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Forming a Corporation
Limited Liability? A corporation will only provide limited liability if the "requisite corporate formalities are observed". That means that you have dotted all of your "i"s and crossed all your "t"s so that if your corporation get sued or audited you stand a very good chance of not ending up in trouble (or as much trouble) as you could have. Once established, the corporation becomes a separate legal entity. It is important to understand that, as corporate counsel, I am representing that legal entity and not individuals who have an interest in it. Forming a Corporation To properly form a corporation, generally we need the following documents:
Articles of Incorporation The Articles of Incorporation is a document that specifies the name of the company, the name of the Registered Agent (the person or entity that is designated to receive service of process in case the corporation is sued), the address for the Registered Agent, the address for the company (must be a street address, not a PO Box), the mailing address for the company, the number of shares the company will issue and the contact information for the person filing the Articles. The Subscription Agreement When a corporation is first formed, it is an empty shell. You and all other prospective shareholders must contribute something to the corporation (cash, assets, work, etc.) to the corporation in exchange for shares in the corporation. The Subscription Agreement is a contract between you and the corporation regarding the amount of money or property you will transfer to the corporation for your shares of stock. It is useful to have a record of that understanding for purposes of the tax and securities laws. Under Section 351 of the Internal Revenue Code, assets transferred to the corporation are tax free; no taxes are incurred by you or the corporation. The restrictions on transfer of the stock are to avoid the necessity for registering the stock with the Securities Division. You will need to determine the specific cash or property that you will be transferring to the corporation for those shares of stock. Please work with the corporate CPA or other tax advisor to prepare the exhibit which states the consideration you paid the corporation in exchange for your stock. That information needs to be included in the Subscription Agreement which will be attached to the Statement of Actions in Lieu of an Organizational Meeting of the Board of Directors. Statement of Actions in Lieu of an Organizational Meeting The Statement of Actions in Lieu of an Organizational Meeting of the Board of Directors basically describes the business done at that meeting. Through the Statement of Actions, the Board of Directors will adopt the Bylaws, a copy of which is enclosed. In addition, the Statement of Actions reflects the intention of the corporation to have its stock qualify under Section 1244 of the Internal Revenue Code. The effect of this is explained in the Statement of Actions. Please note that the decisions are written as resolutions. Either this format or minutes of a meeting should be used for all corporate decisions. The Statement of Actions also requires a selection of a bank for the corporation and specifies that you will be the only authorized signer on the corporate account and that you have total authority to execute documents on behalf of the corporation. Additionally, the Board of Directors should resolve to reimburse you for the expenses incurred in the incorporation procedure, including any attorney fees. Bylaws The Bylaws are the basic operating rules for the corporation. I usually include many provisions which may not seem relevant to a corporation of such a small size; however, they are standard Bylaws and expansion of the corporation will require the same or similar provision. Bylaws can be amended by action of the Board of Directors at any time. Subchapter S? After consulting with your tax advisor you may wish to elect for your corporation to be treated as a subchapter "S" corporation. Typically the corporation’s CPA or other tax advisor files the subchapter "S" election form (IRS Form 2553) on behalf of the corporation. To avoid unnecessary complications, that form must be filed within 75 days of the date on which you are incorporated. Please work with the corporate CPA or other tax advisor to make sure that deadline is met. Employer Identification Number (EIN) If your corporation will have salaried employees, you will need to obtain an employer identification number. In addition, in Oregon an employer needs a Business Identification Number (BIN). Typically our office does not apply for EINs or BINs. Typically the corporate CPA or other tax advisor prepares the applications for these numbers on your behalf. Operating the Corporation After It’s Formed In connection with your corporation, please keep in mind the following: Limited personal liability and the tax benefits of doing business in the corporate form are available only when you comply with the numerous requirements of corporate law. This information is intended to acquaint you with some of the basic requirements of corporate operation, and to alert you to areas in which it is unsafe to act without further legal guidance. The benefits of corporate operation flow from the legal recognition of the corporation as an entity separate from its shareholders, directors, and officers. To enjoy these benefits you must operate the corporation as a separate entity and in accordance with certain formal requirements. It is essential that corporate and personal affairs be kept separate. Never mix corporate and personal funds, assets, or accounts. Do not use corporate funds or assets for personal or other non-corporate purposes. Business should be done in the corporate name. Avoid any indication that you are dealing in a personal capacity. The corporate name should be used on the telephone, all advertisements, letterheads, cards, signs, etc. When signing documents, it should always be made clear that you are acting on behalf of the corporation. This is accomplished by signing in the following manner: XYZ, Inc By: Pat Doe, President
