US Corporate Law/Introduction

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This chapter introduces the subject of corporate law.

What is a corporation?[edit | edit source]

A corporation is an entity created by people as a method to pool capital and socialize liability. This text focuses on business corporations, which are created for profit. A corporation can also be created for other reasons. Many churches and charities are established as non profit corporations. Many government entities take a corporate form. Whatever its purpose, a corporation has several unique features under the law.

  1. Individuality. Corporations are legal entities. They can theoretically last forever: some corporations have been in continuous operation for hundreds of years. A corporation is also treated like an artificial person for many (but not all) legal purposes. It can enter into contracts under its own name, it can sue or be sued, and it has many of the same constitutional rights enjoyed by natural persons.
  2. Separation of ownership and control. A corporation used to be owned by shareholders, but, as it increased in size and shareholders became dispersed at the turn of the 20th century, it became controlled by a board of directors. While shareholders vote on the board of directors, in practice, board members are selected by other board members who then manage the corporation. The board has a fiduciary duty to the corporation as a whole, not just shareholders. Shareholders can also freely transfer their interest in the corporation, which is known as stock.
  3. Limited liability. Under normal circumstances, shareholders cannot lose any more than the amount of their investment in the corporation. If creditors demand more than the corporation can pay, the shareholders' personal assets are usually safe.

Corporations versus other business entities[edit | edit source]

While corporations are perhaps the archetype of a business entity, they are by no means the only way to form a business. The choice to form a corporation is not always an easy one.

Sole Proprietorship[edit | edit source]

Rather than start a corporation, an entrepreneur can go into business under their own name as a sole proprietor. This has the advantage of simplicity: there is no need to file paperwork with the government or hold meetings and elections, all of which must take place in a corporation.

A sole proprietor, however, is "one with their business." Their profits and losses are treated as personal income on their taxes. If they accumulate business debts, creditors can go after their personal assets. If a sole proprietor dies, their business is treated like any other personal asset, and ends up in the hands of whomever they will it to. Most importantly, a sole proprietorship is just one person: if more than one person wants to start a business, they need a more complex form.

Partnership[edit | edit source]

The partnership is the most basic form of collaborative business. Like a sole proprietorship, it has the advantage of simplicity.

Two or more people can start a business with no special formalities, and their business will be treated as a general partnership. They directly control the partnership and can make binding decisions with a simple majority vote. Assets of the business will be listed in their names individually, and the partners will jointly be liable for any debts incurred by the partnership. The partners are also entitled to take home any profits made by the partnership. They are taxed individually on their share of the partnership's profits, regardless of whether they keep these profits or reinvest: the partnership is not taxed separately, which offers a huge advantage over corporate taxation.

Limited partnerships (LPs) allow individuals to invest as "limited partners," which gives them the limited liability of shareholders at the expense of relinquishing their right to participate in management of the partnership. A partnership can also file with the state to be treated as a limited liability partnership (LLP), which offers some of the limited liability benefits of a corporation. A few states allow the general partners in an LP to file for LLP status, creating a limited liability limited partnership (LLLP), but such organizations are still rare. (See, e.g., Fla. Stat. § 620.1102(10), Va. Code § 50-73.78.)

Regardless of type, all partnerships are considered to be an aggregate of their partners, rather than a separate entity. Unlike corporations, in which stock can be freely traded (assuming a willing buyer), a partner involved in the management of the partnership can only transfer their interest with the consent of the other partners. If the mutual consent to form a partnership breaks down, the partnership breaks down as well. This means that partnerships do not last as long as corporations, and the form is unsuited for larger businesses, especially those that wish to take advantage of public equity markets, like stock markets, to seek new investors.

Limited liability companies[edit | edit source]

A Limited Liability company (LLC), or a Limited Liability Partnership (LLP), is an entity that limits liability to its owners. In this way, it is similar to a corporation. However, unlike a corporation, an LLC is not subject to double-taxation. In this way, an LLC is similar to a partnership or an S-Corporation. An LLC differs from a partnership in that it continues to exist if one of the owners dies. An LLC differs from an S-Corporation in that it does not require that profits be paid evenly to share holders.

History of corporate law[edit | edit source]

This section incorporates text from Wikipedia, "Corporation."

Early corporations of the commercial sort were formed under frameworks set up by governments of states to undertake tasks which appeared too risky or too expensive for individuals or governments to embark upon. The alleged oldest commercial corporation in the world, the Stora Kopparberg mining community in Falun, Sweden, reportedly obtained a charter from King Magnus Eriksson in 1347. Many European nations chartered corporations to lead colonial ventures, such as the Dutch East India Company, and these corporations came to play a large part in the history of corporate colonialism.

