur that may lead a
court to pierce the corporate veil, is especially great in a closely held corporation.
CASE SYNOPSIS—
Case 39.3: Schultz v. General Electric Healthcare Financial Services
Thomas Schultz was president and sole shareholder of Intra-Med Services, Inc., a Kentucky corporation. General
Electric Healthcare Financial Services, Inc. and others (GE) entered into a contract to lease medical equipment to Intra-
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Notes and Questions
As a shareholder and officer of Intra-Med, did Schultz breach his fiduciary duty to act in good faith and in the best
interest of the corporation? Yes. How did he breach this duty? He spent corporate funds that should have been used to
pay the judgment against the firm for his own personal purposes.
How might this suit have been avoided altogether? The obvious answer is that to avoid legal problems, including
those in this case, the defendant could have kept his business and personal finances separate. Another possibility might
Is it common for courts to disregard the corporate form of business organization and impose liability on
shareholders? No. Courts rarely pierce corporate veils.
Was Schultz’s disregard for the corporate form unethical? Why or why not? Schultz’s conduct was fundamentally
ANSWERS TO QUESTIONS AT THE END OF CASE 39.3
1. Schultz argued that even if the corporate veil should be pierced, the $450,000 judgment against him was too much
and should be reduced. How might the court have responded to this argument? The court refused to give much
2. Suppose that Schultz had turned over the proceeds from the sale of his properties to his corporation, Intra-Med,
and used them to pay part or all of GE’s judgment. In this situation, if the funds were insufficient to cover the debt,
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would the court have pierced the corporate veil to obtain the balance from Schultz personally? Explain. It is hard to
say with certainty what the outcome of the case would have been in this situation. The court listed the three elements
that must be established to pierce the corporate veil under the “instrumentality theory”—the corporation must be a
mere instrumentality of the shareholder; the shareholder must exercise control over the corporation in such a way as
to defraud or to harm the plaintiff; and a refusal to disregard the corporate entity must subject the plaintiff to unjust
loss. If Schultz had turned over the proceeds of the sales to the corporation, he would be in a better position to argue
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent 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).
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.
V. Corporate Financing
The principal method of corporate financing is the issuance of bonds (debt) and stocks (equity).
A. BONDS
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B. STOCKS
Stock represents the purchase of ownership in the firm.
1. Common Stock
Common stock provides a proportionate interest in a corporation with regard to control, earning capacity,
2. Preferred Stock
Holders of preferred stock have priority as to dividends and payment on dissolution of the corporation.
1. Venture Capital
2. Private Equity Capital
Private equity investors pool their funds to buy an existing corporation to reorganize or sell.
ANSWER TO VIDEO QUESTION LTR. C
Given that Anna and Caleb conduct their business (Wizard Internet) over the Internet, can you think of any
drawbacks to forming an LLC? There are two possible drawbacks to becoming a LLC while engaged in business in
several states. First, there is the issue of jurisdiction. While a corporation is considered to be a citizen of the state
where it is incorporated, LLCs are frequently deemed by the courts to be citizens of every state in which their members
are citizens. Thus, if Anna and Caleb live in different states or if Wizard Internet has members in other states, the LLC
may be deemed a citizen of all of those states. This would be a problem in the event that the company is sued and
wants to claim that a federal court has diversity jurisdiction, and the plaintiff lives in the same state as one of the LLC
964 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ANSWER TO VIDEO QUESTION LTR. D
If you were in Anna and Caleb’s position, would you choose to create a corporation or LLC? Why? The answer to
this question will vary, of course, because individuals will see the matter differently. The object of the question is to
TEACHING SUGGESTIONS
1. Ask students to discuss when a promoter’s liability for acts done on behalf of the corporation should terminate in
the absence of an express release by the corporation. What should a promoter do if the corporation refuses to assume
preincorporation liabilities? How should one decide which preincorporation expenses and liabilities should be assumed
or rejected by the corporation once it begins its existence?
