Community Associations Are Corporations
The purpose of this information is to stress the importance of the concepts that COMMUNITY ASSOCIATIONS (HOA) are in fact CORPORATIONS. And therefore, the Board of Directors and the homeowners should conduct the business affairs of the HOA in a professional manner (as a corporation and as a business) pursuant to the laws governing corporations. Not withstanding, nor forgetting the notion that this is your home, this is the place you have chosen to live, when proper and professional business procedures are followed, the homeowners will realize true strength in the unity of the homeowners and the Board of Directors. And moreover, the value of your property will increase and you can be more certain of the enjoyment of your property.
The following information has been taken from “West’s Business Law” Fifth Edition by Kenneth W. Clarkson, Roger LeRoy Miller, Gaylord A. Jentz and Frank B. Cross pages 768 thru 805.
1. Introduction, and Management Powers
The corporation is a creature of statute. A corporation is an artificial being, existing in law only and neither tangible nor visible. Its existence depends generally upon state law, although some corporations, especially public organizations, can be created under federal law. Each state has its own body of corporate law, and these laws are not entirely uniform. The Model Business Corporation Act (MBCA) is a codification of modern corporation law that has been influential in the codification of corporation statutes in many states. Today, the majority of state statutes are guided by the revised MBCA, known as the Revised Model Business Corporation Act (RMBCA). It should be kept in mind, however, that there is considerable variation among the statutes of the states that have used the MBCA or the RMBCA as a basis for their statutes, and several states do not follow either act. Because of this, individual state corporation laws should be relied on rather than the MBCA or RMBCA. The corporation is an important form of business organization in the United States and has been for over one hundred years.
2. Nature of the Corporation
A corporation is a legal entity created and recognized by state law. It can consist of one or more persons identified under a common name.
3. The Corporation as a Legal “Person”
A corporation is recognized under state and federal law as a “person,” and it enjoys many, but not all, of the same rights and privileges that U.S. citizens enjoy. The Bill of Rights guarantees to “persons” certain protections, and corporations are considered persons in most instances. Accordingly, a corporation has the same right as a natural person to equal protection of the laws under the Fourteenth Amendment. A corporation has the right of access to the courts as an entity that can sue or be sued. It also has the right of due process before denial of life, liberty, or property, as well as freedom from unreasonable search and seizure and from double jeopardy.
Under the First Amendment, corporations are entitled to freedom of speech, just as individuals are. In addition to freedom of commercial speech (advertising), corporations may express their political viewpoints on particular issues. The right of corporations to free political speech has been challenged in the past by those who assert that news publishing corporations should give equal space to opposing points of view. Recently, however, the United States Supreme Court has made it clear that no such restrictions should be placed on a corporation’s freedom of speech.
Only the corporation’s individual officers and employees possess the Fifth Amendment fight against self_incrimination, however. And the privileges and immunities clause of the Constitution (Article IV, Section 2) does not protect corporations, nor does it protect an unincorporated association. This clause requires each state to treat citizens of other states equally with respect to access to courts, travel rights, and so forth.
An unsettled area of corporation law has to do with the criminal acts of a corporation. Because obviously a corporation cannot be sent to prison even though, under law, it is a person_most courts hold a corporation that has violated the criminal statutes liable for fines. When criminal conduct can be attributed to corporate officers or agents, those individuals, as natural persons, are held liable and can be punished for their acts.
4. Characteristics of the Corporate Entity
A corporation is a legal entity with rights and responsibilities. The corporation substitutes itself for its shareholders (homeowners) in conducting corporate business and in incurring liability, yet its authority to act and the liability for its actions are separate and apart from the individuals who own it. Responsibility for the overall management of the corporation is entrusted to a board of directors, which is elected by the shareholders (homeowners) [RMBCA 8.01, 8.03]. Corporate officers and other employees are hired by the board of directors to run the daily business operations of the corporation. Officers are agents of the corporation. They answer to the board of directors rather than to the shareholders (homeowners) directly.
