United States Corporate Law: Part 2

Incorporation and charter competition.

The process of starting up a new corporation is quick, though each state differs. A corporation is not the only kind of business organization that can be chosen. People may wish to register a partnership or a Limited Liability Company, depending on the precise tax status and organizational form that is sought. Most frequently, however, people running major enterprises will choose corporations which have limited liability for those who become the shareholders: if the corporation goes bankrupt the default rule is that shareholders will only lose the money they paid for their shares, even if debts to commercial creditors are still unpaid. A state office, perhaps called the "Division of Corporations" or simply the "Secretary of State", will require the people who wish to incorporate to file "articles of incorporation" (sometimes called a "charter") and pay a fee. The articles of incorporation typically record the corporation's name, if there are any limits to its powers, purposes or duration, and identify whether all shares will have the same rights. With this information filed with the state, a new corporation will come into existence, and be subject to the legal rights and duties that the people involved create on its behalf. The incorporators will also have to adopt "bylaws" which identify many more details such as the number of directors, the arrangement of the board, requirements for corporate meetings, duties of officer holders and so on. The certificate of incorporation will have identified whether the directors or the shareholders, or both have the competence to adopt and change these rules. All of this is typically achieved through the corporation's first meeting.

One of the most important things that the articles of incorporation determine is the state of incorporation. Different states can have different levels of corporate tax or franchise tax, different qualities of shareholder and stakeholder rights, more or less stringent directors' duties, and so on. However, it was held by the Supreme Court in Paul v Virginia that in principle states ought to allow corporations incorporated in a different state to do business freely. This appeared to remain true even if another state (for example Delaware) required significantly worse internal protections for shareholders, employees, or creditors than the state in which the corporation operated (for example New York). So far, federal regulation has affected more issues relating to the securities markets than the balance of power and duties among directors, shareholders, employees and other stakeholders. The Supreme Court has also acknowledged that one state's laws will govern the "internal affairs" of a corporation, to prevent conflicts among state laws. So under the present law, regardless of where a corporation operates in the 50 states, the rules of the state of incorporation (subject to federal law) will govern its operation. Early in the 20th century, it was recognized by some states, initially New Jersey, that the state could cut its tax rate in order to attract more incorporations, and thus bolster tax receipts. Quickly, Delaware emerged as a preferred state of incorporation. In the 1933 case of Louis K Liggett Company v Brandeis J Lee, represented the view that the resulting "race was one not of diligence, but of laxity", particularly in terms of corporate tax rates, and rules that might protect less powerful corporate stakeholders. Over the 20th century, the problem of a "race to the bottom" was increasingly thought to justify Federal regulation of corporations.