A corporation is an organization formed by an individual or group of individuals in order to give structure to an enterprise. Profit making generally comes to mind when we think of corporations, but there are non profit corporations. People choose to form a corporation primarily for the following reasons:
a) the legal and financial liability of the owners or members can be no more than the amount they have contributed to the corporation.
b) there are certain tax advantages in the corporate form of ownership.
c) the corporation has a separate legal identity from its shareholders, directors and officers.
d) shares of stock of a corporation may be sold or transferred without disrupting the organizational or business operations of the corporation.
e) a corporation, unlike other forms of business organizations, will not dissolve or disband upon the death, withdrawal or departure of an owner, director or officer.
PRIMARY ELEMENTS OF A CORPORATION
a) STOCK - an investment tool by which a person acquires an ownership interest in the corporation. See below for additional information from the Delaware Law.
b) THE SHAREHOLDERS - also known as a stockholder, these are the individuals who own the corporation. An individual's ownership interest is generally shown in the form of a stock certificate, which signifies how many shares of stock are owned by that person. See below for additional information from the Delaware Law.
c) THE BOARD OF DIRECTORS - The Board of Directors are elected by the shareholders to elect the officers, manage the business affairs of the corporation. (link to additional information from the Delaware Law)
d) THE OFFICERS - The officers are responsible for managing the day-to-day activities of the company. (link to additional information)
STOCK AND STOCKHOLDERS (8 Del. C. §§ 151-203)
What is stock?
Shares of stock are units or proportionate shares of ownership in a corporation. 11 Fletcher Cyclopedia of Corporations §§ 5083, 5084. The owner of shares of stock in a corporation is known as a stockholder or shareholder; the terms are used interchangeably. "Stock" represents the equitable interest of the shareholder in the property of the corporation while the term "shares" represents the extent of that interest. Id. A share of stock gives the owner an interest or right in the management of the corporation, in its surplus profits and, upon dissolution, in all its assets remaining after the payment of its debts. Id. The relationship between a corporation and its shareholders has been said to be contractual in nature; requiring a subscription or contract giving the right to hold shares or upon some condition to demand and to exercise the rights of a shareholder.
Authorized, Issued and Outstanding Shares
The number of shares that the corporation has the authority to issue is set forth in the corporate charter, e.g., articles of incorporation. Id. at § 5082. There is an important distinction between "authorized" shares and "issued" shares. Issued shares are shares that have been authorized by the corporate charter and actually sold to subscribers. Stock of a corporation that has been authorized, issued and in the hands of the general public would be considered issued and outstanding. Conversely, any stock that has been authorized but not yet distributed to subscribers would be considered unissued stock and would not be outstanding. Stock that has been issued and then later reacquired by the corporation is known as treasury stock. 8 Del. C. § 153. It may be held by the corporation, reissued to the public or retired. Treasury stock has no voting or dividend rights. 11 Fletcher Cyclopedia of Corporations §§ 5088.
Normally when a corporation issues shares of stock it gives the purchaser a stock certificate. The stock certificate indicates the owner of the shares as well as the number of shares purchased. Although this is the preferred method of issuing shares, it is possible for a corporation to issue shares of its stock without issuing a stock certificate. Those shares issued with a certificate are known as "certificated" shares while those issued without a certificate are known as "uncertificated" shares. 8 Del. C. § 159. However, even when a corporation has uncertificated shares, holders of such shares may request, and are entitled to, a certificate from the corporation that states the number of shares owned by that person. 8 Del. C. § 158.
Stock as personal property
Shares of stock are considered personal property, 8 Del. C. § 159, and therefore may generally be bought, sold, mortgaged, pledged, taxed, made the subject of a trust agreement and bequeathed or distributed like any other item of such property. 11 Fletcher Cyclopedia of Corporations §§ 5096. However, it should be noted that corporations can place certain restrictions on the transfer of its stock. More information on stock transfer restrictions is set forth below.
Voting, Classes and Series of Stock
Anyone owning stock in a corporation is normally entitled to vote for that corporation's Board of Directors. The number of votes a person has is usually equal to the number of shares owned by that individual. However, this is not always necessarily so. Some corporations have different classes and/or series of stock. The primary classification of stock, if there is any, is what is known as common and preferred stock. These can be further subdivided into different classes or series. The corporation has the power to give certain shareholders more voting rights than others or even designate a particular class or series of stock as having no voting rights at all.
