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Home -> Essel R. Dillavou -> Principles Of Business Law -> CHAPTER VI

Principles Of Business Law - CHAPTER VI

1. CHAPTER I

2. CHAPTER II

3. CHAPTER III

4. BOOK I CHAPTER I

5. CHAPTER II

6. CHAPTER III

7. CHAPTER IV

8. CHAPTER V

9. CHAPTER VI

10. CHAPTER VII

11. CHAPTER VIII

12. BOOK II CHAPTER I

13. CHAPTER II

14. CHAPTER III

15. CHAPTER IV

16. BOOK III CHAPTER I

17. CHAPTER II

18. CHAPTER III

19. CHAPTER IV

20. CHAPTER V

21. CHAPTER VI

22. CHAPTER VII

23. CHAPTER VIII

24. CHAPTER IX

25. CHAPTER X

26. BOOK IV CHAPTER I

27. CHAPTER II

28. CHAPTER III

29. CHAPTER IV

30. CHAPTER V

31. CHAPTER VI

32. CHAPTER VII

33. CHAPTER VIII

34. CHAPTER IX

35. CHAPTER X

36. CHAPTER XI

37. CHAPTER XII

38. CHAPTER XIII

39. BOOK V CHAPTER I

40. CHAPTER II

41. CHAPTER III

42. BOOK VI CHAPTER I

43. CHAPTER II

44. CHAPTER III

45. CHAPTER IV

46. CHAPTER V

47. BOOK VII CHAPTER I

48. CHAPTER II

49. CHAPTER III

50. CHAPTER IV

51. BOOK VIII CHAPTER I

52. CHAPTER II

53. CHAPTER III







PART II
CORPORATIONS

CHAPTER VI
CHARACTERISTICS OF CORPORATIONS

Sec. 49. Essential features. The corporation is the most ef-
fective vehicle yet discovered to manage and control modern busi-
ness enterprises. It permits, with the minimum risk of loss to
investors, the combination of capital and skill for vast business
operations. No other method has been found by which large
amounts of capital are so easily assembled for huge business control.
A great portion of the business today is conducted by means of the
corporate organization.

A corporation is a collection of individuals but in law is treated
primarily as an entity.

Since a corporation is regarded in the law as a person, for the
purpose of convenience, there is a limitation with respect to what
it can do, in that it has only those rights and powers which are given
to it by the state. In order that it may function as a person, a
legal entity separate and distinct from its members, it has certain
inherent rights and powers: a corporation may sue and be sued in
its own name ; it has the capacity of perpetual succession, although
there may be a change in its members by death or withdrawal; it
may take, hold, and transfer property, both real and personal, in
its own name as a legal entity, separate and distinct from its mem-
bers; it may enter into contracts with its own members; it may
take and convey property from its own members; and it may sue
and be sued by them as a distinct person.

A corporation is a resident and a citizen, for jurisdictional pur-
poses, of the state which creates it. Wherever the word "person"
or "persons" is used in constitutional and statutory provisions, cor-
porations "are deemed and considered persons when the circum-
stances in which they are placed are identical with those of natural
persons expressly included with such statute." * Thus, a corpora-
tion is a person within the meaning of the fourteenth amendment
to the federal constitution, which provides that "no state shall
make or enforce any law which shall abridge the privileges or im-
munities of citizens of the United States; nor shall any state de-

1 Judge McKinley- Beaston v. Bank, 12 Pet., 102,

260



CHARACTERISTICS OF CORPORATIONS 261

prive any person of life, liberty, or property without due process
of law, nor deny to any person within its jurisdiction the equal
protection of the laws." However, a corporation is not included
within the word "person" under the fifth amendment to the consti-
tution, which pertains to rights of natural persons in criminal pro-
ceeding; also, a corporation is not a "citizen" within the meaning
of section 2, article IV of the constitution of the United States,
which provides that "the citizens of each state shall be entitled to
all privileges and immunities of citizens in the several states."