3. Point out that at one time, opening a small business was relatively simple in terms of the obligations to the gov-
ernment. Now many businesspersons feel, however, that there is an ocean of federal, state, and local laws that
4. You might want to use the corporations 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?
1. How is corporate income double-taxed? Because a corporation is a separate legal entity, corporate profits are taxed by
2. Does a corporation have a right to freedom of speech? The First Amendment gives corporations—similar to individuals—
3. What steps must a foreign corporation take to qualify to do business in a state? Because a foreign corporation does not
4. How does a court decide whether it may exercise jurisdiction over a foreign or alien corporation? The court will examine
5. What is an eleemosynary corporation? An eleemosynary corporation is a charitable corporation formed without a profit-
6. What is the major advantage of an S corporation? Corporate profits received by S corporations are not taxed but instead
7. To what extent is a promoter liable for preincorporation contracts? As a general rule, a promoter is held personally liable
8. What is the doctrine of ultra vires? The term ultra vires means “beyond the powers” and refers to acts by a corporation
9. What is the difference between common stock and preferred stock? Common stock provides the shareholder with a
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 of hazardous waste in an illegal
manner, for example, or approving of questionable accounting practices, would support criminal sanctions against a supervisor
or other corporate party.
ACTIVITY AND RESEARCH ASSIGNMENT
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 2: Brian Gauthier, a truck driver for Angelo Todesca Corp., drove a dump truck designated AT-56. When
Gautier discovered that AT–56’s back–up alarm was missing, Angelo ordered a new one. Meanwhile, Gautier continued to drive
AT-56. A month later, while backing up at a work site in Centerville, Massachusetts, Gautier struck and killed a police officer. The
commonwealth of Massachusetts charged Gautier and Angelo with motor vehicle homicide. Angelo was convicted and fined
$2,500. A state intermediate appellate court reversed. The state appealed. In Commonwealth v. Angelo Todesca Corp., the
Massachusetts Supreme Judicial Court affirmed. A corporation is not a “living person” and “can act only through its agents.”
Thus, if an employee commits a crime, “while engaged in corporate business that the employee has been authorized to
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conduct,” the corporation can be liable. Here, the crime was “Gauthier’s negligent operation of the defendant’s truck, resulting
in the victim’s death * * * . Clearly, a corporation cannot be criminally liable for acts of employee negligence that are not
criminal; however, [a Massachusetts state statute] criminalizes negligence in a very specific context (the operation of a motor
vehicle on a public way) and with a specific outcome (resulting in death).”
Under the reasoning of the court in this case, could a corporation be criminally liable if its employees sell alcohol to
minors, even if corporate officials have no knowledge of the sales and corporate policy strictly prohibits selling alcohol to
minors? Yes. The court acknowledged that “before criminal liability may be imposed on a corporate defendant . . . [t]he
Commonwealth must prove that the individual for whose conduct it seeks to charge the corporation criminally was placed in a
position by the corporation where he had enough power, duty, responsibility and authority to act for and in behalf of the
corporation to handle the particular business or operation or project of the corporation in which he was engaged at the time
that he committed the criminal act . . . and that he was acting for and in behalf of the corporation in the accomplishment of
that particular business or operation or project, and that he committed a criminal act while so acting.” But “there is no
requirement that corporate officials had knowledge of their employees’ criminal acts.”
Footnote 7: In 1952, Kearns-Tribune Corp. (KTC), the owner of The Salt Lake Tribune, and Deseret News Publishing
Co., the owner of Deseret News (The Tribune’s chief competitor in Salt Lake City, Utah) entered into a “Joint Operating
Agreement” (JOA). The JOA created the Newspaper Agency Corporation (NAC) to conduct the production operations of both
newspapers and restrict the transfer of NAC stock to anyone but KTC and Deseret. In 1997, the KTC shareholders, most of whom
were members of the Kearns-McCarthey family, sold KTC. As part of the deal, the family formed Salt Lake Tribune Publishing Co.
to later repurchase The Tribune’s physical assets under an “Option Agreement.” In 1999, AT&T Corp. acquired KTC and
reorganized it as Kearns-Tribune LLC. In 2002, Salt Lake Tribune Publishing Co. filed a suit in a federal district court against AT&T
and others, seeking specific performance of the Option Agreement. The court ruled that a transfer of The Tribune’s assets would
violate the JOA’s stock transfer restriction. The plaintiff appealed. In Salt Lake Tribune Publishing Co. v. AT&T Corp., the U.S.
