Dynamic business law 4e kubasek 4e CH38

Chapter 38 Corporations: Formation and Financing Copyright © 2017 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGrawHill Education Overview • LO38-1: What are the characteristics of corporations? • LO38-2: What are the powers granted to corporations by the states? • LO38-3: How are corporations classified? • LO38-4: How are corporations formed? • LO38-5: What are some potential problems with the formation of corporations? • LO38-6: How corporations get funding? 38-2 Chapter 38 Hypothetical Case • Tim Ratigan's white-water rafting service has been very successful, and he has decided to convert his form of business ownership from a sole proprietorship to a corporation Ratigan has 135 friends, family members, and customers who would like to own stock in Ratigan's Raging Rapids Rafting, Inc., including Ratigan's college roommate George Bygraves, a citizen and resident of England Ratigan would like to use the S corporation form of business ownership, since the S corporation includes the dual advantages of limited liability and single taxation • Can Tim Ratigan use the S corporation form of business ownership for Ratigan's Raging Rapids Rafting, Inc.? 38-3 Chapter 38 Hypothetical Case • Best friends Phoebe Main and Franklin Kilbride love to cook The two are so inseparable that, some time ago, those who knew them began to jokingly refer to Main and Kilbride as "Ma and Pa." One of their concoctions, kettle corn, became so popular (Main and Kilbride love to share their caloric creations) that others have encouraged them go into business and sell their kettle corn as a product Main and Kilbride agree They have decided to form a traditional corporation as co-owners, and they have agreed on a name for their company: Ma and Pa Kettle Corn Company, Inc In the articles of incorporation (the document Main and Kilbride will send to the Kansas Secretary of State's office for approval of corporate status), the two are required to indicate the total number of stock shares the company is authorized to issue Main and Kilbride are perplexed Both have always considered themselves good with numbers, but they cannot decide what number of shares of stock to indicate in the articles of incorporation 38-4 • What is your recommendation to Phoebe Main and Franklin Kilbride? Characteristics of Corporations • Legal entity • Rights as person and citizen • Creature of state • Limited liability of shareholders • Unrestricted transferability of corporate shares • Perpetual existence • Centralized management • Corporate taxation 38-5 Corporate Powers • Corporations have both express and implied powers • Express powers: Perpetual existence; right to litigate; right to make contracts; right to borrow/loan money; right to make charitable donations; ability to establish rules for managing corporation • Implied powers: Whatever actions necessary (within the law) to execute express powers 38-6 Classifications of Corporations • Public/private • For-profit/nonprofit • Domestic/foreign/alien • Publicly held/closely held • S corporation • Professional corporation 38-7 Public versus Private Corporation • Public corporation: Corporation created by government to administer law, with specific government duties to fulfill • Example: Federal Deposit Insurance Corporation (FDIC) • Private corporation: Corporation created for private purposes 38-8 For-Profit versus Nonprofit Corporations • For-profit corporation: Objective is to operate for profit; shareholders seeking to make profit purchase stock that these corporations issue • Nonprofit corporation: May earn profits, but they not distribute these profits to shareholders (nonprofit corporation does not issue stock, nor does it have shareholders); instead, corporation reinvests profits in business 38-9 Domestic, Foreign, and Alien Corporations • Domestic: Doing business within state of incorporation • Foreign: Doing business in states other than state of incorporation • Alien: Doing business country other than country of incorporation 3810 Publicly Held versus Closely Held Corporation • Publicly held corporation: Stock available to public • Closely held corporation (aka a close, family, or privately held corporation): Generally does not offer stock to public 3811 Subchapter S Corporation • Named after provision of Internal Revenue Service (IRS) code that provides for it • Particular type of closely held corporation (no more than 100 shareholders) • Combines advantages of limited liability and single taxation 3812 Formation of Corporation • Promoters organize corporate formation • Subscribers offer to purchase stock in corporation in formation process • State selected for incorporation 3813 Considerations When Selecting a State for Incorporation • How much flexibility does the state grant to corporate management? • What rights state statutes give to shareholders? • What restrictions does the state place on the distribution of dividends? • Does the state offer any kind of protection against takeovers? 