Private corporations, according to the character of their organ-
ization, may be either stock corporations or nonstock corporations.
In stock corporations the membership is represented by shares of
stock. In nonstock corporations there are no shares of stock, but
the membership is determined by rules and regulations set out in
the by-laws. The stock corporations are organized for the purpose
of profit, whereas the nonstock corporations are organized as not-
for-pecuniary-profit corporations, such as mutual benefit associa-
tions, fraternal organizations, clubs, and the like.

Sec. 50. Entity disregarded. Occasionally, the courts feel free
to look behind the corporate entity and take action as though no
entity separate from the members existed. There are three dis-
tinct situations in which the entity is often disregarded. First, if
the use of the corporation is to defraud or to avoid an otherwise
valid obligation, the court may handle the problem as though no
corporation existed. To illustrate, let us assume that A and B sold
a certain business and agreed not to compete with the buyer for a
given number of years. Desirous of reentering business, in viola-
tion of the contract term, they organize a corporation, becoming
the principal stockholders and managers. The buyer may have the
corporation enjoined from competing with him as effectively as he
could have enjoined A and B from establishing a competing busi-
ness.

A parent corporation, owning a controlling interest in a subsid-
iary, often completely dominates the activity of the latter so that
it becomes purely an agent or arm of the parent company. Under
such circumstances, the courts have often held the parent company
liable for torts committed by the subsidiary. Occasionally, if the
finances of the two companies have been used somewhat indiscrim-
inately to meet the obligations of either company, ordinary credi-
tors of the subsidiary are permitted to sue the holding company.

The stock of a corporation is often held by one or two persons.
If the stockholders in such a case treat the corporation as though
it were their own personal business, not a separate entity, they are
not in a very good position to demand that outsiders treat the cor-



262 BUSINESS ORGANIZATIONS CORPORATIONS

poration as a separate entity. The law in this situation has not
been fully developed, but some courts treat the parties as though
no corporation had been formed.

Sec. 51. Foreign corporations. A corporation organized under
the laws of a particular state or country is called within that par-
ticular state or country a "domestic corporation." A corporation
doing business within another state or country is called a "foreign
corporation." Nearly all corporations transact business across state
lines, and in order to do so must satisfy the requirements of the
particular state in which the business is conducted as to right of
admission, service of process, and taxation, and must comply with
such other restrictions as the state may see fit to impose.

A corporation is a creature of the state which grants it a charter,
and it has no existence beyond the boundaries of the state creating
it. "It must dwell in the place of its creation and cannot migrate
into another sovereign." It may, however, like a natural person,
enter into contracts, hold title to property, have agents, and engage
in business in other states, subject to such limitations as those
states prescribe. The constitution of the United States provides
that "the citizens of each state shall be entitled to all privileges and
immunities of the citizens in the several states." Under this con-
stitutional provision a citizen of one state has a right to go into
another state for the purpose of engaging in lawful commerce,
trade, or business. However, a corporation has been held by the
Supreme Court of the United States not to be a citizen entitled to
the rights or protection of this particular constitutional provision.
Therefore, an absolute power remains in the states to restrict or to
exclude therefrom foreign corporations.

Sec. 52. Conditions under which foreign corporations may
"do business." Since a state may absolutely exclude or prescribe
the conditions under which a foreign corporation may do business
within its territorial limits, many states have taken advantage of
this power by enacting statutes requiring foreign corporations to
register by filing a copy of their articles with the secretary of state,
to appoint an agent upon whom service of process may be served,
to pay license fees, to designate and maintain an office in the state,
to keep books and records, and to deposit bonds or securities with
the treasurer of the state for the purpose of protecting any indi-
vidual who might suffer loss by reason of the corporation's conduct.
Refusal or failure by a foreign corporation to comply with these re-
quirements justifies the state in denying the corporation the right
to engage in business. Contracts of noncomplying foreign corpo-
rations are void and unenforceable by the corporation, because such



CHARACTERISTICS OF CORPORATIONS 263

corporations are denied the use of the courts by the state in which
they are doing business without authority. But noncompliance
cannot be used as a defense by the corporation when sued by a third
party. If a contract is fully performed, neither party may seek
restitution. Transacting business within the state without com-
plying with the statute subjects the corporation or its officers to
penalties.