When an individual purchases a share of stock in a corporation, that person becomes a shareholder and an owner of the corporation. As a general rule, a shareholder is not personally liable for the corporation’s business debts; nor is the corporation responsible for a shareholder’s personal debts. Each shareholder’s liability is limited to the amount of the investment (that is, the money actually paid when the stock was acquired) [RMBCA 6.221. Unlike the members in a partnership, the body of shareholders (homeowners) can change constantly without affecting the continued existence of the corporation. A shareholder can sue the corporation, and the corporation can sue a shareholder. Also, under certain circumstances, a shareholder can sue on behalf of a corporation. These rights, as well as the rights and duties of all corporate personnel, will be discussed in the following chapter.
Because a corporation is a separate legal entity, corporate profits are taxed by state and federal governments. Corporations can do one of two things with corporate profits_retain them or pass them on to shareholders (homeowners) in the form of dividends. The corporation receives no tax deduction for dividends distributed to shareholders (homeowners). Dividends are again taxable (except when they represent distributions of capital) as ordinary income to the shareholder receiving them. This double taxation of corporate income is one of its major disadvantages. Retained earnings, if invested properly, will yield higher corporate profits in the future and thus cause the price of the company’s stock to rise. Individual shareholders (homeowners) can then reap the benefits of these retained earnings in the gains they receive when they sell their shares.
5. Public and Private Corporations
A public corporation is one formed by the government to meet some political or governmental purpose. Cities and towns that incorporate are common examples. In addition, many federal government organizations, such as the U.S. Postal Service, the Tennessee Valley Authority, and Amtrak, are public corporations. Private corporations, in contrast, are created either wholly or in part for private benefit. Most corporations are private. Although they may serve a public purpose, as a public utility does, they are owned by private persons rather than by the government.
6. Nonprofit Corporations
Corporations that are formed without a profit making purpose are called nonprofit, not_for_profit, or eleemosynary (charitable) corporations. Usually (although not necessarily) private corporations, they can be used in conjunction with an ordinary corporation to facilitate making contracts with the government. Private hospitals, educational institutions, charities, religious organizations, and the like are frequently organized as nonprofit corporations. The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without the individual members’ being personally exposed to liability.
7. Close Corporations
A close corporation is one whose shares are held by members of a family or by relatively few persons. Close corporations are also referred to as closely held, family, or privately held corporations. Usually, the members of the small group that is involved in a close corporation are personally known to each other. Because the number of shareholders (homeowners) is so small, there is no trading market for the shares. In practice, a close corporation is often operated like a partnership.
8. Formation of Corporations
The formation of a corporation involves two steps: (1) preliminary organizational and promotional undertakings_particularly, obtaining capital for the future corporation_and (2) the legal process of incorporation.
9. Promotional Activities
Before a corporation becomes a reality, people invest in the proposed corporation as subscribers, and contracts are frequently made by promoters on behalf of the future corporation. Promoters are those who, for themselves or others, take the preliminary steps in organizing a corporation. They issue the prospectus’ for the proposed organization and secure a charter.
Exact procedures for incorporation differ among states, but the basic requirements are similar.
11. State Chartering
Because state incorporation laws differ, individuals have found some advantage in looking for the states that offer the most advantageous tax or incorporation provisions. Delaware has historically had the least restrictive laws. Consequently, many corporations, including a number of the largest, have incorporated there. Delaware’s statutes permit firms to incorporate in Delaware and carry out business and locate operating headquarters elsewhere. (Most other states now permit this.) In contrast, closely held corporations, particularly those of a professional nature, generally incorporate in the state in which their principal stockholders live and work.
II. ARTICLES OF INCORPORATION
The primary document needed to begin the incorporation process is called the articles of incorporation. The articles include basic information about the corporation and serve as a primary source of authority for its future organization and business functions. The person or persons who execute the articles are called incorporators and are discussed below. Generally, the following should be included in the articles of incorporation.