In the United States, government chartering began to fall out of vogue in the mid-1800s. Corporate law at the time was very restrictive and very closely regulated by the states. Forming a corporation usually required an act of legislature. Investors generally had to be given an equal say in corporate governance, and the corporation's activities were tightly restricted to its express purposes. Many private firms in the 19th century avoided the corporate model for these reasons (Andrew Carnegie formed his steel operation as a limited partnership, and John D. Rockefeller set up Standard Oil as a trust).

Eventually, state governments began to realize the economic value of providing more permissive corporate laws. New Jersey was the first state to adopt an "enabling" corporate law, with the goal of attracting more business to the state. Delaware followed, and soon became known as the most corporation-friendly state in the country; even today, most major public corporations are set up under Delaware law.

The 20th century saw a proliferation of enabling law across the world, which helped to drive economic booms in many countries before and after World War I. After World War II, and especially starting in the 1980s, many countries with large state-owned corporations moved toward privatization, the selling of publicly-owned services and enterprises to private, normally corporate, ownership. Deregulation - reducing the public-interest regulation of corporate activity - often accompanied privatization as part of an ideologically laissez-faire policy. Another major postwar shift was toward conglomerates, in which large corporations purchased smaller corporations to expand their industrial base. Japanese firms developed a horizontal conglomeration model, the keiretsu, which was later duplicated in other countries as well.

While corporate efficiency (and profitability) skyrocketed, small shareholder control was diminished and directors of corporations assumed greater control over business, contributing in part to the hostile takeover movement of the 1980s and the accounting scandals that brought down Enron and WorldCom following the turn of the century.

Sources of corporate law[edit | edit source]

State statute[edit | edit source]

Most corporate law comes from state statutes. Under the internal affairs doctrine, every corporation is internally governed by the law of the state in which it is incorporated, or formed. As a result, many larger corporations are incorporated in states that are known for having a business-friendly corporate legal structure. The state best known for this is Delaware, which houses more than half of the Fortune 500: Delaware is known for having a favorable franchise fee structure and highly specialized courts (one court, the Court of Chancery, deals primarily with corporate issues). Smaller corporations usually find it advantageous to incorporate in the state where they do most of their business.

State statutes are all subtly different, but many follow the structure of the Model Business Corporation Act, a "model statute" drafted by the American Bar Association. The MBCA is associated with smaller states which might not have the time or the motive to develop their own corporate statutes. Larger, more economically important states, like New York and California, have more unique corporate statutes, incorporating rules from many sources. The Delaware General Corporation Law is the most important statute because of the number of corporations it governs. Most American lawyers study the MBCA and DGCL in law school, and this text will focus on the provisions of those two statutes.

Statutes based on the MBCA[edit | edit source]

The Model Business Corporation Act (2002) is copyrighted by the American Bar Association.

Other statutes[edit | edit source]

Federal statute[edit | edit source]

State laws govern the mechanics of corporations, but many federal laws are applicable to corporations as well. Publicly-traded corporations must comply with federal securities laws, the most important of which are the Securities Act of 1933 (1933 Act) and Securities Exchange Act of 1934 (1934 Act). The Sarbanes-Oxley Act of 2002 (SOXA) imposed many new rules on public corporations. Corporations must also comply with the wide variety of federal laws governing employment, environmental protection, food and drug regulation, intellectual property and other areas.

Common law[edit | edit source]

Much of corporate law comes from common law - the judge-made law based on tradition, which governs where statutes are silent. Common law principles of agency, contracts and torts are all important in the corporate context.

The common law of corporate governance has not been the subject of a Restatement, but the American Law Institute has compiled a set of suggested rules called the ALI Principles of Corporate Governance.

Internal law[edit | edit source]

Corporations also make their own internal laws. They chiefly do this through two documents: the articles of incorporation and the bylaws.

Articles of incorporation can be thought of as the "constitution" of a corporation. The articles, sometimes known as the charter or certificate of incorporation depending on the state, contain a few provisions required by statute, such as the name of the corporation and the location of its registered agent, as well as other provisions that regulate the corporation's affairs. The articles of incorporation bind the board of directors and can only be altered with the approval of the shareholders.

Bylaws are "statutes" written by the board of directors and can usually be amended by the board of directors without first obtaining shareholder approval. The bylaws generally establish internal rules for the governance of the corporation, such as officer positions and meeting procedures.

The articles of incorporation must comply with the statute under which the corporation is incorporated, and the bylaws must comply with the articles of incorporation as well as the statute.

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