Corporations (Part 1)

The valet at the fronton

On December 15, 1977, Gladys Sykes pulled into the valet line at a jai-alai fronton, the arena where the game is played. She bought a parking ticket, got out, and walked toward the entrance through the gap between her car and the car ahead. The attendant got in and shifted into drive. When he saw her in the gap, about four feet wide, he tried to brake, but his foot slipped onto the accelerator. Her car moved forward and pinned her against the car in front. She sued three corporations. Dania Jai-Alai Palace, Inc. ran the fronton. Carrousel Concessions, Inc. ran the valet parking and employed the attendant. Saturday Corporation owned every share of both. A jury returned a $775,000 verdict against all three.

Why three? Each was a corporation, a legal person separate from the people who own it, and each one’s debts were its own. The attendant worked for Carrousel. To make Saturday pay as well, Sykes had to give the courts a reason to look past two corporations to the company that owned them. That is the question under this reading: how a corporation comes to exist apart from its owners, how it is organized inside, and when a court will set that separateness aside. The five fact patterns in the activity test each of those rules.

Signing before the filing

A Florida corporation begins to exist when the Department of State files its articles of incorporation. The articles can name a later effective date, or one up to five business days before the filing, but no earlier (section 607.0203). Before then there is no corporation, and nothing can bind it. A person who makes deals for the business in that gap is a promoter, and the law puts the risk of the gap on the promoter.

Joel Ratner found out how far that risk reaches. On November 3, 1978, he signed a merchant agreement with Central National Bank of Miami that let his business, The Stereo Corner, take credit card sales. He signed it for “The Stereo Corner, Inc.,” a corporation that would not exist for another eight months. In 1979 a store employee forged sales drafts, the bank charged them back against the store’s account, and the store became insolvent. The bank sued Ratner personally, and the trial court held him liable for $32,756.56.

Ratner argued that the corporation, once formed, had ratified the agreement, so the debt was no longer his. The Third District Court of Appeal disagreed in Ratner v. Cent. Nat’l Bank of Miami, 414 So. 2d 210 (Fla. 3d DCA 1982) (opens in a new tab). A promoter is liable on a contract made for a corporation not yet formed, the court said, unless the other party agreed to look elsewhere for payment. The corporation’s later adoption of the contract does not by itself release the promoter. Without a novation or an express release, the two can end up liable together. The record showed neither, and the judgment against Ratner stood.

In other words, adoption adds a second party who owes; it does not remove the first. What removes the first is the other party’s agreement: a release, or a novation that takes the corporation in the promoter’s place. Only the other party can give either one, so a promoter cannot get free alone.

Florida’s current statute adds a rule of its own. Under section 607.0204 (opens in a new tab), everyone who acts as or for a corporation, knowing it has not been incorporated, is jointly and severally liable for every liability created while acting that way. A creditor can collect the whole amount from any one of them.

The articles and the bylaws

Florida requires five things in the articles: a name, a principal office address, the number of authorized shares, a registered agent, and each incorporator’s name and address (section 607.0202). Anything else is optional, including a purpose. A Florida corporation whose articles state no purpose may engage in any lawful business (section 607.0301). Delaware’s corporation law (opens in a new tab) does require a statement of purpose, but a sentence saying the corporation may engage in any lawful act or activity is enough (section 102(a)(3)).

Founders who write a narrow purpose are choosing a limit. An act outside it is ultra vires, beyond the corporation’s powers, and Florida controls who may attack one. Under section 607.0304, a corporation’s lack of power can be raised in only three kinds of cases. A shareholder can sue to stop the act, the corporation can sue its own directors, officers, employees, or agents, and the state’s Department of Legal Affairs can bring a proceeding. In the shareholder’s suit, the court may block the act or set it aside, but only if that is equitable and everyone the act affects is a party. It may also award damages for losses its order causes, though not for profits someone expected to make.

The bylaws are the corporation’s own rulebook. The incorporators or the first board must adopt them, unless the articles give that power to the shareholders (section 607.0206). The statute has that happen at an organizational meeting after the filing, where the officers are appointed too, or by the written consent of every incorporator or director (section 607.0205). Bylaws may contain any rule consistent with the law and the articles, and they typically cover meetings, the election of directors, and what each officer does.

