Percentage of corporations incorporated in delaware

Business Forms And Governance

Please read and understand the assignment before bidding. I have attached the reference chapters.

Assignment Content

Resources: Legal Environment of Business: Online Commerce, Business Ethics, and Global Issues: Ch. 14, 15, 16 and 17; Week 2 Electronic Reserve Readings; Legal Source database located in the Week 2 Electronic Reserve Readings

Scenario: You are sole proprietor presenting to a group of investors where you are seeking 20 million dollars to raise capital for your manufacturing company.

Prepare a memo discussing the following to investors:

Choose the one form of organization best suited for your manufacturing company and explain why:

Partnership
Limited Liability Partnership
Limited Liability Company (including single member LLC)
S Corporation
Franchise
Corporation
Explain for the investors which form of organization (from the list above) would be the least suited and why?

(The legal form an entity or individual takes is a decision that must be considered from a risk and liability perspective, not simply one of ease of formation or cost. Form can impact the entities ability to grow and, in some circumstances, its ability to survive. As you consider this reality and approach this assignment, consider not only the form the business takes but also the way it will be governed. Remember the law requires business leaders conduct their business ethically and within the boundaries of the law.)

Summarize for investors what legal liabilities could arise for the Director or officer of that board?

Explain how you could minimize those liabilities for the Director or officer of that board.

CHAPTER 16 Corporations and Corporate Governance

Stock Certificate

Corporations have existed since medieval Europe when individual charters were granted by the ruler, usually a monarch (king or queen). In the United States today, corporations are created by meeting the requirements established by corporation codes. A corporation is owned by its shareholders, who elect members of the board of directors to make policy decisions and who, in turn, employ corporate officers to run the day-to-day operations of the corporation.

Learning Objectives

After studying this chapter, you should be able to:

1. Define corporation and list the major characteristics of a corporation.

2. Describe the process of forming and financing a corporation.

3. Explain the rights, duties, and liability of directors, officers, and shareholders.

4. Describe how the Sarbanes-Oxley Act affects corporate governance.

5. Describe the operation of multinational corporations.

Chapter Outline

1. Introduction to Corporations and Corporate Governance

2. Nature of the Corporation

1. Case 16.1 • Menendez v. O’Niell

3. Incorporation Procedure

1. BUSINESS ENVIRONMENT • S Corporation Election for Federal Tax Purposes

4. Financing the Corporation

1. BUSINESS ENVIRONMENT • Delaware Corporation Law

5. Shareholders

1. ETHICS • Shareholder Resolutions

6. Board of Directors

1. DIGITAL LAW • Corporate E-Communications

7. Corporate Officers

8. Fiduciary Duties of Directors and Officers

9. Sarbanes-Oxley Act

1. ETHICS • Sarbanes-Oxley Act Improves Corporate Governance

10. Dissolution of a Corporation

11. Multinational Corporations

1. GLOBAL LAW • Bribes Paid by U.S. Companies in Foreign Countries

“ The biggest corporation, like the humblest private person, must be held to strict compliance with the will of the people.”

—Theodore Roosevelt Speech (1902)

A corporation is an artificial being, invisible, intangible, and existing only in the contemplation of law.

John Marshall, Chief Justice Dartmouth College v. Woodward, 4 Wheaton 518, 636 (1819)

Introduction to Corporations and Corporate Goverance

Corporations are the most dominant form of business organization in the United States, generating more than 85 percent of the country’s gross business receipts. Corporations range in size from one owner to thousands of owners. Owners of corporations are called shareholders. Shareholders are owners of a corporation who elect the board of directorsand vote on fundamental changes in the corporation. The directors are responsible for making policy decisions and employing officers. The officers are responsible for the corporation’s day-to- day operations.

After decades of many financial frauds and scandals involving directors and officers at some of the largest companies in the United States, in 2002 Congress enacted the Sarbanes-Oxley Act (SOX). This federal statute established rules to improve corporate governance, prevent fraud, and add transparency to corporate operations.

The limited liability corporation is the greatest single invention of modern times.

Nicholas Murray Butler

President, Columbia University

This chapter discusses the formation and financing of corporations; the rights, duties, and liability of corporate shareholders, directors, and officers; the rules established by the Sarbanes-Oxley Act; and issues involving corporate governance.

Nature of the Corporation

Corporations can be created only pursuant to the laws of the state of incorporation. These laws—commonly referred to as corporation codes —regulate the formation, operation, and dissolution of corporations. The state legislature may amend its corporate statutes at any time. Such changes may require a corporation’s articles of incorporation to be amended.

corporation codes

State statutes that regulate the formation, operation, and dissolution of corporations.

