Start Here: 5 Things You MUST Know
A corporation is a separate legal entity — stockholders have limited liability (they can only lose their investment)
Courts pierce the corporate veil when owners commingle funds, undercapitalize, or ignore formalities
A "foreign" corporation means incorporated in another STATE (not country) — another country = "alien" corporation
Only the STATE can challenge a de facto corporation — private parties cannot
Directors owe duties of care (act prudently) and loyalty (no self-dealing) — insider trading penalties up to 3x profits
1. What Is a Corporation?
Corporation
A legal entity created under state law that exists separately from its owners (stockholders). Think of it as a "legal person" — it can own property, enter contracts, sue and be sued, all on its own. The #1 reason to incorporate is limited liability.
Real-World Scenario: Limited Liability Works
The Setup: Sarah invests $10,000 to buy stock in ABC Corp. ABC Corp gets sued and owes $2 million in damages.
What Happens: The corporation's assets are used to pay the judgment. Sarah's personal bank account, house, and car are NOT touched.
The Result: Sarah loses her $10,000 investment (stock becomes worthless), but her personal assets are safe. This is limited liability in action.
Types of Corporations
Publicly Held
Stock traded on public exchanges (NYSE, NASDAQ). Many stockholders. Subject to SEC regulations.
Privately Held (Close)
Stock NOT publicly traded. Small number of owners. Think family businesses that incorporated.
Professional Corp (PC)
Formed by doctors, lawyers, accountants. Liable for OWN malpractice but protected from other members' malpractice.
Critical Distinction: Foreign vs. Alien
Foreign Corporation
Incorporated in another STATE. A Delaware corporation doing business in New Jersey is "foreign" in NJ.
Alien Corporation
Incorporated in another COUNTRY. A Canadian company doing business in the US is an "alien" corporation.
Runaway Corporation Statute
A state law designed to prevent corporations from incorporating in one state (like Delaware, known for lenient laws) just to avoid the stricter regulations of the state where they actually do business.
2. Piercing the Corporate Veil
When Limited Liability FAILS
"Piercing the corporate veil" means a court ignores the corporation's separate identity and holds stockholders personally liable. This happens when owners abuse the corporate form.
Exceptions to Limited Liability (Exam Favorite)
Unpaid Wages
Several states hold stockholders liable for employees' wages and unemployment benefits earned but unpaid before insolvency.
Wrongful Acts
Courts hold stockholders liable when a corporation forms for an illegal purpose.
Ignoring Corporate Identity
If stockholders treat the corporation as a personal piggy bank — mixing funds, no records, no meetings — courts pierce the veil.
Inadequate Capitalization
Corporation set up with laughably little money relative to its business risks. Signals it was never meant to be a real separate entity.
Real-World Scenario: Veil Pierced
The Setup: Bob forms "Bob's Construction LLC" with only $500 in capital. He uses the company bank account to pay his personal mortgage and car payments. He never holds board meetings or keeps minutes.
What Happens: A worker is injured on the job and sues. The corporation has no real assets.
The Result: The court "pierces the corporate veil" because Bob treated the corporation as his alter ego. Bob is personally liable for the worker's injuries — his house, car, and savings are all at risk.
3. Corporation Formation
Three Stages of Forming a Corporation
Promoters
Take initial steps: finding investors, securing space, negotiating contracts. Owe a fiduciary duty to the future corporation. Personally liable on pre-incorporation contracts unless the other party agreed to look solely to the corporation.
Incorporation
The incorporator files articles of incorporation with the state. The state issues a certificate of incorporation. The corporation is legally born.
Organizational Meeting
First meeting after formation: adopt bylaws, elect officers, issue stock, open bank accounts, handle initial business.
De Jure Corporation ("in law")
Formed in full compliance with all legal requirements. Its validity cannot be challenged by anyone.
De Facto Corporation ("in fact")
Has minor defects in its formation process. Only the STATE (not private parties) can challenge its validity. A private party who dealt with it cannot escape obligations by claiming it was improperly formed.
Articles of Incorporation (Corporate Charter)
The corporation's "birth certificate." Typically contains:
Ultra Vires ("Beyond the Powers")
Acts a corporation takes that go beyond what its charter or state law allows. If a charter says "manufacture furniture" but the board invests in crypto speculation, a stockholder could challenge this as ultra vires. Most modern charters avoid this by stating purpose as "any lawful purpose."
4. Corporate Ownership & Stock
Debt Security (Bond)
A loan to the corporation. Bondholder is a creditor, NOT an owner. Gets fixed interest and money back at maturity.
Equity Security (Stock)
An ownership share in the corporation. Stockholders ARE owners. Value depends on company performance.
Common Stock
Basic ownership. Voting rights. Dividends not guaranteed. Last in line if the company dissolves.
Preferred Stock
Priority over common stock for dividends and capital distribution upon dissolution. Often no voting rights. A hybrid between bond and common stock.
Key Stock Terms
Par Value
Minimum price for initial issuance (legal concept, NOT market value)
Stated Capital
Total par value of all issued shares — protected floor for creditors
Capital Surplus
Money received ABOVE par value when stock is sold
Preemptive Right
Right to buy proportionate share of NEW stock to maintain ownership %
Treasury Stock
Issued then repurchased by corp. No voting rights, no dividends
Stock Split
Divide existing shares into more shares (2-for-1 doubles shares, halves price)
Real-World Scenario: Preemptive Rights
The Setup: You own 10% of XYZ Corp (100 out of 1,000 shares). XYZ decides to issue 500 new shares.
What Happens: If you have preemptive rights, you get the chance to buy 50 of the new shares (10% of 500) before they are offered to others.
