The Law of Corporations and Other Business Organizations

Lecture Notes

An Introduction to Corporations

1. Corporations are artificial entities separate
from their owners that may exist perpetually
and have certain rights and powers exercised
through their agents.
2. Because the corporation is a separate entity,
the corporation itself is liable for any
debts and obligations it incurs.
3. Corporate shareholders, directors, and officers
are generally free from personal liability
for the debts and obligations of the
corporation.
4. The corporation’s state of domicile is the
state in which the corporation was incorporated.
5. Internal affairs of the corporation are generally
governed by state statutes of the corporation’s
state of domicile.
6. Corporations are also subject to common
law, case law, federal statutes, and local
ordinances.
7. Most state business corporation acts are
modeled after the Model Business Corporation
Act, first published in 1950, or
the 1984 Revised Model Business
Corporation Act. The 1984 Revised
Model Business Corporation Act continues
to be revised periodically.
Corporations in the United States
8. With business receipts of several trillion
dollars each year, large corporations play a
very important role in the economy of the
United States.
9. In 2007, more than half of the households
in the United States owned shares of stock
or mutual funds.
Corporate Rights and Powers
10. Corporations, as artificial persons, are entitled
to many of the same rights as natural
persons.
11. The state business corporation act may
enumerate specific powers granted to corporations.
In general, state statutes grant a
corporation the right to perpetual duration
and succession in its corporate name and
all the powers of an individual to do all
things necessary or convenient to carry out
the corporation’s business and affairs.
Advantages of Doing Business as a
Corporation
12. Transacting business as a corporation offers
many advantages over other types of
business organizations, including the following:
• Corporations provide officers, directors,
and shareholders with limited liability.
• The corporation has the ability to exist
perpetually. Shares of stock may be
sold or gifted to others without affecting
the continuity of the corporation or
its business.
• The centralized management of a corporation
may streamline the decisionmaking
process.
• The ownership interest of a corporation
may be easily transferred.
• Owners of a corporation may be in a
position to take advantage of several
qualified benefit plans.
• The shareholders of a corporation may
choose its tax year.
• Corporations have increased potential
for raising capital.
Disadvantages of Doing Business as a
Corporation
13. Transacting business as a corporation has
its disadvantages as compared to other
types of business organization, including
the following:
• Corporations are one of the most complex
types of business organization,
and the formation and operation of
corporations involves more formalities
and reporting requirements than most
other forms of business.
• The double taxation on corporate income,
as well as the taxes assessed only
on corporations, can be a serious
disadvantage to transacting business as
a corporation.
Piercing the Corporate Veil
14. Under certain circumstances, the corporate
veil may be pierced and the corporate entity
disregarded. If the corporate veil is
pierced, the corporate shareholders, directors,
or officers may be held personally accountable
for the corporation’s obligations.
15. The corporate veil may be pierced when a
corporation is formed or operated to commit
fraud or other illegal activity, or to defend
a crime.
16. The corporate veil of a small corporation
may be pierced to prevent an inequity, injustice,
or fraud, especially when the corporate
formalities are not followed and the
corporation is found to be merely an alter
ego of a sole shareholder.
Types and Classifications of Corporations
17. Business corporations are by far the most
common type of corporation in the United
States.
18. Professional corporations are formed only
for the purpose of rendering the services of
a single profession.
19. All shareholders of professional corporations
must be licensed professionals.
20. Nonprofit corporations, or not-for-profit
corporations, are formed only for certain
nonprofit purposes.
21. Certain nonprofit corporations may qualify
to be tax-exempt, but an application must
be made to the Internal Revenue Service
pursuant to IRC § 501(c).
22. S Corporations are a special type of corporation
formed pursuant to Subchapter S of
the Internal Revenue Code.
23. S Corporations are taxed as partnerships.
24. Shareholders of corporations who wish
partnership taxation status may file an
election to be treated as an S Corporation
with the Internal Revenue Service on
Form 2553.
25. S Corporations must meet several eligibility
requirements. For example, S Corporations
may have no more than 100
shareholders and the corporation may not
issue more than one class of stock.
26. Pass-through taxation has made the S Corporation
one of the most popular types of
business organization in the United States.
27. Corporations with a small number of
stockholders and stock that is not publicly
traded are often referred to as closely held
corporations or close corporations. These
corporations are subject to the business
corporation acts of their states of domicile.
28. Many states have adopted special close
