US Corporate Law/Printable version

US Corporate Law

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This chapter introduces the subject of corporate law.

What is a corporation?


A corporation is an entity created by people as a method to pool capital and socialize liability. This text focuses on business corporations, which are created for profit. A corporation can also be created for other reasons. Many churches and charities are established as non profit corporations. Many government entities take a corporate form. Whatever its purpose, a corporation has several unique features under the law.

  1. Individuality. Corporations are legal entities. They can theoretically last forever: some corporations have been in continuous operation for hundreds of years. A corporation is also treated like an artificial person for many (but not all) legal purposes. It can enter into contracts under its own name, it can sue or be sued, and it has many of the same constitutional rights enjoyed by natural persons.
  2. Separation of ownership and control. A corporation used to be owned by shareholders, but, as it increased in size and shareholders became dispersed at the turn of the 20th century, it became controlled by a board of directors. While shareholders vote on the board of directors, in practice, board members are selected by other board members who then manage the corporation. The board has a fiduciary duty to the corporation as a whole, not just shareholders. Shareholders can also freely transfer their interest in the corporation, which is known as stock.
  3. Limited liability. Under normal circumstances, shareholders cannot lose any more than the amount of their investment in the corporation. If creditors demand more than the corporation can pay, the shareholders' personal assets are usually safe.

Corporations versus other business entities


While corporations are perhaps the archetype of a business entity, they are by no means the only way to form a business. The choice to form a corporation is not always an easy one.

Sole Proprietorship


Rather than start a corporation, an entrepreneur can go into business under their own name as a sole proprietor. This has the advantage of simplicity: there is no need to file paperwork with the government or hold meetings and elections, all of which must take place in a corporation.

A sole proprietor, however, is "one with their business." Their profits and losses are treated as personal income on their taxes. If they accumulate business debts, creditors can go after their personal assets. If a sole proprietor dies, their business is treated like any other personal asset, and ends up in the hands of whomever they will it to. Most importantly, a sole proprietorship is just one person: if more than one person wants to start a business, they need a more complex form.



The partnership is the most basic form of collaborative business. Like a sole proprietorship, it has the advantage of simplicity.

Two or more people can start a business with no special formalities, and their business will be treated as a general partnership. They directly control the partnership and can make binding decisions with a simple majority vote. Assets of the business will be listed in their names individually, and the partners will jointly be liable for any debts incurred by the partnership. The partners are also entitled to take home any profits made by the partnership. They are taxed individually on their share of the partnership's profits, regardless of whether they keep these profits or reinvest: the partnership is not taxed separately, which offers a huge advantage over corporate taxation.

Limited partnerships (LPs) allow individuals to invest as "limited partners," which gives them the limited liability of shareholders at the expense of relinquishing their right to participate in management of the partnership. A partnership can also file with the state to be treated as a limited liability partnership (LLP), which offers some of the limited liability benefits of a corporation. A few states allow the general partners in an LP to file for LLP status, creating a limited liability limited partnership (LLLP), but such organizations are still rare. (See, e.g., Fla. Stat. § 620.1102(10), Va. Code § 50-73.78.)

Regardless of type, all partnerships are considered to be an aggregate of their partners, rather than a separate entity. Unlike corporations, in which stock can be freely traded (assuming a willing buyer), a partner involved in the management of the partnership can only transfer their interest with the consent of the other partners. If the mutual consent to form a partnership breaks down, the partnership breaks down as well. This means that partnerships do not last as long as corporations, and the form is unsuited for larger businesses, especially those that wish to take advantage of public equity markets, like stock markets, to seek new investors.

Limited liability companies


A Limited Liability company (LLC), or a Limited Liability Partnership (LLP), is an entity that limits liability to its owners. In this way, it is similar to a corporation. However, unlike a corporation, an LLC is not subject to double-taxation. In this way, an LLC is similar to a partnership or an S-Corporation. An LLC differs from a partnership in that it continues to exist if one of the owners dies. An LLC differs from an S-Corporation in that it does not require that profits be paid evenly to share holders.

History of corporate law

This section incorporates text from Wikipedia, "Corporation."

Early corporations of the commercial sort were formed under frameworks set up by governments of states to undertake tasks which appeared too risky or too expensive for individuals or governments to embark upon. The alleged oldest commercial corporation in the world, the Stora Kopparberg mining community in Falun, Sweden, reportedly obtained a charter from King Magnus Eriksson in 1347. Many European nations chartered corporations to lead colonial ventures, such as the Dutch East India Company, and these corporations came to play a large part in the history of corporate colonialism.

In the United States, government chartering began to fall out of vogue in the mid-1800s. Corporate law at the time was very restrictive and very closely regulated by the states. Forming a corporation usually required an act of legislature. Investors generally had to be given an equal say in corporate governance, and the corporation's activities were tightly restricted to its express purposes. Many private firms in the 19th century avoided the corporate model for these reasons (Andrew Carnegie formed his steel operation as a limited partnership, and John D. Rockefeller set up Standard Oil as a trust).

Eventually, state governments began to realize the economic value of providing more permissive corporate laws. New Jersey was the first state to adopt an "enabling" corporate law, with the goal of attracting more business to the state. Delaware followed, and soon became known as the most corporation-friendly state in the country; even today, most major public corporations are set up under Delaware law.

