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|2||Show/Hide More||DGCL Sec. 101 - Formation|
A certificate of incorporation is the functional equivalent of a corporation's constitution. The certificate goes by different names in different states. In other states it is known as the articles of incorporation or the corporate charter, or the articles of organization. All of these refer to the same document.
As the corporation's constitution, the certificate may limit or define the power of the corporation and the corporation's board of directors. Drafter's of certificates have a great deal of flexibility when drafting these documents. Although most certificates are “plain vanilla” certificates that rely almost entirely on the state corporate law default rules for limiting the power of the corporation and its directors, such a minimal approach to drafting corporate documents is not required.
For example, some corporations, like the Green Bay Packers professional football team, have highly tailored certificates of incorporation. The Green Bay Packers' certificate is available on the course website. Promoters of the Green Bay Packers corporation tailored the rights of shareholders so that no shareholder can expect to receive any portion of the profits of the Packers – those have to be donated to a charity – and that no shareholder can expect their shares of the Packers to have any resale value on a stock exchange – any attempt to transfer shares to someone other than a family member will result in the corporation redeeming the shares for pennies.
Section 101 makes it clear that the filing of a certificate of incorproation is sufficient to form a corporation. This is the essence of an enabling statute. Rather than require the state to provide permission, enabling statutes like Delaware's General Corporation Law require only a ministerial filing in order to establish a corporation and permit the corporation's promoters a high degree of freedom in the design of their internal governance mechanisms.
|3||Show/Hide More||DGCL Sec. 102 - Contents of Certificate of Incorporation|
The certificate of incorporation is the corporation's basic governing document. It lays out the basic understanding about governance of the corporation and the corporation's powers. It also limits the power and discretion of the corporation's board of directors in the management of the corporation. To the extent they comply with the requirements of the corporation law, the promoters of a corporation have the flexibility to tailor the internal governance of the corporation as well as to limit the powers of the board of directors.
Section 102 describes the contents of every corporation's certificate of incorporation. Section 102 has two basic components. First, §102(a) lays out the required elements of every certificate of incorporation. Many of the required elements relate to notice (e.g. how can the state contact responsible parties in the corporation). To the extent some of the required elements of §102 seem out of place (e.g. par value), remember they were first included in the code following the transition from discretionary charters to general enabling laws. Consequently, they may reflect a number of vestigal elements of the corporate law.
Second, §102(b) lays out the optional elements of every certificate of incorporation. Many of the optional elements in a certificate relate to corporate governance rights of stockholders and/or the board of directors. Section 102 does not generally limit promoters' ability to tailor governance structures, but it does often provide promoters with menus of options that they can choose from as they draft certificates.
|4||Show/Hide More||DGCL Sec. 103 - Filing requirements|
|5||Show/Hide More||Amendment of Certificate of Incorporation|
|5.1||Show/Hide More||DGCL Sec. 242 - Amendments to Certificate|
Like a constitution, a corporation's certificate of incorporation may be amended at any point in the future; it is not a “forever” contract. A board of directors or stockholders can amend a certificate of incorporation. Section 242 outlines the procedures for amending a certificate.
There are two features of the amendment process that are worth pointing out. First, any amendment to a corporation's certificate of incorporation must be initiated by the corporation's board of directors and requires the board's assent. A certificate may not be amended against the will of the board of directors. Second, any amendments recommended by the board of directors must be approved by a vote of a majority of the outstanding shares of the corporation. A certificate may not be amended against the will of the majority of the stockholders.
These dual requirements make the process of amending a certificate of incorporation difficult. Thus, the limitations placed on a board or a corporation's stockholders by the certificate of incorporation are effective constraints.
Although any portion of the certificate may be amended, the most common amendment to certificates of incorporation involves increases to the number of authorized shares.
|5.2||Show/Hide More||DGCL Sec. 245 - Restating the Certificate|
|6||Show/Hide More||DGCL Sec. 107 - Powers of Incorporators|
Corporations can not incorporate themselves. The parties who incorporate a business are known as “incorporators” or “promoters”. An incorporator need not be a person. An incorporator may also be another corporation.
Typically, the promoter names the initial board of directors of the corporation immediately as part of the incorporation process, but if not, the incorporator has plenary power to manage the corporation until such time as the initial board of directors is appointed.
|7||Show/Hide More||DGCL Sec. 108 - Organization Meeting|
|9||Show/Hide More||Piercing the Corporate Veil|
Legal personality and limited liability are two critical features of the modern corporate structure. Although these two features are often described as different, they are in fact two sides of the same coin. The “coin” in this case is the principal of separateness. Legal personality means that the corporate entity stands on its own, independent of its stockholders, such that the debts and other liabilities of the stockholders of the corporation are not the debts or liabilities of the corporation.
