could be limited to the corporation itself.
The shareholders, the investors in the corporation, were liable only to the extent of their contribution to the business. This was a significant development in world economic history.
Case No. 3: The English Rose/Sir Richard Starkey
In the late 1500s maritime activity was increasing. The New World beckoned with the promise of riches and opportunity. The then small segment of Europeans with money were investing in sailing ships to pursue trading opportunities. If your ship could make it across the Atlantic with supplies, sell them or trade them for commodities, and return with a valuable cargo, you could make a fortune. This scenario was the origin of the phrase: “When my ship comes in.”
During this time, two groups of London promoters were soliciting investors to outfit a ship and send it to the Caribbean in search of trading opportunities. A ship known as the Royale Returne had just recently arrived at the London docks and its investors had reaped profits of 1,000 percent. Investors were excited by these opportunities. The first group was outfitting a ship known as the English Flyer. The promoters brought investors in as general partners, offering 10 percent of the profits in exchange for £250. In Elizabethan England, as today, there was no special requirement to get permission to operate as a general partnership.
Two British gentlemen, Sir Richard Starkey and Master John Fowles, were potential investors. Master John Fowles was astounded by the profits the Royale Returne had generated for its investors. He wanted to invest in the very next ship set to sail. It didn’t matter that the English Flyer was a partnership. The personal liability of a general partnership did not trouble him—not when huge profits were in sight. Fowles invested £250 in the English Flyer as soon as he could.
The second group of promoters was outfitting the English Rose. They wanted the limited liability of a new entity called a corporation. The problem was that, like today, it cost extra money to form and you had to wait for the Crown to give you a charter. But the second group of promoters was more careful than the first. They did not want to put themselves or their investors at risk in case the ship never returned. Sir Richard Starkey, being prudent and cautious, chose to invest in the English Rose. He knew there was risk in venturing across the Atlantic. He wanted to limit his exposure to just £250.
As it turned out, the English Rose and the English Flyer left London for the Caribbean at about the same time. As they set sail the risks to the investors in each enterprise were as follows:
| The English Player | The English Rose | |
| Business Entity | General Partnership | Corporation |
| Investment | £250 for 10% of general partnership interests | £250 for 10% of corporation’ shares |
| Liability | Unlimited joint and several | Limited to £250 |
| If ship does not return | Each investor personally liable for all debts and obligations | Each investor’s liability limited only to the £250 put into corporation |
As luck would have it, the English Flyer was lost near the Bermuda Triangle. The promoters had leased the ship, provided their own captain, and were now responsible to the owners for its loss. The promoters and 90 percent of the general partners did not have as much money as Master John Fowles did. As we learned in Louise’s case, and as has been the case for centuries, creditors will go after the easiest target with the deepest pockets. And so Master John Fowles, only a 10 percent general partner, was sued and held responsible for the entire loss of the English Flyer. He learned the hard way what happens when your ship does not come in, and you are responsible for it.
As Sir Richard Starkey’s luck would have it, the English Rose did well on each side of the Atlantic and provided a huge return to its investors. Unlike Master John Fowles, Sir Richard Starkey was willing to lose £250 and no more. By using a corporation instead of a partnership he was able to establish his downside risk, while allowing for his upside advantage to be unlimited.
Sir Richard Starkey and other knowledgeable and sophisticated investors have used corporations, and other good entities, to limit their liability for centuries.
Forming a corporation is simple. Essentially, you file a document that creates an independent legal entity with a life of its own. It has its own name, business purpose, and tax identity with the IRS. As such, it—the corporation—is responsible for the activities of the business. In this way, the owners, or shareholders, are protected. The owners’ liability is limited to the monies they used to start the corporation, not all of their other personal assets. If an entity is to be sued it is the corporation, not the individuals behind this legal entity.
A corporation is organized by one or more shareholders. Depending upon each state’s law, it may allow one person to serve as all officers and directors. In certain states, to protect the owners’ privacy, nominee officers and directors may be utilized. A corporation’s first filing, the articles of incorporation, is signed by the incorporator. The incorporator may be any individual involved in the company, including, frequently, the company’s attorney.
The articles of incorporation set out the company’s name, the initial board of directors, the authorized number of shares, and other major items. Because it is a matter of public record, specific, detailed, or confidential information about the corporation should not be included in the articles of incorporation. The corporation is governed by rules found in its bylaws. Its decisions are recorded in meeting minutes, which are kept in the corporate minute book.
When the corporation is formed, the shareholders take over the company from the incorporator. The shareholders elect the directors to oversee the company. The directors in turn appoint the officers to carry out day-to-day management.
The shareholders, directors, and officers of the company must remember to follow corporate formalities. They must treat the corporation as a separate and independent legal entity, which includes holding regularly scheduled meetings, conducting banking through a separate corporate bank account, filing a separate corporate tax return, and filing corporate papers with the state on a timely basis.
Failure to follow such formalities may allow a creditor to disregard officers, directors, and shareholders. This is known as “piercing the corporate veil” – a legal maneuver in which the creditor tries to establish that the corporation failed to operate as a separate and distinct entity; if this is the case, then the veil of corporate protection is pierced and the individuals involved are held personally liable. (And know that piercing the veil is successful in almost half of all cases!) Adhering to corporate formalities is not at all difficult or particularly time-consuming. In fact, if you have your attorney handle the corporate filings and preparation of annual minutes and direct your accountant to prepare the corporate tax return, you should spend no extra time at it with only a very slight increase in cost. The point is that if you spend the extra money to form a corporation in order to gain limited liability it makes sense to spend the extra, and minimal, time and money to ensure that protection is achieved.
One disadvantage of utilizing a regular (or C) corporation to do business is that its earnings may be taxed twice. This generally happens at the end of the corporation’s fiscal year. If the corporation earns a profit it pays a tax on the gain. If it then decides to pay a dividend to its shareholders, the shareholders are taxed once