The 20th century saw a proliferation of enabling law across the world, which helped to drive economic booms in many countries before and after World War I. After World War II, and especially starting in the 1980s, many countries with large state-owned corporations moved toward privatization, the selling of publicly-owned services and enterprises to private, normally corporate, ownership. Deregulation - reducing the public-interest regulation of corporate activity - often accompanied privatization as part of an ideologically laissez-faire policy. Another major postwar shift was toward conglomerates, in which large corporations purchased smaller corporations to expand their industrial base. Japanese firms developed a horizontal conglomeration model, the keiretsu, which was later duplicated in other countries as well.

While corporate efficiency (and profitability) skyrocketed, small shareholder control was diminished and directors of corporations assumed greater control over business, contributing in part to the hostile takeover movement of the 1980s and the accounting scandals that brought down Enron and WorldCom following the turn of the century.

Sources of corporate law


State statute


Most corporate law comes from state statutes. Under the internal affairs doctrine, every corporation is internally governed by the law of the state in which it is incorporated, or formed. As a result, many larger corporations are incorporated in states that are known for having a business-friendly corporate legal structure. The state best known for this is Delaware, which houses more than half of the Fortune 500: Delaware is known for having a favorable franchise fee structure and highly specialized courts (one court, the Court of Chancery, deals primarily with corporate issues). Smaller corporations usually find it advantageous to incorporate in the state where they do most of their business.

State statutes are all subtly different, but many follow the structure of the Model Business Corporation Act, a "model statute" drafted by the American Bar Association. The MBCA is associated with smaller states which might not have the time or the motive to develop their own corporate statutes. Larger, more economically important states, like New York and California, have more unique corporate statutes, incorporating rules from many sources. The Delaware General Corporation Law is the most important statute because of the number of corporations it governs. Most American lawyers study the MBCA and DGCL in law school, and this text will focus on the provisions of those two statutes.

Statutes based on the MBCA


The Model Business Corporation Act (2002) is copyrighted by the American Bar Association.

Other statutes


Federal statute


State laws govern the mechanics of corporations, but many federal laws are applicable to corporations as well. Publicly-traded corporations must comply with federal securities laws, the most important of which are the Securities Act of 1933 (1933 Act) and Securities Exchange Act of 1934 (1934 Act). The Sarbanes-Oxley Act of 2002 (SOXA) imposed many new rules on public corporations. Corporations must also comply with the wide variety of federal laws governing employment, environmental protection, food and drug regulation, intellectual property and other areas.

Common law


Much of corporate law comes from common law - the judge-made law based on tradition, which governs where statutes are silent. Common law principles of agency, contracts and torts are all important in the corporate context.

The common law of corporate governance has not been the subject of a Restatement, but the American Law Institute has compiled a set of suggested rules called the ALI Principles of Corporate Governance.

Internal law


Corporations also make their own internal laws. They chiefly do this through two documents: the articles of incorporation and the bylaws.

Articles of incorporation can be thought of as the "constitution" of a corporation. The articles, sometimes known as the charter or certificate of incorporation depending on the state, contain a few provisions required by statute, such as the name of the corporation and the location of its registered agent, as well as other provisions that regulate the corporation's affairs. The articles of incorporation bind the board of directors and can only be altered with the approval of the shareholders.

Bylaws are "statutes" written by the board of directors and can usually be amended by the board of directors without first obtaining shareholder approval. The bylaws generally establish internal rules for the governance of the corporation, such as officer positions and meeting procedures.

The articles of incorporation must comply with the statute under which the corporation is incorporated, and the bylaws must comply with the articles of incorporation as well as the statute.

(Back to US Corporate Law)


Forming a corporation is generally considered a simple matter, however if it is done incorrectly this can have severe consequences for all involved. Many corporations are formed with the help of a lawyer (or several) - usually through a service company or directly through a business entity service company. The actual process of forming a corporation is usually a matter of filling in a few blanks on a form, but the process can sometimes be complex depending on what the persons or entities incorporating wish to accomplish. For example, some jurisdictions have statutes that grant liability protection to the officers and directors but these statutes need to be specifically invoked before they apply to the business entity and this is not always available on a generic form provided by the business entity filing agency in the jurisdiction where one is incorporating.

Chapter 2 of the MBCA and Subchapter I of the DGCL outline how a corporation is formed. There are three main steps in the process:

  1. An incorporator files articles of incorporation with the secretary of state's office. (Note that although the filing office in most United States jurisdictions for corporate filings is the Secretary of State, many United States jurisdictions use other agencies. Alaska, for instance, uses the Department of Commerce, Community and Economic Development and Michigan accepts new corporate filings through the Department of Labor & Economic Growth.)
  2. The corporation holds an organizational meeting to select a board of directors.
  3. The board of directors meets to adopt bylaws, appoint officers, and other tasks.

Considerations when incorporating


All of these things should be considered when choosing what entity type to use, what jurisdiction to incorporate in and how the articles should be drafted - or if a stock form should even be used. This is why this is a process and decision generally considered best left to an attorney or service company specializing in such matters - just as you would likely have a dentist to pull a tooth even though this is also considered a simple matter. Note that some jurisdictions require by statute that an official state form be used when filing a business entity, additional provisions can generally be attached.

