Corporate
Structure
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Introduction
The
corporate law in most states imposes the same requirements on all “for
profit” corporations, large and small. For instance, every corporation
must have certain officers. These include a president, a chief financial
officer and a secretary, although one individual may simultaneously fill
more than one position. Corporations must also have a Board of Directors. Every
corporation must issue stock to the owners (called shareholders), evidencing
their share of ownership of the corporation. And every corporation must
adopt certain governing instruments (bylaws) and must maintain records
(called minutes) of corporate decisions and transactions.
Ownership
and Operation: The People Involved in the Corporation
Overview
Corporations
are usually governed at three levels: by shareholders, directors, and officers.
The shareholders are the owners of the corporation. They choose
the initial directors of the corporation, by either having them listed
in the Articles of Incorporation, or having the incorporator appoint them. The
shareholders typically do not exercise any control over the overall plans,
goals, or day-to-day operations of the corporation. However, corporate
statutes give shareholders rights to approve or dissent from certain major
corporate actions that are outside the normal course of business (such
as merger, or sale of all – or substantially all – of the corporation's
assets).
The directors are responsible for managing and exercising the
rights and powers of the corporation. More specifically, directors, either
acting as a board or through one or more committees of the board, establish
corporate policy, set short- and long-term plans and strategies, and determine
the overall direction of the corporation's business. In most states, including
California, one person may be the sole director of a corporation.
Directors
elect or appoint officers. In most states, three offices must be filled:
president, treasurer or chief financial officer, and secretary. The role
of the officers is to carry out the policies of the directors and to run
the corporation on a day-to-day basis. In most states and in California,
one person may fill all required officer positions.
Additionally,
the incorporator of a corporation is the individual responsible
for setting up the corporation by filing the necessary document (usually
the Articles of Incorporation) with the appropriate state agency (usually
the Secretary of State).
It
is important to remember that for small corporations, in general, not
only may one person simultaneously serve in more
than one of these capacities, but also one person may serve in all
capacities. In California, for example, a corporation may have only one
person who is the sole shareholder, sole director, and also fills all
three required officer positions. However, when a California corporation
has two shareholders, there must be at least two directors, and when there
are three or more shareholders, there must be at least three directors.
The relevant statutes vary by state.
The conduct of these people, that is, their duties and responsibilities,
powers and restrictions, is regulated ultimately by state statute and
more immediately by the corporation's governing instruments.
Incorporator
Legally,
an incorporator is the person who signs the incorporating document (usually
called “Articles of Incorporation,” “Certificate of Incorporation,” or
similar name) that is filed with the appropriate state agency (usually
the Secretary of State, or the Division of Corporations) to form the corporation.
An incorporator may be a person that will also serve in a continuing
capacity with the corporation, such as an officer, director or shareholder.
Typically,
however, the incorporator is an attorney or other person whose
sole function is to create the corporation by signing and filing the Articles
of Incorporation, appointing the initial directors of the corporation,
and then resigning as the incorporator and having no further involvement
with the new corporation.
Directors
The
board of directors is the management body for the corporation. Responsibilities
of the board of directors include establishing all business policies and
approving major contracts and undertakings. In addition, the directors
also elect or appoint the officers, who carry out the ordinary business
practices of the corporation under the directives and supervision of the
directors. The rights and responsibilities of the directors are described
in the bylaws adopted by the corporation, and by statute.
The directors must act collectively for their votes and decisions
to be valid. In a formal setting, generally dictated by a greater number
of people involved as directors and shareholders, this usually requires
certain procedures, such as notification of a forthcoming meeting
in a prescribed manner. There must also be a quorum of directors present
(a quorum is usually a majority of the directors then serving on the board;
but the bylaws may specify another minimum number or percentage).
In
smaller corporations where strict formalities are generally unnecessary,
decisions of the directors are typically made by written consent
without a formal meeting.This practice is authorized by the statutes of
most states, and is usually provided for in the corporation's Articles
of Incorporation or bylaws.
The first meeting of the board of directors is an organizational
meeting. It is important because resolutions adopting the bylaws, corporate
seal, and stock certificates are approved. Other resolutions authorizing
the opening of bank accounts, issuance of stock, electing officers and
making certain tax elections are also approved.
Directors, like officers, have a fiduciary duty to the
corporation, meaning that they must act in the best interests of the
corporation and cannot put their own interests ahead of the corporation's. Directors
must also act prudently in managing the affairs of the corporation. Finally,
the directors must properly exercise their authority in managing the corporation
and may not abrogate their responsibilities to others.