1. Corporate Name
Choice of a corporate name is subject to state approval to ensure against duplication or deception. Fictitious_name statutes usually require that the secretary of state run a check on the proposed name in the state of incorporation. Some states require that the incorporators, at their own expense, run a check on the proposed fictional name for the newly formed corporation. Once cleared, a name can be reserved for a short time, for a fee, pending the completion of the articles of incorporation. All corporate statutes require the corporation name to include the word Corporation, Incorporated, or Limited, or an abbreviation of one of these terms. A corporate name is prohibited from being the same as, or deceptively similar to, the name of an existing corporation doing business within the state.
2. Nature and Purpose
The intended business activities of the corporation must be specified in the articles, and naturally, they must be lawful. A general statement of corporate purpose is usually sufficient to give rise to all of the powers necessary or convenient to the purpose of the organization. The corporate charter can state, for example, that the corporation is organized “to engage in the production and sale of agricultural products.” There is a trend toward allowing corporate charters to state that the corporation is organized for “any legal business,” with no mention of specifics, to avoid Unnecessary future amendments to the corporate charter.
A corporation can have perpetual existence under most state corporate statutes. A few states, however, prescribe a maximum duration after which the corporation must formally renew its existence.
III. CORPORATE POWERS
Corporations have both express and implied powers. These are distinguished and defined below.
1. Express Powers
The express powers of a corporation are found in its articles of incorporation, in the law of the state of incorporation, and in the state and federal constitutions. The following order of priority is used when conflicts arise among documents involving corporations:
1. The U.S. Constitution.
2. State constitutions.
3. State statutes.
4. The certificate of incorporation (charter).
6. Resolutions of the board of directors.
2. Implied Powers
Certain inherent powers attach when a corporation is created. Barring express constitutional, statutory, or charter prohibitions, the corporation has the implied power to perform all acts reasonably appropriate and necessary to accomplish its corporate purposes.
The acquisition of a share of stock makes a person an owner and shareholder in a corporation. As a shareholder, that person acquires certain powers in the corporation. These powers are discussed here along with the relationship of the shareholders (homeowners) to the corporation.
3. Shareholders (homeowners)’ Powers
Shareholders (homeowners) must approve fundamental changes affecting the corporation before the changes can be effected. Hence, shareholders (homeowners) are empowered to amend the articles of incorporation (charter) and bylaws, approve the merger or dissolution of the corporation, and approve the sale of all or substantially all of the corporation’s assets. Some of these powers are subject to prior board approval.
Election and removal of the board of directors are accomplished by a vote of the shareholders (homeowners). The first board of directors is either named in the articles of incorporation or chosen by the incorporators to serve until the first shareholders (homeowners)’ meeting. From that time on, selection and retention of directors are exclusively shareholder functions.
Directors usually serve their full term; if they are unsatisfactory, they are simply not reelected. Shareholders (homeowners) have the inherent power, however, to remove a director from office for cause (breach of duty or misconduct) by a majority vote. Some state statutes even permit removal of directors without cause by the vote of a majority of the holders of outstanding shares entitled to vote. Some corporate charters expressly provide that shareholders (homeowners), by majority vote, can remove a director at any time without cause.
IV. Relationship between
Shareholders (homeowners) and Corporation
As a general rule, shareholders (homeowners) have no responsibility for the daily management of the corporation, although they are ultimately responsible for choosing the board of directors, which does have such Control. Ordinarily, corporate officers and other employees owe no direct duty to individual stockholders. Their duty is to the corporation as a whole. A director, however, is in a fiduciary relationship to the corporation and therefore serves the interests of the shareholders (homeowners) as a whole.
Generally, there is no legal relationship between shareholders (homeowners) and creditors of the corporation, Shareholders (homeowners) can, in fact, be creditors of the corporation and have the same rights of recovery against the corporation as any other creditor. The rights and liabilities of shareholders (homeowners) are discussed in detail in the following chapter.