Revised Model Business Corporation Act (RMBCA)

A 1984 revision of the MBCA that arranges the provisions of the act more logically, revises the language to be more consistent, and makes substantial changes in the provisions.

The Committee on Corporate Laws of the American Bar Association first drafted the Model Business Corporation Act (MBCA) in 1950. The model act was intended to provide a uniform law regulating the formation, operation, and termination of corporations. In 1984, the committee completely revised the MBCA and issued the Revised Model Business Corporation Act (RMBCA) . Certain provisions of the RMBCA have been amended since 1984. Most states have adopted all or part of the RMBCA. The RMBCA serves as the basis for the discussion of corporation law in this text. There is no general federal corporation law governing the formation and operation of private corporations.

The courts interpret state corporation statutes to decide individual corporate and shareholder’s disputes. As a result, a body of common law has evolved concerning corporate and shareholder rights and obligations.

A corporation is a separate legal entity (or legal person) for most purposes. Corporations are treated, in effect, as artificial persons created by the state that can sue or be sued in their own names, enter into and enforce contracts, hold title to and transfer property, and be found civilly and criminally liable for violations of law. Because corporations cannot be put in prison, the normal criminal penalty is the assessment of a fine, loss of a license, or another sanction.

corporation

A fictitious legal entity that is created according to statutory requirements.

They [corporations] cannot commit treason, nor be outlawed, nor excommunicated, for they have no souls.

Lord Edward Coke (1552–1634)

Reports, vol. V, Case of Sutton’s Hospital

Characteristics of a Corporation

Corporations have unique characteristics. Some of the major characteristics of a corporation are as follows:

· Free transferability of shares. Corporate shares are freely transferable by a shareholder by sale, assignment, pledge, or gift unless they are issued pursuant to certain exemptions from securities registration. Shareholders may agree among themselves as to restrictions on the transfer of shares. National securities markets, such as the New York Stock Exchange and NASDAQ, have been developed for the organized sale of securities.

· Perpetual existence. Corporations exist in perpetuity unless a specific duration is stated in a corporation’s articles of incorporation. The existence of a corporation may be voluntarily terminated by the shareholders. The death, insanity, or bankruptcy of a shareholder, a director, or an officer of a corporation does not affect its existence.

· Centralized management. A corporation usually has a centralized management composed of the board of directors and officers of the corporation. The board of directors makes policy decisions concerning the operation of a corporation. The members of the board of directors are elected by the shareholders. The directors, in turn, appoint corporate officers to run the corporation’s day-to-day operations. Together, the directors and officers form the corporate management .

Limited Liability of Shareholders

As separate legal entities, corporations are liable for their own debts and obligations. Generally, the shareholders have only limited liability. The limited liability of shareholders means that they are liable only to the extent of their capital contributions and do not have personal liability for the corporation’s debts and obligations (see Exhibit16.1 ).

limited liability of shareholders

A general rule of corporate law that provides that generally shareholders are liable only to the extent of their capital contributions for the debts and obligations of their corporation and are not personally liable for the debts and obligations of the corporation.

Critical Legal Thinking

1. What does limited liability of shareholders mean? What would be the economic consequences if shareholders were held personally liable for corporate debts and obligations?

Example

Tina, Vivi, and Qixia form IT.com , Inc., a corporation, and each contributes $100,000 capital. The corporation borrows $1 million from State Bank. One year later, IT.com , Inc., goes bankrupt and defaults on the $1 million loan owed to State Bank. At that time, IT.com , Inc.’s only asset is $50,000 cash, which State Bank recovers. Tina, Vivi, and Qixia each lose their $100,000 capital contribution, which IT.com , Inc., has spent. However, Tina, Vivi, and Qixia are not personally liable for the $950,000 still owed to State Bank. State Bank must absorb this loss.

In the following case, the court was asked to decide the liability of a shareholder for a corporation’s debts.

Exhibit 16.1 Corporation

CASE 16.1 STATE COURT CASE Shareholder’s Limited Liability Menendez v. O’Niell

986 So.2d 255 (2008) Court of Appeal of Louisiana

“As a general rule, a corporation is a distinct legal entity, separate from the individuals who comprise them, and individual shareholders are not liable for the debts of the corporation.”

