Associations Class Notes 5/27/04
us tie up the loose ends of incorporating.
What’s the rule about the number of directors? The Ohio statutory scheme is
common. The usual rule is a minimum of
three directors. However, if you have
only one shareholder, you have only one directors, and if you have only two shareholders
then you can get by with only two directors.
Also, if § 1701.591 is invoked, you could have a company with 20
shareholders and only one or two directors.
But there is no upper limit to
the number of directors.
there a minimum number of shareholders?
Up to 1950, there were court decisions that followed the European
practice that since the state statutes required a minimum of three directors,
you had to have a minimum of three shareholders. Statutes in the 1960’s reversed this, and in
the United States today, a single shareholder
corporation is perfectly legal. The
smaller the number of shareholders, the more likely the corporate veil will get
But: (1) In many countries,
there must be a minimum of three shareholders.
In those countries, if there is an American parent that is the only
shareholder, then you get two locals to buy one share each, and they will known
as accommodation shareholders. The
parent will have the option to buy back these shares. Watch foreign statutes carefully! (2) Even in England, and especially in civil
law countries, there will be three or four different classes of
corporations. One of the four will
essentially be a hybrid between a corporation and a partnership. One of the hybrid features will be that the
shareholders have joint and several liabilities. So be careful! In this country, for professional
corporations in some states, they say that doctors may incorporate, but they
will have the same liabilities as a partnership. For example, in England, PLC stands for public limited company. This is the category for public companies
with limited liability.
end the name of the company with “(comma) Inc.” or “(comma) Incorporated”. That is recognized throughout the United States and most of the rest of the
world as signifying a corporation with limited liability. Avoid using “Co.”! The Ohio statute lets you do this,
but “don’t touch it with a million foot pole!”
At common law, that denominated joint and several liability on the part
of shareholders. A few statutes in the United States still say that, but you
should make the name “(comma) Inc.” and worldwide people will know what you’re
talking about. Some state statutes
authorize the use of “(comma) Ltd.” Don’t
fool with it because it’s not exactly clear.
It could also mean “limited partnership”. You have to hold yourself out as a
corporation in every way if you want to be treated like a corporation.
goal is to file the charter, filled out correctly. It’s called the articles of incorporation in Ohio and the certificate of
incorporation in Delaware. You fill out the form, take the filing fee,
and have it signed by one or more competent
incorporator. When you pay the fee,
the Secretary of State will timestamp your copy. What’s important? In Ohio, fees are titled by
statute. They’re in Title I. The filing fees are usually not tiny, but not
high either. Look at the schedule of
fees to determine how many shares you want.
Don’t form a corporation with 100 or 500 shares because they’re
ultimately going to be spread around a family.
If there are too few shares, you may have to set up a trust to subdivide
value: under our statute, you can use par or no-par. But never
use no-par! Also, never use high par
except for preferred stock! How
come? Many states, like Ohio, impose both a franchise
tax and an income tax, and you pay the higher of the two. The franchise tax is a percentage applied
against the assets of the company. If
low par stock is used, and generally that will be either $0.01 or $0.0001 per
share, then they will use the par value to determine the tax. But if there is no par, they will use the
fair market value of the stock instead!
Check if the state has a separate stock issuance or stock transfer
tax. Ohio has neither, but nine
states have such a tax. Sometimes that
tax can be avoided by holding the closing of a transaction in another
state. For example, there are New York state taxes that can be
avoided by closing in Jersey City.
is a federal estate and gift tax. Some
states have a gift tax too. If Mother is
setting up a company and putting $1 million in with 1000 authorized shares at
$1 par per share, and she immediately give 40% of the shares to her children as
tenants in common, go see the tax lawyer because there is a gift there for federal and state
state has records that you’ll be interested in from time to time: The Secretary of State can give you, for a
fee, not only a certified copy of the articles of incorporation, you can also
get a certified copy of the docket sheet for the corporation running back to
formation. Plus, you can get certified
copies of everything that’s there. The
Secretary of State, also for a fee, will give you a certificate of good standing. What does this indicate? All state statutes provide that if you don’t
make the required filings annually with the Secretary of State and/or your
state tax returns, then they can cancel
your corporation. The certificate of
good standing says that a particular corporation is in good standing with the
state. If you’re going to make a big
deal, you always send someone to the Secretary of State’s office to get
that. Also, you will have to get an
attorney’s opinion that the corporation is duly and validly organized and
existing as a corporation under Ohio law. Therefore, the first thing you do is send
someone to the Secretary of State’s office to get all this stuff.
many states, you can get a certificate of tax
good standing from the tax authorities.