  • The laws of the individual state where the business entity is to be filed
  • Whether or not the business entity may be ever conducting business in other jurisdictions
  • The business entity type
  • The business entity's projected revenue
  • The business entity's number of shareholders
  • The likelihood that the business entity will be sued (in the case of a high-risk business).
  • Other variables

Articles of incorporation


The articles of incorporation can be very minimal. Many states provide a one or two-page form for the articles of incorporation: the incorporator can simply fill out the form, provide the filing fee, and their corporation will be chartered. MBCA § 2.02 only requires four elements:

  1. corporate name
  2. number of authorized shares
  3. name and address of the corporation’s registered agent
  4. name and address of each incorporator

DGCL § 102 also requires:

  1. a statement of the "nature of the business" of the corporation (Note that most jurisdictions allow the articles to simply state "Any Legal Purpose" or a variation of this statement).
  2. the par value of each share, or a statement that all shares are to be without par value (see the chapter on Securities)
  3. name and address of each director, if the incorporator's duties are to end upon filing

Corporate name


Under MBCA § 4.01, a corporate name must include the word “corporation,” “incorporated,” “company,” or “limited,” or an abbreviation or foreign equivalent thereof. DGCL § 102 allows the corporation to choose a number of other signifying terms, including "association," "society," and "syndicate." The point of this rule is to place other parties on notice that they are dealing with a limited liability entity.

Authorized shares


The registered agent


The registered agent (AKA "RA", "Resident Agent" or "Statutory Agent") is a person or company designated to receive service of process within the state of incorporation. (Service of process is the act of serving a defendant with court papers in the event of a lawsuit.) The registered agent must provide a physical address to which a process server may personally go to deliver the complaint. Some states require that the registered agent accept his or her appointment by signature, other states do not. The state Articles of Incorporation form will indicate whether the registered agent's signature is required.

Most commonly, a registered agent service company is the designated registered agent. In some cases, the entity's attorney is the designated registered agent. If there is no attorney, the entrepreneur him or herself may be the registered agent, however there are numerous very good reasons for the entrepreneur to NOT serve as the registered agent.

The incorporator


Traditionally, corporations had to have three individual incorporators, who had to meet a number of legal requirements, such as being residents of the state of incorporation. Nowadays, one is the norm. The incorporator is usually inconsequential to the company they incorporate. An incorporator might be a lawyer, a secretary, a bicycle messenger, or any other competent adult; other corporations are also allowed to be incorporators in many jurisdictions. Besides having to sign the articles, an incorporator may also (depending on local law):

  • Receive the corporate charter in the mail from the secretary of state
  • Call the first meeting of the board of directors
  • Dissolve the corporation before the board meets
  • Amend the articles of incorporation before the board meets

Purposes and the ultra vires doctrine


Traditionally, corporations had to list their purposes in the articles of incorporation. Some states, such as Delaware, retain this requirement, but those states which have such a requirement are very lax about it: the corporation can be formed for "any and all lawful purposes," or list a few primary purposes with the "any and all" clause tacked on the end. Before this was legally possible, corporate lawyers would load up articles of incorporation with every conceivable purpose for a corporation up to mining cheese on the moon.

Ultra vires, Latin for "beyond the powers," is a legal doctrine stating that corporations cannot act beyond the purposes for which they were incorporated. Many English common law courts applied a dramatic form of ultra vires: any such act of a corporation was legally void. Other courts applied an estoppel theory to force corporations to follow their contracts even if the deal was ultra vires: this is the approach taken by MBCA § 3.04, which provides that "the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act." Compare NYBCL § 203.

Although ultra vires is rare due to the lack of fixed corporate purposes, the issue still comes up in states that restrict the powers of corporations by statute. In some jurisdictions, for instance, corporations cannot enter partnerships or make contributions to a non-profit organization. The MBCA comments suggest that ultra vires can be applied:

  • When the corporation or its shareholders sue former directors, to recover damages
  • When shareholders sue directors to get an injunction against an ultra vires act
  • When the state's attorney general wants to dissolve the corporation

The birth of the corporation


While rules vary from place to place, the usual law is that the existence of the corporation begins at the time the articles are filed, even though they have not been reviewed or accepted by the government at that point. This means that a corporation can begin operations while its articles are pending approval. If something goes wrong during this period and the articles are later rejected by the state, the corporation's limited liability generally protects the shareholders and directors, so long as they were acting in good faith.

On the other hand, if they knew the corporation was invalid to begin with, they can be personally liable for anything the corporation does during its period of presumptive validity.

Organizational meeting


First board meeting


(Back to US Corporate Law)


Securities represent a financial interest in a corporation.

Equity vs. debt financing


Generally, a corporation receives capital in exchange for equity securities or debt securities or a combination of the two. Equity securities are also known as stock. Debt securities are commonly known as bonds: although they are formally divided into bonds and debentures, the word "bond" is often used to refer to both.

A bond evidences a loan to the company, rather than a share of the company's equity. The money or other consideration received in exchange for a bond becomes both an asset and a liability to the company. In contrast, the consideration received for stock becomes an asset of the company without becoming a liability; it adds to the company's equity (the difference between assets and liabilities).

Bonds and debentures


Life is full of surprises, and even more so when it comes to finances. A person having a good income today may face financial crisis in future. To avoid these unforeseen financial crises everyone invests in different instruments that can fetch extra income. There are many options available in the market that can be classified as risky and non risky. It is very well understood that risky options yield higher gains but non risky ones can give very low returns. Debentures and bonds are two such options that can be taken for good returns on ones investment. Debenture is an instrument issued by a company that can be convertible or non convertible into equities. Bonds are issued by companies or by government and can be seen as a loan taken by them to meet their financial needs. These two instruments are basically loan taken from the investor but have very different repayment conditions.