—Welch, Judge

Facts

A vehicle driven by Michael O’Niell crashed while traveling on Louisiana Highway 30. Vanessa Savoy, a 19-year-old guest passenger in the vehicle, sustained severe injuries as a result of the collision. O’Niell, who was under the legal drinking age, had been drinking at Fred’s Bar and Grill prior to the accident. Fred’s Bar is owned by Triumvirate of Baton Rouge, Inc., a corporation. Marc Fraioli is the sole shareholder and president of Triumvirate. Fraioli was not at Fred’s Bar the night that O’Niell was served alcohol at the bar. Savoy, through a legal representative, brought a lawsuit against O’Niell, O’Niell’s automobile insurance company, Triumvirate, and Fraioli, seeking damages for her injuries. Savoy alleged that O’Niell was intoxicated at the time of the accident and that his drinking caused the collision. Savoy alleged that Triumvirate Corporation was liable for serving O’Niell alcohol when he was underage and that Fraioli was liable as the owner of Triumvirate.

Fraioli filed a motion for summary judgment asserting that, as the shareholder of Triumvirate, he was not liable for the corporation’s debts. The trial court granted summary judgment to Fraioli and dismissed him as a defendant in the case. Savoy appealed.

Issue

Is Fraioli personally liable for the debts of Triumvirate, a corporation of which he is the sole shareholder?

Language of the Court

As a general rule, a corporation is a distinct legal entity, separate from the individuals who comprise them, and individual shareholders are not liable for the debts of the corporation. Mr. Fraioli met his burden of proving Triumvirate’s corporate existence. Plaintiff failed to offer any evidence identified by law as indicia that Mr. Fraioli and Triumvirate are not actually separate entities. The involvement of a sole or majority shareholder in a corporation is not sufficient alone, as a matter of law, to establish a basis for disregarding the corporate entity.

Decision

The court of appeal held that Fraioli was not personally liable for the debts of the Triumvirate corporation of which he was the sole shareholder. The court of appeal affirmed the trial court’s grant of summary judgment dismissing Fraioli from the case.

Ethics Questions

1. What reasons could there be for Fraioli to operate his business as a corporation rather than as a sole proprietorship? Was it ethical for Fraioli to assert the corporate shield to avoid liability in this case?

Publicly Held and Closely Held Corporations

Private corporations are formed to conduct privately owned business. They are owned by private parties, not by the government. They range from small one-owner corporations to large multinational corporations such as Microsoft Corporation.

Publicly held corporations are for-profit corporations that have many shareholders. Often, they are large corporations with hundreds or thousands of shareholders, and their shares are usually traded on organized securities markets.

publicly held corporation

A corporation that has many shareholders and whose securities are often traded on national stock exchanges.

Examples

Google, Inc.; Facebook, Inc.; eBay, Inc.; Starbucks Corporation; Apple Computer, Inc.; The Procter & Gamble Company; Wal-Mart Stores, Inc.; Ford Motor Company; and Yahoo!, Inc. are examples of publicly held corporations.

A closely held corporation , or privately held corporation, on the other hand, is a private for-profit corporation whose shares are usually owned by a few shareholders who are often family members, relatives, or friends. However, some privately held companies are large in size, such as S. C. Johnson & Son, Inc. (often referred to as “S. C. Johnson, A Family Company”), which is a global company with more than 10,000 employees.

closely held corporation (privately held corporation)

A corporation owned by one or a few shareholders.

The corporation is, and must be, the creature of the state. Into its nostrils the state must breathe the breath of a fictitious life for otherwise it would be no animated body but individualistic dust.

Frederic William Maitland

Introduction to Gierke, Political Theories of the Middle Ages (1915)

Incorporation Procedure

Corporations are creatures of statute. Thus, the organizers of a corporation must comply with the state’s corporation code to form a corporation. The procedure for incorporating a corporation varies somewhat from state to state. The procedure for incorporating a corporation is discussed in the following paragraphs.

Selecting a State for Incorporating a Corporation

A corporation can be incorporated in only one state, even though it can do business in all other states in which it qualifies to do business. In choosing a state for incorporation, the incorporators, directors, and/or shareholders must consider the corporation law of the states under consideration.

For the sake of convenience, most corporations (particularly small ones) choose the state in which the corporation will be doing most of its business as the state for incorporation. Large corporations generally opt to incorporate in the state with the laws that are most favorable to the corporation’s internal operations (e.g., Delaware).

A corporation is a domestic corporation in the state in which it is incorporated. It is a foreign corporation in all other states and jurisdictions. An alien corporation is a corporation that is incorporated in another country.

domestic corporation

A corporation in the state in which it was formed.

foreign corporation

A corporation in any state or jurisdiction other than the one in which it was formed.

When starting a new corporation, the organizers must choose a name for the entity. The name must contain the words corporation, company, incorporated, or limited or an abbreviation of one of these words (i.e., Corp., Co., Inc., Ltd.). A trademark of the name can be obtained if available and desired. Also, a domain name for use by the corporation on the Internet should also be obtained.