What’s the significance of that?
It’s limited, but useful, according to Shipman. They will certify that there are no assessed taxes unpaid. How does assessment take place? Case law tells us that assessment occurs in
the office of the tax official when that official makes the assessment by
writing or typing in the office! It’s
basically a claim by the tax commissioner that you owe money. Then the assessment is sent to you. This certificate will not deal with non-assessed tax claims. That is to say, all tax authorities will have
informal or formal audits ongoing, or they will be planning them before the
expiration of the statute of limitations.
This certificate of tax good standing does not estop them as to that.
However, it’s still a worthwhile document to obtain. It’s a part of due diligence. In many
states, a failure to file your tax return or pay your taxes on time can mean
the loss of your corporate charter.
Classes of corporations
off, there is the de jure
corporation. It has either been
perfectly formed, or close enough that not even the state in a quo warranto action can challenge.
People v. Ford
is an Illinois Supreme Court case from around 1921. The people were represented by the Illinois Attorney General or Cook
County Prosecutor. The corporate statute
in Illinois had a requirement that before articles be accepted
for filing, they had to be executed under
seal. How do you do that? (1) “You can do like Julius Caesar did!” You put some wax on paper and take your ring
and stick it on the wax. In the rest of
the world they do a lot more of this formal stuff. (2) You can go to the store and have them
print up wafer seals. You put some water
on the back, and then put it on the document.
“Not quite as good as a wax job, but it works. Nothing’s quite as good as a wax job.” (3) More often today, in states that require
or give significance to the seal, you can simply put “L.S.”, meaning “in place
of a seal”, and then you draw a squiggly, irregular closed line around it.
are still used in a few states!
Contracts under seal have a longer statute of limitations in some
places. In Ohio, the statute of limitations
for a written contract is fifteen years.
Always put in a cause shortening the statute of limitations to a
reasonable period. Many people think you
can’t go below two, and maybe not below four.
Secretary of State screwed up. Everyone
filed on forms provided by him. They
neglected to put the “L.S.” on there!
This was a “friendly action” for a declaration by the Illinois Supreme
Court as to whether these were de jure corporations. If you’re only de facto or by estoppel, it
doesn’t save you as against a suit by the sovereign. You must be de jure! The Illinois Supreme Court said that the
legislature did say this, but the
requirement was merely directory,
meaning, legally non-binding. Therefore,
the corporations were de jure corporations despite the screw-up.
this merely directory business? Many
state constitutions that didn’t give their own constitutions a lot of effect,
when the state Supreme Court was faced with a strong directive in the
constitution, they would say that the statement is merely directory, meaning it’s a directive by the people to the
legislature. But there was no recourse
if the legislature didn’t do what the constitution said! If you’re in a state with constitutional
initiatives such as Ohio, Massachusetts, and California (along with eight other
western states), then if you’re putting a provision in a state constitution this
way, you should add a last clause that says: “this provision is not merely
directory to the legislature. This
provision is the law and private citizens may sue on it and enforce it.”
up at the top is de jure. As of 1940,
below de jure, the average state would say even if you aren’t de jure, if
you’re a de facto corporation or a corporation by estoppel, then private
parties cannot argue that you’re not a valid corporation even though the state
may come in a say that you’re not de jure and “cut your head off”. So in a case involving contract creditors
contracting with a corporation that hadn’t gotten its certificate filed, if
there’s no fraud by anybody, the contract is made in the corporate name, there
was no individual guarantee from the shareholder then you have a corporation by
estoppel, if not a de facto corporation.