Owners of ordinary or "common" stock generally receive the same interest in the corporation. All common stockholders stand on equal ground, and each is entitled to share in the profits of the corporation, whenever they are distributed in the form of dividends, in proportion to the number of shares held by each stockholder. Common shareholders are usually entitled to one vote per share owned. Again, keep in mind that the number of votes per share can vary depending on the class or series of stock.
Preferred stock also provides an individual with an ownership interest in the corporation. As the name implies, preferred stockholders generally have priority over common stockholders when it comes to dividends or dissolution or liquidation of the company and may or may not have voting rights. Some owners of preferred shares can have more rights, vis a vis the corporation, than other preferred shareholders. It would be advisable for an individual contemplating buying preferred stock to review the corporation's charter or subscription agreement to determine his/her rights as a preferred shareholder.
The specific rights and privileges of a particular stock are determined by the corporation itself. Smaller corporations generally have only one class of stock with equal rights for each shareholder. Larger corporations, on the other hand, sometimes have one or more classes of stock and one or more series within each class. The stock can have no par value, which means that no dollar amount was placed on the stock by the company, or it can have a par value in an amount determined by the corporation.
Restrictions on Stock
A corporation can place other requirements or restrictions on its stock. For example, a corporation can make its stock:
- subject to redemption by the corporation or the shareholders. Under Delaware law, at the time of redemption the corporation must have one class or series of stock which is not subject to redemption; 8 Del. C. § 151(b)
- convertible to another class or series of stock upon the occurrence of certain events; 8 Del. C. § 151(e)
- subject to special preferences or other rights. 8 Del. C. § 151(f)
When a corporation does place restrictions or preferences on a series or class of stock, in addition to stating such restrictions or preferences in the certificate of incorporation or an amendment thereto or in the corporate resolution providing for the issuance of such stock, 8 Del. C. § 151(a), those restrictions or preferences are also set forth on the back of the stock certificate. In lieu of stating this information on the back of its stock certificate, a corporation MAY place a notice on the certificate that indicates that this information will be furnished to the shareholder upon request. 8 Del. C. § 151(f). When a corporation issues uncertificated shares of stock which is subject to certain restrictions or preferences, the corporation must send a written notice to the registered owner either setting forth the same information which is on the back of certificated shares or a notice that such information will be furnished upon request. 8 Del. C. § 151(f).
In addition to the preferences a corporation may give to a certain class or series of stock, it can also place restrictions on the transfer of its stock. 8 Del. C. § 202. Similar to any preference or limitation, restrictions on the transfer of stock must be in writing and stated on the back of the certificate in the case of certificated shares. In the case of uncertificated shares the shareholder must either receive notice of the restrictions or notice that such information will be furnished to him upon request. 8 Del. C. § 202(a). The restrictions on transfer may be imposed by the Certificate of Incorporation, the by-laws, agreement among the shareholders or agreement between the shareholders and the corporation. 8 Del. C. § 202(b). Under the statute, any lawful restriction is allowed. 8 Del. C. § 202(d). However, if the notice requirements of § 202 are not met, the restrictions on transfer are invalid unless the person has actual knowledge of the restriction. 8 Del. C. § 202(a).
Purchase of Stock
A person seeking to buy stock can purchase it in a variety of ways. The most common method and probably the most preferred, is to pay for stock in some form of cash, i.e., cash, check, money order, etc. However, stock can also be paid for with services rendered, personal property, real property, and leases of real property or a combination thereof. In addition, a purchaser can make a partial payment that is greater than the par value of the shares to be purchased and give the corporation a binding obligation to pay the balance. 8 Del. C. § 152. In any event, the value placed on stock for purchase must be a value not less than the stock's par value. 8 Del. C. § 152.
GENERAL DUTIES OF DIRECTORS
The responsibilities of a director are governed by 8 Del. C. § 141(a) of Delaware's General Corporation Law. Generally, the statute provides that the directors of a corporation are under a duty to perform those functions necessary to manage the corporation within the ordinary scope of its business.
The "basic management functions of directors" include, but are not limited to:
1) selecting the corporation's chief executive and senior officers;
2) controlling executive compensation, pension and retirement policies;
3) delegating authority for administrative action to the chief executive and subordinate executives;
4) fixing policies as to pricing, labor relations, expansion and new products;
5) determining dividend payments, financing and capital changes;
6) supervision and vigilance for the welfare of the whole enterprise.