Promoters and Incorporators

A promoter is a person who organizes and starts a corporation, finds the initial investors to finance the corporation, and so on. Promoters sometimes enter into contracts on behalf of a corporation prior to its actual incorporation. Promoters’ contracts include leases, sales contracts, contracts to purchase real or personal property, employment contracts, and the like. Promoters’ liability and the corporation’s liability on promoters’ contracts follow these rules:

promoter

A person or persons who organize and start a corporation, negotiate and enter into contracts in advance of its formation, find the initial investors to finance the corporation, and so forth.

promoters’ contracts

A collective term for items such as leases, sales contracts, contracts to purchase property, and employment contracts entered into by promoters on behalf of the proposed corporation prior to its actual incorporation.

· If the corporation never comes into existence, the promoters have joint personal liability on the contract unless the third party specifically exempts them from such liability.

· If the corporation is formed, it becomes liable on a promoter’s contract only if it agrees to become bound to the contract. A resolution of the board of directors binds the corporation to a promoter’s contract.

· Even if the corporation agrees to be bound to the contract, the promoter remains liable on the contract unless the parties enter into a novation, a three-party agreement in which the corporation agrees to assume the contract liability of the promoter with the consent of the third party. After a novation, the corporation is solely liable on the promoter’s contract.

The parties who sign the articles of incorporation are called incorporators [RMBCA Section 2.01]. Promoters and incorporators often become shareholders, directors, or officers of the corporation.

Articles of Incorporation

The articles of incorporation (or corporate charter) form the basic governing document of a corporation. It must be drafted and filed with, and approved by, the state before the corporation can be officially incorporated. Under the RMBCA, the articles of incorporation must include the following [RMBCA Section 2.02(a)]:

articles of incorporation (corporate charter)

The basic governing documents of a corporation. It must be filed with the secretary of state of the state of incorporation.

· The name of the corporation

· The number of shares the corporation is authorized to issue

· The address of the corporation’s initial registered office and the name of the initial registered agent

· The name and address of each incorporator

WEB EXERCISE

To view the articles of incorporation of Microsoft Corporation, go to http://www.microsoft.com/investor/CorporateGovernance/PoliciesAndGuidelines/articlesincorp.aspx .

The articles of incorporation may also include provisions concerning (1) the period of duration (which may be perpetual), (2) the purpose or purposes for which the corporation is organized, (3) limitation or regulation of the powers of the corporation, (4) regulation of the affairs of the corporation, or (5) any provision that would otherwise be contained in the corporation’s bylaws. Today, corporations most often provide their articles of incorporation online.

Exhibit 16.2 illustrates sample articles of incorporation.

Registered Agent

The articles of incorporation must identify a registered office with a designated registered agent (either an individual or a corporation) in the state of incorporation [RMBCA Section 5.01]. Attorneys often act as the registered agents of corporations. The registered agent is empowered to accept service of process on behalf of the corporation. Service of summons, complaints, and other pleadings to start a lawsuit or legal proceeding against the corporation are served on the registered agent.

registered agent

A person or corporation that is empowered to accept service of process on behalf of a corporation.

bylaws

A detailed set of rules adopted by the board of directors after a corporation is incorporated that contains provisions for managing the business and the affairs of the corporation.

Corporate Bylaws

In addition to the articles of incorporation, corporations are governed by their bylaws . Either the incorporators or the initial directors can adopt the bylaws of the corporation. The bylaws are much more detailed than are the articles of incorporation. Bylaws may contain any provisions for managing the business and affairs of the corporation that are not inconsistent with law or the articles of incorporation [RMBCA Section 2.06]. They do not have to be filed with any government official. Today, corporations most often provide their bylaws online. The bylaws govern the internal management structure of a corporation.

Exhibit 16.2 Articles of Incorporation

WEB EXERCISE

To view the bylaws of Microsoft Corporation, go to www.microsoft.com/investor/CorporateGovernance/PoliciesAndGuidelines/bylaws.aspx .

Examples

Bylaws typically specify the time and place of the annual shareholders’ meeting, how special meetings of shareholders are called, the time and place of annual and monthly meetings of the board of directors, how special meetings of the board of directors are called, the notice required for meetings, the quorum necessary to hold a shareholders’ or board meeting, the required vote necessary to enact a corporate matter, the corporate officers and their duties, the committees of the board of directors and their duties, where the records of the corporation are kept, directors’ and shareholders’ rights to inspect corporate records, the procedure for transferring shares of the corporation, and so on.

The shareholders of a corporation have the absolute right to amend the bylaws, and the board of directors may also usually amend the bylaws [RMBCA Section 10.20]. The bylaws are binding on the directors, officers, and shareholders of the corporation.

