Formation: Paper
As was discussed in the previous section, one way to think about the
incorporation process is to remember the three pieces of the process:
people, paper and acts. In this section, we will discuss some of the
filings that need to be made with various state and local agencies in
order to comply with the law and ensure that the corporation is properly
formed.
In this section, we will discuss several of the major items that will
be created and, in most cases, filed. Note, however, that this is not
inclusive and varies from state to state. As such, the legal professional
engaged in the incorporation process should consult with attorneys (either
in his own firm or elsewhere) along with any documentation provided
by the state to ensure that all required material is completed.
Articles of Incorporation
The Articles of Incorporation (sometimes also referred to as a Certificate
of Incorporation) for a company represent the basic contract that exists
between the corporation and the state of its incorporation; as such,
the Articles are filed with the state (usually the Department of State
or State Secretary) and are available for review by the public. This
same document also serves as a contract between the corporation and
its shareholders. As a contract, the Articles define the basic nature
of the corporation as well as providing some specific rules about how
the corporation chooses to govern its operation. See
8 Del. C. § 102.
Violation of this contract by the corporation may result in potential
liability for the corporation or its directors and officers. See
N.Y. Bus. Corp. Law 203.
The basic elements of the Articles include the company’s name
and address along with the name and address of each incorporator. In
addition, the Articles will also designate the duration of the company
(if it is something other than perpetual) and the purpose of the company.
Very general purposes such as “incorporated to conduct all lawful
business” are generally allowed.
EXAMPLE: Big
Co. is sued by its shareholders for performing business acts outside
the scope of the business. Big Co’s executives say that they did
not know that the business they were conducting was outside the scope
of their power. When the litigation reaches court, the judge points
out that the executives should have known they were acting outside of
their powers as the Articles of Incorporation for Big Co., which were
filed with the state, specifically limit the manner in which executives
may act.
See
Rowe v. Franklin County, 318 N.C. 344 (N.C. 1986).
The Articles will also indicate the capital structure of the firm. This
includes the number of shares that the company is allowed to issue (authorized
stock), the nature of this stock as to voting, class, and dividend rights,
and any other elements of the stock which are relevant (including preferences
in dilution as to dividends, etc. and the par of the stock). Note, that
while the list above is fairly inclusive, different states may require
additional information that must be provided in the Articles. See, e.g.
N.Y. Bus. Corp. Law §§ 301-308.
Generally, a company’s articles of incorporation, while not necessarily
complex, need to be designed with some care. This is particularly true
for the capital structure of the firm and the nature of each class of
stock and its associated rights. While amendments to the Articles of
Incorporation are permitted in every state, such amendments will require,
in most cases, votes by the board and shareholders (perhaps even a super
majority of the shareholders) and will entail added cost and delay.
As such, the well advised company will try and get it right the first
time by specifying the exact design of the corporation in this opening
stage. This is especially important because a corporation may have a
complex system of allocating rights and powers among shareholders. For
example:
EXAMPLE: C
Corp has stock classes designated as classes X, Y, and Z. Class X is
the class of “common stock” indicating that the stock has
1 vote per share, unlimited rights to dividends (payments of cash by
the company) and no preference on dissolution (bankruptcy or sale of
the company). Class Y was given an extended voting preference whereby
each share of Class Y is entitled to ten votes on a particular issue.
Finally, Class Z has a preference on dividends or dissolution, where,
for example, Class Z shareholders get paid two times the dividends of
everyone else or get their distribution from a bankruptcy before other
shareholders.
Thus, care should be taken when drafting the original certificate of
incorporation.
Corporate Bylaws
While no state specifically requires the formation of corporate bylaws,
virtually every U.S. company of substantial size will create bylaws
concurrent with the company’s Articles. See
8 Del. C. § 109. While not a binding contract with the state in the way that the Articles
are, the bylaws do represent a form of contract with the shareholders.
As such, the company should understand and consider the ramifications
of each bylaw that it adopts.
EXAMPLE: After
incorporating LMN Co., its incorporators hold their first meeting and
draft bylaws for the company. They choose to place the bylaws on file
with the state. This is fine, but states only require the filing of
the Articles of Incorporation, not the bylaws.
In essence, the bylaws of a company contain the internal rules and regulations
that the company has chosen to follow. While there is no specific formula
for what it is included in a company’s bylaws, there are some
typical items that often come up.
• Voting: The bylaws may specify
the rules the company will follow as to who is allowed to vote, what
issues are to be voted on, and when votes will occur. Specifically,
bylaws will often state when the annual shareholder meeting will occur
(when the Board is elected) and will discuss how votes should be conducted.
In addition, voting, as it applies to the Board (i.e. not just the shareholders),
may be discussed in the bylaws and requirements as to voting –
for example if “super majority” voting or certain quorum
sizes are required for votes on certain issues – will be indicated.