3814 Legal Process of Incorporation • Selection of corporation name • Drafting and filing articles of incorporation • First organizational meeting held 3815 Remedies for Defective Incorporation • De jure corporation: Lawful corporation that has met the substantial elements of incorporation process • De facto corporation: Corporation that has not met the requirements of state incorporation statute, but courts recognize it as a corporation for most purposes to avoid unfairness to third parties who reasonably believed it was properly incorporated • Corporation by estoppel: Corporation prevented by court from denying its corporate status • Piercing corporate veil: Shareholders personally liable when they have used corporation to engage in illegal/wrongful acts 3816 Situations When Courts May Pierce Corporate Veil • Corporation lacked adequate capital when initially formed • Corporation did not follow statutory mandates regarding corporate business • Shareholders' personal interests and corporate interests are commingled (corporation has no separate identity) • Shareholders attempt to commit fraud through corporation 3817 Debt Securities versus Equity Securities • Debt securities: Bonds (representing loans to corporation from another party) • Equity securities: Stock 3818 Types of Bond Debt Securities • Unsecured bond (debenture): No assets support corporation's obligation to repay face value of bond • Secured bond (mortgage bond): Specific property supports corporation's obligation to repay; creditor can seize secured interest if bond not repaid • Income bond: Corporation pays interest on bond in proportion to earnings • Convertible bond: Allows shareholders to exchange bond for shares of company stock • Callable bond: Allows corporation to call in and repay bond at specific times 3819 Equity Securities: Preferred versus Common Stock • Preferred stock: Stockholder enjoys preferences regarding assets and dividends • Common stock: Stockholder owns portion of corporation, but no preferences regarding assets and dividends 3820 Chapter 38 Hypothetical Case • Since 2006, Clyde Monett has operated an art restoration business specializing in the refurbishment of portraits and paintings He operated the enterprise as a sole proprietorship called Monett's Art Restoration Services until 2012, when he attended a business structures, licenses, and permits workshop at a local community college The presenting attorney at the workshop suggested Monett convert his business to a corporation in order to shield his personal property and real estate from liability for his business's financial obligations (Monett's personal net worth is approximately $150,000) Following the incorporation process, the only change to the business's name was the addition of the word "Incorporated." Monett was the only incorporator of the business He serves as the president, vice president, and treasurer of the corporation; his sister, Rachel Monett, is the secretary 3821 Chapter 38 Hypothetical Case (cont'd) • Since the corporation's formation in 2012, the siblings have convened only one official corporate meeting; the meeting lasted approximately one hour, and the two shared family gossip for 45 minutes of that hour Monett's Art Restoration Services, Incorporated has maintained an average daily balance of $45.22 in the corporate checking account at Homeland National Bank Last week, Monett inadvertently purchased the wrong art refurbishment materials (the cleaning solution was too acidic), and the oversight resulted in irreparable damage to a painting conservatively valued at $75,000 The owner of the painting, Svetlana Poe, demands $75,000 in damages from Monett Monett apologizes, offers two free coupons for future restoration services, and refuses to pay the $75,000 The current corporate checking account balance is $52.84 • Is Clyde Monett personally liable for the $75,000 damage claim? Is he ethically obligated to pay Poe $75,000? 3822 Chapter 38 Hypothetical Case • Nathalie Sawyer is the founder, president, and CEO of Can-Do Fabricators, a Connecticut-based corporation that fabricates granite, marble, and quartz countertops Can-Do is a closely held corporation with 20 stockholders other than Sawyer All of the other stockholders are Sawyer's family members or personal friends Sawyer herself owns 60 percent of the shares of Can-Do; the remaining stockholders each own percent of the shares Sawyer has plans to expand the company into New York; in order to so, she needs a significant influx of capital—$4 million Sawyer's present facility is valued at $5 million Sawyer decides to issue corporate bonds in order to raise the capital she needs She is considering issuing unsecured, secured, or convertible bonds If she chooses unsecured bonds, Can-Do will end up paying much more interest on the bonds than either of the other two choices • What are the potential downsides (other than higher interest) and benefits of choosing each of the types of bonds? Explain your answer 3823 ... corporation reinvests profits in business 38-9 Domestic, Foreign, and Alien Corporations • Domestic: Doing business within state of incorporation • Foreign: Doing business in states other than state... corporation form of business ownership, since the S corporation includes the dual advantages of limited liability and single taxation • Can Tim Ratigan use the S corporation form of business ownership... 2012, when he attended a business structures, licenses, and permits workshop at a local community college The presenting attorney at the workshop suggested Monett convert his business to a corporation