Corporations are created under state law as stand-alone legal entities separate from their founding owners and shareholders. There are various forms of incorporation, and each has its advantages and disadvantages. A promoter creates the corporation by filing prescribed documents with a state and finding investors to subscribe to the initial offering of stock. When a business seeks to incorporate, its founders must follow many laws. State law regulates corporations in the state where they are incorporated. Directors and executives manage the business and owe the corporation a fiduciary duty to make decisions that are in its best interests. Shareholders do not have a right to manage the corporation, but they may vote for directors who then select the officers and inspect business records.
At A Glance
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Corporations are for-profit or nonprofit business entities that are separate legal persons from their owners (the shareholders). Corporations offer limited liability for their shareholders, unlimited life for the corporation, and—in the case of larger or publicly held corporations—the separation of management from ownership. Corporations are formed by filing articles of incorporation with the governing secretary of state and paying a filing fee.
- Entities that enjoy separate legal personhood apart from their shareholders include C corporations, S corporations, nonprofit organizations, and limited liability companies (LLCs).
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Corporate governance may present certain legal issues relating to agency theory, a board of directors, executive compensation, and ownership concentration. Corporate governance laws such as the Sarbanes-Oxley Act of 2002 have tried to align the interests of management and shareholders.
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Corporate promoters are generally jointly liable for a contract if the new corporation adopts the contract, unless a third party agrees to release the promoter from liability. Promoter liability convinces creditors to enter into agreements with businesses that have no proven track record or credit history.
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The powers of a corporation and any limitations the incorporators wish to place on the corporation are stated in the articles of incorporation. If no limitations are stated, then the corporation has all the powers of a natural person. The term ultra vires means "beyond the powers" and refers to actions that are outside the permitted powers of a corporation.
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Directors have the power to run the corporation and owe a fiduciary duty to the corporation and its shareholders. Officers also owe a fiduciary duty to the corporation and are responsible for the day-to-day operation of the business.
- The business judgment rule is a doctrine of immunity. It protects the directors of a corporation from personal liability for bad decisions that were made as part of a good decision-making process involving legal, competent, informed, and reasonable reliance.
- The voluntary termination of a corporation is a three-step process. First, a majority of shareholders agree the corporation should be dissolved; next, the articles of dissolution is filed with the secretary of state; and finally, managers wind up the corporation to pay debts and then pay shareholders with the remaining money.
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Capital stock is the totality of stock of all kinds that a corporation has issued or may issue. On a balance sheet, capital paid-in stock is the historical investment that the founding shareholders made in the corporation in exchange for their original stock. The other portion of the capital stock is made of common stock sold subsequently. Other key stock terms include preferred shares, dividends, initial public offering, and buybacks.
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Double taxation occurs when a corporation pays taxes on earnings and shareholders pay taxes on their dividends.
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Shareholders typically do not have rights in management. Instead, they have the right to vote to elect the board of directors every year. Shareholders also have inspection rights and voting rights for matters that fundamentally change the corporation.
