Incorporation and Organization (Extra Table of Contents).
1.
No corporation can exist without the consent or grant of the sovereign, since the corporation is a creature of the state and derives its powers by legislative grant. There is no inherent right to conduct business as a corporation. The right to act as a corporation does not belong to citizens by common right, but is a special privilege conferred by the sovereign power of the state or nation. Until there is a grant of such privilege, whether by special charter or under general law, there can be no corporation. The ability to conduct business as a corporation, being a privilege, may be withheld by the state
or may be made subject to appropriate terms and restrictions. Any means of incorporation that a state sees fit to adopt are appropriate.
i. To form a business corporation, the planner must know what is required under state law to bring the corporation into existence.
ii. The law of jurisdiction in which a corporation is organized governs who may form a corporation, how it is formed, and the powers it will have after it is formed.
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1.1 |
Power of Legislature. The creation of corporations is exclusively a legislative function, and the legislature of the states, have plenary power to make provisions, therefore, unless restricted by constitutional provision. Moreover, the conditions under which corporations are organize and operate are matters within the exclusive province of the state, as long as the conditions do not clash with the federal constitution. The constitutionality of state corporation statues has been upheld against contentions that such provisions violate due process and impair the obligations of contracts.
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1.1.1 |
Power of legislature. The legislative power to create corporations cannot be delegated to the courts, though the legislature may require application to, or approval of, the court, a board, a commission, or an official as a condition of securing the right to act as a corporation.
The federal government has the power to create corporations or to grant corporations created by a state additional franchises of a similar nature. However, Congress has no explicit power to create corporations. Such power exists only as a means, under the necessary and proper clause, to effectuate the powers expressly conferred on the national government. Thus, Congress has enacted general laws for the formation of corporations such as national banking corporations. Congress has also enacted legislation for the creation of various corporations to further national interests and policies, all of which operate as a private corporations but subject to congressional control and supervision.
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1.2 |
Deciding whether to incorporate. When a client comes to an incorporator's office for the purpose of establishing a new business
enterprise, the most important decision to be made regarding the enterprise is whether it should be operated as a corporation or in an unincorporated form. Clients may well have a preconceived notion as to the form in which he wishes to do business, but the incorporator would be amiss simply to accept that notion without critical analysis. Clients seeking to establish a business too often decide to conduct business in a corporate form of organization without being aware of alternative forms of association. Business may, in fact, be conducted in a wide spectrum of association, and the incorporator should inform the client of the available alternatives. The incorporator should discuss with the clients the
advantages and disadvantages of incorporating as opposed to operating in another business form (such as a proprietorship or a partnership), and then weigh these factors in the context of the client's
specific business operations. A discussion of advantages and
disadvantages of available business organizational forms should focus on a number of factors, both taxable and non-taxable.
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1.3 |
Overview of alternative forms of business organization. A business may be operated in a number of different corporate and unincorporated forms. A brief description of the most common types of business organizational forms, highlighting the situations in which the forms are generally used as well as their significant advantages and disadvantages my aid the client in determining whether or not to incorporate. An overview of the common business organizational forms is provided in the following sections:
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1.3.1 |
Sole proprietorship is typically one owner - the "proprietor" may have any number of employees.
Bookkeeping and tax accounting are basic and inexpensive. For example, the proprietorship income can be shown on the proprietor's own individual tax return. No additional income tax returns are required. This is advantageous for a "hobby" type of business which is an adjunct to a person's principal activities. It should be kept in mind that a proprietor is personally liable for debts and obligations of the business.
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1.3.2 |
Partnership and joint venture, are often useful when there to be two or more owners of the enterprise. The rights, management and ownership interests of the partners are set forth in a partnership agreement which may be as simple or as complex as the business situation
dictates. partnerships are referred to as "General Partners" when all of the partners are actively involved in the conduct of the business and as "Limited Partners" when there are to be more passive investors (limited partners) who will
be actively involved in the conduct of the business. Like the proprietor, the general partner is personally liable for the debts and obligations of the business. However, partnerships are usually more complex as a separate books must be maintained and separate tax returns filed. Partnerships are often simple to operate in simple situations. However, in complex situations they might, where the owners desire to, have the income or loss reflected on their own tax returns choose this form.
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i. |
Relationships between partners, and between partners and their parties, are extensively regulated by statute, therefore, counseling should be advised.
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ii. |
Joint ventures are, in essence, a sub-category of partnership tax and accounting rules normally apply. A joint venture, however, is usually formed to deal with one specific business objective. When the business is obtained or abandoned, the venture comes to an end.
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iii. |
Business trust. The trust, with
transferable shares, or so called Massachusetts Business Trust. Like the corporate form, ownership and management of the
enterprise can be separated. The "trustees" manage the business while the "beneficiaries" or shareholders are the equity owners. In a business trust, business is conducted by fewer than all or by representatives of the owners, and there may be some limitations on the personal liability of some or all of the owners.
