Illinois Law
Illinois Publicly Held Corporations Law
- Publicly Held Corporations Law
Publicly Held Corporations Law
There is no definitive line that separates a publicly held corporation from a close corporation. Some issues, such as restrictions regarding stock, are regulated by the Illinois Business Corporations Act of 1983. Federal law requires that publicly held corporations with more than five million dollars in assets and whose outstanding securities are held by more than 500 shareholders of record must meet several unique requirements of the Federal Securities and Exchange Act of 1934, including a requirement to submit periodic financial information to the Securities and Exchange Commission.
This chapter discusses how to form a publicly held corporation, the advantages and disadvantages of corporate status, and mergers and acquisitions.
Forming a Publicly Held Corporation
Advantages of Corporate Status
Becoming a corporation gives a business several advantages over other forms of business organization such as sole proprietorship or partnership.Survivability
One advantage of corporate status is that because a corporation is an artificial person, its existence does not depend on who its owners are at any given time. A corporation survives the death of an individual shareholder or director, or the transfer of shares. The corporation "dies" only when it is voluntarily or involuntarily dissolved. The ability to survive the death or departure of any individual person gives the corporation stability and makes it a more attractive candidate for long-term financing. Survivability also permits the corporation to raise funds by selling shares to new investors, because new owners can be added without disturbing the corporate form.Shareholder Insulation from Debt and Liability
A corporation is liable for its own debts and obligations without limit, but because the corporation can take out loans and be sued in its own name, the shareholders are not personally liable for debts should the corporation become unable to pay. Absent an agreement to the contrary, a corporation's creditors may not seek to collect debts from the owners of the corporation. In other words, the shareholders enjoy "limited liability." Limited liability makes investment in a corporation more attractive to potential investors because the most that can be lost is the initial investment.Incorporators of new corporations may not be able to enjoy limited liability immediately, however, because owners of a new corporation may be required by financial institutions to give personal financial assurances in order to receive funding. Financial institutions understand the risk they take by lending to young corporations without established credit records. They may try to limit their exposure by requiring shareholders to personally guarantee loans should the corporation become unable to make payments.
In addition to the possibility that financial institutions will require personal guarantees for loans to corporations, on rare occasions a court will ignore a business' corporate status and make its shareholders personally liable for the debts of a corporation. Disregarding corporate status is known as "piercing the corporate veil." In Illinois, piercing the corporate veil is extremely rare. Illinois courts use a two-prong test in deciding whether to pierce the corporate veil and ignore a corporation's corporate status. The first prong considers unity of interest and ownership between the corporation and the individual officers and directors. The second prong of the test focuses on the plaintiff's relationship to the corporation and asks whether piercing the veil is necessary to prevent injustice or fundamental unfairness. In other words, would allowing the individual corporate officer or shareholder a "shield" from liability sanction a fraud or promote injustice? The court considers many factors, including:
- Issuance or non-issuance of stock
- Whether there was sufficient capitalization for corporate undertakings
- Observance or non-observance of corporate formalities such as regular meetings and elections
- Payment or nonpayment of dividends
- Solvency or insolvency of the corporation at the time of the transaction in question
- Functioning of other officers
- Existence or absence of corporate records
- Whether the corporation was used as a facade for individual dealings
Centralized Management
Another benefit of corporate status is centralized management. The shareholders of a publicly held corporation are its owners, but management and control of the corporation are the responsibility of the board of directors, who may or may not be shareholders. In contrast, in a partnership each partner has a right to participate in management.Transferability of Interest
Shares of stock in a corporation may be freely bought, sold, assigned, or otherwise disposed of by their owners unless there are special circumstances. In contrast, partnership interests are freely transferable only with the permission of remaining partners. The free transferability of shares increases their value because investors know they will be able to sell the shares quickly and easily should they choose to do so.Disadvantages of Corporate Status
Becoming a corporation is not the best course of action for all businesses, since corporate status does have its disadvantages.Double Taxation
The biggest drawback of corporate status is double taxation. Most publicly held corporations file their own tax returns and pay taxes on corporate profits before paying dividends to the shareholders. When the shareholders receive the dividends, these profits are taxed on the individual shareholders' tax returns. In contrast, the profits of a partnership are taxed only once because a partnership pays no taxes before distributing profits. Partners only pay taxes on their individual share of the profits.Cost
Given the more complex nature of organizing and running a corporation as compared to other forms of business organization, most corporations pay more for professional services, such as accounting and legal services. In addition, the fees for incorporating are generally higher than fees for other forms of business organization. Finally, a corporation that sells securities faces substantial costs to comply with a myriad of securities regulations.Inflexibility
Another significant drawback to corporate status is the loss of flexibility in running the business. In order to avoid the possibility of a court piercing the corporate veil, a corporation needs to observe several formalities, such as regular meetings and elections. For some small businesses, the loss of flexibility may make corporate status more trouble than it is worth.State of Incorporation