The board of directors has the authority to amend the bylaws unless the articles of incorporation reserve that right for the shareholders. The shareholders of the corporation have the absolute right to amend the bylaws even though the board of directors may also amend the bylaws [RMBCA Section 10.20].

Organizational Meeting of the Board of Directors

An organizational meeting of the initial directors of a corporation must be held after the articles of incorporation are filed. At this meeting, the directors must adopt the bylaws, elect corporate officers, and transact such other business as may come before the meeting [RMBCA Section 2.05].

organizational meeting

A meeting that must be held by the initial directors of a corporation after the articles of incorporation are filed.

Examples

Actions taken at the meeting may include accepting share subscriptions, approving the form of the stock certificate, authorizing the issuance of the shares, ratifying or adopting promoters’ contracts, authorizing the reimbursement of promoters’ expenses, selecting a bank, choosing an auditor, forming committees of the board of directors, fixing the salaries of officers, hiring employees, authorizing the filing of applications for government licenses to transact the business of the corporation, and empowering corporate officers to enter into contracts on behalf of the corporation.

The following feature discusses an election that can be made regarding federal tax obligations.

Business Environment S Corporation Election for Federal Tax Purposes

A C corporation is a corporation that does not qualify to or does not elect to be federally taxed as an S corporation. Any corporation with more than 100 shareholders is automatically a C corporation for federal income tax purposes. A C corporation must pay federal income tax at the corporate level. In addition, if a C corporation distributes its profits to shareholders in the form of dividends, the shareholders must pay personal income tax on the dividends. With a C corporation, there is double taxation , that is, one tax paid at the corporate level and another paid at the shareholder level.

C Corporation

A C corporation is a corporation that does not qualify for or has not elected to be taxed as an S corporation. Where there is a C corporation, there is double taxation; that is, a C corporation pays taxes at the corporate level, and shareholders pay taxes on dividends paid by the corporation.

equity securities (stocks)

Representation of ownership rights to a corporation.

Congress enacted the Subchapter S Revision Act to allow the shareholders of some corporations to avoid double taxation by electing Subchapter S corporation status. 1 If a corporation elects to be taxed as an S corporation , it pays no federal income tax at the corporate level. As in a partnership, the corporation’s income or loss flows to the shareholders’ individual income tax returns. Shareholders pay the tax on the corporation’s profits, even if the income is not distributed. Subchapter S election only affects the taxation of a corporation; it does not affect attributes of corporate form, including limited liability.

Corporations that meet the following criteria can elect to be taxed as S corporations:

· The corporation must be a domestic corporation.

· The corporation cannot be a member of an affiliated group of corporations.

· The corporation can have no more than 100 shareholders.

· Shareholders must be individuals, estates, or certain trusts. Corporations and partnerships cannot be shareholders.

· Shareholders must be citizens or residents of the United States. Nonresident aliens cannot be shareholders.

· The corporation cannot have more than one class of stock. Shareholders do not have to have equal voting rights.

An S corporation election is made by filing Form 2553 with the Internal Revenue Service (IRS). The election can be rescinded by shareholders who collectively own at least a majority of the shares of the corporation. If the election is rescinded, however, another S corporation election cannot be made for five years.

Bottom of Form

Financing the Corporation

A corporation needs to finance the operation of its business. The most common way to do this is by selling equity securities and debt securities. Equity securities (or stocks) represent ownership rights in the corporation. Equity securities can be common stock and preferred stock. These are discussed in the following paragraphs.

S Corporation

A corporation that has met certain requirements and has elected to be taxed as an S corporation for federal income tax purposes. An S corporation pays no federal income tax at the corporate level. The S corporation’s income or loss flows to the shareholders and must be reported on the shareholders’ individual income tax returns.

Common Stock

Common stock is an equity security that represents the residual value of a corporation. Common stock has no preferences. That is, creditors and preferred shareholders must receive their required interest and dividend payments before common shareholders receive anything. Common stock does not have a fixed maturity date. If a corporation is liquidated. the creditors and preferred shareholders are paid the value of their interests first, and the common shareholders are paid the value of their interests (if any) last. Corporations may issue different classes of common stock [RMBCA Sections 6.01(a), 6.01(b)].

common stock

A type of equity security that represents the residual value of a corporation.

Persons who own common stock are called common stockholders . Common stockholders are issued common stock certificates to show evidence of their ownership interest in the corporation. However, electronic registration of common stockholder ownership interests is supplanting paper stock certificates. Corporations are no longer required by law to issue paper certificates, and many do not.

common stockholder

A person who owns common stock.

Common stockholders have the right to elect directors and to vote on mergers and other important matters. In return for their investment, common stockholders receive dividends declared by the board of directors.

