BUSINESS LAW

TEXT AND CASES

Fourteenth Edition

CLARKSON MILLER CROSS  

CHAPTER 39: CORPORATE

FORMATION AND FINANCING
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 §1: THE NATURE AND
CLASSIFICATION OF CORPORATIONS
(1 OF 19)
 A corporation is a legal entity created and
recognized by state law.
 Corporations can have one or more

shareholders that are comprised of natural

persons or other businesses. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
2
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (2 OF 19)
 A corporation is a legal “person” and
enjoys the same rights and privileges as a
natural person:
• Access to court systems.
• Constitutional guarantees of free
speech, due process, and freedom from
unreasonable search and seizures.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
3
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (3 OF 19)
 Corporate Personnel:
Responsibility for management of
company rests with board of directors
(elected by shareholders).
Board of directors makes policy decisions
and hires officers to run corporation on a
daily basis. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
4
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (4 OF 19)
 Corporate Personnel:
Shareholders can sue the corporation
and be sued by the corporation and
bring a derivative suit on behalf of the
corporation in some instances.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
5
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (5 OF 19)
 Limited Liability of Shareholders:
Generally, shareholders are not
personally liable for corporate acts.
But in certain situations, the corporate
“veil” of limited liability can be pierced,
holding the shareholders personally
liable. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
6
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (6 OF 19)
 Corporate Earnings and Taxation:
Profits can either be kept as retained
earnings or passed on to the
shareholders as dividends.
Corporate Taxation: Can be taxed twice,
first to corporation, then to shareholders
via dividends. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
7
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (7 OF 19)
 Corporate Earnings and Taxation:
Holding Companies (parent company):
Company whose business activity
consists of holding shares in another
company.
Typically, a holding company is
established off shore.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (8 OF 19)
 Criminal Acts: A corporation can be liable for the
criminal acts of its agents and employees.
Corporations can be fined and, under the
“responsible officer” doctrine, corporate officers
may go to prison.
 Tort Liability: Under respondeat superior,
corporations are also liable for torts committed
by agents within the scope of their employment.
• SEE CASE IN POINT 39.1 BELMONT V. MB
INVESTMENT PARTNERS, INC. (2013).
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
9
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (9 OF 19)
 Classification of Corporations:
Domestic: Corporation does business
within its state of incorporation.
Foreign: Corporation in X state does
business in Z state.
Alien: Corporation formed in another
country.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
10
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (10 OF 19)
 Classification of Corporations:
Public and Private Corporations:
• Public corporations are formed by the
government for some purpose (e.g., U.S.
Postal Service).
• Private corporations are created either
wholly or in part for private benefit (for
profit). 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
11
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (11 OF 19)
 Classification of Corporations:
Nonprofit Corporations: Those formed
for purposes other than making a profit
(e.g., private hospitals and charities). 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (12 OF 19)
 Classification of Corporations:
Close Corporation: One whose shares are
held by relatively few persons and is often
operated like a partnership.
• Management of Closely Held
Corporations: Resembles that of a sole
proprietorship or a partnership. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
13
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (13 OF 19)
 Classification of Corporations:
Close Corporation:
• Transfer of Shares: Because there are few
shareholders, transfer of shares to an
outsider can cause management
problems.
• To avoid this situation, a close corporation
can restrict the transferability of shares via
the shareholder agreement. 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
14
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (14 OF 19)
 Classification of Corporations:
Closely Held Corporations:
• Misappropriation of Closely Held
Corporation Funds: A majority shareholder
in a close corporation may misappropriate
company funds. The normal remedy for
the injured minority shareholders is to
have their shares appraised and to be paid
the fair market value for them.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
15
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (15 OF 19)
 Classification of Corporations:
“S” Corporations—Important Requirements:
• Corporation must be domestic.
• Corporation must not be a member of an
affiliated group of corporations.
• Shareholders must be individuals, estates,
certain trusts and tax-exempt organi-
zations, or (under certain circumstances)
corporations.  16
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (16 OF 19)
 Classification of Corporations:
“S” Corporations—Important Requirements:
• The corporation must have no more than
one hundred shareholders.
• The corporation must have only one class
of stock.
• No shareholder of the corporation may be
a nonresident alien. 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
17
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (17 OF 19)
 Classification of Corporations:
“S” Corporations:
• Effect of S Selection: Avoids federal
“double taxation” of regular
corporations at the corporate level.
• Only dividends are taxed to the