The Mass. Business Trust was
formerly a common form of doing business in that state when income from certain types of operations was not taxed to the trust for state income tax purposes. However, this tax exemption was abolished and the business trust rapidly fell from favor among planners.
For federal income tax purposes, business trusts are usually taxed as corporations, because they typically have more corporate than non-corporate characteristics.
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iv. |
Business corporation. In the corporate form of organization the business is conducted by the corporation, which is legally separate from the stockholders who won it. Unlike
proprietorships and general partnerships the owners are not liable for liabilities of the business. In all jurisdictions, the formation of corporations and the rights and obligations of the owners among themselves and in the management of the business are governed by statues.
Regarding discussions regarding various forms of corporations. See Title II, Classes and kinds of corporations.
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1.4 |
Deciding where to
incorporate, checklists.
A corporation may incorporate in one state even though all of its business is carried on on one or more other states. The powers of the corporation and questions involving its internal management will generally be governed by law of the state of incorporation. Accordingly, where a corporation conducts its business will be done only one factor in determining where to incorporate. However, if business is to be done only in one state it might save some expense if the corporation were incorporated in that state since it would not have to pay both the costs of incorporating in one state or qualifying in another if required. Also, the corporation would also have to pay someone to act as its registered agent of process in the state of incorporation if it maintains an office there.
In some cases, however, the added expense of incorporating in one state and qualifying to do business in another state may be more than offset by the benefits of incorporating in a state whose law would enable the founders to tructure the corporation in a manner closer to their desires than the laws of the state where business was to be conducted. Thus, the founders of a public corporation would want to incorporate in a state which would enable them to adopt provisions that would more readily allow them to retain effective control of the corporation while the founders of a close corporation would want to incorporate in a state whose law enables them to operate the corporation as the particular type of close corporation they had in mind. For example pro-management law.
Checklist of factors:
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1.1 |
If a public corporation does state law allow provisions to be adopted which will help founders retain control of the corporation?
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1.2 |
If a unanimous consent close corporation is envisioned, does state law allow the corporation to be so organizes that each stockholder will have a veto power over corporate action?
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1.3 |
If a control stockholder(s) close corporation is envisioned, does state law allow a corporation to, in affect, delegate control to such stockholder or stockholders?
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1.4 |
Does state law either give corporation, or allow the articles to give corporation all powers necessary to carry on it proposed business activity?
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2. |
If local state law does not allow all that the founders need to operate corporation in manner they desire, what other states have laws that would allow the corporation to be so operated?
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3. |
Assuming that the corporation is to be incorporated in a state other than the state where it will be doing business, the following factors should be considered in choosing from alternative states that seem to have satisfactory laws from the standpoint of the founders:
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3.1 |
Costs, filing fees, organizations taxes, annual taxes, both franchise tax and or income tax earned out of state.
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3.2 |
Judiciary policy - General attitude of courts and how have particular provisions of state statute applicable to the corporation been interpreted?
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3.3 |
Corporate name - Is the corporate name available, if not, is another suitable name available in both the state of incorporation and the state of where it will qualify to do business?
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3.4 |
May
stockholders meetings be held out of state?
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3.5 |
Are any liabilities (e.g. wages of employees) imposed on stock holders other than liability for unpaid stock subscriptions?
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3.6 |
Are any corporate records required to be kept in state and if so, which? List of
stockholders, minute book, record of accounts?
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3.7 |
What information is required in tax returns or other reports required to be filed with the state that may be required on other states?
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4. |
After considering all factors involved in incorporating in a state other than the state where business is to be conducted, determine whether the benefits of such incorporation outweigh the additional costs, and other potential disadventages such as:
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4.1 |
Need for duplicate records.
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4.2 |
Increased
potential stockholder liabilities.
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4.3 |
Need to file reports in state of incorporation which may make information public that would not be made
public if reports only had to be filed in state where business was done.
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The corporate founders should be aware of certain other differences in provisions of state law even if nothing can be put in the articles of incorporation to change the affect of such provisions on the operation of a corporation. In some cases the differences may be sufficient to cause the founders to
divide to incorporate in a state other than the one where the corporation will be doing business.
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Checklist of regulated matters:
The following are matters which may be subject of statutory regulations:
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1. |
Liability of stockholders.
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2. |
Corporate indebtedness.
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3. |
Liabilities and indemnifications of directors.
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4. |
Redemption and/or purchase of a corporation's own shares.
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5. |
Sources out of which dividends may be paid.
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6. |
Power to place stocks in voting trusts.
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7. |
Validity of stockholders agreements as to voting their shares.
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8. |
Appraisal rights of dissenting stockholders.
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9. |
Requirements of advance disclosure of intention to make offer to acquire shares.
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10. |
Removal of directors.
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11. |
Taxes on corporations.