Equally important, limited liability (the default rule, provided under 102(b)(6)) means that the debts and other liabilities of the corporation are the debts and liabilities of the corporation and not the stockholders. The separate life of the corporation and the power of limited liability are extremely powerful policy choices that have implications for third parties as well as for corporate decision-makers.
Businesses can and do fail. When they do, limited liability means that the costs of that failure will mostly be borne by third party creditors of the firm and not by the directors or the stockholders of the firm. This creates may create incentives for third parties to careful when dealing with corporations. But, it also creates incentives that improve the liquidity of capital markets and encourage corporate risk-taking.
“Piercing the corporate veil” is an equitable doctrine that is the exception to the rule. In extreme cases, courts may look through the protective barrier of limited liability and assign the corporation's liabilities to the stockholders. The following cases raise of the issues common in veil piercing cases.
Although the concept of corporate separateness is well understood at the state level, in recent years a series of First Amendment cases have provided the US Supreme Court the opportunity to give its own view on the traditional state law question of corporate separateness. Unlike state level courts, the US Supreme Court has taken a much more malleable view towards the doctrine of corporate separateness as that concept relates to the First Amendment.
|9.1||Show/Hide More||Walkovszky v. Carlton|
The default rule for the corporation is that stockholders face limited liability for the debts of the corporation. The liability of stockholders is limited to the capital contributed they to the corporation. For instance, if a stockholder contributes $100 in equity capital to the corporation (assume this represents all the equity capital available to the corporation), and if the corporation has $150 in debts, the corporation may be required to pay all of its equity capital (i.e. $100) to settle the corporation's debts. In most circumstances, stockholders will not be liable for the balance of the corporation's debt of $50. The liability of stockholders is thus limited to only their capital contributions.
Although limited liability as described above is the default rule, in extreme cases courts may look through the corporate form, or “pierce the corporate veil”, and assign liability for corporate debts to stockholders.
The following case is paradigmatic. The owner of the corporation has obviously established the corporations in question to limit their exposure to debts of each of the corporations the owner controls. In deciding whether the stockholder should receive the benefit of corporate limited liability, the court lays out a test to determine whether it should look through the veil of limited liability protection and find the shareholders liable for the debts of the corporation.
If the corporation is a mere “alter ego” of the stockholders (e.g. if the corporation is operated without formality and for mere convenience of its stockholders), it is more likely, though not certain, that a court will look through the corporate form and assign corporate liabilities to stockholders in order to prevent a fraud or inequitable result.
|9.2||Show/Hide More||Kinney Shoe Corp. v. Polan|
Courts have long recognized that a corporation is an entity, separate and distinct from its officers and stockholders, and the individual stockholders are not responsible for the debts of the corporation.
In the following case, a Federal court lays out its approach to the question of whether a court should depart from the limited liability norm and “pierce the corporate veil” thus making stockholders liable for the debts of the corporation. The approach taken by the Federal court here differs only slightly from the approach to piercing taken by various state courts, including Walkovszky.
Central to a court's inquiry will be whether the stockholders treated the corporation as a separate entity with respect for the formalities due to a separate entity such that a court should also respect the corporation's limited liability.
Although the court in this case provides us with a convenient “test” it is worth remembering that piercing the corporate veil is an equitable remedy, therefore courts can – at times – appear to be inconsistent in their application of these tests. Success will usually require highly idiosyncratic facts and very sympathetic plaintiffs. In the most general terms, piercing the corporate veil is never going to be a court's first instinct.
|9.3||Show/Hide More||Fletcher v. Atex Inc.|
A subsidiary corporation is a corporation whose shares are owned entirely (or mostly) by another corporation. As between parent corporations and their subsidiaries, the default rule of limited liability still applies. A parent corporation will not normally be held liable for the debts of its subsidiary corporations.
In Fletcher, tort victims are asking the court to pierce the corporate veil of one of its defunct subsidiaries in order to make Kodak liable for the subsidiaries debts that resulted from an alleged product defect that caused repetitive stress disorders in customers.
The Fletcher court uses two different theories to test whether it should pierce the corporate veil and make Kodak, the sole stockholder of Atex, liable for the damages caused by Atex. The first theory is the same two prong test applied in other piercing the corporate veil cases. The second theory relies on more straightforward concepts of agency law. These theories are not necessarily mutually exclusive.
Brian JM Quinn
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