Corporations — Formation

MBEMax wiki article — paired with the Business Associations question set on mbemax.com.

One-line summary

A corporation is formed by filing articles of incorporation with the state, which creates a separate legal entity whose shareholders, directors, and officers have defined, limited roles and whose shareholders are generally not personally liable for corporate debts.

Mnemonic

ARBO — Articles filed, Registered agent, Bylaws, Organizational meeting.

Think of the four Ps of life after birth that a corporate child needs: papers filed, agent for process, bylaws, and first board meeting.

Formation steps

1. Draft articles of incorporation — corporate name (with indicator "Inc." / "Corp." / "Ltd."), registered agent and office, authorized shares (type and number), incorporators, optionally purpose and directors.
2. File with Secretary of State. Corporation exists when filed unless articles specify later date.
3. Initial bylaws. Adopted by incorporators or board; govern internal affairs.
4. Organizational meeting. Elect directors, appoint officers, adopt bylaws, approve pre-incorporation contracts, issue stock.

De facto, de jure, estoppel

• De jure corporation — properly formed.
• De facto corporation — good-faith effort to incorporate under a valid statute + colorable compliance + corporate conduct; limited shareholder liability preserved in a collateral attack; only the state may challenge.
• Corporation by estoppel — third party who dealt with entity as a corporation is estopped from denying corporate existence; equitable doctrine, not absolute; usually contract cases only.
• MBCA — many states have abolished the de facto and estoppel doctrines, making liability turn on whether persons acted knowing no corporation existed.

Pre-incorporation contracts

• Promoter — someone who procures commitments for a corporation not yet formed.
• Promoter's liability — promoter personally liable on pre-incorporation contracts unless third party specifically agrees to look only to the corporation.
• Corporation's liability — not liable unless it expressly or impliedly adopts / ratifies after formation (adoption by accepting benefits).
• Novation — only way to release the promoter; requires agreement among all three (promoter, corporation, third party).
• Promoter fiduciary duty — to the corporation; no self-dealing; disclosure + fair-dealing.

Capital structure basics

• Authorized shares — ceiling set by articles.
• Issued shares — sold by corporation.
• Outstanding shares — issued and still in the hands of shareholders (excludes treasury).
• Par value — stated minimum; shares sold below par create "watered stock" liability in traditional states; many states (and MBCA) have eliminated par value.
• Consideration for stock. Historically cash, property, services rendered; many states and MBCA now allow promissory notes, future services.
• Preemptive rights. Default depends on state — MBCA: only if articles provide; some older statutes: default yes.

Ultra vires

• Classical doctrine — acts outside corporate purpose are unenforceable.
• Modern rule — ultra vires is not a defense to a contract; remedies are limited to shareholder suit, suit by corporation against officers, or state action.

Piercing the corporate veil

Courts disregard corporate form to reach shareholder assets when:

• Alter-ego / mere instrumentality — failure to observe formalities, commingled funds, undercapitalization, domination by a shareholder.
• Fraud or injustice — corporation used to perpetrate fraud or evade obligations.

More readily pierced in tort than contract cases.

NCBE loves to test

• Promoter vs. corporation liability. Pre-formation contracts bind the promoter until the corporation novates.
• Ultra vires modern rule. Contract enforceable; ultra vires defense is now limited.
• Preemptive rights default. Check the jurisdiction. Under MBCA: opt-in. Under older acts: opt-out.
• Adoption vs. ratification vs. novation. Adoption can be implied from accepting benefits; ratification at common law requires pre-existing principal; novation requires three-party agreement.
• De facto vs. estoppel. De facto = good-faith attempt at proper incorporation. Estoppel = equitable block on denial by those who dealt with it as a corporation.
• Watered stock liability. Directors who approve and shareholders who knowingly receive discounted shares can be liable for the difference.

Fast hypos

Hypo 1. Promoter signs a lease "on behalf of a corporation to be formed." Corporation never forms. Promoter personally liable unless the lease specifically disclaims promoter liability and looks only to the non-existent entity.

Hypo 2. Promoter signs lease. Corporation forms, moves in, pays rent. Adoption — corporation liable. Promoter remains liable absent novation.

Hypo 3. Shareholders run three closely held corporations with commingled funds, no meetings, and thin capitalization. A tort victim sues. Veil-piercing analysis: alter-ego + injustice; likely pierced.

Hypo 4. Corporation issues stock worth $10 for $1 to an insider. Watered stock — insider liable for $9 difference to creditors in traditional states; MBCA eliminates par-value doctrine but directors still liable for improper issuance.

Case anchors

• Walkovszky v. Carlton, 223 N.E.2d 6 (N.Y. 1966) — veil-piercing and taxi-cab enterprise liability.
• Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991) — alter-ego test articulated by Posner.
• Stone Street Services v. Daniels, 2000 WL 1909373 (E.D. Pa. 2000) — promoter-liability framework.
• Elsing v. Shelby County, 223 Ky. 543 (1928) — corporation by estoppel.

See also

• Agency
• Partnerships
• Shareholder rights

Sources

Model Business Corporation Act §§ 2.01–2.06, 3.01–3.04, 6.01–6.04, 6.21, 6.40; Del. Gen. Corp. Law §§ 101, 102, 108, 141, 153; Walkovszky v. Carlton, 223 N.E.2d 6 (N.Y. 1966); Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991).