Types of Organizations
Rights & Duties within the Corporation
Fiduciary duties of directors & officers
- Sole Proprietorship: over 2/3 of all U.S. businesses & less than 1% earn over $1 million a year; governed by common law.
- Advantages:
- Proprietor receives all the profits
- Independence
- Flexibility
- Tax-exempt retirement accounts
- Disadvantages:
- Proprietor alone bears the burden of any loses
- Opportunity to raise capital is ltd
- General partnership
- A legal entity only for limited purposes
- Partners liable
- Partnership reports, but doesn't pay taxes on its income
- Individual partners are liable for taxes & subject to personal liability
- Limited Partnerships
- At least 1 partner & 2+ limited partners
- Have limited liability; general unlimited & can be a corporation
- Limited partners should avoid being involved in management because may be liable if engage in any management direction, superintending, restriction, regulation, government, admin or overseeing.
- Corporations
- Consist of shareholders
- A creature of statute
- Artificial being
- Separate legal entity
- Certificate of authority required to do business outside of home state
- Double Taxation
- Corporation is taxed on profits
- Distributed profits tax at the individual level
- Corporation receives no tax deduction for dividends.
- Classes of Corporations
- Public Corporations. Formed by the government to meet some political or governmental purpose (e.g. Amtrak).
- Private Corporations. Created either wholly or in part for private benefit. Most are private although they may serve a public purpose (e.g. pub utility is privately owned).
- Non Profit Corporations. Formed w/out a profit-making purpose. Usually private corporations (e.g. private hospitals, schools & churches).
- Close Corporations. Like a partnership; many <30 shareholders; no public securities; courts reluctant to overturn shareholder agreements & provisions of close corporations; shares are held by members of a family or by relatively few persons. Stat for Close Corps:
- Ltd number of shareholders
- Restricted stock transfer
- No pub offerings
- S corporations
- Small corporations (<=35 shareholders)
- Under subchapter S of the internal revenue code
- No corporate level tax
- Same corporate advantages
- Disadvantages relate to fringe-benefit payments to employee/shareholders w/ > 2% stock not deductible
- Qualifications for S Corporation status
- Must be a domestic corp.
- Corporation must not be a member of an affiliated group of corporations
- Shareholders must be individuals, estates, or certain trusts (corporations, partnerships, & nonqualifying trusts cannot be shareholders.)
- <= 35 shareholders (5 only one class of stock; not all shareholders need have the same voting rights.)
- No shareholder of the corporation can be a nonresident alien
- Benefits of S Corporation
- Corporation losses can be offset by shareholder income
- Corporation tax at lesser of shareholder or corporation rate
- One tax on corporate income at individual rate
- Corporation Formation
- Preliminary organization & promotional undertaking -- particularly, obtaining capital for the future corporation
- Legal process of incorporation
- Promoter liability
- Personally liable on pre-incorporation Ks
- Promoters are not agents when corporation has yet to come into existence
- Not able if an breach of K
- Formation releases the promoter & makes the corporation liable
- Subscribers & Subscriptions
- Subscribers agree to purchase stock in the future corporation from the promoter
- The agreement is a subscription agreement
- Incorporation Procedures
- Look for the states that offer the most advantageous tax or incorporation provisions (i.e., Delaware Articles of Inc. = executed by the incorporators); must include:
- Corporation Name (must include Corporation, Incorporated, Co., or Ltd in name; can't be similar to existing names)
- Nature & Purpose: must be lawful duration: perpetual existence
- Capital Structure: share & value described
- Internal Organization: management structure
- Registered Office & Agent: location of its registered office - usually, also the principal office of the corporation
- Incorporators: name & address
- Certificate of Incorporation: issued by secretary of state
- Corporation Financing: description of securities
- Improper Incorporation: important when 3rd party is trying to enforce suit for tort.
- De Jure & De Facto Corporation in the event of substantial compliance w/ all conditions precedent to incorporation; must be:
- A state statute under which the corporation can be validly incorporated
- Parties must have made a good faith attempt to comply w/ statute
- Enterprise must have already undertaken to do business
- Corporation by Estoppel when a fake corporation is stopped from acting as a corporation
- Disregarding the corporate entity (piercing the corp. veil = directors or agents held personally liable): in cases where owners perpetrate a fraud, circumvent the law, or accomplish an illegitimate objective. Factors:
- Tricked or misled into dealing w/ the corporation rather than the individual
- The corporation is set up never to make a profit - thin cap
- Stated corporation formalities are not followed
- Personal & corporation interest are mixed together to the extent the corporation has no separate identity.
- Joint Venture: 2 or more persons combine for a single transaction or project, or related series of both.
- Syndicate: a group getting together to finance a project.
- Joint Stock Co: a hybrid of a partnership & corporation
- Business Trust: resembles a corp.
- Cooperative: an association to provide an economic service w/out profit to its members (shareholder).
- Limited Liability Corporation (LLC): hybrid that offers the limited liability of a corporation but the tax adv of partnership.
- Franchises: more than a third of retail. Types include
- Distributorship (e.g. Ford)
- Chain-style (e.g. McDonald's)
- Manufacturing or processing plant (e.g. coke)
Rights & Duties within the Corporation
Fiduciary duties of directors & officers
- Duty of Care
- May be held liable for negligence or mismanagement of corporate personnel
- Directors must carry out their responsibilities in an informed, businesslike manner
- A director may usually make decisions in reliance on information furnished by competent officers or employees, professionals such as attorneys & accountants or even an executive committee of the board, w/out being accused of acting in bad faith if such information turns out to be faulty
- When the required duty of care has not been exercised, directors & officers are liable for the damages caused to the corporation by their negligence
- Duty of Loyalty
- Faithfulness to one's obligations & duties
- Subordination of self-interest
- Cases usually involve:
- Competing w/ the corporation
- Usurping a corporate opportunity
- Having an interest which conflicts w/ the corporate interest
- Engaging in insider trading
- Authorizing a corporate transaction which is detrimental to minority shareholders
- Selling control over the corporation
- Conflict of interest must be fully disclosed
- Contracts not voided if fair & reasonable to the corporation at the time the contract was made & if they were approved by a majority of the disinterested directors or shareholders
- Antitrust laws may be violated if the same person sits on the boards of competing companies
- Liability of Directors & Officers
- Personally liable for crimes & torts committed w/in the scope of employment
- May be held personally liable for wrongful acts committed by corporate personnel under their direct supervision
- Business judgment rule: if there is a reasonable basis for a business decision, the court is unlikely to interfere even if the corporation suffers by the decision
- Directors & officers must:
- act in good faith
- act in what they consider to be the best interests of the corporation
- act with the care that an ordinarily prudent person would exercise in similar circumstances (this requires an informed decision with a rational basis & with no conflict between the decision maker's personal interest & the interest of the corporation)
- Rights of Directors
- Participation—must be notified of board meetings
- Inspection—access to all corporate books & records
- Compensation—trend toward more than nominal compensation
- Indemnification —corporation may purchase liability insurance for directors.
- Rights of Officers & Managers
- Same duties of care & loyalty as directors
- Same obligations concerning corporate opportunities & conflicts of interest as directors
- No business judgment rule defense
- Rights defined by employment contracts.
- Rights of Shareholders
- Stock certificate or equivalent
- Preemptive rights:
- determined in articles of incorporation
- generally apply only to additional, newly issued stock sold for cash
- generally must be exercised w/in a specified time period
- may be in the form of transferable stock warrants; called "rights" if warrant option if for a short period of time