It takes a bit more to be a de facto corporation rather than by
estoppel. If you’re de facto, it operates
against tort and contract creditors,
but if you’re by estoppel, it only applies to contract creditors who made a
deal with you in the corporate name.
know a document has been filed when you have a time-stamped copy with the
official seal on it that says it’s been filed.
You don’t know before that whether the document has been filed. Always print and file a day or two
early. Things can get screwed up! Leave yourself time to recover!
1946, the old MBCA, which Shipman said was a “hare-brained” statute, said that
you’re either a corporation or not, and there’s no de facto or by estoppel
defense. That’s the situation in Robertson v. Levy. How far was the old MBCA pushed? In Sherwood
and Timberline, the courts had to
follow what the statute said as to the people active in the formation and
running of the company. There’s no
out! They were liable just as general
partners would be! Both cases, however,
used a lot of common sense. As to purely
inactive investors, in good faith, the joint and several liability would not
apply. That is generally true throughout
the United States. They will distinguish between those who are
active in the formation and running of a corporation and the mere investor, including, often, the spouse, parent, or
child of the guy who is running the company.
Shipman says that the courts are exactly right! The point of limited liability legislation is
to get inactive investors to invest in business enterprises, and in a
capitalist system, there are ups and downs.
Maybe inactive investors are willing to risk $10,000 or $20,000, but not
their home and everything else. That’s
what makes the system work!
suppose the defectively organized company itself is suing and the articles
haven’t been filed. California adopted a common name statute in the 1870’s. It spread throughout most of the United States, and Ohio has a common name
statute. This statute says if you’re
suing an organization in its common name simply for the recovery of the assets
that the company has, the fact that it’s not incorporated or defectively
incorporated is no defense. On the other
hand, an unincorporated association or defective incorporated association suing
someone else in contract or tort can do so in the common name. These are widespread statutes, but there are
five or six states that don’t have them.
In a state that doesn’t have such a statute and you’re suing a law firm,
you need to make copies of the complaint for all the partners. In Ohio, if you sue a law firm for
$10,000, you simply lay one copy of the complaint on the managing partner. Consequently, if that law firm is suing
someone, you’ll need a signature for the firm plus a signature for every
partner. In Ohio, however, the law firm
could sue under its own name under the common name statute.
means beyond the powers. What’s the history of the doctrine? The legal history is highly disputed! Check out Roman law. It seemed to authorize, without legislation,
something called the corporation sole.
The Catholic Church asserted this as they went into Britain. Bishops would hold the land in trust for the
Catholic Church as a corporation sole.
When they died, they would make out their will to their successor and
the successor would take over. The
Church asserted that the parent church could not be reached in tort and that
each bishop was a corporation sole. In
this country, there are three different theories of the Catholic Church. Churches may be centralized or decentralized,
such that a “renegade church” may be under greater or lesser control by the
British government was uncomfortable with this claim. Under Henry VIII, all hell broke loose for
200 years between the church and the state!
The British crown distrusted corporations because of this history. The first corporations formed were
instruments of British foreign policy like the East India Company and the
Hudson Bay Company. Until 1868, it was
the East India Company that ruled India, not England directly! Then they had the “South Sea Bubble”. They formed the South Sea Company, and it was
like an IPO. MPs scrapped it out to get
shares. The South Sea bubble burst! It wasn’t until 1848 that Britain went back to allowing
the United States, until about 1805, you had
to go to the legislature, which would grant you a special act to
incorporate. Divorce was handled that
way until the 1840’s! The “Second
American Revolution” was the Jacksonians!
It’s hard to classify them rigidly.
They believed in “bottom up” democracy, as opposed to the Hamiltonians
who are more “top down”. The early
statutes would heavily restrict the activities of corporations. They would say how many plants you could
have, how much money you could raise and exactly what business you could engage
Jacksonians were devotees of Adam Smith.