• Board: The bylaws may indicate
that only people with a specific business or educational background
are allowed to run for the board. While most companies leave the field
of individuals fairly open, recent laws requiring a certain number of
“outside directors” on the board, and in addition to certain
requirements relating to directors’ knowledge of accounting and
legal rules, may force companies to clearly stipulate as to required
characteristics required of candidates. See,
e.g., 24-A M.R.S. § 3489.
EXAMPLE: Given the recent spate of accounting
scandals, Vavoom Co.’s shareholders pass a bylaw indicating that
any candidate for a position on the company’s board must be a
CPA. This bylaw is totally legal and within the power of the shareholders
to pass.
• Other issues: A
variety of other issues, such as how meetings will be conducted, further
rights and responsibilities on share ownership, and rules regarding
corporate business or dissolution may also be discussed in the bylaws.
Bylaws are generally amended with votes taken of the shareholders. In
certain circumstances, the board itself is allowed to create bylaws
for the company. Bylaws created by the board are often subject to the
constraint that any such bylaw may be struck down by a vote of the shareholders. See 8 Del. C. § 110. Additionally, to the extent that the bylaws conflict with the company’s
Articles of Incorporation, the nearly universal rule is that the Articles,
not the bylaws, will be the controlling rule for the firm.
Employer Identification Number
Paralegals are often called on to request a tax
Employer Identification Number (EIN) for a new corporation from the
Internal Revenue Service (IRS). If the company is to have any employees
at all, then an EIN is required by the taxing authorities to insure
that the company complies not only with the various tax requirements
imposed by the state and federal government, but also ancillary concerns
such as state programs like worker’s compensation and other employee
benefit schemes.
With the evolution of modern technology, the process of applying for
an EIN is virtually hassle-free. Typically, all that is required is
that the individual requesting the EIN log on to the IRS web page and
fill out the necessary forms. Certain information, such as the incorporators’
social security numbers, may be required, but generally, the information
is fairly straightforward.
EXAMPLE: After
forming his corporation and operating it for several months, Merv decides
to hire Sal as a manager to keep the company’s books. Merv realizes
that he needs to handle withholding taxes for Sal from Sal’s pay,
but is not sure how that is done. He goes to XYZ Law firm who tells
him that he needs to apply for an EIN with the Internal Revenue Service
and to separately withhold and report Sal’s taxable income on
a form W2.
Foreign Registered Company
Companies that do business in a state are typically
required to register with the Secretary of State or Commerce Department
in that state. The amount of business done by the corporation in the
state in order to trigger this requirement is often very moderate.
However, the business done in a state must be more than an isolated
transaction or two for there to be a filing requirement. See
Coyle v. Peoples, 349 A.2d 870 (Del. 1975). The registration process,
often known as registration of a “foreign” company, (where
foreign does not mean “international” but rather, from
a state other than the one where registration is occurring) is
generally a simple process, and is accomplished by filing a single
form along with providing proof of “good standing” from
the company’s
state of incorporation. See 8
Del. C. § 371.
The reason for the registration requirement for a foreign company is
quite simple. If an individual in a state other than the company’s
state of incorporation wishes to sue the company, that individual may
accomplish that goal more quickly if the company is registered in his/her
state. The registration of a foreign corporation will entail the company
designating the Secretary of State in the host state as its agent for
service of process. In that way, the individual suing the company need
only go to his/her Secretary of State to serve the litigation papers
on the company, and the company may then be required to appear in court
in the host state.
In most cases, failure to register in the host state will have a two-tiered
result. First, fines will likely be applied to the company if and when
it finally registers. More importantly is the fact that while, even
if the company fails to register, an individual in the host state may
sue the company, the company itself may NOT sue (or counter-claim) in
the host state until it registers. See
8 Del. C. § 383.
EXAMPLE: Huge
Co., a New York State incorporated company, has been selling its high-fashion
shoes at trendy Las Vegas hotel shops for the last seven years without
registering as a foreign corporation in Nevada. Helen, wearing one of
Huge Co.’s shoes, is injured when the six inch heel of the shoe
breaks off due to shoddy workmanship. Helen sues Huge in a Nevada court.
Huge Co wants to counter claim that Helen had acted negligently herself
by filing a hole through the heel that she thought would make the shoe
look better. Huge will be denied the opportunity to assert this claim
until it files, and will be fined upon that filing.
Stock Certificates
One final set of papers that cannot be overlooked
in the incorporation process is the issuance of the requisite stock
certificates to the new firm’s owners. See, e.g., Wis. Stat. § 185.21. While this is a fairly simple
process, failure to properly create and issue the certificates can result
in myriad of problems for the company and its owners when the shares
are later transferred.
Generally, there are a variety of services available for the creation
of stock certificates, and many mid-to-large size law firms that work
with companies will also have internal means for certificate creation.
In the process of making the certificates, however, the legal professional
needs to be very aware that state and federal ordinances are complied
with as to any disclosures that must be made on the face and/or reverse
side of the certificates. While this may sound like “nitpicking,”
all such laws which require notice as to things like transferability
and rights of the shareholder must be complied with for the certificate
to validly represent the owner’s interest.
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