Business Associations/Corporations Class 7

1. Business Associations/Corporations Class 7 Professor Hill

2. Vocabulary • Capital account • Book value • Cost basis • Fair market value • Distributions • Good Will

3. Capital Accounts • Example: Smith and Jones are partners. They buy 50% partnership interests for $20,000 each. Their capital accounts now are: • Smith $20,000; Jones $20,000 • Note that what Smith and Jones have is also their “equity” – in a sense, what the partnership ‘owes’ them • Partnership’s total assets, all cash =$40,000 • They agree to share profits and losses equally. In the first year, the partnership loses $20,000 • Smith: $20,000-10,000=10,000. Same for Jones • Partnership’s total assets=$20,000

4. Capital Accounts • Partnership buys a building for $10,000 • No change to capital accounts. • Partnership’s balance sheet has $10,000 of cash and building with “cost basis” of $10,000=$20,000 • Next, Smith takes out $5000 as a distribution (assume the partnership agreement permits this) • Smith: 10,000-5,000=5000. Jones: 10,000. • Partnership: $5,000 of cash and $10,000 worth of building= $15,000.

5. Capital Accounts • Next, assume the asset the partnership had that it paid $10,000 a few months ago for sells for $200,000. • Partnership has “gain” of $190,000. Has total assets of $205,000 now (old $5,000 + new $200,000, (or, old $5,000 + old $10,000 +$190,000 gain), now consisting of cash. • Profits divided equally. Jones has capital account of $10,000 + $95,000 (half of gain); Smith has capital account of $5,000 + $95,000. Total is $205,000

6. Valuation: Cost vs. FMV • Purchase asset for 100. 6 months later, asset is worth 50 • “cost”? • FMV? • What if asset is worth 100? • What # goes into capital accounts in the normal course?

7. Valuation • How much? • Future cash flows (for going concern) • Value of underlying assets (if not going concern, or if assets worth more than as part of business) • “Distress sale” value • [Other, agreed upon value]

8. Valuation • How determined? • Appraisal • Who chooses appraiser(s)? • Use of comparables? • Different possibilities • Formula • Disputes over application of formula • Auction (or holding out for sale) • How/how much to specify parameters? • Timing? Permitted bidders? Required terms?

9. Partnerships, LLEs and Corporations Most Entity- Like Most Aggregate- Like Large “C” Corp Limited Liability Corp (LLC) Smaller “C” or “S” Corp Limited Liability Partnership (LLLP) Limited Partnership (LP): Limited Liability Partnership (LLP): Partnership

10. Fiduciary Duties of Partners • (General) partners (including gps of LPs) have fiduciary duties to one another and to partnership • Limited partners: no fiduciary duties • Limited liability entities • only GP correlate may have fiduciary duties • For LLCs: RULLCA (2006) §409 • members if member-managed • Managers, if manager-managed

11. Fiduciary Duty of Partners in General Partnerships • UPA (1914) §21: “Partner accountable as a fiduciary” • Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with formation, conduct, or liquidation of the partnership of from any use by him of its property.”

12. Fiduciary Duty of Partners in General Partnerships (and LLPs) • RUPA (1997) §404 sets forth “the only” fiduciary duties of partners to each other, including duties of loyalty, care and good faith, arguably narrower than earlier regime, AND • RUPA (1997) §103 provides that partners can waive provisions of statute except: (next slide)

13. Fiduciary Duty of Partners (in general partnerships and LLPs), RUPA §103(b) • Can’t eliminate duty of loyalty except • Can “identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable; or” • Partners can authorize and ratify after disclosure act that would otherwise violate duty of loyalty • Can’t unreasonably reduce duty of care • Can’t eliminate obligation of good faith and fair dealing, except can prescribe standards, if not manifestly unreasonable

14. Fiduciary Duties of Partners in Limited Partnerships (and LLLPs) • GP fiduciary duties from RUPA applied to general partners in RULPA (1976/85) §403 • GP fiduciary duties in ULPA (2001) §408, with correlate to §103, §110(b)5-7. • Limited partner has no fiduciary duties. ULPA (2001) §305. • In LLC, duties are similar to ULPA, RULLCA §409, with analogue to limited partner owing no fiduciary duties. RULLCA also has correlate to RUPA §103 and ULPA §110(b)5-7, RULLCA §103(b)(2)-(4)

15. Fiduciary Duties: Bottom Line • Agency law applies to general partnerships (and joint ventures) and general partners strong fiduciary duty • BUT: arguably, trend, even in general partnerships, and certainly in other types of entities, to narrow fiduciary duties, and allow parties to narrow (but not eliminate) such duties via agreement

16. Comparisons • Entity vs. Aggregate • Size • Limitations on Liability of Owners • (Most) Owners=Managers? • Note: LLCs can be “member managed” or “manager managed” – former is more like partnership (general or limited, depending on # of members and proportion who are managers) and latter is more like corporation • Fiduciary duties • Owners to other owners • Managers to owners

17. Comparisons • Free transferability of interests • Ability to exit (and be paid for interest) • Ability to expel • Ability to dissolve entity • Entity level tax? • Source of $ returns • Dividends/Distributions? • Salary? • Sale of interest? • Classes of Ownership Interests • Many ‘off the shelf’ choices for corporations • Can/often do customize for LP/LLLP and LLC • S corporations can only have one class of stock

18. Comparisons • Liability • General partnership: all are unlimitedly liable • Limited partnership: limited liability for limited partners • LLP: “general” partners, but less liability than GP • Maybe only for own acts and maybe negligence of others? Different levels of liability • LLLP: like limited partnership, except general partners have less liability (like “GP” of LLP) • LLC: limited liability for all • Corporation: no liable for owners (unless….veil piercing, etc.)

19. Smaller vs. Larger Entities: Issues • General partnerships, agency relationships, intended or not: • Arguments about liability for partner or principal or “partner” or “principal” • Partnerships, partnership-like LLCs • Partner’s ability to dissolve? • Partner’s ability to leave • Partner/member ability to force payout of value of interest • Economic interest vs. mgmt/control interest

20. Smaller vs. Larger Entities: Issues • Partnerships, LLCs, close corporations • Management arrangements • %s vote required for various actions • Rights of various partners/members/shareholders • Sale of interest • Entry of new partner/member/owner

21. Smaller vs. Larger Entities: Issues • Partnerships, LLCs, close corporations • Structure and division of payments • Valuation of interests • For partners/members, expulsion • Close corp almost-analogue=“squeeze-out” • Partnership/LLC can also do squeeze-out • Owner/lender issues

22. Smaller vs. Larger Entities: Issues • Close corporations (and in theory, also LLCs) • Voting agreements • Sale of control • Take-along? • Traditional corp. management or management by owners? • Veil piercing (owner liability for debts of entity)

23. Smaller vs. Larger Entities: Issues • Large, publicly traded corporations • Owner vs. manager conflicts • Owner rights re: elections, proposals • Existence of statutory procedures in State and Federal law • Owner rights re: litigation • Mergers and Acquisitions • Shareholder activism

24. Smaller vs. Larger Entities: Issues • Large, publicly traded corporations • Manager vs. Potential Acquiror • Controlling Owner vs. Other Owners • (also in smaller entities, but important differences) • Securities law duties • Mostly, disclosure • Some substantive regulation • Other: Indemnification & Insurance • Lender issues • ALL: Fiduciary Duties