7.3 Corporations: Formation & Structure

A corporation is a legal person separate from its owners, created by state statute. Many states base their statutes on the Model Business Corporation Act (MBCA), and the NALA CP exam expects you to know the formation documents, the three-tier governance structure, the C/S tax divide, and when the liability shield fails.

Formation: Articles of Incorporation

A corporation exists only upon filing articles of incorporation (called a charter or certificate of incorporation in some states) with the secretary of state. Under the MBCA the articles must include:

• The corporate name, containing "corporation," "company," "incorporated," "limited," or an abbreviation
• The number of authorized shares the corporation may issue
• The name and address of the registered agent and registered office
• The name and address of each incorporator

Articles often add optional provisions: the corporation's purpose (modern statutes allow "any lawful purpose"), limitations on director liability, and shareholder preemptive rights. One or more incorporators sign and file the articles; an incorporator's only job is to execute the filing and, if directors are not named in the articles, hold the organizational meeting to adopt bylaws and elect the initial board. After that, the incorporator's role ends.

Two exam-favorite doctrines rescue a business whose owners thought they incorporated but botched the filing:

• De facto corporation: Exists when there is a statute under which the entity could validly incorporate, a good-faith attempt to comply, and actual use of corporate powers. The defect can be attacked only by the state, not by private creditors.
• Corporation by estoppel: A party who dealt with the business as if it were a corporation is estopped from denying its corporate status to reach the owners personally.

Bylaws

Bylaws are the corporation's internal operating rules: meeting procedures, quorum and voting requirements, officer titles and duties, and record-keeping. They are not filed with the state, do not need to appear in the articles, and bind only the corporation and its insiders — not third parties. A frequent exam trap swaps "articles" and "bylaws"; remember: articles are filed and create the entity; bylaws are internal and govern its operation.

Governance: Shareholders, Directors, Officers

Directors' duty of care requires acting in good faith, with the care of an ordinarily prudent person in a like position. The duty of loyalty forbids self-dealing and usurping corporate opportunities. Courts apply the business judgment rule: an informed, disinterested, good-faith decision will not be second-guessed, even if it turns out badly. Shareholders exercise power at the annual meeting (and special meetings), voting by proxy if they cannot attend.

C Corporation vs. S Corporation

The C/S distinction is a federal income tax distinction, not a state-law entity difference — both are ordinary corporations under state law.

• C corporation: The default under Subchapter C of the Internal Revenue Code. The corporation pays tax on its income, and shareholders pay tax again on dividends — double taxation. There are no limits on the number or type of shareholders or classes of stock.
• S corporation: A corporation that elects pass-through treatment under Subchapter S by filing Form 2553, signed by all shareholders. Eligibility requirements:
  • A domestic corporation
  • 100 or fewer shareholders (family members may count as one)
  • Shareholders must be individuals, estates, or certain trusts — no corporations, partnerships, or nonresident aliens
  • Only one class of stock (differences in voting rights are permitted)

An S corporation's income, losses, deductions, and credits pass through to shareholders' individual returns (Form 1120-S with Schedule K-1s), avoiding entity-level tax. A common exam trap: the S election does not change the shareholders' limited liability under state law — only the tax treatment.

Piercing the Corporate Veil

Shareholders' limited liability is the corporation's defining feature, but courts will pierce the corporate veil and hold shareholders personally liable — in an equitable, case-by-case analysis — when factors such as these are present:

• Alter ego / domination: The corporation is a mere instrumentality of the shareholder with no separate mind of its own
• Undercapitalization: The entity was set up with capital inadequate for its foreseeable risks
• Failure to observe formalities: No meetings, no minutes, no bylaws, no separate records
• Commingling of personal and corporate funds
• Fraud or injustice: The shield is being used to defeat a legitimate creditor

Piercing is most common in closely held corporations, and the absence of any single factor is rarely fatal — but a one-shareholder corporation is not pierced merely for being closely held; legitimate one-person corporations are perfectly valid.

Paralegal scenario: a client runs a delivery business as a corporation but pays personal rent from the corporate account, never holds meetings, and keeps the company chronically underinsured. After a serious accident, the injured plaintiff sues the owner individually. This fact pattern is a veil-piercing classic — commingling, ignored formalities, and undercapitalization all point to alter ego.

Common exam traps: (1) Crediting bylaws as the formation document — articles create the corporation. (2) Saying shareholders manage the daily business — that is the officers' role; shareholders elect directors and vote only on fundamental changes. (3) Believing an S corporation can have preferred stock or a corporate shareholder — both destroy the election. (4) Assuming veil piercing is automatic for small corporations — it requires misuse of the form, not small size.