5.TWO EXTREMES TO AVOID IN PIERCING THE CORPORATE WALL:
a)Old model--Superman (sh) used corp as his puppet;
b)New Model--Superman (sh) and corp are inseparable (alter ego)
D.SUBORDINATION OF SHAREHOLDER DEBTS--”DEEP ROCK” DOCTRINE--if a corp goes into bankruptcy, debts to its controlling shs may be subordinated to claims of other creditors. When subordination occurs, shareholder loans are treated as if they were invested capital (stock). Major factors in determining whether to subordinate include fraud, mismanagement, undercapitalization, commingling, excessive control, etc.
II.ORGANIZING THE CORPORATION--generally, corps are created under and according to statutory provisions of the state in which formation is sought.
A.FORMALITIES IN ORGANIZING CORPORATION:
1.CERTIFICATE OR ARTICLES OF INCORPORATION--state law governs the content of the articles, which are filed with the secretary of the state. Usually, the articles must specify the corp name, number of shares and classes of stock authorized, address of the corp’s initial registered office, name of initial registered agent, and the name and address of each incorporator.
a)Purpose Clause--under most statutes, no elaborate purpose clause is needed. It is sufficient to state that the purpose of the corp is to engage in any lawful business activity.
b)State of Incorporation--incorporators need to consider how flexible the state’s corporate law is versus the costs associating with incorporating in that state
2.ORGANIZATIONAL MEETING--filling the articles in proper form creates the corporation, after which an organizational meeting is held by either the incorporators or dirs named in the articles. Matters determined at meeting:
1)Incorporators elect directors, if no dirs are named in the articles;
2)Directors choose officers;
3)Directors ratify pre-incorporation transactions;
4)Directors authorize issuance of shares
5)Directors adopt by-laws (if necessary), corporate seal and stock certificate
B.DEFECTS IN FORMATION PROCESS--”DE JURE” AND “DE FACTO” CORPS--when there is a defect or irregularity in formation, the question is whether the corp exists “de jure,” “de facto,” “by estoppel,” or not at all. This issue usually arises when a third party seeks to impose personal liability on would-be shs. Another method of challenging corporate status, used only by the state, is a quo warranto proceeding. Note: where there has not been compliance with the statute, we apply principles of de facto, de jure and corp by estoppel. Where there has been compliance with the statute, we apply principles of disregard of corporate fiction, a/k/a “piercing the corporate veil,” which is an exception, rather than a rule.
1.DE JURE CORPORATION--this exists when the corp is organized in compliance with the statute. Its status cannot be attacked by anyone--not even the state. Most courts require only “substantial compliance”; others require exact compliance with the mandatory requirements.
2.DE FACTO CORPORATION (substantially abolished)--this exists when there is insufficient compliance as to the state (i.e., state can attack in quo warranto proceeding), but the steps taken are sufficient to treat the enterprise as a corp with respect to its dealings with third parties. Requirements:
1)Colorable or apparent attempt;
3)Some use of corporate franchise; Then ct will recognize status as to all but state
3.CORPORATION BY ESTOPPEL
a)Definition--estoppel is an equitable evidentiary rule which prevents a party from denying the existence of a fact notwithstanding that he fact is not true. Thus, certain parties are estopped from asserting defective incorporation when they have dealt with the corp as though properly formed.
b)Example--shs who claimed corp status in an earlier transaction are estopped to deny that status in a suit brought against the corp. The estoppel theory normally does NOT apply to bar suits against would-be shs by tort claimants or other involuntary creditors.
c)Overlap With De Facto--many of the facts which we would point to support a claim of de facto status are the same ones we point for estoppel. However, substantial abolition of de facto concept doesn’t necessarily abolish estoppel.
d)De Facto is For All; Estoppel is For One--estoppel depends on relationship between party and corp.
4.WHO MAY BE HELD LIABLE--when a would-be corp is not a de jure or de facto or a corp by estoppel, the modern trend imposes personal liability against only those owners who actively participated in management of the enterprise.