Incorporators usually choose to incorporate under the laws of the state in which the corporation is primarily located, although they can choose to incorporate under the laws of another state. For example, close to one-third of the corporations in the United States are incorporated under the laws of the state of Delaware, even though most of them do little, if any, business in Delaware. The state of Delaware purposefully seeks to entice corporations to incorporate under its laws by maintaining an especially efficient system of courts that exclusively handles corporate matters. Because so many corporations are organized under Delaware laws, the Delaware Corporate Code has been litigated extensively. A result of the extensive amount of case law interpreting the Delaware Corporate Code is that outcomes of lawsuits are often easier to predict in Delaware, so many business operators now feel more comfortable knowing that corporate disputes will be handled in Delaware courts applying Delaware laws.Illinois Requirements for Corporations
Corporations formed under Illinois law must comply with the requirements set forth in the Illinois Business Corporations Act (IBCA). Any natural person at least 18 years of age may form a corporation by filing articles of incorporation with the office of the Illinois Secretary of State.Articles of Incorporation
The IBCA allows corporations to have very simple articles of incorporation. Articles of incorporation must include only:- Name of the corporation
- Address of the corporation's registered office and name and address of the registered agent
- Corporate purpose
- Authorized number of shares the corporation may issue
- Name and address of each incorporator
- Board of directors has the power to adopt, amend, or repeal bylaws
- Absent directors must be given an opportunity to give written consent or opposition to proposals
- An affirmative vote of a majority of directors present at a meeting is required for board action
- All shares have equal rights and preferences in all matters
Name Registration
Illinois statutes require that any business operating in Illinois under a name other than the full name of the business owner must register the assumed name with the Illinois Secretary of State. A "Certificate of Assumed Name" form is available from the Secretary of State's office. The business owner must fill out the form and submit it and the accompanying fee to the Secretary of State. The corporation's name registration is valid for ten years and can be renewed.Tax Issues
A corporation in Illinois must obtain a federal tax identification number. A corporation with employees also must register with the Illinois Department of Labor for Unemployment Compensation Insurance. Businesses that sell goods or services that are taxable must obtain a sales and use tax permit from the Sales Tax Division.Forms of Corporations
Corporations may be formed in a number of different ways.Subchapter C Corporation
Most large, publicly held corporations are Subchapter C corporations. The Subchapter C corporation takes its name from Subchapter C of the Internal Revenue Code. A Subchapter C corporation is subject to the general corporate taxation rules discussed above.Subchapter S Corporation
A Subchapter S corporation derives its name from Subchapter S of the Internal Revenue Code. Under Subchapter S, a corporation that meets certain requirements may be treated as a corporation for purposes of insulating its shareholders from personal liability for corporate debts, but treated as a partnership for tax purposes. Shareholders of a Subchapter S corporation receive limited liability protection, and their profits from the business are included on their individual income tax returns. Illinois has similar tax treatment for such corporations.To be treated as a Subchapter S corporation under federal tax laws, the corporation must:
- Be a domestic (not foreign) corporation
- Not be part of an affiliated group of corporations
- Not have more than 35 shareholders
- Have only one class of stock
- Have only shareholders who are individuals, a decedent's estate, or one of a special class of trusts (not corporations or partnerships)
- Have no shareholders who are nonresident aliens.
Director's Fiduciary Responsibilities
The attitude of lawmakers toward corporate directors is somewhat contradictory. Because directors hold great power in a corporation's management structure, the law imposes upon them a high standard of fidelity and loyalty to the interests of the corporation. On the other hand, because most Americans value the freedom of corporations to take risks and pursue untested ventures, lawmakers are loathe to restrict the actions of directors.Directors are said to owe the corporation "fiduciary duties." The parameters of directors' fiduciary duties are frequently the subject of lawsuits alleging that a director had a conflict of interest in his or her dealing with the corporation or failed to exercise good business judgment. Illinois statutes require a director to act in good faith, in a manner the director reasonably believes to be in the best interest of the corporation, and with reasonable care. Directors who perform their duties in compliance with this standard are not liable for their actions merely by reason of being or having been a director of the corporation. Put another way, directors' decisions made honestly and with reasonable prudence do not subject a director to liability even if the decisions turn out badly for the corporation.
Mergers and Acquisitions
Benefits of Merging and Acquiring
There are many possible reasons for mergers and acquisitions. By consolidating purchasing, advertising, and administrative functions, a larger, merged company may be more efficient than two smaller companies. A merger may give a company better access to credit and new products and may help to even out peaks and valleys in cash flow and profits. The Internal Revenue Code provides some incentive for a financially healthy corporation to acquire a troubled business. If the acquiring corporation meets several strict requirements, it may be able to use a limited part of the net operating loss carryover of the acquired business against the acquiring company's taxable income.There may be personal considerations that motivate a merger or acquisition. An owner preparing to retire or to resolve dissent within the company may look to a sale or merger to make assets more liquid. Sometimes a business may be growing so quickly that its owners need the skills and resources of a competitor to keep up with the growth. In some instances an older, more stable company may be interested in sharing its experience in exchange for the higher profit margin of a smaller, up-and-coming business.
