Chapter 21 Forms of Doing Business

1. MARIANNE M. JENNINGS Its Legal, Ethical, and Global Environment 7th Ed. Chapter 21Forms of Doing Business

2. Sole Proprietorships • Formation: • Done by an individual. • May have a fictitious name. • Example: Ralph Jones d/b/a Spuds Brewery. • No formal requirements for formation. • May have to publish d/b/a name.

3. Sole Proprietorships • Sources of Funding: • Loans. • Government help. • Liability: full personal liability of owner. • Tax Consequences: • Owner claims all income and losses. • No separate filing requirement. • Management and Control: • All assets with one person.

4. Sole Proprietorships • Transferability of Interest: • Business can be sold—property, inventory, and goodwill. • Owner will usually sign a non-compete agreement.

5. Partnerships • Governed by the Uniform Partnership Act (UPA). • Adopted in 49 states. • In absence of a partnership agreement, UPA controls. • Revised Uniform Partnership Act (1994)—adopted in nine states.

6. Partnerships • Definition: • An association of two or more persons to carry on as co-owners, a business for profit. • Can include corporations and natural persons. • Formation: • Voluntary formation: By agreement. • Draw up articles of partnership. • Involuntary formation

7. Partnership Formation • Case 21.1Byker v. Mannes (2002). • Was there a partnership created? • When did the relationship legally end? • Is Mannes liable to Byker?

8. Partnership Formation • Involuntary formation: By implication. • Sharing of profits. • Constitutes prima facie evidence that a partnership exists. • Exceptions—rent, wages, annuity to widow or estate, payment for goodwill.

9. Partnership Formation • Involuntary formation: Partnership by estoppel (or ostensible partner). • Results when someone allows the inference to be made that he/she is a partner. • Allowing name to be used to get a loan.

10. Partnership Funding • Sources of Funding: • Capital contributions of partners. • Loans by partners. • Outside loans.

11. Partnership Liability • Mutual principals and agents: • Partnership assets reachable by partnership creditors. • Personal assets reachable by partnership creditors when partnership assets are exhausted. • Case 21.2Vrabel v. Acri(1952). • Why wasn’t Mr. Acri a defendant? • Is Ms. Acri liable for the injuries?

12. Partnership Management • Partnership control: • Unless otherwise agreed, each has equal management authority. • May delegate day-to-day authority to one partner. • Each partner is mutual principal and agent of the others.

13. Partnership Management • Borrowing—done routinely in most partnerships. • Unanimous consent required for confession of judgment, selling goodwill, and admission of another partner. • No compensation for work unless agreed.

14. Partnership Management • Fiduciary duties. • Mutual principals and agents. • Each is to act in the best interests of the partnership. • Partnership property. • Property contributed to the firm or purchased with partnership assets. • Own property as tenants in partnership.

15. Partnership Management • Transfers of partners’ interest. • Partner’s interest is personal property. • Can be pledged to creditors and transferred. • Transferee does not become a partner.

16. Partnership Management • Transfers of partners’ interest. • Admission of new partner requires unanimous consent. • Transferring partner is not relieved of liability. • Some partnership agreements require partners to offer it first to remaining partners.

17. Partnership • Tax Issues: • Partnership does not pay taxes. • Partnership files informational return. • Partners report income and losses on their returns.

18. Partnership Dissolution • One partner no longer associated with the partnership. • Examples: Retirement, death. • Can just be a change in structure or can proceed to termination.

19. Partnership Dissolution • Dissolution Methods: • By agreement. • By operation of law: Death of a partner, bankruptcy of partnership or partner. • Court order. • Termination: • Assets are liquidated. • Distribute in this order: outside creditors; partners’ advances (loans); capital contributions; profits.

20. Limited Partnerships • Governed by Uniform Limited Partnership Act (ULPA). • Revised Uniform Limited Partnership Act (RULPA). • Recent revision adopted in nearly all states. • Use ULPA or RULPA when no agreement. • RULPA addresses the needs of the larger limited partnership.

21. L.P.’s: Formation • Structure: • Must have at least one general partner. • Must have at least one limited partner. • Liability of limited partner is limited to capital contribution. • Liability of general partner is unlimited. • Formation: • Must meet statutory requirements; if not met a general partnership may be created.

22. L.P.’s: Formation • Must file certificate of limited partnership; see text for list of requirements and note differences between ULPA and RULPA. • RULPA is much briefer • Corrections can be filed by limited partners.

23. L.P.’s: Formation • Formation. The RULPA requires the following information for formation of a Limited Partnership: • Name - must contain the words “Limited Partnership”. • Address of principal place of business. • Name and address of statutory agent for services process. • Business address of general partner. • Latest date for dissolution of partnership.

24. L.P.’s: Funding • Sources of Funding: • Limited partners provide most of the financing. • Limited partners can contribute services under RULPA. • Loans are used—called advances when made by partners. • Under RULPA, limited partners can use services already given as a contribution.

25. L.P.’s: Liability • Limited partners have limited liability but cannot participate in management. • Under RULPA, can do the following and still retain limited liability status: • Can be an employee. • Can consult with and advise the general partner. • Can act as a surety guarantor for the limited partnership. • Can vote on amendments, dissolution, sale of property, and debt assumptions.

26. L.P.’s: Profits • Partner Relationships: management is responsibility of general partner. • Profits and Distributions: • Authority belongs to general partner to make decisions here. • Profits and losses are allocated on the basis of capital contributions. • RULPA requires agreement for splitting profits and losses to be in writing.