2 Fletcher Cyc. Corp., § 505 (Perm Ed 1990).
While performing their managerial functions, corporate directors are charged with an absolute fiduciary duty to act in the best interests of the corporation and its stockholders. The director's fiduciary duty is composed of the duties of care, loyalty and good faith. This triad of duties requires corporate directors to fully inform themselves prior to making a business decision, to put the corporation's interests and those of its stockholders ahead of personal concerns and to perform their obligations with honesty and sincerity.
The director's actions on behalf of a corporation are protected to some degree by the Delaware courts as well as the Delaware General Corporation Law. The business judgment rule is a court-created presumption that the directors of a corporation "acted on an informed basis [i.e., with due care], in good faith and in the honest belief that the action taken was in the best interest of the corporation." CEDE v. Technicolor, Inc., Del. Supr., 634 A.2d 345, 360 (1993). The protection of the rule is not absolute, it may be overcome by a showing that the board breached its fiduciary duties.
Specific provisions of Delaware's General Corporation Law limit a director's potential liability for actions taken on the corporation's behalf. 8 Del. C. § 102(b)(7) allows a corporation to limit or eliminate a director's liability to the corporation or its stockholders in certain situations. Director's are also "fully protected" for good faith reliance on corporate reports or records in making business decisions. 8 Del. C. §§ 141(e) and 172. Under 8 Del. C. § 145, a corporation must indemnify a director for the expenses of litigation, including attorney's fees, if the director is vindicated. If the director is unsuccessful, then the corporation may indemnify her.
In essence, the role of a director is to guide and advise a corporation in its business endeavors. Every decision made on the corporation's behalf should turn on whether it is in the best interests of the corporation and its stockholders. In this way a director may perform his duties according to the standards demanded by Delaware's General Corporation Law as well as Delaware's Courts.
The duties of corporate directors are defined by 8 Del. C. § 141(a) (1991) which provides:
[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.
The Delaware General Corporate Law charges the corporate directors, not the stockholders, with managing the "business affairs" of the Delaware corporation. Maldonado v. Flynn, Del. Ch., 413 A.2d 1251 (1980), rev'd on other grounds, Del. Supr., 430 A.2d 779 (1981). The Delaware Court of Chancery, in discussing what is meant by the phrase "manage a corporation," stated that the "duties of directors are administrative and relate to supervision, direction and control, while the details of the business are delegated to inferior officers, agents and employees, and this is what is meant by management." Cahall v. Lofland, Del. Ch. 114 A. 224, 229 (1921), aff'd Del. Supr., 118 A. 1 (1922).
Barring any express limitations in the certificate of incorporation or the general law, the directors "have the power to bind it [the corporation] by any contract which is within its express or implied powers, and which in their judgment is necessary or proper to carry out the objects for which the corporation was created, and generally, to do or authorize any act which falls within what may be properly regarded as the management of the ordinary business of the corporation." 2 Fletcher Cyc. Corp. § 505 (Perm Ed. 1990) (citing Sinclair Oil Corp. v. Levien, Del. Supr., 280 A.2d 717 (1971)).
The director's powers to manage the interests of the corporation are "absolute as long as they act in accordance with their best judgment, and, in the absence of a dishonest purpose, or of fraud, bad faith or negligence so gross as to amount to a breach of trust, their discretion will not be reviewed by the court in an action attacking their conduct." Id. (citing Unocal Corp. v. Mesa Petroleum Co., Del. Supr., 493 A.2d 946 (1985); Pogoston v. Rice, Del. Supr., 480 A.2d 619 (1984). Note that absolute does not mean unlimited; the director's powers are limited to those within the ordinary scope of the corporation's business. Id.)
Additionally, under 8 Del. C. § 143 (1991), the board of directors may "lend money to, or guarantee any obligation of, any officer or employee of the corporation or its subsidiary, including any employee who is a director of said corporation provided such loan or guarantee may reasonably be expected to benefit the corporation. The loan may be with or without interest, and may be secured or unsecured."
THE BUSINESS JUDGMENT RULE
Under Delaware's General Corporation Law, the business judgment rule is an extension of the principle that directors, not stockholders, control the business affairs of a corporation. CEDE, 634 A.2d at 360. (referring to 8 Del. C. §141(a) supra). The business judgment rule is a court created "...presumption that in making a business decision, the directors of a corporation acted on an informed basis [i.e., with due care], in good faith and in the honest belief that the action taken was in the best interest of the company." Id. (quoting Aronson, 473 A.2d at 812). If the board's decision can be related to "a rational business purpose," then the court will not replace the board's determination with their own. Id.