corporation statutes that take into consideration
the unique characteristics of the
smaller corporation. Qualifying corporations
may elect to be treated under the
close corporation statutes in certain states.
29. Close corporation statutes may provide
for restrictions on the transfer of shares
of close corporations. They may also
provide that close corporations are not
subject to all of the formalities placed on
other corporations.
30. Parent corporations hold stock in their subsidiary
corporations sufficient to control
the subsidiaries.
31. The terms sister corporation and affiliate
corporation refer to corporations owned or
controlled by the same owners.
The Paralegal’s Role
32. Corporate paralegals who work for corporations
and for law firms that represent corporations
perform a wide variety of tasks.
Resources
33. Resources commonly used by corporate
paralegals include the following:
• State statutes
• Federal statutes
• Secretary of state (or other state corporation
agency) resources
• Online information on corporations
34. The following types of information may be
found online to assist corporate paralegals:
• State corporate statutes
• Federal statutes concerning corporations
• Case law concerning corporations
• General research for corporate law
issues
• General information and treatises
concerning issues in corporate law
• Information concerning filing corporate
documents
• Financial and other information on
publicly held corporations
• Annual reports and other pertinent
documents filed with the Securities and
Exchange Commission
• Forms for forming corporations and
transacting business as a corporation
• Discussions concerning corporate law
• Association information, including
listservs and online discussions for
corporate paralegals
CASE BRIEFS
Hunting v. Elders, 597 S.E.2d 803
(Ct.App.2004)
Purpose: This case is an example of a successful
attempt to pierce the corporate veil of a corporation
when the corporation is found to be the
alter ego of its owner.
Facts: This case is an appeal by a defendant in
an action that was commenced to recover damages
sustained in an accident caused by a drunk
driver. Catherine Hitchcock, the plaintiff in this
case represented by a guardian ad litem, brought
suit against Chris Gordon, the drunk driver who
caused an accident that left Hitchcock permanently
brain damaged, as well as Elmyer Enterprises,
Inc., the owner and operator of the bar
that served Gordon, and William Elders, shareholder
of Elmyer Enterprises.
In the first portion of the bifurcated trial in this
matter, damages of $1.5 million were awarded
against Gordon and Elmyer Enterprises. The
second phase of the trial, which is the subject of
the appeal, resulted in a holding that Elders was
the alter ego of Elmyer Enterprises, justifying
piercing the corporate veil, thereby holding Elders
personally liable for the $1.5 million verdict.
Evidence presented at trial indicated that
corporate formalities were not followed for
Elmyer Enterprises and that the corporation was
undercapitalized. Testimony by one expert witness,
a forensic accountant, indicated that Elders
siphoned off between $400,000 and $800,000
from the business over a three-year period. Testimony
by another expert witness indicated that
Elmyer Enterprises had income that was unaccounted
for and profit that was not adequately
revealed. He further testified that, in his opinion,
Elders was the alter ego of Elmyer Enterprises.
Issue: Should the corporate veil be pierced because
corporate formalities were disregarded by
the defendant/appellant and because the defendant
apparently siphoned money from the corporation,
which was undercapitalized?
Holding: Yes
Reasoning: “If any general rule can be laid
down, it is that a corporation will be looked upon
as a legal entity until sufficient reason to the
contrary appears; but when the notion of legal
entity is used to protect fraud, justify wrong, or
defeat public policy, the law will regard the corporation
as an association of persons….”
In this case, the court used a twopronged
test (Sturkie v. Sifly, 313 S.E.2d 316,
318 [Ct. App. 1984]) to justify piercing the corporate
veil and finding defendant/appellant Elders
personally liable for the debt of Elmyer Enterprises.
The first part of the test considers
whether corporate formalities were observed by
the dominant corporate shareholders. In this
case, the court found they were not. The second
prong of the test requires “that there be an element
of injustice or fundamental unfairness if
the acts of the corporation be not regarded as the
acts of the individuals” (Sturkie). In this case,
the court found that Elders knew of the plaintiff’s
claim against the corporation and that he
nevertheless acted in a self-serving and unfair
manner by siphoning off substantial sums of
money, commingling and transferring assets to
different entities, transferring stock in the corporation
to other individuals, and then finally dissolving
the corporation. The court further found
that “the essence of the fairness test is simply
that an individual businessman cannot be allowed
to hide from the normal consequences of
carefree entrepreneuring by doing so through a
corporate shell.” The court found that Elders’s
actions satisfied the second prong of the test for
piercing the corporate veil and found Elders to
be the alter ego of Elmyer Enterprises and personally
liable for that corporation’s obligation to
the plaintiff.