27. L.P.’s: Partner Authority • Partner Authority: • General partner has same authority as in general partnership. • Can restrict by agreement. • Consent of limited partners required for: • Admitting a new general partner. • Admitting a new limited partner (can give authority in the agreement). • Extraordinary transactions (selling assets). • Limited partners have right to inspect books and records.

28. L.P.’s: Transferability • ULPA allows transfer of interests: • May have significant restrictions on transfer to prevent liability under federal securities laws. • The more easily an interest can be transferred, the more likely the IRS is to label it a corporation. • Transfer of a limited partner’s interest does not dissolve the partnership. • Under RULPA, assigning limited partner can be given the authority to make the assignee a limited partner.

29. L.P.’s: Tax Issues • Taxed the same as general partnerships. • Partners report profits and losses on individual returns. • Limited partners get direct tax benefits with limited liability. • IRS scrutinizes to be certain it is a partnership and not a corporation.

30. L.P.’s: Dissolution • RULPA provides for the following means: • Expiration of time period in agreement or event as provided in agreement. • Unanimous written consent of all partners. • By court order. • Withdrawal of general partner.

31. L.P.’s: Dissolution • If termination is elected, assets are distributed as follows: • Outside creditors. • Partners’ distributions. • Return of capital contributions. • Remainder split according to agreement.

32. Corporations • Characteristics of a Corporation: • Legal existence. • Unlimited duration. • Free transferability of interest. • Limited liability. • Centralized management. • Can hold legal title to property. • Can sue and be sued.

33. Types of Corporations • For Profit. • Not for profit. • Domestic—in the state of incorporation. • Foreign–everywhere else. • Government corporations—like FNMA. • Professional corporations—limited liability on everything except professional malpractice.

34. Types of Corporations • Close or closely held corporations: Limited number of shareholders, subject to less formality. • Subchapter S or S corporation. • IRS election to be treated as partnership for tax purposes. • Still have limited liability. • Limits on size for this election. • The Law of Corporations: Model Business Corporation Act (MBCA). • Liberal statute. • One-third of the states have adopted. • Revised in 1984.

35. Corporate Formation • Must comply with statutory requirements. • File articles of incorporation: • Name. • Names and addresses of all incorporators. • Capital structure of the corporation. • Types of stock.

36. Corporate Formation • File articles of incorporation: • Classes of stock. • Rights of shareholders. • Voting rights. • Statutory agent.

37. Corporate Formation • Where to incorporate: • Status of state’s corporation laws. • State tax laws. • Ability to attract employees. • Incentives.

38. Corporate Formation • Incorporators: • Idea people—also called promoters. • Will be personally liable for contracts entered into before incorporation. • Corporation can ratify contracts—promoter is secondarily liable. • Corporation can enter into a novation with the third party—promoter or incorporator is released from liability.

39. Corporate Formation • Must hold initial meeting after incorporation: • Elect new directors. • Adopt bylaws (day-to-day procedures). • Issue Stock. • Ratify Pre incorporation contracts.

40. Corporate Capital • Capital and Sources of Corporate Funds. • Debt Financing—The Bond Market. • Short-term financing—loans from banks. • Bond market. • Benefits of debt financing. • Interest is tax deductible. • Debt holders get paid first. • Limitation: too much debt renders corporation financially unstable.

41. Corporate Capital • Equity financing—shareholder. • Common stock: Has voting rights, receives dividends when paid. • Preferred stock: Receiver preference over common stock can be cumulative or noncumulative. • Liability Issues. • Must make full payment for shares—if not, there is liability (water stock). Not paying par value.

42. Corporate Liability • Liability Issues: • Shareholders’ liability generally limited to amount of investment. • If corporate veil is pierced, there is shareholder liability. Means corporate immunity from liability is set aside. • Reasons for piercing: • Inadequate capitalization—must put in enough money to meet the risks of doing business • Alter ego theory—separate nature of corporation is disregarded.

43. Corporate Liability • Reason for Piercing the Veil: • No formalities—personal and corporate properties are mixed together. • Ignoring corporate formalities - elections, meetings. • Forming to perpetrate a fraud on creditors.

44. Piercing the Veil • Case 21.3U.S. v. Best Foods, Inc. (1998). • Is there a special CERCLA rule for piercing the corporate veil? • What must be shown to hold a parent liable for the action of a subsidiary?

45. Corporate Directors • Election of Directors. • Elected by shareholders to make corporate policy. • May operate by committee. • Hire officers of corporation and set officers’ salaries. • Director liability. • Protected by the Business Judgment Rule. Directors and Officers must act in good forth and with prudence to avoid personal liability. • Can consult experts but must study issues.

46. Director Liability • Case 21.4Grobow v. H. Ross Perot(1988). • Why is director independence important? • How does the business judgement rule apply in the repurchase?

47. Corporate Liability • Officer liability. • Increasing personal liability. • Increasing prosecutions. • Particularly when environmental laws are violated.

48. Sarbanes-Oxley Act • Liability for Officers and Directors: • Prohibitions on Loans to Officers. • Code of Ethics for Financing Reporting. • Lawyer’s new duties to company and officers. • Board Membership-majority must be independent.

49. Shareholder Rights • Voting shareholders: • Elect the board. • The Proxy. • Vote on critical corporate issues. • Pooling agreement. • Voting trust.

50. Shareholder Rights • Shareholders have right to vote on mergers, consolidations, and sale of all assets, not on acquisition. • Procedure: • Board of Directors adopts resolution in favor of combination or sale. • Resolution with notice of meeting sent to all shareholders. • Shareholders vote on resolution at meeting.