Guide to Operation of a Newly Formed California Corporation

GUIDE TO OPERATION OF NEWLY FORMED
CALIFORNIA CORPORATIONS

The purpose of this memorandum is to discuss certain procedures and operations relevant to a newly formed California corporation. The summaries below are not a complete analysis of the areas discussed, rather they are provided to give a basic understanding of the legal requirements which a California corporation should follow. Because this discussion is general in nature, it should not be relied upon as complete information regarding any of the matters discussed, but rather, should be used as a general guide.

1. Articles of Incorporation

   A California corporation is considered to be in existence when its Articles of Incorporation have been filed with the Secretary of State’s Office. Generally the Articles are brief, because very few items must be covered in the Articles to make them effective; however, there are many matters that the corporation might choose to include.

   The Articles must include the name of the corporation; a statement of business purpose; the name and address of the corporation’s initial agent for service of process; and a statement of the total number of shares of stock and a description of the different classes of stock (if there is more than one class).

   Certain provisions are only effective if contained in the Articles, such as granting the corporation the power to levy assessments on shares; granting shareholders preemptive rights; creating special qualifications for shareholders; limiting the corporation’s duration; increasing the required number of votes for actions by shareholders and directors over the amount set forth by statute; restricting the powers of the corporation or the businesses in which it may participate; giving debtholders voting rights; limiting certain liabilities of directors and permitting certain indemnification of corporate agents; and granting shareholders the right to determine the consideration for which corporate stock shall be issued.

   California law allows a corporation to amend the Articles in any way it desires, so long as the amendment is lawful at the time the corporation chooses to add it to the Articles. Before the corporation has issued its stock, the Articles may be amended by a writing signed by a majority of the incorporators, if directors have not been elected and have not been listed in the original Articles, or by a majority of the directors, if they have been elected or have been named in the original Articles. Once stock has been issued, the Articles generally may be amended or repealed by approval of the Board and a majority of the outstanding corporate stock entitled to vote. Once an amendment is adopted, the corporation must file a Certificate of Amendment with the Secretary of State to make the amendment effective.

2. Bylaws

   The Bylaws of the corporation set forth various corporate procedures and matters affecting the governance of the corporation. The Bylaws set forth in general terms the responsibilities of the directors and corporate officers, the number or range of directors, the manner (including required notice for) of calling meetings of the shareholders and directors, the maintenance of corporate records, the issuance of reports to shareholders, the voting and proxy procedures, the regulation of the transfer of corporate stock, and other general corporate matters.

   Bylaws generally may be adopted, amended, or repealed by either the Board or by a vote of the shareholders; however, the Bylaws may limit the Board’s powers in this respect. Certain provisions in the Bylaws require the approval of a majority of the outstanding shares before they may be adopted or changed, such as a change in the number of directors.

3. Following Corporate Formalities

   Corporate status generally shields the shareholders of the corporation from individual liability for the acts of the corporation. Courts allow this corporate privilege to exist only as long as the corporation remains properly organized, adequately capitalized, and completely separate as a legal entity. If a court finds that the corporate privilege has been abused, the corporate entity may be disregarded for the purpose of remedying the specific abuse and the corporate shareholders may be liable for the corporation’s acts relating to that abuse.

   The legal theory upon which shareholder liability is based is generally called the alter-ego doctrine. An individual attacking the corporate status to achieve shareholder liability will try to pierce the corporate veil, to prove that the corporation is merely an agent of the individuals behind it. An individual trying to pierce the corporate veil and assert the alter-ego doctrine must generally prove two things: first, that there is a unity of interest and ownership between the corporation and the shareholders, such that the corporation and the shareholders are no longer separate or individual; and second, that an injustice or fraud will occur, if the corporation’s actions are treated solely as the acts of the corporation.

   A corporation can reduce the possibility that the individual shareholders will be subject to liability for the corporation’s actions by following the guidelines listed below:

   1. The corporation should ensure that it is adequately capitalized from its organization to enable it to carry on its business.
   2. The corporation should obtain insurance to cover all of its insurance needs. It is suggested that the corporation consider coverage including general liability insurance, fire and casualty insurance, life and disability insurance for key personnel, insurance to fund share repurchases in the event of death or disability of a shareholder, business interruption insurance, and workers’ compensation insurance.