1. Shareholders (homeowners)’ Forum
Shareholders (homeowners)’ meetings must occur at least annually and additional special meetings can be called to take care of urgent matters. Because it is usually not practical for owners of only a few shares of stock of publicly traded corporations to attend the shareholders (homeowners)’ meetings, they normally give third persons a written authorization to vote their shares at the meeting. This authorization, called a proxy, is often solicited by management, as will he discussed later.
2. Notice of Meetings
The notice and time of meetings, including the day and the hour, are announced in writing to each shareholder at a reasonable length of time prior to the date of the shareholders (homeowners)’ meeting. The shareholder can waive the requirement of a written notice by signing a waiver form. A shareholder who does not receive written notice, but who learns of the meeting and attends without protesting the lack of notice, is said to have waived notice by such conduct. State statutes and corporate bylaws typically set forth the time within which notice must be sent, what methods can be used, and what the notice must contain.
Special_Meeting notices must include a statement of the purpose of the meeting; business transacted at a special meeting is limited to that purpose.
3. Conduct of Meetings
Corporate Articles or Bylaws may provide for the conduct of shareholders (homeowners)’ meetings. Typically, the company president or the chairperson of the board of directors presides, and the corporate secretary records the minutes of the meeting. The agenda may include reports of management, the amendment or repeal of bylaws, resolutions submitted on behalf of management or shareholders (homeowners), extraordinary corporate matters or decisions that require shareholder approval, and other subjects. Shareholders (homeowners) can offer and respond to proposals and resolutions. For example, shareholders (homeowners) concerned about social and political issues have used shareholders (homeowners)’ meetings to propose changes in corporate activities that pertain to those issues.
4. Share Holder Voting
In order for shareholders (homeowners) to act, a minimum number of them (in terms of number of shares held) must be present at a meeting. This minimum number, called a quorum, is generally more than 50 percent. Corporate business matters are presented in the form of resolutions (or letters, proposals etc.), which shareholders (homeowners) vote to approve or disapprove. Some state statutes have set forth voting limits, and corporations’ Articles or Bylaws must remain within these statutory limitations. Some states provide that obtaining the unanimous written consent of shareholders (homeowners) is a permissible alternative to holding a shareholder’s meeting.
Once a quorum is present, a majority vote of the shares represented at the meeting is usually required to pass resolutions. At times, a larger_than majority vote will be required either by statute or by corporate charter. Extraordinary corporate matters, such as merger, consolidation, or dissolution of the corporation require the approval of a higher percentage of the representatives of all corporate shares entitled to vote, not just a majority of those present at that particular meeting.
5. Voting Lists
Voting lists are prepared by the corporation prior to each shareholders (homeowners)’ meeting. Persons whose names appear on the corporation’s stockholder records as owners are the ones ordinarily entitled to vote. The voting list contains the name and address of each shareholder as shown on the corporate records on a given cutoff date, or record date. (RMBCA 7.07 allows a record date to be as much as seventy days before the meeting.) The voting list also includes the number of voting shares held by each owner. The list is usually kept at the corporate headquarters and is available for shareholder inspection.
6. Cumulative Voting
Most states permit or require shareholders (homeowners) to elect directors by cumulative voting, a method of voting designed to allow minority shareholders (homeowners) representation on the board of directors. Cumulative voting operates as follows: The number of members of the board to be elected is multiplied by the total number of units owned. The result equals the number of votes a shareholder has, and this total can be cast for one or more nominees for director. All nominees stand for election at the same time. When cumulative voting is not required either by statute or under the articles, the entire board can be elected by a majority of shares at a shareholders (homeowners)’ meeting.
7. Corporate Management Directors
Every corporation is governed by directors. Subject to statutory limitations, the number of directors is set forth in the corporation’s Articles or Bylaws. Historically, the minimum number of directors has been three, but today many states permit fewer.
8. Directors’ Election and Term of Office
The first board of directors is normally appointed by the incorporators upon the creation of the corporation, or directors are named by the corporation itself in the articles. The first board serves until the first annual shareholders (homeowners)’ meeting. Subsequent directors are elected by a majority vote of the shareholders (homeowners).
