Introduction to Business Organization
(part C)
by
Charles Lamson
Corporations
The Supreme Court described the corporation as "an association of individuals united for some common purpose, and permitted by law to use a common name and to change its members without dissolution of the association." The law creates a corporation---it does not exist merely by agreement of private individuals. It comes into existence by the state's issuing a charter. A corporation may be organized for any lawful purpose, whether pleasure or profit.
The law recognizes a corporation as an entity, something that has a distinct existence separate and apart from the existence of its individual members. The law views a corporation as an artificial person substituted for the natural persons responsible for its formation who manage and control its affairs. When corporation makes a contract, the contract is made by and in the name of this legal entity, the corporation, not by and in the name of the individual members. It has almost all the rights and powers of an individual. It can sue and be sued, it can be fined for violating the law, and it has recourse to the Constitution to protect its liberties.
Importance of Corporations
There are two major reasons why the corporation is such an important form of business organization. Corporations allow:
Pooling of Capital. The rapid expansion of industry from small shops to giant enterprises required large amounts of capital. Few people had enough money of their own to build a railroad or a great steel mill, and people hesitated to form partnerships with any but trusted acquaintances. In addition, even though four or five people did form a partnership, insufficient capital was still a major problem. Such a business needed hundreds or even thousands of people, each with a few hundred or a few thousand dollars, to pool their capital for concerted undertakings. The corporate form of business provided the necessary capital from any number of investors.
Limited Liability. Incorporation is attractive to business persons as a means of obtaining limited liability. Limited liability means that the maximum amount an investor can lose equals that person's actual investment in the business. Suppose three people with $20,000 each form a partnership with capital of $60,000. Each partner risks losing not only this $20,000 but also almost everything else owned, because of personal liability for all partnership debts. If a corporation is formed and each investor contributes $20,000 this amount is the maximum that can be lost, since an investor has no liability for corporate debts beyond the investment. Many businesses that formerly would have been organized as either a partnership or a sole proprietorship are today corporations in order to have the benefit of limited liability. The partners or the sole proprietor simply owns all, or virtually all, the stock of the corporation.
Piercing the Corporate Veil. Courts will, however, ignore the corporate entity under exceptional circumstances. When courts do, they say they are piercing the corporate veil. This can occur if one individual or a few individuals own all the stock of a corporation and ignore the corporate entity. Ignoring the corporate entity might be shown by such actions as an insolvent corporation loaning money to the stockholder, by commingling corporate and personal funds, and by having corporate assets go to the stockholder rather than the corporation. Instead of avoiding the disadvantage of unlimited liability of a sole proprietorship and a partnership, a corporate investor can thus be held personally liable
Disadvantage of Corporations
In a sole proprietorship, the investor completely manages the business. In a partnership, each investor has an equal voice in the management of the business. The main disadvantage of a corporation is that the people who own or control a majority of the voting stock have not merely a dominant voice in management but the sole voice. If there are 15 stockholders but one owns 51% of the voting stock, this stockholder is free to run the corporation as desired. The stockholder who owns the majority of the voting stock has the ability to dominate the board of directors and therefore the corporate officers. People who invest their savings in a business in the hope of becoming their own boss will not find the corporate type of business organization the most desirable unless they can control a majority of the voting stock.
INTERNET RESOURCES FOR BUSINESS LAW  *SOURCE: LAW FOR BUSINESS, 15TH ED., 2005, JANET E. ASHCROFT, J.D., PGS. 381-383, 385*
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