A state cannot impose arbitrary and unreasonable requirements,
particularly after having once admitted a foreign corporation to
do business within the state. Such state cannot deny the corpora-
tion the equal protection of the law granted under the fourteenth
amendment to the federal constitution. Discriminatory license
taxes on capital stock, denial of the right of appeal to the federal
courts, regulations interfering with interstate commerce by impos-
ing taxes and license fees on the right to transport goods into or
through the state from another state, are illustrations of unconsti-
tutional restrictions upon "foreign corporations."

Sec. 53. What constitutes "doing business" by a foreign cor-
poration. The term "doing business" is not reducible to an exact
and certain definition. The Uniform Foreign Corporation Act in
Section 2 defines the term to mean that a foreign corporation is
"doing business" when "some part of its business substantial and
continuous in character and not merely casual or occasional" is
transacted within a state. Section 2, II, of the Uniform Foreign
Corporation Act states that a corporation is not "doing business"
in a state merely because :

"(a) It engaged in a single or isolated transaction in this state
where its action in engaging in such single or isolated transaction
indicates no intent or purpose of continuity of conduct in that re-
spect; or ...

(e) It does any act or acts which is or are merely preliminary to
or looking toward the future transaction of business in this state ; or

(f ) It does any act or acts in this state relating solely to the man-
agement or control of the internal affairs of the corporation, such
as the holding of corporate meetings, issuance of stock certificates,
authorization of issue of bonds, making of calls on stock, or other
acts of like nature ; or

(g) It acquires and holds stock of domestic corporations and ex-
ercises in this state the incidents of such ownership unless through
such stock ownership the domestic corporation is controlled by the
foreign corporation and is in reality acting as the agent of the for-
eign corporation and doing business in this state for it and in its
behalf . . ."



264 BUSINESS ORGANIZATIONS CORPORATIONS

Section 6 of the Uniform Foreign Corporation Act states that a
foreign corporation shall not be required to obtain a license to do
business or to file amended articles by reason of the fact that:

"(a) It is in the mail order or a similar business, receiving orders
by mail or otherwise, in pursuance of letters, circulars, catalogs or
other forms of advertisement, or solicitation, accepting such orders
outside this state and filling them with goods shipped into this state
from without same direct to the purchaser thereof, or his agent ; or

(b) It employs salesmen, either resident or traveling, to solicit
orders in this state, either by display of samples or otherwise
(whether or not maintaining sales offices in this state), all orders
requiring approval at the offices of the corporation without this
state, and all goods applicable to such orders being shipped in pur-
suance thereof from without this state to the purchaser; provided
that any samples kept within this state are for display or advertis-
ing purposes only, and no sales, repairs, or replacements are made
from stock on hand in this state . . ."

A foreign corporation licensed to do business, or doing business
without a license, or whose license has been canceled, is subject to
suit upon any cause of action arising in the state, or upon any cause
of action arising outside the state, if the plaintiff was a resident of
the state when the cause of action arose.

Sec. 54. Incomplete corporations de jure and de facto. A
corporation de jure is a corporation which has been formed in com-
pliance with the law authorizing such a corporation. A corpora-
tion de facto is one which operates as a corporation for all practical
purposes, but has failed to comply with some provision of the law
with respect to its creation and has no legal right to its corporate
existence. Its corporate existence can be challenged only by the
state itself, and not by third parties. Where persons have at-
tempted in good faith to organize a corporation under a valid stat-
ute, but have failed in some particular and thereafter have assumed
to exercise corporate power, a corporation de facto is said to exist. 2
It must be clear that the three following situations are present: (1)
a valid law authorizing such a corporation; (2) a bona fide attempt
to organize and comply with the statute; (3) the exercise of cor-
porate power. The corporation de facto can make contracts, pur-
chase and hold real estate, sue and be sued in its corporate name,
and do any and all things necessary to its corporate existence that
a de jure corporation may do. The mere illegalities in the organ-
ization can be questioned only by the state itself.

