(A Basic Look at a Corporation's Legal Attributes)
Hello readers! Took me a bit longer to post than I’d like, but my summer job as a legal research assistant (RA) comes first. My job entails researching current legal trends in the securities regulation and corporate law world. The information I dig up will be used to update two Examples and Explanations (E&Es) text books that cover Securities
Regulation and Corporations Law.
It was honestly an honor to be chosen by my professor as an RA, so I try to put in my best work, but I often feel lacking. Professors at law school like to label this feeling as “imposter syndrome.” But sometimes I honestly wonder if that’s a term imposters made up to feel better about themselves. . .
Impostor syndrome (noun) - a psychological pattern in which one doubts one's accomplishments and has a persistent internalized fear of being exposed as a "fraud.”
Well, I better stop myself before this post turns into a philosophical tangent about the red pill – blue pill debate. . . So, if you’re still with me, back to discussing my work as an RA.
This past week I waded through the 2016 Model Business Corporation Act (MBCA) to update a Corporations Law E&E book. Luckily most of the changes from the 2002 MBCA to the 2016 MBCA were straight forward, but unfortunately (or perhaps fortunately if you are not an RA) almost anything involving the Official Comments has been updated.
As my head is full of Corporations law, I thought I’d write a quick bit about what a corporation legally is. I know that before law school my biggest source of information on the topic was the 2005 indie documentary Walmart: The High Cost of Low Business, and while this was no doubt interesting and entertaining, it was a specific take on one corporation, and it didn’t exactly answer my basic legal questions about what a corporation is. So, hopefully today that’s what I can do for you.
1. What is a Corporation?
Corporation (noun) – a legal construct enabled by state statutes and supplemented by judicial norms and federal securities law that gives business participants an investment vehicle for the pooling of money and labor. Corporations are artificial persons with theoretically eternal lifespans that are legally distinct from the lives of its members.
2. Five Basic Attributes of a Corporation
A) Existence. Corporations have an independent, perpetual existence and they own the business assets and are liable for any business debts.
Some Pros: Brand name outlasts members, creating and maintaining value for shareholders. Also, corporations as “persons” largely receive broad commercial rights with equal protections under the 1st (free speech) and 14thAmendment (deprivation of Due Process). (Corporations do not however have the right to plead the 5th.)
Some Cons: Corporations as persons have a great deal of power, and in 2010 this power expanded to include campaign spending. See the Citizens United case. Personally, I’m not a fan of this decision, but for the complete arguments from each side, check out the oral argument transcripts on the Supreme Court’s website.
B) Management. Corporate power rests with the Board of Directors which manages and supervises the business. (Though, often the Board delegates much of its power to committees.) Shareholders on the other hand have limited power. They can vote to elect directors, approve fundamental corporate changes, and initiate limited reform, but that’s about it. Due to this power imbalance, directors are subject to fiduciary duties.
Fiduciary duties (Adj.) - A duty to act for someone else's benefit, while subordinating one's personal interests to that of the other person.
Some Pros: In a start-up company, directors may be the original founders, and having the power means that they can guide the business in the manner they originally imagined. On the other hand, experienced “lifer” directors may bring a steady hand to the ship. For many shareholders, governance is not the goal, and benefiting from the work of other is a plus.
Some Cons: Directors can become embedded in an organization and use their power to fend off would be “usurpers.” Decisions involving golden parachutes have also become a buzz topic of late. Meanwhile shareholders may be outgunned by directors who can perform tricky legal maneuvers that largely strip them of their voting power. Directors may also plausibly come up with a myriad of reasons why, even though a corporation is thriving, it is not in its best interests to pay out dividends do its shareholders. (Cough. Cough. Facebook.)
Golden Parachute (noun) - a large payment or other financial compensation guaranteed to a company executive should the executive be dismissed as a result of a merger or takeover.
C) Return on Investment (ROI) – Payouts of corporation’s financial returns are based on a hierarchal system. Creditors have priority based on their prospective contracts. Creditors include bank lenders, bondholders, trade creditors, and employee. Shareholders are residual claimants who receive discretionary dividends.
Some Pros: For creditors high up on the food chain, business failure does not necessarily mean a loss. (That’s a good thing, because according to data from the Bureau of Labor Statistics: about 20% of small businesses fail in their first year, and about 50% of small businesses fail in their fifth year.)
Some Cons: Business investments made by shareholders or loans given by secondary creditors can be highly risky, which means such shareholders and creditors will expect more bang for the buck. This can serve as a huge barrier for the would-be business owner. On the other hand, secondary creditors and shareholders are often left with huge losses when businesses fail.
D) Liquidity. Shares (ownership interests) are freely transferable. Shareholders can sell their financial rights and receive returns, and corporations can repurchase if ownership interests if they wish to. Managers on the other hand, cannot sell their positions, but they can resign at any time.
Some Pros: The more liquid the market, the easier it is for shareholders to offload and obtain shares. Of course, there are laws in place that govern when and how such transactions occur, but in general the greater the liquidity, the happier the market, the happier the shareholder.
Some Cons: Securities Regulation governs the sale of shares, and it is replete with complications. Investors beware.
E) Liabilities. What happens in the corporation stays in the corporation. As mentioned earlier, the corporation is responsible for its own assets and liabilities. Corporate insiders are not personally liable to outsiders for corporate obligations. This limited liability setup shifts the risk taking to outsiders.
Some Pros: The more liquid the market, the easier it is for shareholders to offload and obtain shares. Of course, there are laws in place that govern when and how such transactions occur, but in general the greater the liquidity, the happier the market, the happier the shareholder.
Some Cons: Plaintiffs seeking relief from an errant corporation may end up SOL if the corporation is bust or designed in a manner that shifts all the risk to a shell corporation.
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All right, well this article explained the basic attributes of a corporation. I hope it was fun. (Don’t judge. Law school did this to me.) Please message me if you have any questions or would like to dive deeper into a topic.
Sources:
Black's Law Dictionary (11th ed. 2019).
Bureau of Labor Statistics, available at https://www.bls.gov/.
Citizens United v. Federal Election Comm’n, 558 U.S. 310 (2010).
Alan R. Palmiter, The Corporation – an Overview, Corporations E&E, 3-14, (8th ed. 2015).
Supreme Court, Oral Arguments, available at https://www.supremecourt.gov/.