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History and Nature of Corporations Organization and Financial Structure of Corporations Management of Corporations Shareholders’ Rights and Liabilities Securities Regulation Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 41 – History and Nature of Corporations

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Page 1: Chapter 41 – History and Nature of Corporations

History and Nature of Corporations

Organization and Financial Structure of Corporations

Management of Corporations

Shareholders’ Rights and Liabilities

Securities Regulation

Legal and Professional Responsibilities of Auditors,

Consultants, and Securities Professionals

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Chapter 41 – History and Nature of Corporations

History and Nature of Corporations

In every era, society must strike the right balance between the freedom businesses need to compete for a market share and to make profits and the preservation of family and community values.

Hillary Clinton, inIt Takes a Village (1996)

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Page 3: Chapter 41 – History and Nature of Corporations

Learning Objectives

v History of corporationsv Classifications of corporationsv Regulation of for-profit corporationsv Regulation of nonprofit corporationsv Regulation of foreign and alien

corporationsv Piercing the corporate veil

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Page 4: Chapter 41 – History and Nature of Corporations

v By the time of the Roman Empire, the corporate form of business had evolved

v Governments allowed the corporate form special privileges and powers believing that the benefit to society outweighed any harm

History

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Page 5: Chapter 41 – History and Nature of Corporations

v England granted corporations monopolies in trade and broad powers of governance

v In 1776, American colonists quickly limited corporations by special charters issued by a state’s legislature:w Limited time, limited purpose, revocable

The American Corporation

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Page 6: Chapter 41 – History and Nature of Corporations

v By the end of the Civil War, corporate charter laws were being amended to give more, rather than limit, corporate powers

v Abraham Lincoln wrote: “…corporations have been enthroned…”

The American Corporation

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Page 7: Chapter 41 – History and Nature of Corporations

v In 1886, the US Supreme Court declared that a private corporation was a "natural person" under the Constitution and should receive the protections under the Bill of Rightsw Santa Clara County vs. Southern Pacific Railroad

v By 1919, corporations employed more than 80% of the workforce

The Corporation As a Person

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Page 8: Chapter 41 – History and Nature of Corporations

v Modern statutes are enabling statutes, giving substantial powers and flexibility

Modern Statutes

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Page 9: Chapter 41 – History and Nature of Corporations

v Corporations share unique characteristics in the way they are created, a legal status as a fictitious “person,” specific authority for operation and management, limited liability for owners, easy transferability of an owner’s interest, and the obligation to pay taxes that results in double taxation of profitw See Fig. 1, page 1009

Principle Characteristics

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Page 10: Chapter 41 – History and Nature of Corporations

v By purpose:w For-profit corporationsw Not-for-profit corporations

v By ownership:w Publicly held (shareholders)w Close (a few shareholders)

wSubchapter S

w Government-owned corporations

Classes of U.S. Corporations

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Page 11: Chapter 41 – History and Nature of Corporations

v By origin – a company is:w Domestic in the state in which the company

incorporatesw Foreign in all other states in which a company

operatesw Alien in all countries other than the country in

which it incorporated

Classes of U.S. Corporations

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Page 12: Chapter 41 – History and Nature of Corporations

v Under the Commerce Clause of the U.S. Constitution, the federal government has the power to regulate interstate commerce wArticle 1, Section 8, Clause 3: “The

Congress shall have Power …To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes”

Federal Regulation of Firms

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Page 13: Chapter 41 – History and Nature of Corporations

v A state law that regulates business activities is constitutional (i.e., does not unduly burden interstate commerce) if: 1. It serves a legitimate state interest

2. It is the least burdensome means of promoting that interest,

3. That legitimate state interest outweighs the burden on interstate commerce

Federal Regulation of Firms

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Page 14: Chapter 41 – History and Nature of Corporations

v In the U.S., states regulate how a corporation is created and operatedw Generally follows Model Business Corporation

Act (MBCA) or Model Nonprofit Corporation Act (MNCA)

v A state may require a foreign corporation to qualify to do business within the statew By obtaining a certificate of authorityw But what does “doing business” mean?