If persons hold themselves out as a corporation and create lia-

Tinnegan v. The Knights of Labor Building Association et al., 1893, 52 Minn.
239, 53N.W. 1150; p. 687.



CHARACTERISTICS OF CORPORATIONS 265

bility, and such organization is less than a de facto corporation,
they are generally held liable as partners. Some courts, however,
hold that the liability rests not upon partnership relationship but
upon the theory that such persons are agents for the other mem-
bers of a pretended corporation. A few jurisdictions and author-
ities maintain that shareholders of a defectively organized corpora-
tion less than de facto should not be held individually liable on
contracts, because the persons dealing with the pretended corpora-
tion contracted for corporate liability instead of for individual lia-
bility. For example, A, B, and C represent to X that they are a
corporation, whereupon X purchases stock. X takes no part in the
management of the pretended corporation. The pretended corpo-
ration contracts with F, and F, upon learning the fact that A, B,
and C are not a corporation, sues X as a partner. Under these cir-
cumstances it would seem that F's claim should be merely a cor-
porate one and X's cause of action should be against A, B, and C
individually.

Promoters

Sec. 55. Who are promoters. A promoter is one who usually
performs the preliminary duties necessary to bring a corporation
' into existence. He calls together and supervises the first meeting of
the organizers; enters into pre-corporation contracts with brokers,
bankers, and subscribers; draws the preliminary articles of incor-
poration; and provides for registration and filing fees. He pre-
pares the advertising, usually called a prospectus, which has for its
purpose the informing of the public as to the character of the in-
vestment, so that they may be induced to subscribe for stock or
other securities created by the company when organized.

Sec. 56. Corporate liability on contracts of promoters. The
corporation, after its creation, may become bound by "adoption"
upon contracts made by its promoter. The term "adoption" does
not mean ratification as applied in the law of agency, because, at
the time the contract was made by the promoter with a third party,
the corporation as principal was not in existence. More accu-
rately, what occurs is a novation. When the corporation assents
to the contract, the third party agrees to discharge the promoter
and to look to the corporation. The discharge of the promoter by
the third party is consideration to make binding the corporation's
promise to be bound upon the contract.

In the absence of evidence to show that such a novation has oc-
curred, the promoter will continue to be personally liable on the
contract. Since the contract made with the promoter was made in
anticipation of the formation of a corporation, the acceptance of



266 BUSINESS ORGANIZATIONS CORPORATIONS

the contract by the corporation after its creation is some evidence
from which to draw an inference that a novation has occurred, but
usually both the promoter and the corporation 3 are liable, since the
latter merely assumes, by implication, the obligation of the pro-
moter without any agreement as to his release.

Sec. 57. Corporate liability for expenses and services of pro-
moters. Corporations are generally not liable for expenses and
services of promoters, unless specifically made so by statute or by
charter. However, a promise made after incorporation to pay for
expenses and services of promoters will be binding and supported
by sufficient consideration, on the theory of services previously ren-
dered. 4 It is held in some jurisdictions that corporations are lia-
ble by implication for the necessary expenses and services incurred
by the promoters in bringing them into existence, and such ex-
penses and services inure to the benefit of the corporation.

Sec. 58. Duty of promoters to corporation and stockholders.
Promoters occupy a fiduciary relationship toward the prospective
corporation and have no right, therefore, to secure any benefit or
advantage over the corporation itself or over other stockholders,
because of their position as promoters. A promoter cannot pur-
chase property and then sell it to the corporation at an advance,
nor has he a right to receive a commission from a third party for the
sale of property to the corporation. In general, however, he may
sell property acquired by him prior to the time he started promot-
ing the corporation, provided he sells it to an unbiased board of
directors after full disclosure of all pertinent facts.