5.EFFECT OF STATUTES:
a)On De Facto Doctrine--states following the prior version of the Model Act have abolished the de facto doctrine, thus making all purported “shs” jointly and severally liable for all liabilities incurred as a result of the purported “incorporation.” However, statutes based on Revised Model Business Corporation Act require a person acting on behalf of the enterprise to know that there was no incorporation before liability attaches.
b)On Estoppel Doctrine--the effect of both acts is an unsettled issue.
c)On Liability--under the prior Model Act, liability extends to investors who also exercise control or actively participate in policy and operational decisions. It is expected that the Revised Model Act will be interpreted in the same manner.
III.LIABILITIES FOR TRANSACTIONS BEFORE INCORPORATION.
A.PROMOTERS--a promoter participates in the formation of the corp, usually arranging compliance with the legal requirements of formation, securing initial capital, and entering into necessary contracts on behalf of the corp during the time it’s being formed.
a)Fiduciary Duties to Each Other--Full disclosure and fair dealing are required between the promoters and the corp and among promoters themselves.
B.CONTRACTS MADE BY PROMOTERS ON CORP’S BEHALF
1.RIGHTS AND LIABILITIES OF CORPORATION:
a)English Rule--the corp is not directly liable on pre-incorporation contracts even if later ratified. Rationale: the corp was not yet in existence at the time the promoter was acting.
b)American Rule--the corp is liable if it later ratifies or adopts pre-incorporation K.
c)Corporation’s Right to Enforce Contract--under either rule, the corp may enforce the contract against the party with whom the promoter contracted, if it chooses to do so.
2.RIGHTS AND LIABILITIES OF PROMOTERS.
a)Liability on Pre-incorporation Contract--generally, promoters are liable if the corp rejects the pre-incorporation contract, fails to incorporate, or adopts a contract but fails to perform, unless the contracting party clearly intended to contract with the corporation only and not with the promoters individually.
b)Right to Enforce Against the Other Party--if a corp is not formed, the promoter may still enforce the contract.
C.OBLIGATIONS OF PREDECESSOR BUSINESS--a corporation that acquires all of the assets of a predecessor business does not ordinarily succeed to its liabilities, with exceptions:
a)Exceptions--the successor corp may be liable for its predecessor liabilities if:
1)the new corp expressly or impliedly assumes the predecessor obligations (the creditors of the old corp may hold the new corp liable as third-party beneficiaries);
2)the sale was an attempted fraud on the creditors; or
3)the predecessor is merged into or absorbed by the successor.
IV.POWERS OF THE CORPORATION.
A.CORPORATE POWERS--generally, corporate purposes and powers are those expressly set forth in the corporation’s articles, those conferred by the statute, and the implied powers necessary to carry out the express powers. Transactions beyond the purposes and powers of the corporation are ultra vires.
1.TRADITIONAL PROBLEM AREAS--the following three powers are particularly significant express powers, since older statutes did not specifically confer them:
a)Guarantees--modern statutes confer the power to guarantee the debts of others if it is in furtherance of the corporate business;
b)Participation in a Partnership--present-day statutes explicitly allow the corp to participate with others in any corp, partnership, or other association;
c)Donations--because the general rule is that the objective of a business corporation is to conduct business activity with a view to profit, early cases held that charitable contributions were ultra vires; the modern view permits reasonable donations without showing the probability of a direct benefit to the corp.
1.DEFINITION--agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other to so act." Rest2dAg
a)Parties to an agency relationship--Principal & Agent. Thus, three essential elements of an agency relationship:
1)Manifestation by principal that agent shall act for him in some undertaking;
2)Acceptance by the agent; and
3)Understanding that the principal is in control of the undertaking.
I)Note that these are factual issues; if they are satisfied, then the relationship is one of agency, regardless of what the parties themselves call it (but the parties' labels may provide evidence of their intent)