Commercial Law

by Richard D. Currier; Richard William Hill; Samuel Williston

FOREIGN CORPORATIONS.—A foreign corporation is one which is organized under the laws of some foreign country or some other State. Foreign corporations are not necessarily confined to doing business in their own State; they may enter other States. As for example, a company organized in New Jersey may enter the State of New York and do business. If, however, the New Jersey corporation comes to New York and makes a regular practice of doing business, it must comply with the provisions of the corporation law of New York, and secure a license to do business in New York. It is not uncommon to enforce this provision in an indirect method by providing that if a foreign corporation does not take out this license, it shall not be allowed to sue in the courts of the State where it is doing business.

MANAGEMENT OF CORPORATIONS.—The management of any corporation rests directly with the board of directors and they may be considered as the agents of the corporation to direct its business affairs. The directors, however, are subject in their action to any limitation upon their power which may have been included in the charter or certificate of incorporation or which may have been adopted in the by-laws. The directors are also subject to any provisions in the statutes of the State, which frequently provide that they shall not take certain important actions, such as the mortgaging of corporate property, etc., without special procedure involving a meeting and vote of the stockholders. Where, however, the directors' authority is not limited by the statutes or the charter or by-laws, they may be considered as having full power to manage the affairs of the corporation. In connection with that power they may elect a president and other corporate officers and may appoint any other agents or employees at their discretion. They may also define the powers to be exercised by the president and the other officers and employees. This would give them power to limit the authority of the president or any other officer. However, where a person deals with the president or any other officer of a corporation in behalf of the corporation, he may usually rely reasonably upon the president or other officer having similar power to that generally possessed by such an officer, and in many cases the corporation would be held bound by the acts of such officer even though he actually violated some limits placed upon him by the directors. This may be illustrated by assuming that the X Company was in the business of manufacturing furniture, and A, the president thereof, had made a contract with B, an outsider, for the purchase from the latter of certain wood to be used in the corporate business. As a matter of fact, however, A, the president, had no power to make such contract, since the directors had passed a resolution forbidding him to purchase any raw materials without first having the proposed purchase approved by the board of directors. Therefore, A, as a matter of fact, would have no power to make the contract with B, on behalf of the corporation. Yet, B had not in any way been warned of this limitation upon A's power, and as the purchase of materials would be a usual one for the president or executive head of such a corporation to make, B might reasonably assume that A had power to make the contract. Therefore, B would be able to hold the corporation to the contract under the principle of apparent authority, considered in connection with the law of agency. Naturally, in turn, the directors would have a claim against the president for any loss sustained, as he had not only violated his duty but had also disobeyed and disregarded explicit instructions. The by-laws of a corporation are generally adopted by the stockholders and provide for all matters relating to the corporate management which are not provided for in the charter or certificate of incorporation. Such by-laws are binding upon all persons who know of them, or reasonably should know of them, provided they are not in violation of law and are reasonable. It is the general rule that meetings called to adopt new by-laws or to alter previous by-laws should be announced in some special way so that all interested parties may receive due notice and thus have an opportunity to arrange to be present and vote on the matters to be taken up at such meeting.

ELECTION OF DIRECTORS.—The directors of a corporation are elected by the stockholders and the election generally takes place at the regular annual meeting of stockholders of the corporation. Either the entire board of directors is elected at that time for the ensuing year, or a portion of them. In this connection it is provided by the statutes of many States that at least a certain proportion of the total number of directors shall be elected annually. The method of electing such directors at the annual meeting is usually provided for by the statutes of the various States, but it is commonly the rule that each stockholder shall have one vote for each share of stock owned by him, although in some States they also allow what is termed "cumulative voting." This method of voting generally allows each stockholder to have as many votes as he owns shares of stock multiplied by the number of directors to be elected at the meeting and he may cast all of his votes for one or more of the candidates. In other words if five directors are to be elected he may concentrate all his votes upon one or more of the candidates and is not compelled to vote for each one. This cumulative voting is authorized for the purpose of allowing the minority stockholders to concentrate their votes upon one or two of the candidates and thus have some representation upon the board of directors. As an illustration of this, let us assume that the X Company had an authorized capital stock of $100,000, composed of 1,000 shares at the par value of $100 per share, and that all these 1,000 shares are issued and fully paid up. Let us further assume that six individuals each own 100 shares of stock and act in unison, thereby constituting a majority, the other 400 shares of stock being held by the minority stockholders. Each stockholder would usually have one vote for each share of stock owned by him, and therefore, if five directors were to be elected under the usual method of voting, those individuals composing the majority of the stockholders would succeed in casting a majority of votes for each of the five directors. This would leave the minority without representation upon the board. If, however, cumulative voting were used, the minority having a total of 2,000 votes (400 multiplied by 5, the number of directors to be elected) could concentrate 2,000 votes upon one or two of their candidates and this would probably insure the election of such candidates to the board, thus giving the minority representation. In the case of a non-stock or membership corporation, each member has simply one vote for directors or for other purposes. It may be noted that the directors themselves, in their meetings, have also one vote each and this is entirely independent of the amount of stock which they may own in the corporation. It should also be noted that the directors in their meetings may not vote by proxy, but sometimes the members of a membership corporation may vote in this way. Voting by proxy is a usual practice in stock corporations. A proxy is merely a power of attorney or agency given in writing by one stockholder whereby he authorizes another person as his proxy to vote, at a corporate meeting, his shares of stock in his place. A proxy should be in writing and in a form in accordance with the statutes of the State involved, and is often, but not necessarily, under seal. A stockholder who has given a proxy may revoke it whenever he chooses and this would prevent the holder of the proxy from voting on it. This would be entirely independent of whether the person giving the proxy had by revoking it violated his contract with the person to whom it was given. That contract would be only a private matter between them.