In order to overcome the presumption, the plaintiffs must prove, with particularity, that the board breached its fiduciary duties of "good faith, loyalty or due care." Id. at 364. Once the plaintiffs have met their burden, the burden then shifts to the board to demonstrate the "entire fairness" of the transaction. Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 710 (1983) (entire fairness addresses both fair dealing and fair price).
It should be noted that the business judgment rule "operates only in the context of director action, it has no role where directors have either abdicated their functions or absent a conscious decision, failed to act." Aronson v. Lewis, Del. Supr., 473 A.2d 805, 813 (1984).
THE FIDUCIARY DUTIES OF DIRECTORS
In discharging their managerial duties, the directors are also "...charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of its shareholders." CEDE & Co. v. Technicolor, Inc., Del. Supr., 634 A.2d 345, 360 (1993). See also, Aronson v. Lewis, Del. Supr., 473 A.2d 805, 811 (1984); Smith v. Van Gorkom, Del. Supr., 488 A.2d 858, 872 (1985).
This rule was first enunciated by the Delaware Supreme Court in Guth v. Loft, Inc. when the court stated:
While technically not trustees, [corporate officers and directors] stand in a fiduciary relationship to the corporation and its stockholders. A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation or to deprive it of profit or advantage which his skill and ability might properly bring to it, or enable it to make in the reasonable and lawful exercise of its powers. The rule requires an undivided and unselfish loyalty to the corporation and demands that there shall be no conflict between duty and self interest. The occasions for the determination of honesty, good faith and loyal conduct are many and varied and no hard and fast rule can be formulated. The standard of loyalty is measured by no fixed scale. Del. Supr., 5 A.2d 503, 510 (1939).
A director's fiduciary duty encompasses both the duty of loyalty and the duty of care. 1 Ernest L. Folk, Delaware General Corporation Law, § 141.2 (3d ed. Supp. 1993) (citing Van Gorkum, 488 A.2d at 872); See also, CEDE, 634 A.2d at 367. Within the scope of performing these duties, there is a presumption that the director acted in good faith and in the best interests of the company. Aronson, 473 A.2d at 812.
THE DUTY OF CARE
The duty of care requires that directors have a "duty to inform themselves, prior to making a business decision, of all material information reasonably available to them." CEDE, 634 A.2d at 367 (quoting Aronson, 473 A.2d at 812). Once the directors have this knowledge, they are required to then execute their duties with the mandatory care. Id. The focal point of any inquiry as to whether the duty of care has been breached is the "decision making process" leading up to the director's decision. Id. The standard under which the duty of care is scrutinized is gross negligence. Id.
THE DUTY OF LOYALTY
The duty of loyalty demands that the interests of the corporation and its shareholders take priority over any concerns personal to the director rather than the stockholders in general. CEDE, 634 A.2d at 361 (citing Pogostin v. Rice, Del. Supr., 480 A.2d 619, 624 (1984); Aronson, 473 A.2d at 812). Typically, a breach of the duty of loyalty involves a director who appears on "both sides of a business transaction" or a director who receives a personal advantage from a transaction that is not received by the shareholders. Id. at 362.
When a director's decision is due to the "personal or extraneous" benefits he/she will receive from supporting a transaction, then the director's conduct is "self-interested." Id. (citing 1 Folk, Delaware General Corporate Law, § 141.2 at 141:33). In contrast, where the director's decision is based entirely on the "corporate merits of the transaction" rather than the benefits flowing from it, then the director is "independent." Id. Whether or not there is a breach of the duty of loyalty hinges on the director's independence. Id.
8 Del. C. § 144 (1991) of Delaware's General Corporation Law addresses the issue of "interested directors." The section provides that a "contract or transaction" will not be "void or voidable" solely because a director is interested. Fliegler v. Lawrence, Del. Supr., 361 A.2d 218, 222 (1976). The validation of contracts or transactions under this section is dependent on either the circumstances of the director's interest being revealed to the other directors or shareholders, and their subsequent approval of the decision or if the contract or transaction is fair to the corporation at the time it is approved by the other directors or shareholders. Id. Note that the intention of this section is not to sanction "unfairness to a corporation or remove the transaction from judicial scrutiny." Id.
THE DOCTRINE OF CORPORATE OPPORTUNITY
The doctrine of corporate opportunity is an element of a director's unyielding fiduciary duty of loyalty. 3 Fletcher Cyc. Corp., § 861.1 (Perm. Ed 1990). Essentially, "one who occupies a fiduciary relationship to a corporation may not acquire, in opposition to the corporation, property in which the corporation has an interest or tangible expectancy or which is essential to its existence." Id.