Jackson was sort of the early hero of the Reaganites. Also, many of the Jacksonians were rich! This was when general incorporation statutes
came around, just like general statutes on divorce. By the 1870’s, all states had general
incorporation statutes and general divorce statutes. This was very consistent with the Jacksonian
philosophy of “popular sovereignty” and “bottom up” democracy. It used to be that in Texas you had to pick from 81
statutory provisions for the purpose of your corporations. Here in Ohio, in the 1970’s, we were one
of the last states to allow that corporations can be formed “for any lawful
purpose” and may say so in the charter.
In Ohio today, everyone says “any
lawful purpose”. “Any lawful purpose”
doesn’t include insurance or banking!
§ 1701.13, we’re given a helpful enumeration of powers. Why did they do that? In the 1920’s, when you had to enumerate your
purpose, the charters would enumerate five or six purposes and then would
enumerate about 20 powers and then they would say: “the purposes are powers and
the powers are purposes!” They were
trying to get back at the legislatures for not allowing the phrase “for any
lawful purposes!” The federal and state
governments decided early on that in limiting the powers of corporations they
would rely more on antitrust, tax, labor, and environmental laws than they
would on provisions in the charter.
That’s very different from the practice as of 1800! Ultra vires remains important!
was the law as of 1940, and how did it get up to that point? If a contract was fully performed on both
sides, there is limited ultra vires relief; almost none. The exception was corporate directors or
officers engaging in ultra vires acts, which creates a mild presumption of negligence.
In theory, the state can come in and by action of quo warranto cut your
head off for an ultra vires action.
if the bank were a state bank under Ohio law? In this action for money damages, the
plaintiff would have to plead and prove recklessness. It’s an action by or on behalf of the
corporation. That comes from R.C.
1701.59(D), which is about 50 years old.
But that’s not the end of the story!
Look at the “banking trauma” of the 80’s, when many banks and S & Ls
went out of business. The federal
government had to spent billions cleaning it up. It cost a total of around $600 billion to
taxpayers. The federal banking
authorities have federal legislation saying that as to banks, a provision like
R.C. 1701.59(D) can push the level down to gross negligence, but it can’t push
it down to recklessness. In this case,
what the officers and directors did was ultra vires because the charter forbade
the loan and transaction made. They
didn’t run it by a lawyer! The lawyer
would have caught it.
a contract is executory on both sides, then any shareholder of the company can
sue the company and the other party and get an injunction to stop it. R.C. 1701.13, at the end, adopts that rule
with this caveat: if the contract is partially
performed on one side or the other or if an injunction would be inequitable,
then there is no relief. R.C. 1701.13
provides relief in this area. The
casebook talks about a New York case, which indicates that
the courts may go beyond the
legislation in giving relief.
of the biggest cases of all time is Jacksonville. This
came up in diversity litigation in the 1870’s under federal common law (pre-Erie).
A railroad’s charter said that its purpose was to run a railroad between
New York and Florida. The railroad built a hotel at the end of the
line in Florida. There is an
action by a shareholder for damages or to stop the hotel. The U.S. Supreme Court holds, in language
reminiscent of McCullough v. Maryland,
they say “let the end be legitimate and proper and then all reasonable and
necessary means to accomplish that end will be implied.
there’s an Ohio corporation formed in 1921
in Cleveland “to engage in manufacturing”. They’ve never amended their charter. The corporation is closely held. The executive vice president goes to the
board of directors with two proposals: (1) buy 100,000 shares of common stock
of a publicly traded natural gas company listed on the NYSE, and (2) buy 100%
of the capital stock of X Inc., a closely-held Ohio-chartered natural gas
company in Cleveland operating natural gas
wells. How do we advise the board of
directors as the counsel for the company as to the possible ultra vires
problems? How might they be dealt with? Assume you’re at a law firm and a senior
partner asks this question. Then he
asks: what practical problems of a professional responsibility nature is our
law firm going to run into on this transaction in (1) advising the board and
the officers and (2) giving legal opinions to the people on the other side of these transactions? Factor in R.C. 1701.59 and
1701.13(E)(5)(a). Look at R.C.
1701.69-.72 to see how the charter might be amended.
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