If you are also required to obligate yourselves personally, you should know the difference between signing individually (you are personally liable on the obligation) and signing for the corporation. Individual obligations should be avoided unless there is no choice but to sign individually, as well as on behalf of the corporation. A common example is the requirement by many financial institutions that the officers of the corporation sign as individual guarantors in order for the corporation to obtain a loan. If you are presented with any form of document which requires you to sign individually, as well as on behalf of the corporation, do not sign it unless and until you understand the extent of individual liability imposed and you decide that you are willing to undertake that individual liability. Annual (and other) Meetings In keeping with the legal recognition of the corporation as a separate individual, the formalities of corporate operation provide the mechanism by which the corporation governs itself, makes decisions, and takes action. Properly held meetings, either of shareholders or directors, are the key to formal operation. To better understand who must meet and when meetings are required, you should become familiar with the different capacities in which you will be acting at different times. Legally, a meeting which does not comply with the Bylaws is no meeting at all. Any action taken at an improperly conducted meeting really hasn’t been taken. For this reason, it is necessary that you become familiar with the Bylaws governing meetings for shareholders and for directors. Particular attention should be given to the notice requirements. A written record which shows that the meeting was properly held and which shows the actions taken at the meeting must be prepared. These are the functions of the corporate minutes. The Statement of Actions in Lieu of an Organizational Meeting illustrate the proper form. The minutes of a meeting must show that a quorum was present and the proper notice was given to everyone involved. Besides containing the substance of resolutions passed, the minutes should also list the names of those voting against any resolution. If actual meetings are inconvenient, or if a consensus can be reached informally, there is a substitute for the meeting process. Unanimous written consent of all shareholders or all directors will serve as the legal equivalent of a meeting (see Bylaws). The Players In closely held corporations, where the same people act in more than one of these capacities, the practical necessity of keeping the roles straight is very important. Shareholders As shareholders, you own the corporation. Shareholders do not own the business; the corporation owns the business, all assets, and all funds. Shareholder control of the corporation extends only to the election and removal of directors, amendment of the Articles of Incorporation, and a few other major transactions, such as dissolution, merger, sale of all the corporate assets, the making of certain loans, and issuance of new stock. These transactions will be valid only if authorized by the shareholders acting as shareholders, in a properly called shareholders' meeting. Directors As directors you are the managers of the corporation. You make all major business decisions, such as the hiring and firing of officers, compensation of employees, payment of dividends to shareholders, contracting with other businesses, loaning or borrowing money, initiation of new ventures, purchase of new equipment, etc. These decisions are expressed in the form of resolutions adopted by a majority vote in a directors' meeting, and recorded in the corporate minutes. Within areas over which directors have control, only those acts authorized by resolution will be considered acts of the corporation. Your authority is limited by law, the Articles of Incorporation, and the Bylaws, but you may amend the Bylaws. You should also be aware of restrictions on the manner in which directors conduct the corporation's affairs. Directors hold a great deal of power within the corporate structure. In order to protect others, both within and without the corporation, from abuse of this power, the law places certain restrictions on directors' actions. Directors are held to a fiduciary standard of loyalty to the corporation. In the capacity of director, and also as an individual, the director must act in the best interest of the corporation. This means that whenever there is a conflict between the director's personal interest and the corporation's interest, the conflict must be resolved in favor of the corporation. For example, a director is not free to individually pursue a new business opportunity if the opportunity could be pursued by the corporation and is within the corporation's line of business. Of course, a director cannot compete, even indirectly, with the corporation. All dealings between a director and the corporation must be approved after full disclosure, by an independent vote of a majority of the other directors (see Bylaws). Additionally, the dealings must be fair to the corporation. Do not enter into any agreement with the corporation, sell to, rent to or from, buy from, or otherwise deal with the corporation without consulting us. The corporation may not make loans to directors without complying with Oregon corporate law (ORS 60.364). Directors and share¬holders may make loans to the corporation, but these loans may, in some circumstances, be considered capital contributions. Again, our advice is suggested. The directors are responsible for the timely filing of all tax returns and other required reports. The failure to file tax returns and pay the taxes due may make the directors personally liable for the payment of some taxes -- for example, withholding taxes. Your tax advisor should keep you well advised of all of the tax obligations of the corporation so that they can promptly be paid. Officers directly responsible for making payment may also be liable. Officers Under Oregon law, each corporation must have at least a President and a Secretary. Additionally, corporations sometimes have Vice Presidents, Treasurers or Secretary/Treasurers. Most frequently, the corporations we represent have a President and a Secretary/Treasurer. The President and Secretary(/Treasurer) are the officers of the corporation. As officers, you are employees of the corporation. You conduct the everyday business of the corporation under the direction of the Board of Directors. Your acts are the acts of the corporation so long as you act within the authority given by the Articles of Incorporation, the Bylaws, and resolution of the Board of Directors. Voting As stated, directors and officers may be held liable for acts done without proper authority, for acts not in the corporation's best interest, and for failure to file tax returns. In addition, the following acts are specifically prohibited by law and will result in personal liability for directors:
Dissenting Any director present at a meeting where one of these votes is taken will be treated as having voted in favor of the action unless:
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Patricia L. Heatherman |