State Regulation of Firms

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Page 15: Chapter 41 – History and Nature of Corporations

v MBCA lists several activities that are not doing business within a statew Soliciting orders (by mail or employees)w Selling through independent contractorsw Owning property for investment purposesw Conducting an isolated transaction completed

within 30 daysw Maintaining a bank account for collection

purposes

The Meaning of Doing Business

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Page 16: Chapter 41 – History and Nature of Corporations

v Maintaining an office for intrastate businessv Contracts related to local business or salesv Owning/using real property for business v Maintaining stock for order fulfillmentv Performing service activities

Examples of Doing Business

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Page 17: Chapter 41 – History and Nature of Corporations

v Most states have enacted a long-arm statute that allows the state to exercise jurisdiction over an entity that harms a state interest

v See Jet Wine & Spirits, Inc. v. Bacardi & Co., Ltd.w New Hampshire firm (Jet Wine) sued a Liechtenstein

company (Bacardi & Co.) and made a prima facie case for state jurisdiction over foreign corporation based on a contract assumed by the foreign corporation and agency theory

Long-Arm Statutes

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Page 18: Chapter 41 – History and Nature of Corporations

v In the landmark case of International Shoe, the Supreme Court held that under the Due Process Clause of the Fourteenth Amendment, a state may exercise jurisdiction over a foreign corporation only if the corporation has sufficient minimum contacts with a statew Minimum contacts may be less than “doing

business,” including an isolated event that harms a citizen or state interest

The Due Process Clause

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Page 19: Chapter 41 – History and Nature of Corporations

v Facts:wRyan, a Connecticut resident, hired New York

accounting firm Cerullo & Co. to handle taxeswNew York State claimed Ryan was a NY

resident and attached tax penaltieswRyan sued Cerullo and his firm for malpractice

arguing that Connecticut had jurisdiction since Cerullo had not obtained a Connecticut certificate of authority

Ryan v. Cerullo

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Page 20: Chapter 41 – History and Nature of Corporations

v Connecticut Supreme Court Ruling:wRyan worked and had an apartment in New

York City and the taxes were for New YorkwNeither Cerullo individually nor Cerullo & Co.

were required to qualify to do business in Connecticut despite providing tax services to a Connecticut resident, thus not properly subject to a law suit in a Connecticut court

Ryan v. Cerullo

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Page 21: Chapter 41 – History and Nature of Corporations

v Corporation law provides an imaginary wall – the corporate veil – between a corporation and its shareholders to protect shareholders from personal liability for a corporation’s actions

v However, sometimes a court will pierce the corporate veil to reach individual shareholdersw See Fig. 2, page 1022

Piercing the Corporate Veil

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Page 22: Chapter 41 – History and Nature of Corporations

v Two requirements must exist: wDomination of a corporation by its

shareholderswCorporation is an alter ego of shareholderswCorporation is instrumentality of shareholders

wDomination used for an improper purposewDefrauding creditors, circumventing a statute,

or evading an existing obligation

Piercing the Corporate Veil

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Page 23: Chapter 41 – History and Nature of Corporations

v Signs that corporation is an instrumentality or alter ego of shareholders:w Inadequate capitalization (defrauds creditors)w Transfers of corporate assets for less than fair

market value (looting; defrauds creditors)w Commingling assets between corporate entities

or between shareholders and corporation (defrauds creditors)

w Establishing subsidiary to circumvent or evade statutory or contractual obligation

Piercing the Corporate Veil

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Page 24: Chapter 41 – History and Nature of Corporations

Test Your Knowledge

v True=A, False = Bw Prior to the mid-1800s, U.S. corporations

were limited by law in terms of time and scope of operations.

w A corporation is a fictitious, but legal, person.w Corporations may be classified only in terms

of ownership.w Under the Commerce Clause, states have the

power to regulate commerce within their state.

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Page 25: Chapter 41 – History and Nature of Corporations

Test Your Knowledge

v True=A, False = Bw A state organized under Kansas corporate law

is a domestic company when it operates within the state of Kansas and a foreign company in any state other than Kansas.

w Cole Inc. is owned by two people. Each owner built a home with money obtained by a loan from State Bank to Cole Inc. The corporate shield provides absolute protection to both owners from personal liability for repayment of the loans.

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Page 26: Chapter 41 – History and Nature of Corporations

Test Your Knowledge

v Multiple Choicew A state law that regulates business activities

of a foreign corporation is constitutional if : (a) It serves a legitimate state interest

(b) The legitimate state interest outweighs the burden on interstate commerce

(c) It is the most burdensome means of promoting that interest

(d) All of the above

(e) A and B, but not C

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Page 27: Chapter 41 – History and Nature of Corporations

Test Your Knowledge

v Multiple ChoicewWhich of the following activities meet the

requirements for doing business in a state?

(a) Owning personal property as investment

(b) Maintaining a bank account for collection purposes

(c) Maintaining a storefront for product sales

(d) Soliciting product orders through a catalog

(e) All of the above41 - 27

Page 28: Chapter 41 – History and Nature of Corporations

Thought Questions

v Does an online stock transaction meet the sufficient minimum contacts criteria of the International Shoe ruling? In other words, if a consumer is injured by an online stock trade, could the consumer sue the company in her or her state court system?

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