Debentures are issued by a company to raise short to medium term loan needed for expenses or for expansions. Just like equities these can be transferred to anyone, but does not give right of voting in the company’s general meetings. Debentures are simply loans taken by the companies and do not provide the ownership in the company. These are unsecured loans as company is not bound to return the principal amount on the maturity. Debentures are of two types convertible and nonconvertible. The convertible debentures are the ones that can be converted into equity shares at a later time. This convertibility provides attraction to the investor but yield lower interest rates. Non convertible debentures does not convert into equity shares thus can yield a higher interest rate.


Bonds are actual contract notes issued by the borrower to pay interest at regular intervals and return the principal on the maturity of the bond. These bonds are issued by the companies for their expenses and future expansions. The bonds are also issued by the government for its expenses. A bond is seen as loan taken by a borrower from the investor so unlike equity share it does not give stake in the company but he is seen as a lender. These bonds are redeemed at a definite time. These are secured loans and can yield low to medium interest rate.

Difference between bonds and debentures

Both bonds and debentures are instruments available to a company to raise money from the public. This is the similarity between the two, but on closer inspection, we find that there are many glaring differences between the two.

Bonds are more secure than debentures. As a debenture holder, you provide unsecured loan to the company. It carries a higher rate of interest as the company does not give any collateral to you for your money. For this reason bond holders receive a lower rate of interest but are more secure.

If there is any bankruptcy, bondholders are paid first and the liability towards debenture holders is less.

Debenture holders get periodical interest on their money and upon completion of the term they get their principal amount back.

Bond holders do not receive periodical payments. Rather, they get principal plus interest accrued upon the completion of the term. They are much more secure than debentures and are issued mostly by government firms.

In Brief:

• Bonds are more secure than debentures, but the rate of interest is lower

• Debentures are unsecured loans but carries a higher rate of interest

• In bankruptcy, bondholders are paid first, but liability towards debenture holders is less

• Debenture holders get periodical interest

• Bond holders receive accrued payment upon completion of the term

• Bonds are more secure as they are mostly issued by government firms



Holders of stock have two key rights: voting rights and residual rights. Voting rights enable stockholders to elect the board of directors and approve or reject certain fundamental transactions. Residual rights allow the stockholders to share the company's profits, as well as recover some of the company's assets in the event that it folds, although they generally have the lowest priority in recovering their investment.

Types of stock


Common and preferred stock


By default, stock in a corporation is common stock. Common stock is generally accompanied by a voting right and residual right proportional to the number of shares held in the corporation. If a corporation only offers common stock, an owner of 25 percent of the common stock would control 25 percent of shareholder votes, receive 25 percent of any dividend payout and be entitled to 25 percent of any post-liquidation assets after creditors are paid in full.

Stock can also be designated as preferred stock, which gives it a higher level of residual rights. Generally, common stockholders cannot be paid until preferred stockholders are paid. Preferred stock often, but not always, comes with restricted voting rights, or sometimes with no voting rights at all. It is commonly used by investors such as venture capitalists who wish to invest in new companies but also seek to minimize risk.

Preferred stock can be designated as convertible, meaning that it can be converted into common stock at a certain time or times (e.g. at the holder's option). This gives the preferred stockholder the ability to exercise more control over the business later in exchange for giving up their dividend and liquidation preference. Common stock can also be convertible into preferred stock, although such cases are rare.

Classes of stock


The articles of incorporation may also designate various classes (or series) of stock. Generally, this is done to apportion voting rights and liquidation preferences between various types of investor.

For instance, in a small company, the founders may have Class A common stock, one group of investors may have Class B preferred stock, and another group may have Class C preferred stock. Class A stock may be allotted a certain number of seats on the board so that the founders always have the power to remain on the board. Class B and Class C stock can be given separate allotments of board seats as the shareholders agree, and can be given different levels of liquidation and dividend preference as the shareholders agree.


A simple way to define par value is as the "face value" of each share. This is a misleading definition, though: if you buy a share of stock for $75, its par value could theoretically be just about anything. If it has a par value at all, the value is probably low, maybe $1. In most cases, the par value will be completely irrelevant to the shareholder.

Par value comes from an era when small corporations were the norm. Three people might have gotten together and agreed to contribute $10 apiece to form a corporation. When the articles of incorporation were drawn up, the number of shares and par value of each share would be included. For three people investing $10 each, the corporation might issue three shares with a par value of $10, six shares with a par value of $5, or thirty shares with a par value of $1. Whichever numbers its owners chose would be recorded in the articles.

In the beginning, the promoter of a corporation (i.e. the person soliciting investments) would almost always set a fixed ratio between amount invested and number of shares received in exchange for that investment. Par value turned this into an absolute legal requirement. There were several reasons to do this: for one, it ensured that shareholders received equal treatment, as they would get equity and dividend rights proportional to their investment.

The legal capital (also called stated capital and paid-in capital) of the corporation would be determined by multiplying par value by the number of shares issued. Lenders were theoretically supposed to use this figure to know how much the corporation was worth at its outset. In practice, this didn't work. Some people learned to contribute property to a new corporation in return for stock at an inflated par value. On the balance sheet, the property would be the corporation's only capital, and because legal capital was fixed, the value of the property would magically go up. While the promoter had $10,000 in stock, the corporation might only have $5,000 worth of assets, but would still be worth $10,000 on paper.