Founders who want a say over who buys in have to write that rule down. Florida lets the articles, the bylaws, or an agreement among the shareholders restrict the transfer of shares for any reasonable purpose (section 607.0627). One kind gives the corporation the first chance to buy. A restriction binds a buyer only if it is noted conspicuously on the share certificate or the corporation’s information statement, or if the buyer knew of it. And a restriction adopted later does not reach shares already issued unless their owners agreed to it or voted for it.

Who decides, and by how many votes

Power inside a corporation runs through three groups, and in a small one the same few people can fill all three. The shareholders own it. They elect the directors at the annual meeting (section 607.0803). A fundamental change, such as an amendment to the articles, ordinarily needs their approval after the board adopts it (section 607.1003). The board of directors exercises the corporation’s powers and manages its business, directly or by directing and overseeing others (section 607.0801). The officers are the ones the bylaws describe or the board appoints under them, and one person may hold more than one office (section 607.08401).

Votes follow shares, and shares follow the articles. Unless the articles provide otherwise, each outstanding share gets one vote (section 607.0721). The articles may create share classes with different rights, and they must spell out every class and the number of shares in it (section 607.0601). At least one class must carry unlimited voting rights, and at least one must be entitled to what is left when the corporation dissolves, which can be the same class. Beyond that, a class can carry extra votes, limited votes, or none, and a preferred class can come first for dividends or on dissolution.

Suppose two founders start a DeLand company that builds flight-simulation software. They keep 400,000 Class B shares with ten votes each and sell 1,000,000 Class A shares with one vote each to investors. The founders hold about 29 percent of the shares and 4,000,000 of the 5,000,000 votes. In other words, they own less than a third of the shares and cast four of every five votes. When the articles give a share more or less than one vote, Florida counts a majority in votes, not shares (section 607.0721), so the founders choose the board. An investor who buys a share buys the terms the articles attach to it.

What it takes to reach an owner

Florida’s starting point favors the owner. A shareholder’s only obligation for the shares, to the corporation or its creditors, is to pay the full consideration they were issued for (section 607.0622). The articles may make shareholders personally liable for the corporation’s debts, but only to the extent and on the conditions they state (section 607.0202). That is limited liability: the corporation’s creditors collect from the corporation.

Sykes’s case tested the exception. The Fourth District Court of Appeal had upheld the verdict against Saturday because Dania and Carrousel were its mere instrumentalities, holding that no fraud or wrongdoing had to be shown. The theory reached the Florida Supreme Court in its purest form. At trial, Sykes’s lawyer had stipulated that there was no wrongdoing or fraud involving Saturday. Was control alone enough?

It was not. On May 3, 1984, a unanimous Florida Supreme Court answered in Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984) (opens in a new tab). The corporate veil, it held, “may not be pierced absent a showing of improper conduct.” The court traced that rule through its own decisions back to the 1930s and declined to depart from it. Owning and controlling a corporation, even every share of it, does not make the corporation’s debts the owner’s. If it did, the court said, quoting an earlier decision, the corporation would no longer work as a way of doing business.

The ruling did not end Sykes’s case. The court sent it back for further proceedings against the companies that ran the fronton and employed the attendant. What failed was the claim against their owner.

Florida courts now state the rule as three things a creditor must prove. The shareholder dominated the corporation so completely that it had no independent existence. The shareholder used the corporation fraudulently or for an improper purpose. And that misuse caused the creditor’s loss. The Third District laid out the three in Gasparini v. Pordomingo, 972 So. 2d 1053 (Fla. 3d DCA 2008) (opens in a new tab), and other Florida courts apply them.

The court in Sykes’s case pointed to evidence that Carrousel ran as a business of its own. It had offices at the fronton, a written concession agreement with Dania, its own bank accounts and profit and loss statements, and about 120 employees it hired and fired itself. Its parking tickets carried its own name. Facts like those, or their opposites, such as an owner paying personal bills from the company’s account, are evidence on the first part of the test. On their own, they do not prove the second or the third. Your textbook (opens in a new tab) lists a second ground for piercing, a corporation that fails to act like one. In Florida, that shows at most the first part.

Two cases, five fact patterns

Ratner signed eight months before his corporation existed, and the debt stayed his. Saturday Corporation owned every share of two companies, and ownership alone did not make it answer for them. The five fact patterns on the activity page sit between those two cases. When the Analyst asks you to rule as a judge would, rule the way the Florida Supreme Court did in 1984: from what the record proves, not from who owns whom. Then let the Strategist ask what the founders should have done first.