Sec. 59. Procedure for incorporation. Corporations are cre-
ated under either a special or a general law. In most states cor-
porations are now created under a general law. A general law au-
thorizing the formation of a corporation defines the purposes for
which corporations may be formed, and prescribes the steps to be
taken for the creation of the corporation. Such general law usu-
ally prescribes that any number of adult persons, usually not less
than three, who are citizens of the United States and at least one
of whom is a citizen of the state of incorporation, may file an ap-
plication for a charter. The application usually requires the
names and addresses of the incorporators ; the name of the corpo-
ration; the object for which it is formed; its duration; the location
of its principal office; the total authorized capital stock, preferred
and common; the number of shares, with their value; and, if the
statute provides for stock without par value, the number of shares



3 Battelle v. The Northwest Cement and Concrete Pavement Company, 1887, 37
Minn. 89, 33 N.W. 327; p. 688.
*Kridelbaugh v. Aldrehn Theaters Co., 1923, 196 Iowa 147, 191 N.W. 803; p. 689.



CHARACTERISTICS OF CORPORATIONS 267

of such stock. It also requires the names and addresses of the sub-
scribers to the capital stock, and the amount subscribed and paid
in by each subscriber. It further requires the amount and the
character of capital stock proposed to be issued at once, and
whether the stock is paid for in cash or in property. This applica-
tion, signed by all the incorporators and acknowledged by a notary
public, is usually forwarded to the Secretary of State. The Secre-
tary of State then issues a charter which contains all the informa-
tion on the application, and usually sets out the powers, rights, and
privileges of the corporation as prescribed by the general incorpo-
ration act. The law usually requires that, upon the receipt of the
charter, it be filed in the proper recording office located in the same
community as the principal office of the corporation. A fee is usu-
ally charged, payable in advance, for filing an application for a
charter, and no charter will be issued until such fee is paid. Where
the application is for a corporation not for pecuniary profit, no de-
tailed information is required relative to issues of stock, shares, and
so forth. The requirements for securing a charter vary greatly in
the different states and in different types of business in the same
state. The requirements of the statute must be satisfied and com-
plied with in detail for the formation of a de jure corporation.

After the charter has been received and filed, the board of direc-
tors and stockholders meet, draft by-laws, and elect officers. The
receipt of the charter and its filing are the operative facts which
bring the corporation into existence and give it authority and power
to operate.

The charter of a corporation is a contract and cannot be repealed
or amended by the legislature unless such power has been reserved
by the state when the charter was granted. The charter may be
amended, however, by the consent of all of the stockholders or a
certain portion thereof, as provided by the statute of the state.

Review Questions and Problems

1. Who holds title to property purchased by the corporation? How
long does a corporation exist? Where does it derive its powers? How
is the stockholder's share in a corporation represented? What effect has
the death of a stockholder upon the life of the corporation?

2. Distinguish between "domestic corporations" and "foreign corpo-
rations."

3. What must a "foreign corporation" do before it may transact busi-
ness within a state?

4. Explain what is meant by the term "do business/ 7 as applied to
foreign corporations.

5. Distinguish between public and private corporations. What is the



268 BUSINESS ORGANIZATIONS CORPORATIONS

purpose of nonstock corporations? How is their membership deter-
mined?

6. -4, 5, and C petitioned for a corporate charter for the purpose of
conducting a retail shoe business. All the statutory provisions were com-
plied with, except that they failed to have their charter recorded. This
was an oversight on their part, and they felt that they had fully complied
with the law. They operated the business for three years, after which
time it became insolvent. The creditors desire to hold the members lia-
ble as partners. May they do so?

7. What relation does the promoter bear to the corporation? Who is
liable on contracts made by him before the corporation is formed?

8. A and B obtained an option upon a building which had been used
for manufacturing pianos. They acted as the promoters for the corpo-
ration and turned over the building to the new corporation for $100,000
worth of stock. As a matter of fact, their option on the building called
for a purchase price of only $60,000. The other stockholders desire to
have $40,000 of the common stock canceled. Can they succeed in an
action to have it canceled?

9. State the general procedure to be followed in obtaining a charter.
10. Are all corporations organized under the same general law?




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