Business Law Notes: Business Organizations

Types of Organizations

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.

• 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.)
• No more than 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

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)

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.

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