VOTING TRUSTS.—The proxy principle is involved in what are termed "voting trusts." These arrangements involve the placing by a number of stockholders of their stock in the hands of certain persons, giving to the latter the right to vote on the stock; in other words, it is a concentration of the stock of a number of persons in the hands of one or a few persons. The latter are termed "voting trustees." It is necessary to consult the statutes of the various States with regard to the legality of such voting trusts, but they are generally permitted, with the restriction, however, that the agreement under which the stock is deposited with the voting trustee or trustees must be in writing and that any stockholder may have the right to deposit his stock with such trustee or trustees and become a party to the voting trust. The statutes also frequently limit the time during which such a voting trust may continue.

ISSUE OF STOCK.—The stock of a corporation is in theory issued for an amount of money or property equal to the par value of the stock. In practice, however, in many States there is no limitation on the valuation which the promoters of a corporation may put upon the property or rights which are transferred to the corporation. The stock is regarded as fully paid in if property transferred to it is transferred as having the assumed value of the corporation's capital, however little the property may actually be worth. In other States, however, an official must approve the valuation put upon property transferred as payment for stock, and in such States it may be assumed that the assets of a corporation when it begins business represent at least approximately the amount of its capital stock; even in such States, however, there is no difficulty in promoting a corporation which shall have a large capital though its property is of slight value. All that is necessary is to incorporate under the laws of another State which allows greater freedom. Corporations organized in one State are in general allowed to do business in other States; so that a corporation which is intended to carry on business in New York, may be incorporated in another State, where it is not expected to do business.

PROCEDURE IN ISSUING BONDS.—It is sometimes difficult for the investor fully to appreciate the vast amount of detail work involved in the bringing out of a new bond issue. Before the investment banker underwrites the issue, or makes his purchase from the corporation—before the bonds are offered to the public—there is always a painstaking and minute investigation of the new security from many different viewpoints, made by and in behalf of the banker. The investor can never know from the banker's printed circular, descriptive of the issue, the great amount of original work which underlies it and of which it is a meager reflection. The circular is a summary of the banker's investigation; it contains the salient features of the issue and of the issuing corporation, reduced to terms that are intelligible to the average layman. It is a statement of the principal facts which led the banker to make an investigation of the business and upon which investigation he bases his recommendation of the security offered by him to his clients.

WHAT IS A BOND?—This can be explained best by comparing it with a real estate bond and mortgage, the nature of which has already been discussed. When money is loaned on real estate, the mortgagor, or the one who borrows, executes two papers in favor of the mortgagee, or the lender. The first is either a promissory note or a bond. The bond is a sealed writing whereby the borrower binds himself, his heirs, administrators or executors, or assigns, to pay the lender a given sum of money at a specified time, together with interest. The second paper given as security for the note or bond, is a mortgage, which conveys the title to the property to the lender, with the provision, however, that if the borrower satisfies the conditions imposed in the bond—that is, the payment of a certain sum of money at a given time, together with interest as agreed—this conveyance (mortgage) is to be held null and void.