The term of office for a director is usually one year_from annual meeting to annual meeting. Longer and staggered terms are permissible under most state statutes. A common practice is to elect one_third of the board members each year for a three_year term. In this way, there is greater management continuity.
A director can be removed for cause, either as specified in the articles or bylaws or by shareholder action. Even the board of directors itself may be given power to remove a director for cause, subject to shareholder review. In most states, unless the shareholders (homeowners) have reserved the right at the time of election, a director cannot be removed without cause.
When vacancies occur on the board of directors due to death or resignation, or when a new position is created through amendment of the articles or bylaws, either the shareholders (homeowners) or the board itself can fill the position, depending on state law or on the provisions of the bylaws.
9. Directors’ Qualifications and Compensation
Few legal qualifications exist for directors. Only a handful of states retain minimum age and residency requirements. A director is sometimes a shareholder. But this is not a necessary qualification unless, of course, statutory provisions or corporate articles or bylaws require ownership.
Compensation for directors is ordinarily specified in the corporate articles or bylaws. Because directors have a fiduciary relationship to the shareholders (homeowners) and to the corporation, an express agreement or provision for compensation is necessary for them to receive money from the funds they control or for which they have responsibilities. Most, if not all, Homeowners Association Board’s of Directors serve without compensation.
10. Directors’ Management Responsibilities
Directors have responsibility for all policy_making decisions necessary to the management of all corporate affairs. Just as shareholders (homeowners) cannot act individually to bind the corporation, the directors must act as a body in carrying out routine corporate business. One director has one vote, and generally the majority rules.
The general areas of responsibility of the Board of’ Directors include the following:
1. Financial decisions such as the declaration and payment of dividends to shareholders (homeowners) or the issuance of authorized shares or bonds.
2. Authorization for major corporate policy decisions_for example, the initiation of proceedings for the sale or lease of corporate assets outside the regular course of business, the determination of new product lines, and the overseeing of major contract negotiations and major management_labor negotiations.
3. Appointment, supervision, and removal of corporate officers and other managerial employees and the determination of their compensation.
11. Board of Directors’ Meetings
The board of directors conducts business by holding formal meetings with recorded minutes. The date on which regular meetings are held is usually established in the articles and bylaws or by board resolution, and no further notice is customarily required. Special meetings can be called, with notice sent to all directors.
12. Delegation of Board of Directors’ Powers
The board of directors can delegate some of its functions to an executive committee or to corporate officers. In doing so, the board is not relieved of its overall responsibility for directing the affairs of’ the corporation, but corporate officers and managerial personnel are empowered to make decisions
relating to ordinary, daily corporate affairs within well_defined guidelines.
Most states permit the board of directors to elect an executive committee from among the directors to handle the interim management decisions between board of directors’ meetings, as provided in the bylaws. The executive committee is limited to making management decisions about ordinary business matters.
The officers and other executive employees are hired by the board of directors or, in rare instances, by the shareholders (homeowners). In addition to carrying out the duties articulated in the bylaws, corporate and managerial officers act as agents of the corporation, and the ordinary rules of agency apply or have been applied to their employment (unlike the board of directors, whose powers are conferred by the state). Qualifications are determined at the discretion of the corporation and are included in the articles or b~ la%A s. In most states, a person can hold more than one office and can be both an officer and a director of the corporation. Corporate officers can be removed by the board of directors at any time with or without cause and regardless of the terms of the employment contract, although it is possible for the corporation to be liable for breach of contract damages.
13. Rights and Duties of Directors, Managers, and Shareholders (homeowners)
No one individual shareholder or director bears sole responsibility for the corporation and its actions. Rather, a corporation joins the efforts and resources of a large number of individuals for the purpose of producing greater returns than those persons could have obtained individually.
Sometimes actions that benefit the corporation as a whole do not coincide with the separate interests of’ the individuals making up the corporation. In such situations, it is important to know the rights and duties of all participants in the corporate enterprise.
