Chapter 21 Forms of Doing Business

Chapter 21Forms of Doing Business

Its Legal, Ethical, and Global Environment

MARIANNE M. JENNINGS

7th Ed.

Sole ProprietorshipsSole 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.

Sole ProprietorshipsSole 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.

• Transferability of Interest:– Business can be sold—property,

inventory, and goodwill.– Owner will usually sign a non-compete

agreement.

Sole ProprietorshipsSole Proprietorships

• 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.

PartnershipsPartnerships

PartnershipsPartnerships• 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

Partnership FormationPartnership Formation• Case 21.1 Byker v. Mannes (2002).

– Was there a partnership created?– When did the relationship legally end?– Is Mannes liable to Byker?

Partnership FormationPartnership 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.

Partnership FormationPartnership 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.

Partnership FundingPartnership Funding• Sources of Funding:

– Capital contributions of partners.– Loans by partners.– Outside loans.

Partnership LiabilityPartnership Liability• Mutual principals and agents:

– Partnership assets reachable by partnership creditors.

– Personal assets reachable by partnership creditors when partnership assets are exhausted.

• Case 21.2 Vrabel v. Acri (1952).• Why wasn’t Mr. Acri a defendant?• Is Ms. Acri liable for the injuries?

• 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.

Partnership Partnership ManagementManagement

• 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.

• 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.

• Transfers of partners’ interest.– Partner’s interest is personal property.– Can be pledged to creditors and

transferred.– Transferee does not become a partner.

• 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.

PartnershipPartnership• Tax Issues:

– Partnership does not pay taxes.– Partnership files informational return.– Partners report income and losses on

their returns.

Partnership Partnership DissolutionDissolution

• One partner no longer associated with the partnership.– Examples: Retirement, death.

• Can just be a change in structure or can proceed to termination.

• 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.

Partnership Partnership DissolutionDissolution

• 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.

Limited PartnershipsLimited Partnerships

• 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.

L.P.’s: FormationL.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.

L.P.’s: FormationL.P.’s: Formation

L.P.’s: FormationL.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.

• 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.

L.P.’s: FundingL.P.’s: Funding

• 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.

L.P.’s: LiabilityL.P.’s: Liability

• 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.

L.P.’s: Profits L.P.’s: Profits

• 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.

L.P.’s: Partner L.P.’s: Partner AuthorityAuthority

• 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.

L.P.’s: TransferabilityL.P.’s: Transferability

• 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.

L.P.’s: Tax IssuesL.P.’s: Tax Issues

• 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.

L.P.’s: DissolutionL.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.

L.P.’s: DissolutionL.P.’s: Dissolution

• 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.

CorporationsCorporations

• 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.

Types of CorporationsTypes 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.

Types of CorporationsTypes of Corporations

• Must comply with statutory requirements.

• File articles of incorporation:– Name.– Names and addresses of all

incorporators.– Capital structure of the corporation.– Types of stock.

Corporate FormationCorporate Formation

Corporate FormationCorporate Formation• File articles of incorporation:

– Classes of stock.– Rights of shareholders.– Voting rights.– Statutory agent.

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

• 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.

Corporate FormationCorporate Formation• Must hold initial meeting after

incorporation:– Elect new directors.– Adopt bylaws (day-to-day procedures).– Issue Stock.– Ratify Pre incorporation contracts.

• 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.

Corporate CapitalCorporate Capital

Corporate CapitalCorporate 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.

• 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.

Corporate LiabilityCorporate 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.

Corporate LiabilityCorporate Liability

Piercing the VeilPiercing the Veil• Case 21.3 U.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?

Corporate DirectorsCorporate 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.

• Case 21.4 Grobow v. H. Ross Perot (1988).– Why is director independence

important?– How does the business judgement rule

apply in the repurchase?

Director LiabilityDirector Liability

Corporate LiabilityCorporate Liability• Officer liability.

– Increasing personal liability.– Increasing prosecutions.– Particularly when environmental laws

are violated.

Sarbanes-Oxley ActSarbanes-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.

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

Shareholder RightsShareholder Rights

Shareholder RightsShareholder 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.

Shareholder RightsShareholder Rights• Dissenting Shareholders.

– Shareholders not voting in favor of the combination can force corporation to purchase their shares for cash-- called appraisal rights.

• Corporation may use freeze-out to defeat dissenters’ rights.

• Shareholders have access to books and records.– Under revised MBCA, no ownership

requirements. – Must have proper purpose.

• Generally share in a corporation are freely transferable; however sometimes transfers are restricted.

Shareholder RightsShareholder Rights

Shareholder RightsShareholder Rights• Transfer restrictions.

– Must be noted or referenced on stock certificates.

– Must serve a necessary purpose.

– Must be reasonable.

• Voluntary.– Board resolution.– Shareholder approval.

• Involuntary.– Forced by court or state agency.– Example: Fraud.

Corporate DissolutionCorporate Dissolution

• Corporation pays tax.– Shareholders pay tax on dividend

income.• Subchapter S or S corporation.

– Corporate liability protection with partnership tax status.

Corporate Tax IssuesCorporate Tax Issues

Limited Liability Limited Liability CompaniesCompanies

• History: in existence internationally for some time.– GMBH—Europe. – Limitada—South America.– LLC—U.S.

• Nature:– Aggregate organization.– Liability shield.– Income flows through.

• Articles of organization.• Filed centrally.• Name must disclose status - L.L.C. or

LLC: FormationLLC: Formation

• Funding: Members contribute capital.• Liability:

– Members stand to lose capital contributions, but their personal assets are not subject to attachment.

• Tax Consequence:– Income passes through to members.– LLC does not pay taxes.

• Management and Control.– Operating Agreement—specifies voting rights.– One member or an outside consultant can have

operating authority delegated to him or her.• Transferability of Interest:

– Interest can be transferred.– Transferee does not become a member unless

majority of remaining members approve.

• Dissolution and Termination:– Generally withdrawal, death or

expulsion of members will dissolve company.

– Some state permit judicial dissolution.– All state permit voluntary dissolution.

• Formation: Must file to create.• Funding: Capital contribution from

partners.• Tax Consequences: Tax reporting

entity not tax paying.

Limited Liability Limited Liability PartnershipPartnership

• Management & Control: partners can participate in management without personal liability for partnership debts.

• Transferability: transfer must be restricted.

• Dissolution & Termination: similar to limited partnership.

• Joint Ventures Increasing.– Joint ventures with countries

themselves.– Business structure varies.

• Example: Germany and differing board structures.

International IssuesInternational Issues

Chapter 21 Forms of Doing Business

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