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1.5 |
Incorporation in Delaware vs. Nevada. Observation, Delaware has long been used as statute of incorporation, however, the benefits have been lessened in recent years by liberalization of incorporation laws of other states, specifically Nevada. It was argued that these states had less court interpretation than the Delaware
statute, this is no longer the case. Nevada benefits over Delaware, information to be provided.
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1.6 |
Qualification in a foreign state. Once the state of incorporation has been chosen, whether qualifications to do business in a foreign state is necessary or desired should be determined next. A corporation may frequently transact business with customers across state lines. If such business is purely interstate commerce, then the commerce clause of the United States Constitution allows the corporation to conduct its business in the sister state without qualification. When element of intrastate commerce are also present, however, virtually every state requires that a "foreign" corporation receive permission to do business within its borders, subject to a few limited exemptions such as conducting isolated transactions of limited duration or lending money on security.
The line between interstate and intrastate is often difficult to define and is often legal conclusion than an objective statement of fact. Maintaining an inventory of goods in a state which sales are regularly made to in-state customers, for example, will generally be held to constitute "doing business" that requires qualifications, while the solicitation of orders in furtherance of interstate sales will typically not require such a qualification. The variations are infinite, and the only general qualifications of "doing business" within a state when it transacts a substantial amount of its ordinary business there.
Faliure to qualify in a foreign state may subject it to fines or penalties and may affect its right to sue in the "foreign" state. Before deciding whether to qualify in a foreign state, it should be determined if that corporation can do business in that state as some states do not allow certain types of business to be carried out by "foreign" corporations.
Checklist of factors that determine whether corporations qualify to do business in a foreign state:
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Compare activities foreign state allow corporations to carry on without qualifying.
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Weigh costs of qualifying against benefits in the foreign.
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3. |
Discover whether it will be possible to restructure business so that no non-exempt activity is carried on in the foreign state.
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4. |
Discover whether a foreign state's view of when qualifications is required may be challenged.
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5. |
Discover what penalties would apply for not qualifying for carrying on business.
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When a corporation needs to qualify in another state, a firm which provides such services should be used that have the forms, expertise, and personnel to quickly qualify the corporation and to serve as registered agent.
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1.7 |
Interviewing the client and obtaining information checklist.
The interview is usually the first step in the incorporation process. The interview should cover areas such as the form the business entity is best suited for, the advantages and
disadvantages of each. Review of the clients business projections and assistance as required. Also, certain financial advisors may be required. Estate planning might also be considered and projections in changes as might be required.
The checklist - It is a common practice to have the client fill out a prepared questionnaire regarding the business. Per the following:
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What is the name of the corporation?
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What is the first choice?
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What are the possible alternatives?
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2. |
What business to be conducted?
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What is the corporation's primary business?
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b. |
Are there other businesses the corporation is to be authorized to conduct?
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c. |
Are there any limits to be placed on the business the corporation is to be allowed conduct if state law allows corporations to engage in any lawful business?
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d. |
Should specific business purpose to be set out in the articles of incorporation if not required by law?
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3. |
Will the corporation's business be conducted in the state of incorporation?
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4. |
Will the corporation's business be conducted in other state?
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a. |
Through offices or branches in another state?
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b. |
By making sales through independent contractors?
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c. |
By soliciting by mail or through employees, agents of state, before being binding?
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d. |
Through sales made wholly in interstate commerce?
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e. |
As isolated,
no repetitive business only?
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5. |
How much total capital is needed to begin the business?
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How much in capital do the founders plan to contribute?
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a. |
What amount is to be treated as equity?
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b. |
What amount is to be loaned and on what terms?
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7. |
Is any public financing planned?
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a. |
Through sales of stock?
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b. |
By debt financing?
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c. |
If debt financing is planned, what interest would the corporation be willing to pay and what loan period is contemplated?
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d. |
Is the investor's equity interest to be protected against dilution?
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8. |
Do the founders want corporate income taxed directly to stockholders, i.e. should election to be treated as an S-Corporation be made if the corporation is eligible?
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a. |
What are the tax brackets of the stockholders?
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b. |
What is the projected income of the corporation?
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Does the corporation need to
accumulate capital?
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9. |
Who is to have control of the corporation?
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a. |
If public financing is not needed, but there is more than one stockholder, does each founder have a veto over corporate actions, or stockholder, is
each founder to have a veto over corporate actions, or will one of the
founders or a group of founders have effective control of the corporation?
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b. |
If a one-man corporation, what is his marital status and are any shares going to be given to family members including spouse?
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10. |
Their names?
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11. |
What officers will the corporation have?
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Who are they?
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What are the proposed salaries for each officer without cause of only for cause?
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What is the term of office?
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Will the corporation have power to remove officers without cause or only for cause?
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12. |
Where is the principal office to be?
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13. |
Where is the annual meeting of stockholders to be held?
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14. |
What is the corporation's fiscal year?
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