Preferred Stock

Preferred stock is an equity security that is given certain preferences and rights over common stock [RMBCA Section 6.01(c)]. The owners of preferred stock are called preferred stockholders . Preferred stockholders are issued preferred stock certificates to show evidence of their ownership interest in the corporation. Electronic registration of preferred stockholder ownership interests is supplanting paper stock certificates.

preferred stock

A type of equity security that is given certain preferences and rights over common stock.

preferred stockholder

A person who owns preferred stock.

Preferred stock can be issued in classes or series. One class of preferred stock can be given preference over another class of preferred stock. Like common stockholders, preferred stockholders have limited liability. Preferred stockholders generally are not given the right to vote for the election of directors, or the like. However, they are often given the right to vote if there is a merger or if the corporation has not made the required dividend payments for a certain period of time (e.g., three years).

Preferences of preferred stock must be set forth in the articles of incorporation. Preferred stock may have any or all of the following preferences:

dividend preference

The right to receive a fixed dividend at stipulated periods during the year (e.g., quarterly).

liquidation preference

The right to be paid a stated dollar amount if a corporation is dissolved and liquidated.

· Dividend preference. A dividend preference is the right to receive a fixed dividend at set periods during the year (e.g., quarterly). The dividend rate is usually a set percentage of the initial offering price.

Example

A stockholder purchases $10,000 of a preferred stock that pays an 8 percent dividend annually. The stockholder has the right to receive $800 each year as a dividend on the preferred stock.

· Liquidation preference. The right to be paid before common stockholders if the corporation is dissolved and liquidated is called a liquidation preference . A liquidation preference is normally a stated dollar amount.

Example

A corporation issues a preferred stock that has a liquidation preference of $200. This means that, if the corporation is dissolved and liquidated, the holder of each preferred share will receive at least $200 before the common shareholders receive anything. Note that because the corporation must pay its creditors first, there may be insufficient funds to pay this preference.

· Cumulative dividend right. Corporations must pay a preferred dividend if they have the earnings to do so. Sometimes, however, corporations are not able to pay preferred stock dividends when due. Cumulative preferred stock provides that any missed dividend payment must be paid in the future to the preferred shareholders before the common shareholders can receive any dividends. The amount of unpaid cumulative dividends is called dividend arrearages . Usually, arrearages can be accumulated for only a limited period of time (e.g., three years).

With noncumulative preferred stock , there is no right of accumulation. In other words, the corporation does not have to pay any missed dividends.

Example

The WindSock Corporation issues cumulative preferred stock that requires the payment of a quarterly dividend of $1.00 per share. The WindSock Corporation falls behind with six quarterly payments—$6.00 per share of preferred stock. The next quarter, the corporation makes a profit of $7.00 per share. The corporation must pay the $6.00 per share of arrearages to the preferred shareholders plus this quarter’s payment of $1.00 per share. Thus, the common shareholders receive nothing.

· Right to participate in profits. Participating preferred stock allows a preferred stockholder to participate in the profits of the corporation along with the common stockholders. Participation is in addition to the fixed dividend paid on preferred stock. The terms of participation vary widely. Usually, the common stockholders must be paid a certain amount of dividends before participation is allowed. Nonparticipating preferred stock does not give the holder a right to participate in the profits of the corporation beyond the fixed dividend rate. Most preferred stock falls into this category.

· Conversion right. Convertible preferred stock permits the preferred stockholders to convert their shares into common stock. The terms and exchange rate of the conversion are established when the shares are issued. The holders of convertible preferred stock usually exercise this option if the corporation’s common stock significantly increases in value. Preferred stock that does not have a conversion feature is called nonconvertible preferred stock . Nonconvertible stock is more common than convertible stock.

cumulative preferred stock

Stock for which any missed dividend payments must be paid in the future to the preferred shareholders before the common shareholders can receive any dividends.

participating preferred stock

Stock that allows the preferred stockholder to participate in the profits of the corporation along with the common stockholders.

convertible preferred stock

Stock that permits the preferred stockholders to convert their shares into common stock.

Redeemable Preferred Stock

Redeemable preferred stock (or callable preferred stock) permits a corporation to redeem (i.e., buy back) the preferred stock at some future date. The terms of the redemption are established when the shares are issued. Corporations usually redeem the shares when the current interest rate falls below the dividend rate of the preferred shares. Preferred stock that is not redeemable is called nonredeemable preferred stock . Nonredeemable stock is more common than redeemable stock.

redeemable preferred stock (callable preferred stock)

Stock that permits a corporation to buy back the preferred stock at some future date.

authorized shares

The number of shares provided for in the articles of incorporation.

issued shares

Authorized shares that have been sold by a corporation.