In Guft v. Loft, Inc., the Delaware Supreme Court definitively established the doctrine when it found a fiduciary liable under the "theory of corporate opportunity." Del. Supr., 5 A.2d 503 (1939). In its opinion the court stated that if a corporate director is presented with a business opportunity, which the corporation can financially afford to pursue and which is of "practical advantage to it," or is one in which the corporation has an "interest or reasonable expectancy", the law will not allow the director to "seize it for himself." Id. See also, Equity Corporation v. Milton, Del. Supr., 221 A.2d 494, 497 (1966); Schreiber v. Bryan, Del. Ch., 396 A.2d 512, 518-519 (1978).
The natural corollary of the Guth rule is that a director may seize a business opportunity for himself if, because of the nature of the enterprise, it is not one that is "essential or desirable" to the corporation, the corporation has no "interest or expectancy" in the opportunity and if the director has not diverted corporate funds to finance the opportunity. Id. Clearly there are no hard and fast rules as to whether a "corporate opportunity has been wrongfully taken," it is dependent on the particular facts at issue. Schreiber v. Bryan, 396 A.2d at 519.
LIABILITY OF DIRECTORS
According to 3 Fletcher Cyclopedia of the Law of Private Corporations, "a director...must be loyal to his trust, use ordinary and reasonable care, must not exceed the powers of the corporation nor his powers as an officer, and must otherwise act in good faith, and is liable for fraud or misappropriation or conversion of corporate assets, and generally is liable for negligence..." § 990 (Perm Ed. 1990).
If directors unlawfully or negligently pay a dividend or purchase or redeem stock, then they shall be held jointly and severally liable at any time within 6 years after such conduct to the corporation and its creditors if the corporation is insolvent. 8 Del. C. § 174(a) (1991). Note that directors are protected for "good faith reliance" on reports, opinions or statements as to the corporation's assets, liabilities and profits presented by corporate employees or other qualified persons.
When the Delaware General Corporation Law so provides a director, officer or shareholder may be liable and may be sued by creditors and ultimately held responsible for the corporation's debts. 8 Del. C. § 325(a) (1991). The complaint must state the basis of the director's personal liability, and may only be asserted if there is an unsatisfied judgment against the corporation. Id.
Delaware has limited the liability of director's through several provisions in its general corporate law. 8 Del. C. § 102(b)(7) (1991) provides that a corporation may include a provision within its certificate of incorporation "eliminating or limiting the personal liability of a director to the corporation or stockholders for monetary damages for breach of fiduciary duty as a director." Liability for (i) breach of the director's duty of loyalty, (ii) for conduct which is in bad faith or which "involves intentional misconduct or a knowing violation of law," (iii) for acts which occur under § 174 or (iv) for any transaction from which the director receives an inappropriate personal benefit, may not be limited or eliminated. Id.
Directors are also "fully protected" for good faith reliance on reports or records related to the corporation or produced on its behalf by a suitably qualified individual. 8 Del. C. § 141(e) (1991). 8 Del. C. § 172 (1991) specifically extends this protection to reports relating to the payment of dividends or the redemption of stock. (discussed in more detail supra). In Smith v. Van Gorkum, the Delaware Supreme Court held that in order for a report to be protected under 8 Del. C. § 141(e), "it must be pertinent to the subject matter upon which a board is called to act, and otherwise be entitled to good faith, not blind reliance." Del. Supr., 488 A.2d at 875.
In 8 Del. C. § 145 (1991), Delaware's General Corporate Law addresses the right of a director to be indemnified for the expenses, including attorney's fees, incurred in litigation arising out of her position with the corporation. This absolute right is limited to cases where the director is vindicated; otherwise the director may be indemnified by the corporation. This section also permits corporations to obtain liability insurance for its corporate directors.
How many officers is a Delaware corporation required to have?
Every corporation is required to have a president, secretary and a treasurer. It is acceptable for one person to hold all three positions. Generally, two separate officers hold the positions of president and secretary. The reason for this is that most, if not all, corporate documents require the signatures of both the president and secretary and without both signatures the document is not valid. We have found that often times where a person holds both positions, he/she forgets to sign in their capacity as president and secretary, in which case the act set forth in the document is not an authorized act of the corporation. For example, if a corporation that has the same person as president and secretary passes a resolution to open a bank account and that person does not sign as president and secretary, that would not technically be a valid corporate action. If that person is unavailable, no action could be taken until that person can properly sign the resolution as president and secretary.