Stocks sold at inflated par values were called watered stock, because the assets of the corporation were "watered down" to increase the apparent value of the stock. Holders of watered stock could be in trouble if a creditor foreclosed on the corporation's assets. If they had received $10,000 in stock for a $5,000 capital contribution, they would not only lose their $5,000 investment but would also be personally liable for the additional $5,000, whether they were the aforementioned promoter lying about the value of their contribution, or an innocent investor relying on par value to gauge the true value of the corporation.

Because par value was such an unreliable indicator of the actual value of stock, and because high par values could create liability for investors if the corporation went belly up, corporate lawyers began advising their clients to issue stocks with low par values. The legal capital of the corporation would still be determined based on par value, but the balance sheet would include the investment over par value as a capital surplus, and everything would still balance. In 1915, New York got wise and authorized corporations to issue "no par stock" with no par value at all, in which case the board of directors would allocate the incoming capital between stated capital and capital surplus.

Thanks in large part to a proliferation of low par and no par stock, watered stock is less of an issue these days. The last major American court case dealing with watered stock was in 1956. (Most corporate statutes also provide that the board of directors exercises conclusive judgment of the value of any property it exchanges for stock, as long as the directors do so in good faith; watered stock still comes up in the context of fraud, though.)

In most places, par value is optional. Under DGCL § 102(a)(4), a corporation can choose between par or no par stock, but must make the election in the articles of incorporation. MBCA § 2.02 does not mandate par value, but allows corporations to voluntarily place par value on their stock. For lawyers, one of the most important considerations surrounding par value is: "How much will it cost?" States often charge a franchise fee for corporations based upon the par value of the outstanding stock, with no par stock given an arbitrary par value for purposes of the calculation.



A distribution is a transfer of the corporation's wealth to its shareholders. There are two types of distribution: dividends and stock repurchases. From the corporation's standpoint, the two transactions are very similar: they both involve a payment from corporate funds to the shareholders.

In par value states


Under par value regimes, distributions can only be made from the "surplus" of the corporation. The exact definition of "surplus" varies from place to place, but Delaware defines it as the assets that exceed the legal capital of the corporation—the aggregate par value of its shares. This means that in such states, creditors can only rely upon recovering a fraction of the corporation's assets: the rest are free to be distributed to shareholders at any time.

A few other states impose a further restriction: that distributions have to come from earned surplus, the money that comes from corporate profits. This means that companies cannot pay dividends that would bring their assets below the amount of paid-in capital, the total amount that has been directly paid in by shareholders since the company's incorporation.

Under the MBCA


The Official Comments to the MBCA suggest that a corporation must meet two tests before it makes a distribution. These are:

  • Equity insolvency test - After the distribution, the corporation must be able to pay its debts as they become due in the usual course of its business.
  • Balance sheet test - After the distribution, the corporation's total assets must be greater than or equal to its liabilities plus the amount needed to buy out all of the holders of preferred stock.

Some states have adopted these tests verbatim. Others have gone further: in California, for instance, the balance sheet test under CCC § 500 requires the corporation to have assets greater than 125% of its liabilities after the distribution.

Compliance with these rules falls upon the directors themselves. If they break the rules, they can be individually liable to the company's creditors. The Official Comments indicate that the decision to make a distribution should be treated as any other business decision, and therefore should be subject to the business judgment rule. This means that as long as the directors make the decision in good faith, on an informed basis, and absent a conflict of interest, they will usually be safe.

Securities in public corporations


Publicly-traded corporations are subject to a number of additional regulatory regimes, most of them federal:

  • Securities Act of 1933 - Regulates the public issuance of securities.
  • Securities Exchange Act of 1934 - Regulates the public trading of securities.
  • Glass-Steagall Act of 1933 and Gramm-Leach-Bliley Act of 2000 - Bar banks from dealing in corporate securities;
  • Investment Advisers Act of 1940 - Regulates professional investment advisors with more than $25 million in managed assets.
  • Investment Company Act of 1940 - Regulates securities investment companies respectively. Many investment-related companies fall under these acts, even those engaging in the trade of "securities" not defined as such under the Securities and Securities Exchange Acts. The main target of these laws is mutual funds and similar companies. Foreign investment companies may not publicly offer in the US without making ICA registrations first.
  • Commodity Exchange Act - Covers trading in all types of futures contracts, expansively defined. Forward contracts and derivatives are not included, but many securities-based futures contracts are.
  • Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley" or "SOXA") - Adds additional rules to prevent fraud and unfair advantage.
  • Rules of the Securities and Exchange Commission (SEC) passed under the above laws.

In addition, most public corporations must follow the rules of the New York Stock Exchange (NYSE), the National Association of Securities Dealers (NASD) or whichever entity is responsible for listing their securities. These exchanges are known as self-regulatory organizations (SROs), as they can regulate listed companies independently of the federal government.

Securities Act of 1933


The Securities Act of 1933 (also known as the '33 Act) is essentially a consumer protection law for "retail" investors (i.e. not money managers, foundations, pensions, etc.) Its objectives are to provide investors with material financial and other corporate information about issuers of public securities (i.e. stocks and bonds), and to prevent fraud in the offering of such securities.