This
means that the board must be very careful to document that each action
was reasonable, lawful, and in the best interests of the corporation.
This is particularly true with matters involving compensation, dividends
and dealings involving officers, directors and shareholders. The record
or corporate minutes of meetings – or actions taken without a meeting
– must include the reasons or statements to support the board action and
must include sufficient detail indicating that the action was proper.
Officers
The
corporate officers are responsible for carrying out the day-to-day business
of the corporation. Their powers, duties and responsibilities are determined
by the Articles, bylaws, and by resolutions of the board of directors.
Every corporation
must have a president, a treasurer (or chief financial officer), and a
secretary. Optionally, a corporation may also have vice presidents and/or
assistant secretaries or assistant treasurers.
Although most jurisdictions allow one person to serve in all
three capacities, the person's specific responsibility and authority is
dependent upon the specific office the person assumes. For example:
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The
president typically has the overall executive responsibility for
the management of the corporation and is directly responsible for
carrying out the orders of the board of directors. The president
is responsible for entering into contracts on behalf of the corporation.
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The
treasurer is the chief financial officer of the corporation and
is responsible for controlling and recording its finances and maintaining
corporate bank accounts. Actual fiscal policy of the corporation,
however, may rest with the board of directors and be largely controlled
by the president on a day-to-day basis.
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The
secretary is responsible for observing corporate formalities and
maintaining corporate records.
Typically, the authority and responsibilities of each officer
is described in the corporate bylaws and may be further defined by an
employment contract or job description.
Officers
are considered agents of the corporation and can subject the corporation
to liability for their negligent or intentional acts that cause damage
to people or property. The corporation is bound by the contracts and
obligations entered into or incurred by the corporate officers.
Corporate
officers may be compensated for their services to the corporation. The
compensation must be “reasonable” and given for services actually performed
for the corporation.
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Note:
The issue of “reasonable compensation” may take on particular
importance in a small corporation where one or two individuals
are shareholder-employees of the corporation. The IRS may challenge
the compensation paid to such individuals as “excessive” or “unreasonable”
and seek to characterize a portion of the compensation as a disguised
stock dividend rather than salary. Monies paid by a corporation
as dividends are not deductible expenses by the corporation
and therefore do not act to reduce the corporation's taxable income.
The corporation will therefore pay a higher tax and the shareholder-employee
receiving the dividend will also pay tax on the dividend income
received. In other words, the dividend will effectively be taxed
twice. On the other hand, reasonable compensation paid as salary
or bonus to shareholder-employees is a deductible business
expense of the corporation. The tax will only be paid by the shareholder-employee
receiving the compensation.
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Shareholders
Because
shareholders are the owners of the corporation, the corporation's officers
and directors must ultimately serve the interests of the shareholders.
In a small corporation, shareholders often serve in other capacities,
such as an officer or director (or both), but it is not necessary that
they do so.
One
becomes a shareholder (receives an ownership interest) in a corporation
by contributing something of value to the corporation in exchange for
receiving a share certificate indicating ownership of a specified number
of shares in the corporation. The “something of value,” known legally
as “consideration,” may be cash, a promissory note, past
services rendered to the corporation, or property transferred
to the corporation (such as real estate, equipment, vehicles or furniture). It
may be a combination of any of these items as well.
Shareholders vote for the board of directors and thereby
have an indirect voice in the management of the corporation, but in
general have no right or duty to manage the business of the corporation.
While a shareholder's role is not typically managerial, shareholders
are not powerless concerning the affairs of their corporation.
The rights of the shareholders are governed by the bylaws
of the corporation as well as by prevailing state laws. Therefore, shareholders
are generally permitted or required to vote on major changes in the
basic organization of the corporation. These changes, sometimes referred
to as “fundamental corporate changes,” may include the following:
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Change
in the nature of business
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Change
in the type and number of shares of stock issued
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Change
in the size or composition of the board of directors
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Change
in the bylaws, or amendments to the Articles of Incorporation
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Encumbering
corporate assets
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Dissolution
of the corporation
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Selling
all (or substantially all) of the corporation's assets, or consolidating
or merging the corporation with another corporation
Shareholders,
in that capacity, are generally not considered fiduciaries of
the corporation and therefore have no responsibility to the corporation
beyond paying the corporation the full value of shares they purchase. Likewise,
a shareholder (like any other person) can sue the corporation for personal
wrongs and damages suffered as a result of improper or illegal acts
of the corporation or its officers or directors.
Shareholder
Meetings
Shareholders,
like directors, cannot act unilaterally. In a formal setting, they
must act either at a regular shareholders' meeting (ordinarily held
annually after the end of the fiscal year) or at a special meeting of
the shareholders (ordinarily called at the request of the board of directors).