968 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ANSWERS TO ESSAY QUESTIONS IN
STUDY GUIDE TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
BY HOLLOWELL & MILLER
1. What is the significance of the following items as they relate to a company’s articles of incorporation: (1) corporate name,
(2) nature and purpose, (3) duration, (4) capital structure, (5) internal organization, (6) registered office and agent, and (7)
incorporators? The articles of incorporation is the primary document needed to begin the incorporation process; it includes
basic information about the corporation and serves as a primary authority for its future organization and business functions.
Corporate Name. The choice of a corporate name is subject to state approval to ensure against duplication or deception. All
corporate statutes require the corporation name to include the word “corporation,” “incorporated,” or “limited.” A corporate
name is prohibited from being the same as or similar to the name of an existing corporation doing business within the state.
Nature and Purpose. The intended business activities must be specified in the articles and they must be lawful. A general
statement of corporate purpose is usually sufficient to give rise to all of the powers necessary or convenient to the purpose of
the organization. There is a trend toward allowing corporate charters to state that the corporation is organized for “any legal
business” with no mention of specifics to avoid unnecessary future amendments to the corporate charter. Duration. A
corporation can have perpetual existence under most state statutes. A few states, however, prescribe a maximum duration
after which the corporation must formally renew its existence. Capital Structure. The capital structure of the corporation is
2. What are the primary features of nonprofit, close, S and professional corporations? Nonprofit Corporations. Corporations
that are formed without a profit-making purpose are called nonprofit, not-for-profit or eleemosynary corporations. These
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corporations are usually private but may be used in conjunction with an ordinary corporation to facilitate making contracts with
the government. Private hospitals, educational institutions, charities, religious organizations, and the like are frequently
organized as nonprofit corporations. Such corporations allow members to own property and form contracts without assuming
personal liability. Close Corporations. A close corporation is one whose shares are held by members of a family or relatively
few persons. Because the number of shareholders is so small, there is usually no trading market for the shares. Close
corporations are often operated like partnerships. To enjoy the benefits of close corporation statutes, the company must have
a limited number of shareholders and its stock must be subject to transfer restrictions. The company may not offer its securities
for sale to the public. The shareholders of close corporations have unlimited power to restrict decisions of the board of
directors and may choose to do without a board of directors altogether. Close corporations often use shareholder agreements
REVIEWING—
CORPORATIONS—FORMATION AND FINANCING
William Sharp is the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a
popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account, but paid
the club’s employees, suppliers, and entertainers in cash out of the club’s proceeds. Sharp owned the property on
which the club was located and rented it to the club, but made mortgage payments out of the club’s proceeds and
often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, 2005, eighteen-year-old
Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals
under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley’s identification
970 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
Sharp personally liable for the damages? What factors would be relevant to the court’s decision? The court would be
2. Suppose that Chickasaw’s articles of incorporation failed to describe the corporation’s purpose or management
structure as required by state law. Would the court be likely to rule that Sharp is personally liable to Dancause on that
basis? Sharp is likely to be personally liable based on piercing the corporate veil due to ignoring the corporate form.
Technical details in the articles of incorporation alone would not be likely to result in liability being imposed; the fact
3. Suppose that the club extended credit to its regular patrons in an effort to maintain a loyal clientele, although
neither the articles of incorporation nor the corporate bylaws authorized this practice. Would the corporation likely
have the power to engage in this activity? Explain. Extending credit to customers is a normal business activity and is not
improper. Such details need not be discussed in the articles of incorporation or the bylaws, which generally concern the
purpose of the business itself and basic ownership structure issues.
4. How would the court classify the Chickasaw Club corporation—domestic or foreign, public or private? The
corporation was formed and operated in Georgia, so it is a domestic corporation. It is owned by one person, so it is
private; its stock is not traded, so it is also a close corporation.
DEBATE THIS:
The sole shareholder of an S corporation should never be able to avoid liability for the torts of her or his
employees. Perhaps it makes sense to allow individuals to use business organization forms that allow them to pass
through profits to their personal tax returns, but it makes little sense to allow them to escape liability with such
structures when their employees or agents commit torts. Normally, employees do not have liability insurance or even
assets that could pay for tort judgments against them. Those who suffer from these torts would therefore end up
with nothing, even if they win at trial.