Business relationships in relation to US companies

WHAT KIND OF CORPORATION DO YOU HAVE?

As we form business relationships, the question arises whether a sole proprietorship or a corporation is needed. For the purpose of a definition, a corporation is a legal entity, separate from its shareholders, created under the authority of the legislature. As an entity, a corporation is responsible for its debts. Shareholders are not responsible for corporate debts. The shareholders’ risk is limited to the amount of their investment. The ownership interests of the corporation are represented by shares, which are freely transferable. The management control of a corporation is centralized in the board of directors and the officers who act under the direction of the authority of the board. Shareholders generally elect the board, but cannot control the activities of the board and have no power in the management of corporate business.

Corporations have clear differences than partnerships. Associations are governed by the Uniform Associations Act (UPA). Partnerships are not legal entities, but groups of two or more people involved in a business. With corporations, shareholders are limited in their investments. In partnerships, each partner is subject to unlimited personal liability for all debts of the partnership. Know your goals in what you want and do your research on each one before deciding on a partnership or corporation (see my March 2003 article on Chiropractic Products “Associations”).

A corporation, as a legal entity despite the death or disability of its shareholders, can be of perpetual duration. Associations cannot be perpetuated. If a corporation goes bankrupt, the debts of the corporation may, under certain circumstances, be subordinate to the debtors. This means that the debts would have to be paid before the shareholders get money. This occurred in one case (Taylor v. Standard Gas and Electric Corp.) and it is called “Deep Rock Doctrine.” The formation or organization of a corporation is completed under the “general corporate law” or “business law” statutes of the state in which it is being incorporated. Typically, a corporation is organized by the execution and presentation of the “certificate of articles” of incorporation by the person or persons that make up the corporation. The articles must show the names of the shareholders, the address and the name of the corporation’s registered agent, the name and address of each person who forms the corporation. Optional provisions may include:

1. Purpose of incorporation
2. Names of the board of directors and management powers
3. By value of shares or class of shares.

Corporations can engage in any legal business without detailing a long list of corporate purposes. Most states confer certain powers on each corporation, whether or not those powers are set out in the articles. Generally, a corporation receives the following:

1. Perpetual existence
2. Have the ability to sue and be sued.
3. Have a corporate seal
4. Acquire, retain and dispose of movable and immovable property
5. Auxiliary officers
6. Adopt and modify statutes.
7. Conduct business in and out of state.
8. Make contracts
9. Make donations

When a corporation acts beyond purpose and powers, it is called “Ultra Vires”. This is not a defense in tort law or liability to escape civil damages alleging that the corporation had no legal power to commit a wrongful act. This also applies to criminal liability. A corporation must act within its powers and purpose as set forth in state statutes. Most state statutes prohibit the use of Ultra Vires as a defense in a lawsuit between contracting parties. However, if a contract has been performed and resulted in a loss to the corporation, the corporation can sue the officers or directors for damages for exceeding their authority. If the corporation refuses to sue, a shareholder can file a derivative next. States can sue to prohibit the corporation from conducting unauthorized business transactions. If the winning party wins, you may be entitled to damages.

MANAGEMENT AND CONTROL:

Generally, the powers to manage the corporation belong to the board of directors and not to the shareholders. Shareholders cannot order the board of directors to take certain actions in the management of the corporation. However, shareholder approval is required for certain fundamental changes including: amendment to the articles of the corporation, mergers and sale of substantial assets, and dissolution of the corporation. Shareholders also have the power to remove a director for “cause.” Shareholders also have the right to:

1. Ratify certain types of management transactions.
2. Adopt non-binding resolutions.
3. Right to adopt and modify statutes

A “closed” corporation is defined by ownership by a small number of shareholders, does not have a general market for shares, has limitations on the transfer of shares, and adopts special governance rules. In this sense, a close corporation is similar to a partnership. Most states define a close corporation by the number of shareholders. Each state varies in terms of that number. In California there are 35 shareholders, in Delaware there are 30.

DIRECTORS:

The original directors are those people who initially created the Corporation. The shareholders at the annual meeting elect the members of the board, who can also be the original directors if there are no other shareholders. Once elected, shareholders can only be removed for “cause.” The cause can be fraud, dishonesty, etc. Directors can be removed by shareholders without cause if there is specific authority to do so in the bylaws.

The principal to be removed has the right to a hearing before a final vote on removal is cast. Courts generally do not have the authority to remove directors, but some courts have taken the position of removing directors for specific reasons such as fraud or dishonest act. Each director has a fiduciary relationship with the corporation and must exercise the care of an ordinary, prudent and diligent person who would act in similar circumstances. Courts vary on what constitutes a bad decision by a director that would violate his duty to the corporation. When a director has not exercised due care, he may be held liable for corporate losses suffered as a direct and proximate result of his breach of duty. Injury and causation have yet to be proven when duty is breached. There may also be criminal misconduct that would hold a director or officer liable. There are a variety of types of corporations that you can establish. Make sure you set up the right type of corporation that meets your particular needs.