shareholders as personal income.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
18
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (18 OF 19)
 Classification of Corporations:
Professional Corporations: Those formed by
a group of professionals (such as lawyers).
Laws governing the formation and operation
of professional corporations are similar to
those governing ordinary business
corporations. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
19
THE NATURE AND CLASSIFICATION
OF CORPORATIONS (19 OF 19)
 Classification of Corporations:
Benefit Corporations: A for-profit
corporation that seeks to have a material
positive impact on society, but must
comply with certain statutory
requirements. They differ from traditional
corporations in the following areas:
purpose, accountability, and transparency.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
20
 §2: CORPORATION
FORMATION AND POWERS (1 OF 14)
 Promotional Activities: Before
corporation is formed, promoters are
the persons who take the preliminary
steps of organizing the venture and
attracting investors via subscription
agreements.
 Promoter is personally liable for pre-
incorporation contracts on behalf of the
corporation, unless third party agrees to hold
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
21
 CORPORATION
FORMATION AND POWERS (2 OF 14)
 Incorporation Procedures:
Select State of Incorporation.
Secure the Corporate Name: Choice of a
corporate name is subject to state
approval to ensure against duplication or
deception. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
22
 CORPORATION
FORMATION AND POWERS (3 OF 14)
 Incorporation Procedures:
Prepare the Articles of Incorporation: The
primary document needed to incorporate
the business that includes basic information
about the corporation and serves as a
primary source of authority for its future
organization and business functions.
Generally, the articles must include the
following information (RMBCA 2.02):
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
23
 CORPORATION
FORMATION AND POWERS (4 OF 14)
 Incorporation Procedures:
Prepare the Articles of Incorporation:
• The name of the corporation.
• The number of shares of stock the
corporation is authorized to issue
[RMBCA 2.02(a)].
• The name and street address of the
corporation’s initial registered agent and
registered office. 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
24
 CORPORATION
FORMATION AND POWERS (5 OF 14)
 Incorporation Procedures:
Prepare the Articles of Incorporation:
• The name and address of each
incorporator.
File the Articles with State: When articles of
incorporation have been prepared and
signed, they are sent to the appropriate
state official, along with the required filing
fee.  25
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 CORPORATION
FORMATION AND POWERS (6 OF 14)
 First Organizational Meeting to Adopt
Bylaws:
After the corporation is “chartered,”
(created) it can do business.
Shareholders should approve the
bylaws, elect directors, hire officers, and
ratify preincorporation contracts and
activities.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
26
 CORPORATION
FORMATION AND POWERS (7 OF 14)
 Improper Incorporation:
De Jure: A corporation that has substantially
complied with all conditions precedent to
incorporation.
• In most states and under RMBCA 2.03(b),
the secretary of state’s filing of the articles
of incorporation is conclusive proof that all
mandatory statutory provisions have been
met. 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
27
 CORPORATION
FORMATION AND POWERS (8 OF 14)
 Improper Incorporation:
De Facto Corporations: If the defect in
formation is substantial, the outcome will
vary by jurisdiction. Some states
recognize the common law doctrine of de
facto corporation and their courts will
treat a corporation as a legal one if the
following three requirements are met: 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
28
 CORPORATION
FORMATION AND POWERS (9 OF 14)
 Improper Incorporation:
De Facto Corporations:
• A state statute exists under which the
corporation can be validly incorporated.
• Parties have made a good faith attempt
to comply with the statute.
• The parties have already undertaken to
do business as a corporation.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
29
 CORPORATION
FORMATION AND POWERS (10 OF 14)
 Improper Incorporation:
Corporation by Estoppel:
• If it acts like a corporation, it cannot
avoid liability by claiming that no
corporation exists.
• Applies when a third party contracts
with corporation but has not filed
articles of incorporation.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
30
 CORPORATION
FORMATION AND POWERS (11 OF 14)
 Corporate Powers:
Express Powers: Found in the
corporation’s articles of incorporation,
the laws of the state of incorporation,
and in the state and federal corporation
statutes.
Corporate bylaws may also grant or limit
a corporation’s express powers.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
31
 CORPORATION
FORMATION AND POWERS (12 OF 14)
 Corporate Powers:
Implied Powers: The power of the
corporation to perform all acts reasonably
necessary to accomplish corporate
purposes.
A corporate officer can bind corporation in
contract in matters connected with the
ordinary business affairs of the enterprise.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 32
 CORPORATION
FORMATION AND POWERS (13 OF 14)
 Corporate Powers:
Ultra Vires: Corporate acts beyond the
express or implied powers of the
corporation.
Articles of incorporation now adopt very
broad purposes to prevent lawsuits
against the corporation so ultra vires
doctrine has declined in importance.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
33
 CORPORATION
FORMATION AND POWERS (14 OF 14)
 Corporate Powers:
Remedies for Ultra Vires Acts:
Shareholders can seek an injunction from
a court to stop the corporation from
engaging in ultra vires acts. The
corporation or its shareholders can also
seek damages from the officers and
directors who were responsible for the
ultra vires acts. 34
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
§3: PIERCING THE CORPORATE VEIL
(1 OF 5)