Many transactions are exempt from regulation under the Securities Act. Section 4 of the Act limits its application to public offerings (according to SEC guidelines, more than 25 offerees) by issuers and their underwriters (i.e. investment banks). This means that the Act primarily applies to companies offering securities to the public, and not to transactions between investors or to sales of stock to small groups of investors (i.e. private placements.)

For public offerings, the main requirement of the Securities Act is registration. An issuer must prepare an extensive statement describing the securities to be offered and detailing the nature of the issuer's business. Once this statement is registered with and approved by the SEC, its data and forecasts are placed in a prospectus for potential investors. Any offering of the securities by the issuer or underwriter must thereafter be accompanied by the prospectus.

Securities Exchange Act of 1934


While the Securities Act is very limited in scope, the Securities Exchange Act (also known as the Exchange Act or 1934 Act) is much broader. It regulates stock exchanges, brokers, dealers, and even private traders.

SEC Rule 10b-5


One of the most important provisions in securities law is Rule 10b-5, a general provision against fraud:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.

The rule, along with Section 10(b) of the Exchange Act, is used to punish a variety of activities, most notably insider trading.

(Back to US Corporate Law)


Control over a corporation is vested in a board of directors. The board of directors have great leeway to operate the corporation as they see fit, but they owe duties to shareholders, and often to others as well.

The board


Board meetings


The meeting rule states that directors cannot act unless they meet as a board. See Baldwin v. Canfield, 1 N.W. 261 (Minn. 1879) (board members each individually signed a deed on behalf of the corporation; transfer deemed invalid because board never met). There are legal ways for boards to act without actually meeting, but the general rule is that they must meet if possible.

Although the prototypical board meeting takes place in a "board room," hidden away inside a skyscraper, board meetings can take place anywhere and at any time. Under MBCA § 8.20 and DGCL § 141(i), the entire board does not even have to physically meet: a meeting can take place by teleconference or any other method in which the directors can simultaneously hear each other. This permissive rule has caused some courts to take a harder line against board action without a meeting, on the grounds that boards should be able to meet in just about any situation.



MBCA § 8.22 provides that notice is not necessary for regular board meetings, and that special meetings may be called on two days' notice. The DGCL contains no provisions for statutory notice. The articles or bylaws may fix a different notice requirement. If the board acts at a meeting held without the required notice, the action is invalid. See Schmidt v. Farm Credit Svcs., 977 F.2d 511 (10th Cir. 1992).



A quorum must be present at the meeting in order for the board's action to be legally effective. The statutory quorum is a majority of the total number of directors, but can be increased or reduced to as low as one-third under MBCA § 8.24 and DGCL § 141(b).



Each director has one vote, and the majority of the quorum rules. Directors may not vote by proxy; they must be "present" (i.e. communicating) at the meeting. See MBCA § 8.24; Lippman v. Kehoe Stenograph Co., 95 A. 895 (Del. Ch. 1910).

Board decisions without a meeting


Under MBCA § 8.21 and DGCL § 141(f), a board may act by unanimous written consent without a meeting. The idea behind this rule is that forcing unanimous consent ensures that opposing argument will not be silenced during the decision-making process: if a director opposes the action, they can force a meeting by refusing to sign the consent.

Emergency powers


If a quick decision is necessary to prevent great harm or take advantage of great opportunity, and a quorum of the board cannot be assembled in time, the directors who are available may make the decision.

Shareholder consensus


If the shareholders meet and reach a unanimous agreement, that agreement can bind the corporation. See In re Kartub, 152 N.Y.S.2d 34 (Sup. Ct. 1956).

Majority approval


If a majority of directors owning a majority of the corporation's stock reach an agreement, that agreement can bind the corporation. See Phillips Petroleum Co. v. Rock Creek Mining Co., 449 F.2d 664 (9th Cir. 1971).

Duties of directors


Directors' duties are primarily a matter of common law. The DGCL does not address directors' duties at all. MBCA § 8.31 codifies a simplified version of the common law business judgment rule.

Business judgment rule


The business judgment rule is a safe harbor for directors. A director's decision is not subject to review in court so long as it is made in good faith, on an informed basis, and in the best interest of the corporation (i.e. absent a conflict of interest). So long as the director's decision is mere "business judgment," they will not be personally liable for it.

In Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968), a shareholder of the Chicago Cubs' holding company attempted to sue Cubs president Philip Wrigley. At the time, the Cubs were the only Major League Baseball team that didn't have lighting at its home field, Wrigley Field. The court refused to force Wrigley to install lights for night games, stating that "there must be fraud or a breach of good faith which directors are bound to exercise... in order to justify the courts entering into the internal affairs of corporations."

The business judgment rule has been set aside when directors approve a criminal act in the interest of maximizing profit. See Roth v. Robertson, 118 N.Y.S. 351 (Sup. Ct. 1909) ("strict accountability" for director who paid "hush money" to individuals claiming illegal operation of business); Miller v. AT&T Co., 507 F.2d 759 (3d Cir. 1974) (directors not insulated from liability on ground that illegal campaign contribution was made in exercise of business judgment).

Duty of loyalty


Directors are required to deal fairly in any transaction that creates a conflict of interest, such as when the corporation is dealing with the director himself, or another corporation upon whose board the director sits. Directors cannot take personal windfalls from corporate transactions, and if they run a business that competes with the corporation, they must do so in good faith. They cannot use corporate assets for their personal business.

