Articles of incorporation, also called a charter, is usually a standardized form; it identifies the name, address, agent, and business purposes of the corporation, the classes and face value of stock of the corporation, and the names and addresses of the incorporators. Generally, all corporations must use one of these words or the associated abbreviation in its name to identify its incorporated status: corporation, incorporated, company, or limited.
The corporation must provide an official address in the state in which it decides to incorporate. That way the secretary of state can contact the corporation, and anyone who wants to sue the corporation can serve the complaint on the corporation. If the corporation does not have an office in the state it incorporates in, then it will often hire a registered agent to serve as its official presence in the state.
The articles may state the corporation's purpose generally, as long as it describes its purpose for existence. The articles of incorporation must identify the stock's par value, which is the face value of its shares. The corporation must also list the number of its shares and the different classes of stock. The incorporator signs the articles of incorporation, provides their contact information, and files it with the secretary of state in the jurisdiction where the corporation's founders decided to incorporate.
A corporation's articles lists the corporation's powers and any limitations the incorporators wish to place on the corporation. If no limitations are stated, then the corporation has all the powers of a natural person. For example, EQUTI Inc.’s articles of incorporation for EQUTI Inc. describes all of the original founder's powers as both CEO and majority shareholder.If a corporation takes an action beyond the scope of the powers allowed to it under its articles of incorporation or bylaws, then that action is classified as ultra vires, a Latin phrase for "beyond the powers." Acts that are ultra vires cannot be ratified, which means they can never be made valid. A shareholder may sue a corporation based on an ultra vires act, but individual state laws dictate the specific requirements and legal remedies that are available to shareholders.
Ultra Vires Acts
Officers and Directors
Generally, a corporation is required to have at least one director. An exception applies if either all shareholders sign an agreement that eliminates the board of directors or the corporation has 50 or fewer shareholders. Shareholders elect the directors. The directors then appoint the officers of the corporation.
Usually the corporation's bylaws dictate what kind of officers the corporation will have. In the business world, bylaws are rules that organizations develop to run the organization and set limits on the conduct of the organization's members. For example, a corporation's bylaws might dictate how a vacancy on the board of directors will be filled.
Directors run the corporation and owe a fiduciary duty to the corporation and its shareholders. A fiduciary duty is a legal responsibility to act in good faith and always put the interests of the corporation and shareholders above the individual's own interests. Officers also owe a fiduciary duty to the corporation and are responsible for the day-to-day operation of the business. To fulfill their fiduciary duty, officers and directors must act in the best interests of the corporation and its shareholders. The fiduciary duty is divided into two parts: duty of loyalty and duty of care.
The duty of loyalty prevents officers and directors from making decisions that benefit themselves at the expense of the corporation. The largest issues concerning loyalty are self-dealing and the corporate opportunity doctrine.
Self-dealing is a situation in which a fiduciary makes a decision on behalf of the corporation that benefits either that fiduciary or a person with whom they have a relationship. Self-dealing breaches the fiduciary duty of loyalty that officers and directors owe to the corporation and its shareholders. However, self-dealing may be permissible under the following circumstances:
- Disinterested directors form a special committee and approve the transaction. Disinterested means "having no personal interest in a matter." It does not mean "uninterested."
- Disinterested shareholders approve the transaction.
- The transaction is fair to the corporation even if the manager benefits personally in some way.
The corporate opportunity doctrine states that corporate officers and directors commit a wrong against the corporation when, without its consent, they take a business opportunity that should belong to the corporation. An officer can avoid liability under the corporate opportunity doctrine if they first offer the business opportunity to disinterested directors and shareholders. If they decline the opportunity, then the officer has the right to personally take advantage of the opportunity.
The duty of care requires officers and directors to act in the best interests of the corporation and to use a level of care that an ordinary yet prudent person would use under the circumstances.Generally, directors and officers satisfy their duty of care as long as their decisions are legal, have a rational business purpose, and come from an informed decision-making process. Even if there is a duty of care violation, the manager may not be liable if the business decision was fair to the corporation.
Business Judgment Rule
The business judgment rule is a doctrine of immunity that protects the directors of a corporation from personal liability for bad decisions that were made as part of a good decision-making process. The business judgment rule operates under the assumption that directors act within their fiduciary duty to make the best decisions for the corporation. Someone with a fiduciary duty has a legal responsibility to act in good faith and always put the interests of the corporation and shareholders before their own interests. The business judgment rule protects directors and allows them to make decisions that arise from the daily operation of the business. Directors are able to make the decisions that they believe are best for the corporation without the constant fear of prosecution, criminal liability, or civil liability. The rule recognizes that directors are not perfect and that it would be unreasonable to hold them to such a high standard. Even the best business decisions may not provide the projected results, and in those cases, fault is not attributable to anyone in the corporation.
Directors owe the corporation a duty of loyalty and a duty of care. When making a business decision, directors need to investigate all aspects of the decision and its potential ramifications to satisfy their duty of care. Directors must also make their decisions in good faith. Even if a director makes a decision based on information that they believed to be true but was in fact a lie, the business judgment rule will protect them on the basis of good faith.
However, in some cases directors have reason to believe that information they are using to make a decision is unreliable or false, but they continue with their decision anyway. In those situations, the business judgment rule will not protect the directors because they are demonstrating bad faith. Also, directors will not be protected under the business judgment rule when making a decision that benefits their own interests because this is a breach of their duty of loyalty.
If a lawsuit accuses a director of a corporation of violating one of these duties, the business judgment rule applies unless the complainant can show that:
- A director's business decision was made in bad faith.
- It was made without the care that a reasonable person would use.
- It was not made under the reasonable belief that it was in the best interests of the corporation.
Unless these elements can be clearly proven, courts will not intervene, and the business judgment rule will apply.
For example, suppose Emilio is the CEO of the business EQUTI Inc. As the CEO, Emilio spends most of his time negotiating deals and signing contracts. One decision he makes results in an increase to his personal income but a decrease in the profits of the company. This situation may violate the business judgment rule because Emilio may be working against the best interests of the company.