WHAT IS A CORPORATION INDENTURE?—The indenture is a more lengthy instrument than the bond, and, as will be noted, it is called an "indenture" and not a "mortgage." The mortgage strictly is only that portion of the indenture whereby the property is conveyed or deeded to the mortgagee, with the provision that the deed so given is to be held null and void in the event that the conditions named in the bond are faithfully carried out. The indenture is broader than the mortgage; it contains provisions other than those bearing directly on the mortgage. An indenture is a sealed agreement between two or more parties and any number of provisions may be inserted in it, in addition to the mortgage clauses, as may be deemed necessary or desirable. It is always possible for the individual to obtain a loan secured by a lien on his property, provided the security is good and considered ample. If, however, his property was of so great value that he desired to obtain a loan of several millions of dollars, he would find it difficult, or even impossible, to find any one person willing to lend him so large an amount. If, however, the borrower could find a number of persons who could and would jointly contribute enough money to equal the amount of the loan, he could divide this total amount into equal parts and each lender could have such a proportionate interest as might be desired. This, then, is the case with large corporations, which are legalized persons. Owing to the fact that the holders of the bonds have only a fractional interest in the loan and therefore in any property that may be pledged to secure it, it is impossible to create separate mortgages in favor of the individual bondholders on any particular part of the property. No portion of the property can be specifically designated—the interests of the bondholders are in common. For this reason and others, corporations are obliged to create what is known as a Mortgage Deed of Trust—making the mortgage to secure the many bonds in favor of some responsible individual or trust company, who holds it on behalf of the various bondholders in accordance with the definite terms of the trust, and who is therefore known as the Trustee. The indenture of the corporation must in addition to covering the mortgage, contain other related and necessary covenants, especially as to the trust that must be created. As there are so many covenants or provisions necessary in order to fully protect all interests concerned, the corporation indenture becomes bulky, but its form in substance is not very different from that of the bond and mortgage of the individual, which we have already analyzed, and which for this reason it is well for us to keep in mind as we follow the corporation indenture.

ANALYSIS OF INDENTURES.—The indenture, or agreement, must of necessity be made between certain parties, the mortgagor or the corporation and the mortgagee, in this case the Trustee who holds the security given in trust for the various bondholders. It is, therefore, proper that we recite at the very beginning of the indenture the parties in interest, giving their legal residence, or as in the case of corporations the names of the States wherein they are incorporated. It is quite essential that we know in what State a corporation was incorporated, as its rights and privileges are determined by the statutes of the State which created it and by the charter which has been granted to it. What are our reasons for creating the indenture? The very first premise is that the corporation is legally able to borrow money by law. If it did not have this right we could proceed no further. To borrow money and mortgage or pledge property as security therefor is a common law right of corporations, but the amount which may be borrowed is sometimes limited by State statutes. In the event that the corporation desired to borrow in excess of the limitation, additional capital stock is sometimes authorized thereby creating a larger basis for borrowing. If this premise is not incorporated, its omission does not affect the status of the indenture, but it is generally placed, as many other premises are, in the indenture, for the sake of logic, and to show that the matter has been considered, and that the fact is admitted by the parties to the indenture. The purpose for which the bonds are to be issued is sometimes duly set forth, as for instance, to refund certain maturing obligations, to construct a certain extension, to build new terminals, etc. While the purpose may not always be mentioned in the indenture, nevertheless it must accord with the charter of the corporation and the laws of the State. The company cannot exceed the powers that have been granted to it. We next want to know whether the authority to borrow money and issue bonds therefor has been obtained in lawful manner. Provisions covering the manner of securing this authority will be found in the by-laws of the corporation, and the counsel must examine this matter carefully in order to see whether all legal formalities have been strictly observed and whether the resolutions are in proper order. There are certain essential facts that must be stated in the bonds themselves and which are elaborated in the covenants of the indenture. These facts are embodied in the resolutions of the Board of Directors and of the stockholders and are, therefore, incorporated in the premises of the indenture. These facts include the total amount of bonds authorized, title, denomination, form, date of issue and maturity, rate of interest and where payable. In order that there may be uniformity in the wording and form of the bonds, so that no one holder will perchance receive an undue advantage over any other bondholder, the form of the bond, its coupons and trustee's certificate must be duly set forth in the indenture.

LIMITATION OF POWERS OF DIRECTORS.—There are various matters wherein directors of any corporation do not usually have power to act on behalf of the corporation without special authorization. Such matters include the amendment of the corporate charter (thereby changing the purposes of the corporation), the change of the name of the corporation, the increase or decrease of authorized capital stock, the sale of the total corporate assets and franchise, the consolidation of the corporation where permitted by statute, and the giving of mortgages upon the corporate property. This last point is especially important since the validity of a corporate mortgage as security for a loan of money depends upon whether the mortgage was authorized and given in all respects pursuant to statute of the State involved. As these corporate mortgages not only are given as security for a single loan of money but also furnish security often for very large amounts of bonds, the matter of the authority of the directors and the validity of the mortgage becomes of great importance. Therefore the statutes of the State involved must be followed closely as to the procedure in connection with the giving of a mortgage. It may be stated, however, with regard to this matter and the other special matters mentioned, the statutes generally provide that some form of authorization should be obtained from the stockholders, generally through their vote at a special meeting called for that purpose, of which proper notification and announcement have been given; that some form of certificate as to the proceedings at such meeting be made and filed by the secretary and treasurer or other designated officer of the corporation; that it should also be filed in the office of the county clerk of the county involved and in the office of the Secretary of State; and that some notification of the act in question be also given to the directors as well as the stockholders. It is, of course, impossible to take up the details as to such matters, the only safe course to pursue being to follow with extreme care the statutes of the State wherein such action is to be taken. From the foregoing, however, the general purpose and effect of prevailing law may be seen.