The Result: You maintain your 10% ownership stake. Without preemptive rights, your ownership could be diluted to 6.67% (100/1,500).
5. Stockholders' Rights & Actions
Stockholder Powers
- Elect and remove board of directors
- Approve changes to articles of incorporation
- Make or amend bylaws
- Approve mergers, consolidations, and dissolution
- Sue directors for mismanagement (derivative suit)
- Inspect corporate financial statements and books
Proxy
Written authorization for someone else to vote your shares at a meeting
Quorum
Minimum shares represented at a meeting for it to be valid (typically majority)
Cumulative Voting
Pool all votes on fewer candidates — helps minority stockholders elect at least one director
Voting Trust
Transfer shares to a trustee who votes them — consolidates voting control
Direct Action
A suit by a stockholder for damage to their own individual rights. Recovery goes to the stockholder.
Shareholder Derivative Suit
A suit brought on BEHALF of the corporation against those who harmed it. Any recovery goes to the CORPORATION, not the individual stockholder.
6. Directors & Officers
Inside Director
Also an officer or employee of the corporation (e.g., CEO who sits on the board).
Outside Director
NOT an employee or officer. Brings independent perspective and is more credible in oversight roles.
Two Fundamental Duties
Duty of Care
Act with the care a reasonably prudent person would use. Be informed, make careful decisions. No rubber-stamping.
Duty of Loyalty
Put the corporation's interests above your own. No self-dealing, no competing with the corporation, no taking corporate opportunities for personal gain.
Insider Trading Penalties
Directors and officers with material non-public information CANNOT use it to buy/sell stock. Penalties include:
Damages
To stockholders harmed by the trades
Profit Seizure
Corporation can take the profit
3x
Treasury can take up to treble damages
When Can a Director Contract with the Corporation?
A director CAN enter into a contract with the corporation if ANY of these is true:
- Material facts disclosed to and approved by the board
- Material facts disclosed to and approved by the stockholders
- The contract was fair to the corporation
Real-World Scenario: Officer Criminal Liability
The Setup: Carol is president of X Corporation, a food business. The FDA finds rodent infestation at a warehouse and orders compliance.
What Happens: Carol instructs subordinates to fix the problem. After two more inspections, the violations persist. The FDA files criminal charges against both Carol and the corporation.
The Result: Both Carol and the corporation are criminally liable. Officers are responsible for crimes they commit AND for failing to ensure subordinate compliance — even if they gave the right instructions.
7. Dividends, Mergers & Dissolution
Types of Dividends
Property Dividend
Distribution of corporate property (not cash)
Stock Dividend
More shares issued (no cash leaves corp)
Liquidating Dividend
Return of capital, NOT from earnings
Capital Gains
Stockholder's profit from selling stock (NOT a dividend)
Merger
Two or more corporations combine into one surviving entity. The others cease to exist. Insurance mergers require state regulator approval.
Tender Offer / Hostile Takeover
Acquirer goes directly to stockholders, offering to buy shares at a premium. Bypasses the target's board. This is how hostile takeovers work.
Dissolution
Voluntary Dissolution
Board and stockholders decide to end the business.
Involuntary Dissolution
Forced by the state or court. Occurs when:
- Directors are deadlocked, causing irreparable injury
- Directors' acts are illegal, oppressive, or fraudulent
- Stockholders deadlocked for two successive meetings
- Corporate assets are wasted or misapplied
Cheat Sheet
Print this page for quick referenceFormation
- Promoters → Incorporation → Org Meeting
- Promoters personally liable on pre-inc contracts
- De jure = perfect. De facto = minor defects
- Only STATE attacks de facto corps
Piercing the Veil
- Commingling personal/corporate funds
- Inadequate capitalization
- Ignoring formalities (no meetings/records)
- Formed for illegal purpose
Directors & Officers
- Duty of care + duty of loyalty
- Insider trading = up to 3x profit penalty
- Derivative suit recovery goes to CORP
- Officers liable for subordinate noncompliance
Exam Trap Alerts
1. Foreign vs. Alien Corporation
"Foreign" does NOT mean from another country! A Delaware company doing business in NJ is "foreign" in NJ. A Canadian company in the US is an "alien" corporation. The exam loves this mix-up.
2. De Facto Corporation Challenge
Only the STATE can challenge a de facto corporation's existence. A private party who contracted with the de facto corporation cannot claim it was improperly formed to escape their own obligations.
3. Derivative Suit Recovery
In a shareholder derivative suit, any recovery goes to the CORPORATION, not the individual stockholder who brought the suit. Direct action recovery goes to the stockholder.
4. Dividends vs. Asset Distribution
Dividends come from EARNINGS. A return of invested capital is a "liquidating distribution," not a true dividend. The exam tests this distinction.
5. Officer Criminal Liability
Officers can be criminally liable even when they instructed subordinates to comply. The duty is to ensure compliance, not merely request it. Giving orders is not enough if you do not follow up.
6. Promoter Liability
The corporation is NOT automatically bound by promoter contracts. It must ADOPT them after formation. Promoters remain personally liable unless the other party agreed to look solely to the corporation.
Quick Reference Summary
Corporation
Separate legal entity created under state law. Limited liability for stockholders.
Piercing the Veil
Court ignores entity. Caused by commingling, undercapitalization, ignoring formalities.
De Jure vs. De Facto
De jure = fully compliant. De facto = minor defects, only STATE can challenge.
Duty of Care & Loyalty
Act prudently + put corporation first. No self-dealing or insider trading.
Derivative Suit
Stockholder sues on behalf of corp. Recovery goes to the corporation, not the stockholder.
Tender Offer
Buy shares directly from stockholders at a premium. Hostile takeover mechanism.