Duty of care


Duty of oversight


Business activities


A director cannot be a "dummy" on the board. Each director has a duty to attend meetings on a regular basis and to keep track of what is happening in the corporation, including its financial status. Directors who do not fulfill this duty breach their fiduciary duty to the shareholders, and potentially to others; see Francis v. United Jersey Bank, 432 A.2d 814 (N.J. 1981) (holding negligent director of reinsurance broker liable to clients).


Some courts have held that a director need only investigate possible criminal misconduct within the corporation if a "red flag" comes up to alert them to the problem. See Graham v. Allis-Chambers Mfg. Co., 188 A.2d 125 (Del. 1963).

Others have held that the board must have a reasonable information gathering process in place to monitor the corporation's compliance with the law. See In re Caremark Intl., Inc., 698 A.2d 959 (Del. Ch. 1996).

Duty to become informed


Somewhat more problematic than the duty of oversight is the duty to become informed. Many courts have imposed a duty upon directors to actively seek information on any major transaction. One of the most controversial cases regarding the duty to become informed is Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), described below.

The Trans Union case


Van Gorkom was chairman and CEO of the Trans Union Corporation, which made much of its revenue from leasing out railway cars. Due to tax issues, Trans Union needed to boost its revenues in order to stay competitive. In September of 1980, Van Gorkom sat down with a friend, Pritzker, who specialized in corporate takeovers. He proposed a sale of Trans Union to Pritzker at $55 a share, and Pritzker accepted this offer a couple of days later. They worked out a deal over the next couple of days in which Trans Union's shareholders would receive $55 cash for each of their shares, and Pritzker would have the option to buy one million shares of Trans Union's unissued treasury stock at $38 per share, 75 cents above market price. Pritzker demanded a response from the board by September 21, just three days away.

On September 20, Van Gorkom called a senior management meeting. Almost all of the other managers thought the idea was ridiculous. The CFO objected to the $55 per share price and to the option to buy treasury shares. Immediately after the management meeting, Van Gorkom summoned the board. He outlined the deal to them without handing over the actual agreement. He brought in a lawyer from an outside firm, who instructed the board that they might face a lawsuit if they didn't take the offer; after all, it was for a shareholder meeting to decide. The CFO told the board that $55 was "at the beginning of the range" of a fair price. The board approved the merger offer after two hours, on the condition that Trans Union would be able to accept any better offer brought within the next 90 days. Van Gorkom signed the merger agreement that night at a party. Neither he nor any members of the board had actually read it.

After the deal was made public on September 22, many officers threatened to resign. Van Gorkom quieted them down by negotiating amendments that would allow Trans Union to solicit other bids through its investment banker, Salomon Brothers. The board approved these amendments on October 8. Two other offers came in, but neither could be completed within the 90-day window. On December 19, a derivative suit was filed. The Delaware Supreme Court overturned the Court of Chancery's ruling for defendants, stating that:

Under the business judgment rule there is no protection for directors who have made "an unintelligent or unadvised judgment." A director's duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders. Since a director is vested with the responsibility for the management of the affairs of the corporation, he must execute that duty with the recognition that he acts on behalf of others. Such obligation does not tolerate faithlessness or self-dealing. But fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. Thus, a director's duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty.
...In the specific context of a proposed merger of domestic corporations, a director has a duty under (the law), along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. Certainly in the merger context, a director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement. Only an agreement of merger satisfying the requirements of (the law) may be submitted to the shareholders.

The Supreme Court sent the case back to the Court of Chancery with instructions to determine the fair market value of the plaintiffs' shares in Trans Union, and award damages to the extent that the fair value exceeded $55 per share. Before this could happen, the directors agreed to settle the claim for $23.5 million, $10 million of which was paid from liability insurance taken out by the directors, and the remaining $13.5 million paid by Pritzker.

Chicago school academics were up in arms over the case. How could directors be liable for approving a deal where shareholders got a 50% premium over the market price of their stock? And what business did the court have second-guessing the directors' judgment? Ira Millstein contended that "99% of boards didn't think that anything wrong had happened. Most everybody wrote about the decision as 'the Delaware courts are going nuts.'"

On the other hand, the decision put board members on notice that they had to be careful not to rush to judgment, especially in deals where there's a lot of money involved. Millstein again: "If you went into a board room before Van Gorkom and tried to talk about legal obligations, they'd say 'We have more important things to do...' When it came down, you were able to walk into a boardroom for the first time and really be heard."

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Officer positions


Neither the MBCA nor the DGCL mandates any specific officer positions. Traditionally, there were four officers in every corporation: the president, vice president, secretary, and treasurer. Under most traditional statutes, one person could hold more than one of these positions, with the caveat that the president and secretary must be different people. A few jurisdictions allowed all four positions to be held by one person.

  • The president is the person given general supervision and control over the corporation's daily affairs. They are responsible for signing contracts and other documents on behalf of the corporation. The president is often, but not always, chairman of the board as well.
  • The vice president takes over for the president if the president is unavailable. There can be more than one vice president: they take priority in an order the corporation designates, or lacking such an order, in the order in which they were appointed.
  • The secretary is responsible for corporate documents, such as minutes from the board meetings and annual shareholder meetings, and contact records for each shareholder. They also co-sign certain documents, such as stock certificates, with the president.
  • The treasurer is in charge of the corporation's finances.

