Business Associations Class Notes 5/27/04


Let 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.


Is 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 pierced.


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.


Always 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.


The 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 one share!


Par 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.


There 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 purposes.


The 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.


In 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


First 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


This 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.


Seals 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.


The 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.


What’s 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.”


So 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.


You 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!



In 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!


Let’s 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.


Ultra vires


This 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 central church.


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 general corporation.


In 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 in.


The 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!


In § 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!


What 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.


Litwin v. Allen


What 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.


If 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.


One 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.


Say 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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