Corporate Formation and Structure

Introduction

Corporate formation is the process by which a business entity becomes a legally recognized corporation. The corporation is a distinct legal entity, separate from its shareholders, with the capacity to own property, enter contracts, sue and be sued, and continue in existence regardless of changes in ownership. The law governing corporate formation and structure is primarily state law, with the Delaware General Corporation Law (DGCL) serving as the dominant statutory framework for publicly traded corporations and a model for other states.

The Incorporation Process

Forming a corporation requires filing articles of incorporation (or a certificate of incorporation in Delaware) with the secretary of state or other designated state official. The articles must include the corporation’s name, the purpose of the corporation, the number of authorized shares, and the name and address of the registered agent. Many states permit the statement of a general corporate purpose, such as engaging in any lawful business.

The incorporators—the persons who execute the articles—need not be shareholders or promoters. Upon filing, the articles become the corporation’s charter, and the corporate existence begins. The initial directors are typically named in the articles or elected by the incorporators, and they then adopt bylaws, the internal governance rules for the corporation.

Bylaws and Corporate Governance

The bylaws are the corporation’s internal operating manual. They regulate the conduct of corporate affairs, including the time and place of shareholder and board meetings, the number and qualifications of directors, the officers’ duties and powers, and the procedures for issuing stock. Bylaws may be amended by the board of directors or by the shareholders, and they must be consistent with the articles of incorporation and applicable law.

The corporate governance structure has three principal components: shareholders, who own the corporation; directors, who manage the business and affairs of the corporation; and officers, who execute the day-to-day operations under the board’s supervision. The DGCL and most state corporation laws follow this tripartite structure, allocating authority among the three groups.

Types of Stock

A corporation may issue different classes or series of stock with varying rights, preferences, and limitations. Common stock typically carries voting rights and the right to share in residual corporate assets upon liquidation. Preferred stock has preferential rights to dividends and distributions, usually at a fixed rate, and may have priority over common stock in liquidation. Preferred stock may be cumulative, convertible, redeemable, or participating.

Authorized shares are the maximum number of shares the corporation may issue, as specified in the articles of incorporation. Issued shares are those that have been sold to shareholders, and outstanding shares are issued shares that have not been repurchased. Treasury shares are issued shares that have been repurchased; they are authorized but not outstanding.

The DGCL Advantage

The Delaware General Corporation Law is the predominant corporate law statute in the United States. Over half of all publicly traded corporations and approximately two-thirds of Fortune 500 companies are incorporated in Delaware. The DGCL’s success reflects its flexibility, its sophisticated case law developed by the Delaware Court of Chancery and the Delaware Supreme Court, and its responsiveness to corporate needs.

The DGCL permits a wide range of corporate actions with minimal mandatory requirements. It authorizes broad indemnification, limits director liability for monetary damages, and provides a straightforward framework for mergers, acquisitions, and fundamental transactions. The Delaware courts have developed a highly developed body of fiduciary duty law that governs director and officer conduct.

Promoters and Pre-Incorporation Transactions

Promoters are persons who undertake to form a corporation and procure capital for it. Pre-incorporation contracts raise questions about liability: the corporation is not liable on promoters’ contracts until it adopts them, and promoters may be personally liable unless disclosure is made. Upon incorporation, the corporation may adopt pre-incorporation contracts by express resolution, implied conduct, or by accepting their benefits.

Conclusion

Corporate formation creates a legal entity with distinct attributes—separate legal personality, limited liability, perpetual existence, and centralized management. The process of incorporation, the structure of governance, and the types of stock are governed by state law, with the DGCL providing the dominant statutory framework. Understanding corporate formation is essential for any business lawyer or participant in corporate transactions.