Ways of Merging with or Acquiring Another Business
Generally, businesses are acquired or merged by one of three methods. Which method might be the best in a particular situation depends on such considerations as tax laws, antitrust laws, and corporate laws.Asset Acquisition
In this method of merger, a buyer purchases some or all of the seller's assets in exchange for securities, cash, or property of the acquiring corporation. If the seller is a corporation, the structure of the selling corporation will remain intact until the corporation is dissolved and the proceeds from the sale are distributed to shareholders. Minority shareholders generally do not have a say in the sale of the business and, since the buyer is not purchasing an entire business but only part of the whole, the buyer need not assume the liabilities of the seller. Asset acquisition is a way to acquire the physical property and accounts of another business without acquiring its liabilities.Acquiring the assets of a business can be more expensive than other types of acquisitions or mergers. There may be some difficulty in transferring contracts, leases, and licenses from third parties, and the title to each asset sold must be transferred separately.
Stock Acquisition
Under a stock acquisitionfrequently called a takeovercorporation's shareholders (who own the company) sell their shares of stock to a purchaser. In the event that management does not approve of the sale, the acquisition is called a hostile takeover.Under a stock acquisition, the directors' approval is not needed to purchase the corporation. The only documents that need to be transferred are stock certificates, contracts, or any other form of consideration by third parties.
There are a number of problems with takeovers. For example, the new majority shareholders may be liable for debts incurred under the old ownership prior to the purchase. The Securities and Exchange Commission may require registration for the sale. Minority shareholders may be able to hold out and retain positions within the acquired corporation, which may not be the new owners' preference.
Statutory Merger
Under a statutory merger, two corporations agree to combine and form a single corporation under state law. This arrangement must be agreed to by at least two-thirds of the shareholders from each corporation and by both boards of directors. Only one company survives, and it takes over all operations, assets, and liabilities of both companies. The shareholders of the disappearing corporation trade their shares of stock for an equity position in the surviving business. In a related type of merger, called a statutory consolidation, both businesses cease to exist and an entirely new entity is formed.A statutory merger is beneficial because all title transfers are automatic if the arrangement follows state guidelines, and because all assets of both companies are retained in the merger.
On the other hand, the surviving corporation runs the risk of assuming all liabilities of the disappearing corporation. Also, the process can be costly and time-consuming due to the necessity of shareholder meetings and the technicalities of state laws.
Corporate Buy-Sell Agreements
As with any buy-sell agreement, price is the cornerstone of an agreement to buy or sell a corporation or its assets. Determining the worth of a company to be purchased or merged can be determined by the book value of the company, by an independent appraisal, by comparing the price/earnings ratio within the seller's industry, or by any of several other methods. The method of sale can significantly affect the overall cost to the buyer and seller due to tax considerations. Some acquisitions are considered tax-free, while others are taxable. An accountant or tax attorney should be able to help a company understand and take advantage of tax-minimizing schemes.Employee Considerations
An agreement should guarantee that key employees are retained and that contracts for employment are transferred to the buyer company. The buyer should review any collective bargaining agreements thoroughly, since they may be binding. Retirement plans usually transfer to the buyer company as well.Seller Indemnification
It is common for an agreement to dismiss the buyer from any future unassumed liabilities from an asset purchase.Securities Regulations
A buyer of a business who offers securities in exchange for the business, or for significant shares of the business, may be considered an "issuer" of the securities and therefore may be required to register with the Securities and Exchange Commission. The buyer may, however, be eligible for exemption under the law. Determining whether a business must register and which kind of registration it must undertake can affect sellers' ability to resell the securities they receive as payment. There are a number of other considerations under both federal securities laws and state "blue-sky" laws to be aware of in mergers and acquisitions that involve the exchange of stocks. The advice of a competent attorney is highly recommended.Buyer-Seller Representations
The buyer in a transaction in which the seller is being paid in stock generally warrants that the stock is legal, authorized, and fully paid. The seller in the same type of exchange will warrant that the stock is legal, and will further note the condition of the business in financial documents.Resources
John Cotton Howell, Forming Corporations and Partnerships (Liberty Hall Press, Blue Ridge Summit, PA, 2d ed. 1991).
Illinois Attorney General, 100 Randolph W., 12th Floor, Chicago, IL 60601, (312) 814-2595.
Secretary of State, Department of Business Services, Springfield, IL 62756, (217) 782-1834. Internal Revenue Service, Forms Services, 230 Dearborn S., Chicago, IL 60609, 1-800-829-3676.
Michael G. Trachtman, What Every Executive Better Know About the Law (Simon & Schuster, New York, NY 1987).
Carolyn M. Vella & John J. McMonagle, Jr., Incorporating: A Guide for Small-Business Owners (American Management Associations, New York, NY 1984).
The Service Corps of Retired Executives (SCORE) is a fraternity of retired business managers who volunteer to help new or existing businesses and nonprofit organizations. Information about the services offered through SCORE can be gained by contacting one of its regional offices throughout the state.