Authorized, Issued, and Outstanding Shares

The number of shares provided for in the articles of incorporation is called authorized shares [RMBCA Section 6.01]. The shareholders may vote to amend the articles of incorporation to increase this amount. Authorized shares that have been sold by the corporation are called issued shares . Not all authorized shares have to be issued at the same time. Authorized shares that have not been issued are called unissued shares . The board of directors can vote to issue unissued shares at any time without shareholder approval.

unissued shares

Authorized shares that have not been sold by the corporation.

A corporation is permitted to repurchase its shares [RMBCA Section 6.31]. Repurchased shares are commonly called treasury shares . Treasury shares cannot be voted by the corporation, and dividends are not paid on these shares. Treasury shares can be reissued by the corporation. The shares that are in shareholder hands, whether originally issued or reissued treasury shares, are called outstanding shares . Only outstanding shares have the right to vote [RMBCA Section 6.03].

outstanding shares

Shares that are in shareholder hands, whether originally issued shares or reissued treasury shares. Only outstanding shares have the right to vote.

CONCEPT SUMMARY Types of Shares

Type of Share

Description

Authorized

Shares authorized in the corporation’s articles of incorporation.

Issued

Shares sold by the corporation.

Treasury

Shares repurchased by the corporation. These shares do not have the right to vote.

Outstanding

Issued shares minus treasury shares. These shares have the right to vote.

Debt Securities

A corporation often raises funds by issuing debt securities [RMBCA Section 3.02(7)]. Debt securities (also called fixed income securities) establish a debtor–creditor relationship in which the corporation borrows money from the investor to whom the debt security is issued. The corporation promises to pay interest on the amount borrowed and to repay the principal at some stated maturity date in the future. The corporation is the debtor, and the holder is the creditor. Three classifications of debt securities are as follows:

· Debenture. A debenture is a long-term (often 30 years or more), unsecured debt instrument that is based on a corporation’s general credit standing. If the corporation encounters financial difficulty, unsecured debenture holders are treated as general creditors of the corporation (i.e., they are paid only after the secured creditors’ claims are paid).

· Bond. A bond is a long-term debt security that is secured by some form of collateral (e.g., real estate, personal property). Thus, bonds are the same as debentures except that they are secured. Secured bondholders can foreclose on the collateral in the event of nonpayment of interest, principal, or other specified events.

· Note. A note is a short-term debt security with a maturity of five years or less. Notes can be either unsecuredor secured. They usually do not contain a conversion feature. They are sometimes made redeemable.

debt securities (fixed income securities)

Securities that establish a debtor–creditor relationship in which the corporation borrows money from the investor to whom a debt security is issued.

debenture

A long-term unsecured debt instrument that is based on a corporation’s general credit standing.

bond

A long-term debt security that is secured by some form of collateral.

note

A debt security with a maturity of five years or less.

indenture agreement (indenture)

A contract between a corporation and a holder that contains the terms of a debt security.

Indenture Agreement

The terms of a debt security are commonly contained in a contract between the corporation and the holder; this contract is known as an indenture agreement (or simply an indenture). The indenture generally contains the maturity date of the debt security, the required interest payment, the collateral (if any), rights to conversion into common or preferred stock, call provisions, any restrictions on the corporation’s right to incur other indebtedness, the rights of holders upon default, and so on. It also establishes the rights and duties of the indenture trustee. Generally, a trustee is appointed to represent the interest of the debt security holders. Bank trust departments often serve in this capacity.

The following feature discusses why the state of Delaware attracts corporate formations.

Business Environment Delaware Corporation Law

The state of Delaware is the corporate haven of the United States. More than 50 percent of the publicly traded corporations in the United States, including 60 percent of the Fortune 500 companies, are incorporated in Delaware. In total, more than 500,000 business corporations are incorporated in Delaware. But why?

Remember that the state in which a corporation is incorporated determines the law that applies to the corporation: The corporation code of the state of incorporation applies to details such as election of directors, requirements for a merger to occur, laws for fending off corporate raiders, and so on. Even if a corporation does no business in Delaware, it can obtain the benefits of Delaware corporation law by incorporating in Delaware.

On the legislative side, Delaware has enacted the Delaware General Corporation Law . This law is the most advanced corporation law in the country, and the statute is particularly written to be of benefit to large corporations. For example, the Delaware corporation code provides for corporations incorporated in Delaware to adopt so-called poison pills, which make it difficult for another company to take over a Delaware corporation unless the board of directors of the target corporation agrees and removes such poison pills. In addition, the legislature keeps amending the corporation code as the demands of big business warrant or need such changes. For instance, the legislature has enacted a state antitakeover statute that makes it difficult to take over a Delaware corporation unless the corporation’s directors waive the state’s antitakeover law and agree to be taken over.