Most small corporations still use the traditional job descriptions. Most big corporations, on the other hand, use "C level" designations: the president becomes a CEO, or chief executive officer; the treasurer becomes a CFO, or chief financial officer, and so on. Many companies have scores of vice presidents, sometimes in several tiers: senior vice president, executive vice president, and so on.

Authority of managers


Executive compensation


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Shareholder governance


Powers of shareholders


Shareholders have limited powers over the corporation. The only powers they generally exercise are the powers to elect directors, approve amendments to the articles of incorporation and approve "fundamental transactions." Some states grant shareholders additional powers, such as approval of "gifts" from corporate funds, and the power to enact bylaws.

Removal of directors


Shareholders have an inherent power to remove directors for cause. They must serve specific charges on the director and provide adequate notice and a full opportunity to meet the accusation. See Auer v. Dressel, 118 N.E.2d 590 (N.Y. 1954); Campbell v. Loew's, Inc., 134 A.2d 852 (Del. Ch. 1957).

DGCL § 141(k) allows a majority vote of shareholders to remove directors with or without cause, unless the corporation has opted for a staggered board or cumulative voting.

Amendment of the articles of incorporation and bylaws


Under DGCL § 242 and MBCA § 10.03, shareholders must approve any substantive amendments to the articles of incorporation, but such amendments must be proposed by the board first. The board may make minor amendments and corrections to the articles without shareholder approval.

In Oklahoma, which has a statute similar to the DGCL, shareholders have the power to amend the bylaws. Intl. Brotherhood of Teamsters Gen. Fund v. Fleming Cos., 975 P.2d 907 (Okla. 1999). Delaware has not made a conclusive ruling on this issue, but ruled that a bylaw depriving the board of its inherent power is legally invalid in Quickturn Design Systems, Inc. v. Shapiro, 721 A.2d 1281 (Del. 1998), leading many to believe that shareholder-originated bylaws may not pass under Delaware law.

Approval of fundamental transactions


Shareholders have the statutory power to approve fundamental transactions—those which fundamentally change the nature of the corporation. The three basic types of fundamental transaction are dissolution, merger and sale of substantially all assets.

Sale of substantially all assets

Under DGCL § 271(a), shareholders must approve any sale of "all or substantially all" of the corporation's assets. "Substantially all" was defined by the Court of Chancery in Gimbel v. Signal Cos., Inc., 316 A.2d 599 (1974):

If the sale is of assets quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and purpose of the corporation, then it is beyond the power of the Board of Directors.

Right of inspection


Shareholder meetings


The shareholders of a corporation generally exercise their limited powers of control at a shareholder meeting. There are two kinds of shareholder meetings: the annual meeting usually happens once a year, and a special meeting may be called for particular purposes from time to time.

The board of directors has great control over shareholder meetings. The actual date for the annual meeting is fixed in the bylaws of the corporation: since the bylaws are written by the board, the board picks when and where the meeting takes place.

There are some legal restrictions on the board in this respect. Under MBCA § 7.03(a), if the board does not call an annual meeting within 15 months of the last one, any shareholder can force the company to call a meeting. The board also has to send written notice of each shareholder meeting to every shareholder, usually between 10 and 60 days before the meeting.

Special meetings can be called by the board, or by any other party named in the articles of incorporation or bylaws. Many statutes also allow shareholders to call special meetings, but they have to have a certain percentage of the stock in order to do so: 10 percent under MBCA § 7.02(a). DGCL § 211(d) does not allow shareholders to call a meeting unless authorized by the articles. (Delaware makes up for this by making it comparatively easy for shareholders to vote in writing without a meeting: see below.)

There has to be a quorum at the meeting for its actions to be effective. The quorum is usually a majority unless the articles of incorporation state otherwise. Some corporations might have a quorum of one-third or two-thirds.

The actual voting can be very complicated. In corporations with more than one class of stock, each class votes separately, and the approval of every class might be required to pass a measure. Many states practice a further convolution: cumulative voting, where a holder of more than one share can "spread their votes" across multiple choices.

The only thing that has to be discussed at an annual meeting is the election of directors.

Proxies and proxy statements


In larger corporations, shareholders usually don't attend the meetings: instead, they get a form in the mail which authorizes a proxy to vote on their behalf.

Shareholder action outside meetings


Most states allow shareholders to act by "written consent" without calling a meeting. Under MBCA § 7.04(a), every shareholder entitled to vote must give their consent. DGCL § 228 is more liberal: a simple majority of shareholders entitled to vote can give their written consent.

Transfer of control


Derivative litigation


Shareholder liability: piercing the corporate veil


Piercing the corporate veil is a metaphor for ignoring the limited liability of a corporation. When a corporate veil is pierced, the corporation's creditors can go after the assets of its shareholders.

There are no hard and fast rules for determining when the corporate veil should be pierced. The determination is left largely to the determination of judges, who look at the totality of the circumstances to make their ruling, and choose to pierce the veil if it's necessary to prevent fraud or achieve equity.



Equitable ownership


Alter ego doctrine


Enterprise entity doctrine




Piercing other entities


Limited liability companies are similar enough to corporations that many courts have been willing to pierce their veils as well. Piercing a limited liability partnership has been more problematic. Partners in LLPs are generally liable for any torts they commit. The tougher issue involves huge LLPs, like accounting firms, and whether the assets of partners can be used to satisfy the demands of the many people claiming against the firm. The ongoing litigation against Arthur Andersen and other big LLPs may shed more light on this issue in the near future.

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