In
small corporations, the actions of the shareholders, like the actions
of directors, may be documented in minutes by written consent without
a meeting. In short, corporations having just one or two people who
are shareholder/directors will manage the corporation is a much less
formal manner than larger corporations that have many different people
as shareholders, directors and officers.
When
shareholders vote, it is important to remember that shareholders
vote their shares; i.e. it is the number of shares (not the
number of shareholders) that decide a vote. For example, if Shareholder
A holds 500 shares, and Shareholder B holds only 100 shares, there will
be a total of two shareholders present with a total of 600 shares represented.
Obviously Shareholder A has much more voting power than does Shareholder
B. Also, shareholders may typically vote in person or vote by proxy. Voting
by proxy means that a shareholder may designate another person to vote
in his place.
The
Corporation's Governing Instruments
In
order of importance, the activities of the corporation and its people
are governed by the Articles of Incorporation, the bylaws, and by resolutions
of the directors and shareholders. Ultimately, the provisions of the Articles
and bylaws must be consistent with the requirements or restrictions imposed
by the laws of the incorporating state.
Articles
of Incorporation
Filing
a document known as Articles of Incorporation (or “Certificate of Incorporation,”
in some states) with the appropriate state body (usually the Secretary
of State) legally forms a corporation. This document is typically just
one or two pages and must contain certain provisions, which are essentially
the same for each state. They are:
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The
name of the corporation
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The
purpose(s) of the corporation
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The
number of authorized shares of stock
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The
name and address of the agent for service of process
States usually require the name, address, and signature of
each person acting as the incorporator of a corporation.
A
filing fee is paid to the Secretary of State at the time the
Articles are filed. In some states, like California, this is a fixed
amount. In other states, such as Nevada, the filing fee is based on
the value of the authorized shares of stock, subject to a minimum filing
fee.
Bylaws
The corporation’s
bylaws describe the duties, responsibilities, rights and powers of the
directors, officers and shareholders. It is an internal operating document
only, meaning that it is not filed with the Secretary of State
or any other agency. The function of the bylaws is to supplement the
Articles of Incorporation by defining more precisely the powers, rights
and responsibilities of the corporation’s managers and shareholders
and by covering other activities of the corporation that are not generally
set forth in the Articles of Incorporation.
For instance, the bylaws usually state the time and place
at which annual shareholder’s meetings will be held, the procedure for
calling special meetings of shareholders, and the procedures for conducting
shareholders’ and directors’ meetings. The bylaws often contain provisions
for creating special committees of the board, defining their membership
and the scope of their activities. They discuss the procedures for the
transfer of shares, the maintenance of share records, and for the declaration
and payment of dividends.
The initial bylaws are adopted by approval of the board of
directors. The bylaws may be amended from time to time, for example
to change the number of directors that the corporation is authorized
to have. Generally, the directors and the shareholders must approve
any changes or amendments to the bylaws.
Bylaws
are “trumped” by the corporation’s Articles and by state and federal
law. In other words, a bylaw is invalid if it is contrary to the Articles
or to requirements of the laws of the incorporating state. Also, even
though valid in form and on its face, a bylaw provision may be invalid
if it is unreasonable or inherently unfair, or if it was adopted under
circumstances constituting abuse of the corporate structure.
In
California, the basic statute relating to the bylaws (Corp C § 212)
is very permissive, imposing only one requirement: that the bylaws state
the fixed number, or the maximum and minimum number, of directors. Even
this statement is not required in the bylaws if it appears in the Articles.
The bylaws may contain any provision for the management of the business
and the conduct of the corporation’s affairs that is “not in conflict
with law or the Articles” (Corp C § 212(b)).
Corporate
Resolutions
When
the board of directors or shareholders approves actions by the corporation,
the approval is generally described in the form of a resolution and
memorialized in written minutes maintained in the corporation’s minute
book. A corporate resolution commonly authorizes one or more officers
to take specified action in behalf of the corporation. Some common events
that often are the subject of corporate resolutions include:
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Opening
a corporate bank account
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Authorizing
officers to enter into a lease or other agreement
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Adopting
a medical reimbursement plan for employees
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Establishing
a policy for reimbursement of employee business expenses
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Paying
salary bonuses to employees, particularly shareholder-employees
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Borrowing
money from a bank or other lender
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Buying
or selling a major asset of the corporation, such as real estate,
vehicles or equipment
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Pledging
any corporate assets as security for the repayment of a loan or
other obligation
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