On the judicial side, Delaware has a special court—the court of chancery —that hears and decides business cases. This court has been around for more than 200 years. In that time, it has interpreted Delaware corporation law favorably for large corporations in matters such as electing corporate boards of directors, eliminating negligence liability of outside directors, upholding the antitakeover provisions of the Delaware corporation code, and so on. In addition, there are no emotional juries to worry about. The decisions of the chancery court are made by judges who are experts at deciding corporate law disputes. The court is known for issuing decisions favorable to large corporations because the court applies Delaware corporation law to decide disputes. Appeals from the court of chancery are brought directly to the supreme court of Delaware. Thus, Delaware courts have created a body of precedent of legal decisions that provides more assurance to Delaware corporations in trying to decide whether they will be sued and what the outcome will be if they are sued.

The state of Delaware makes a substantial sum of money each year on fees charged to corporations incorporated within the state. Delaware is the “business state,” providing advanced corporate laws and an expert judiciary for deciding corporate disputes.

Critical Legal Thinking

1. Why does Delaware provide corporation-friendly state laws? Should corporations be permitted to “shop” for the best state corporation laws?

Shareholders

A corporation’s shareholders own the corporation (see Exhibit 16.3 ). Nevertheless, they are not agents of the corporation (i.e., they cannot bind the corporation to contracts), and the only management duty they have is the right to vote on matters such as the election of directors and the approval of fundamental changes in the corporation.

Shareholders’ Meetings

Annual shareholders’ meetings are held to elect directors, choose independent auditors, and take other actions. These meetings must be held at the times fixed in the bylaws [RMBCA Section 7.01]. Special shareholders’ meetings may be called by the board of directors, the holders of at least 10 percent of the voting shares of the corporation, or any other person authorized to do so by the articles of incorporation or bylaws (e.g., the president) [RMBCA Section 7.02]. Special meetings may be held to consider important or emergency issues, such as a merger or consolidation of the corporation with one or more other corporations, the removal of directors, amendment of the articles of incorporation, or dissolution of the corporation. A corporation is required to give the shareholders written notice of the place, day, and time of annual and special meetings.

shareholders

Owners of a corporation who elect the board of directors and vote on fundamental changes in the corporation.

Exhibit 16.3 Shareholders of a Corporation

annual shareholders’ meeting

A meeting of the shareholders of a corporation that must be held by the corporation to elect directors and to vote on other matters.

special shareholders’ meetings

Meetings of shareholders that may be called to consider and vote on important or emergency issues, such as a proposed merger or amending the articles of incorporation.

Shareholders do not have to attend a shareholders’ meeting to vote. Shareholders may vote by proxy; that is, they can appoint another person (the proxy) as their agent to vote at a shareholders’ meeting. The proxy may be directed exactly how to vote the shares or may be authorized to vote the shares at his or her discretion. Proxies may be in writing or posted online. The written document itself is called the proxy (or proxy card). Unless otherwise stated, a proxy is valid for 11 months [RMBCA Section 7.22].

proxy

A shareholder’s authorizing of another person to vote the shareholder’s shares at the shareholders’ meetings in the event of the shareholder’s absence.

Quorum and Vote Required

Unless otherwise provided in the articles of incorporation, if a majority of shares entitled to vote are represented at a meeting in person or by proxy, there is a quorum to hold the meeting. Once a quorum is present, the withdrawal of shares does not affect the quorum of the meeting [RMBCA Sections 7.25(a), 7.25(b)]. The affirmative vote of the majority of the voting shares represented at a shareholders’ meeting constitutes an act of the shareholders for actions other than for the election of directors [RMBCA Section 7.25(c)].

quorum to hold a meeting of the shareholders

The required number of shares that must be represented in person or by proxy to hold a shareholders’ meeting. The RMBCA establishes a majority of outstanding shares as a quorum.

Example

A corporation has 20,000 shares outstanding. A shareholders’ meeting is duly called to amend the articles of incorporation, and 10,001 shares are represented at the meeting. A quorum is present because a majority of the shares entitled to vote are represented. Suppose that 5,001 shares are voted in favor of the amendment. The amendment passes. In this example, just over 25 percent of the shares of the corporation bind the other shareholders to the action taken at the shareholders’ meeting.

The articles of incorporation or the bylaws of a corporation can require a greater than majority of the shares to constitute a quorum of the vote of the shareholders [RMBCA Section 7.27]. This is called a supramajority voting requirement (or supermajority voting requirement). Such votes are often required to approve mergers, consolidation, the sale of substantially all the assets of a corporation, and so on.