A corporation is a legal entity created and recognized by state law. It is an artificial being, existing only in law. Corporations are ancient, but have become increasingly prevalent since the industrial revolution.
Nature of Corporations
The law recognizes a corporation as "a person." As a result, it enjoys many of the rights and privileges that you and I enjoy, including access to courts, due process, speech rights, and freedom from unreasonable searches. Most cases involving corporate speech involve advertising.
Corporations, however, do not have the privilege against self-incrimination. In any lawsuit, courts can require corporations to disclose incriminating documents, even if they implicate the officers or directors of the business.
Yet corporations have an incredible protection known as the corporate veil. This veil is a legal concept that separates a corporation from the shareholders and protects them from being personally liable for the debts of the corporation. Unlike a sole proprietorship or general partnership in which the owner(s) are always personally liable for the debts and obligations of the business, the corporate veil shields corporate owners from liability in many circumstances.
Given the magnitude of this liability protection, it is important to note that this veil is not ironclad. In some cases, the courts will "pierce" the corporate veil that divides the corporation from the people or entities behind the corporate decisions. This occurs in instances of fraud and when the corporation does not follow statutory formalities.
If a corporation commits fraud, those officers or directors who facilitated the fraud will be held personally liable for the resulting damages. In one case, a landlord operating as a corporation induced a tenant to repair the leased property (which the landlord was contractually obligated to repair) at a cost to the tenant of over $40,000. When the landlord failed to reimburse the tenant as promised, the tenant sued. Because the tenant was able to prove that the landlord committed fraud by promising to reimburse and then failing to pay the required amount, the tenant was able to pierce the landlord's corporate veil and hold him personally liable.
The second instance of piercing the corporate veil occurs when the corporation does not follow corporate formalities. These include:
- When the corporation is set up to never make a profit or has insufficient capital at the time of formation to meet its prospective debts.
- When the corporation fails to hold required corporate meetings.
- When personal and corporate assets/interests are commingled to the extent that the corporation does not have a separate entity.
This is primarily a problem for smaller companies that lack compliance officers to ensure that all formalities are followed.
There are three groups that you should understand and keep separate. The first involves shareholders. These are the individuals or entities that purchase shares of stock in a corporation. These are the owners of the corporations. Unlike a partnership, the shareholders can change constantly without altering the continued existence of the corporations.
Shareholders elect a board of directors who manage the corporation. This board hires the corporate officers who run the day-to-day operations of the business.
When a corporation earns profits, it can retain those earnings or pass them on to shareholders in the form of dividends. Corporate profits can be subject to double taxation. The company pays taxes on its profits. If the company pays out dividends, the shareholders must report that income to the IRS and pay the appropriate income tax. This is the major disadvantage of the corporate form.
Type of Corporations
Corporations can be classified in a number of ways. A domestic corporation is a corporation that has been formed and is operating in that home state. A foreign corporation is one that is formed in one state, but doing business in another state (i.e., the Target Corporation is incorporated in Minnesota, yet operates in Idaho as a foreign corporation). An alien corporation in a company such as Mercedes Benz that is formed in another country, but is doing business in the United States.
Many corporations are registered in Delaware, yet do business all over the United States. In such cases, the corporation must register with the state in which it desires to operate. On the Idaho Secretary of State's website, there is a section titled Foreign Entity Registration, where a foreign business can register and do business in the state. Once registered, Target Corporation can operate in Idaho while taking advantage of the laws of its home state of registration. This is a reason that most large businesses are registered in Delaware. Delaware has a large and extensive set of corporate laws that are seen as pro-business. A Delaware corporation that files a registration statement to do business in Idaho is subject to many Delaware laws rather than Idaho's meager and sometimes untested corporate statutes.
Private corporations are created for private benefit. A public corporation is one that is formed to meet some political or government purpose. Cities, for example, are public corporations. Not be confused with...
A publicly held corporation is any corporation whose shares are publicly traded in securities markets (e.g. NYSE, or NASDAQ).
Nonprofit corporations are formed without a profit-making purpose. The Church of Jesus Christ of Latter-day Saints or Brigham Young University - Idaho, for example, are nonprofits.
Close corporations, or C-corps, are corporations where the shares are held by a relatively few persons. These businesses typically operate as a partnership because the shareholders typically know each other and are often members of the same family.
A close corporation that meets a number of requirements specified in Sub-chapter S of the Internal Revenue Code can operate as an S corporation. Note that an S-corp is a corporation that has elected to be taxed as a partnership. If a corporation receives S-corp status, it can avoid taxes at the corporate level. There are numerous requirements for S-corp status, including:
- It must be a domestic corporation.
- It cannot be a member of an affiliated group of corporations.
- The shareholders must be individuals, except in certain limited circumstances.
- It cannot have more than 100 shareholders.
- Only one class of stock is permitted.
- No shareholder can be a nonresident alien.
Professional corporations are corporations operated by professionals such as physicians, lawyers, dentists, and accountants. Professional corporations are designated by P.C. (professional corporation) or P.A. (professional association). In Idaho, we use the P.A. designation. For example, if you scroll down to the bottom of Beard St. Clair's website, you'll see that they are a P.A.
The first step in forming a corporation is to receive the corporate charter. In Idaho, this is completed by filing the Articles of Incorporation with the Secretary of State. This document contains basic information about the corporation, including the business name, the number of shares issued, the corporate mailing address, the registered agent's information, the name and address of at least one incorporator, and the names and addresses of the initial directors.
Perhaps the most confusing information involves the registered agent. The registered agent is the person designated to receive notices for the corporation. If the corporation is sued, the summons and complaint will be delivered to the registered agent. Further, the registered agent is not necessarily an agent of the corporation (i.e., someone with authority to act on behalf of the corporation). Therefore you should be sure to differentiate between a registered agent and a corporate agent.
A bylaw is a rule that dictates how a corporation will be governed or managed. The bylaws contain information about officers and directors, the method of election and removal, and lists the duties owed to the corporation. They provide the rules on how to operate the corporation. Failure to comply with the bylaws constitutes a breach of fiduciary duties of a director or officer.
State statutes generally grant corporations the power of 1) perpetual existence, 2) the ability to sue and be sued, 3) to own and convey property, 4) to enter into contracts, and 5) to have all powers necessary to effect its legal purposes. Any acts of a corporation that go beyond its authority granted to it, either by statute or by its own bylaws, is said to be ultra vires, or beyond its authority. If a corporation performs acts that are ultra vires, the state may revoke the corporate charter, or the officer or director that performed the act may be held personally liable for damages to the corporation and the shareholders.