14. Duties of Officers and Directors
A director occupies a position of responsibility unlike that of other corporate personnel. Directors are sometimes inappropriately characterized as agents because they act for and on behalf of the corporation. No individual director, however, can act as an agent to bind the corporation, and as a group, directors collectively control the corporation in a way that no agent can control a principal. Directors are often incorrectly characterized as trustees because they occupy positions of trust and Control over the corporation. Unlike trustees, however, they do not own or hold title to property for the use and benefit of others.
Directors manage the corporation through the officers who are selected by the board. These officers are agents of the corporation. Directors and officers are deemed fiduciaries of the corporation. Their relationship with the corporation and its shareholders (homeowners) is one of trust and confidence. The fiduciary duties of the directors and officers include the duty of care and the duty of loyalty.
V. DUTY OF CARE
Directors are obligated to be honest and to use prudent business judgment in the conduct of corporate affairs. Directors must exercise the same degree of care that reasonably prudent people use in the conduct of their own personal business affairs.
Directors can be held answerable to the corporation and to the shareholders (homeowners) for breach of their duty of care. When directors delegate work to corporate officers and employees, the directors are expected to use a reasonable amount of supervision. Otherwise, they will be held liable for negligence or mismanagement of corporate personnel. For example, assume that a corporate bank director did not attend any board of directors’ meetings in five and one_half years and never inspected any of the corporate books or records. Meanwhile, the bank president made various improper loans and permitted large overdrafts. The corporate director could be held liable to the corporation for any losses resulting from the unsupervised actions of the bank president and the loan committee.
The standard of due care has been variously described and codified in many corporation codes and by judicial decisions.’ The impact of the standard is to require that directors carry out their responsibilities in an informed, businesslike manner.
Directors and officers are expected to act in accordance with their own knowledge and training. Most states and RMBCA 8.30, however, allow a director to make decisions based on information furnished by competent officers or employees, professionals such as attorneys and accountants, or even an executive committee of the board without being accused of acting in bad faith or failing to exercise due care if such information turns out to be faulty.
Directors are expected to attend board of directors’ meetings, and their votes should be entered into the minutes of corporate meetings. Unless a dissent is entered, the director is presumed to have assented. Directors who dissent are rarely held individually liable for mismanagement of the corporation. For this reason, a director who is absent from a given meeting sometimes registers, with the secretary of the board, a dissent to actions taken at the meeting. Directors are expected to be informed on corporate matters and to understand legal and other professional advice rendered to the board.
VI. THE BUSINESS JUDGMENT RULE
Directors are expected to use their best judgment in guiding corporate management, but they are not insurers of business success. Honest mistakes of judgment and poor business decisions on their part do not make them liable to the corporation for resulting damages. This is the business judgment rule. The rule immunizes directors and officers from liability when a decision is within managerial authority, as long as the decision complies with management’s fiduciary duties and as long as acting on the decision is within the powers of the corporation. Consequently, if there is a reasonable basis for a business decision, it is unlikely that the court will interfere with that decision, even if the corporation suffers thereby.
To benefit from the rule, directors and officers must act in good faith, in what they consider to be the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would exercise in similar circumstances. This requires an informed decision, with a rational basis and with no conflict between the decision maker’s personal interest and the interest of the corporation.
To be informed, the director or officer must do what is necessary to become informed: attend presentations, ask for information from those who have it, read reports, review other written materials such as contracts_in other words, carefully study a situation and its alternatives. To be free of conflicts of interest, the director must not engage in self_dealing. For instance, a director should not oppose a tender offer (an offer made by another company directly to the shareholders (homeowners) (homeowners) to purchase shares in the company) in the corporation’s best interest because its acceptance may cost the director his or her position. For a decision to have an apparently rational basis, the decision itself must appear to have been made reasonably. For example, a director should not accept a tender offer with only a moment’s consideration based solely on the market price of the corporation’s shares.