 In certain situations, courts will “pierce

the corporate veil” and hold
shareholders personally liable in the
interests of justice and fairness. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
35
PIERCING THE CORPORATE VEIL (2 OF 5)
 Factors That Lead Courts to Pierce the
Corporate Veil:
A third party tricked into dealing with
a corporation rather than the
individual.
Corporation is set up never to make a
profit, to always be insolvent, or is
undercapitalized. 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
36
PIERCING THE CORPORATE VEIL (3 OF 5)
 Factors That Lead Courts to Pierce the
Corporate Veil:
Corporation is formed to evade an
existing legal obligation.
Statutory formalities are not followed.
There is commingling of personal and
corporate interests or assets. 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
37
PIERCING THE CORPORATE VEIL (4 OF 5)
 A Potential Problem for Close
Corporations:
Separate status must be preserved.
Commingling of funds.
No director meetings.
Shareholder use of corporate property.
• SEE CASE IN POINT 39.6 BRENNAN'S, INC. V.
COLBERT (2012). 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
38
PIERCING THE CORPORATE VEIL (5 OF 5)
 The Alter-Ego Theory: The corporation is
“alter ego” of majority shareholder, and
personal and corporate interest are
commingled such that the corporation has
no separate identity.
Courts use the alter-ego theory to avoid
injustice or fraud that would result when
wrongdoers are protected by limited
liability.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
39
 §4: CORPORATE FINANCING (1 OF 6)
 Corporations usually are financed by the
issuance and sale of corporate securities.
Stocks (equity securities): The purchase of
ownership in the business firm.
Bonds (debt securities): The borrowing of
funds by firms (and governments). 

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
40
 CORPORATE FINANCING (2 OF 6)
 Bonds: Issued by business firms and
government at all levels.
Normally have a maturity date—when
principal is returned to investor.
Sometimes referred to as fixed-income
securities, because bondholders receive
fixed-dollar interest payments.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
41
 CORPORATE FINANCING (3 OF 6)
 Stocks: Common stock represents true
ownership of a corporation. It provides pro-
rata (proportional) ownership interest
reflected in voting, control, earnings, and
assets.
Investors who assume a residual financing
position (whatever is left may go to
dividends to shareholders). 
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
42
 CORPORATE FINANCING (4 OF 6)
 Stocks: Preferred stock holders usually have
priority over holders of common stock as to
dividends and payment on dissolution of
the corporation.
Holders of preferred stock frequently do
not have the right to vote.

© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
43
 CORPORATE FINANCING (5 OF 6)
 Venture Capital: Start-up businesses and
high-risk enterprises need start-up and
expansion capital. The start-up typically
gives a share of its stock to the venture
capitalists that provided funding.
 Private Equity Capital: Obtain capital from

wealthy investors. Ultimately, the company

may sell shares in an IPO.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
44
 CORPORATE FINANCING (6 OF 6)
 Crowdfunding: A cooperative activity in which
people network and pool funds/other resources
via the Internet to fund a cause or a venture.
New Securities and Exchange Commission
(SEC) rules allow companies to sell securities
through crowdfunding.
Companies are limited to raising $1 million
via crowdfunding and are required to make
specific disclosures.
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
45