R6: Business Structures

sole proprietorship

1 person owns the business	sole proprietor personally liable
sole proprietor is not a separate entity from the business	can’t exist beyond the life of the sole proprietor
no formality required to form	P/L flows through the business to the sole proprietor
easily transferable

Circumstances when a sole proprietorship is a good choice as a business entity

• an individual wants to form a business that they will manage

• wants to claim income/losses on taxes

• doesn’t want to bother w/ a lot of formality

general partnership/joint venture basics

formed when 2+ people intend to be co-owners

papers don’t need to be drawn up or filed

express agreement not required

sharing profits gives rise to a presumption that the parties intended to form a partnership

writing required if people want to remain partners >1 year

joint venture→ same as GP but is formed for a single transaction/project or for a related series of transactions/projects (GP is for an ongoing venture)

Which business types can be formed without filing organizational documents with the state?

general partnership or proprietorship

advantages of a partnership vs. corporation

• not taxable entities (flow through instead)

• all partners have equal rights (unless agreement says otherwise)

  • mgmt. & voting power isn’t based on amount contributed

required approval in a partnership

• decisions within the ordinary course of business is controlled by majority vote except the following, which need unanimous consent:

  • admitting new partners

  • confessing a judgment (admitting liability in a lawsuit) or submitting a claim to arbitration

  • making a fundamental change in the partnership business

agency law in partnerships

• every partner is an agent

• the partnership is the principal

  • an act of a partner apparently carrying on in the ordinary course of business the business of the partnership will bind the partnership through apparent authority

  • if partners acts w/o apparent/actual authority, the partnership can be still be bound

rights of partners in partnerships (property)

• partnership owns all money & property; partners do not own the property

• partners have no right to possess or use partnership property other than for business purposes

  • an individual partner can’t assign or sell partnership property for their own benefit

  • a partner’s personal creditors can’t attach partnership property to satisfy an individual partner debt

rights of partners in partnership (partnership interest)

• partner may assign their interest in the profits & surplus at any time

• assignee obtains the right to receive the partner’s share of the profits

  • assignee doesn’t become a partner

• creditor of an individual partner may obtain from a court a charging order against an individual’s share of profits

• when a partner dies, their right to profits vests in their heirs (partner’s right to property vests in the surviving partners)

duties & legal obligations of partners

• each partner owes a fiduciary duty to the business & the other partners

• each partner is personally liable for all partnership obligations

  • partner’s liability is joint and several

  • this means that each partner is personally & individually liable for the entire amount of all partnership obligations

partnership P/L allocations

• unless there’s an agreement, all partners have equal rights to share in profits/losses of the partnership

• partners aren’t entitled to compensation for services rendered to the partnership

termination (dissociation of a general partnership)

• dissociation → change in the relationship of the partners caused by any partner ceasing to be associated in carrying on of the business (partner passes away, withdraws, becomes bankrupt, etc)

  • dissociation of a partner doesn’t necessarily cause a dissolution of the partnership

  • partnership at will may be rightfully dissolved by a partner’s notice of withdrawal or dissociation at any time

  • dissociated partner remains liable for their debts unless creditor releases them or there’s a novation

termination (dissolution of a general partnership)

• partnership is dissolved and its business must be wound up if the partnership is at will (has no expiration date) & a partner gives notice of withdrawal, the partners agree to dissolution, or a court orders dissolution

  • death of a partner doesn’t cause dissolution if remaining partners agree within 90 days to continue the partnership

distribution of assets → final accounting for partnership

cash must be used to pay the partnership’s liabilities in the following order:

• creditors (if a partner loaned $ to the partnership they are considered a creditor)

• partners

limited liability partnership (LLP)

• similar to a general partnership is most aspects except the following differences:

  • partner in an LLP isn’t personally liable for obligations resulting from mistakes/negligence of another partner

  • partner in an LLP is liable for their own mistakes/negligence as well as anyone else under their control

  • partners not personally liable for debts of the LLP

  • LLP must file with the state

  • registration must provide info such as the LLP’s name, name/location of office, # of partners, & a description of the business

limited partnership

• partnership made up of 1 or more general partners (who have personal liability for all partnership debts) & 1 or more limited partners (whose liability for debts is limited to their investment)

• no perpetual life

• limited partners contribute capital in exchange for a partnership interest, but don’t participate in management

• must file with the state

operation of a limited partnership

• general partners responsibility for management

  • only general partners can be held personally liable for partnership debts

• limited partner’s liability is limited to their investment & unpaid capital commitments

  • has no right to take part in the management of the business (no actual or apparent authority)

• P/Ls shared in proportion to the value of the partner’s contributions

termination of a limited partnership

limited partnership can be dissolved by:

• the occurrence of the time or event stated in the partnership agreement

• written consent of all partners (i.e. unanimous written consent to dissolve)

• withdrawal or death of a general partner (death of limited partner doesn’t dissolve partnership)

• judicial decree

order of distribution of assets in the dissolution of a limited partnership

1. creditors

2. former partners in satisfaction of liabilities that weren’t paid on their withdrawal

3. partners, first to return their contributions & then to distribute profits

*if there’s a loss only the general partners are personally liable; limited partners have no personal liability beyond their capital commitments

limited liability company (LLC)

designed to provide its owners (called members) w/ 2 main features:

1. the limited liability that SHs of a corporation enjoy

2. the ability to be taxed like a partnership (flow-through)

• LLC members can adopt operating agreements w/ provisions different from the LLC statute

• LLC formed by filing articles of organization

LLC articles of organization

Contains:

1. statement that the entity is an LLC

2. name of the LLC which must include indicate that it’s an LLC

3. street address of the LLC’s office & name of its registered agent

4. if management is to be vested in managers, a statement to that effect

5. the names of the people who will be managing the company

operation of an LLC

• generally all members have a right to participate in management decisions of the LLC

  • member-managed LLC → each member is an agent of the LLC & has the power to bind the LLC by acts apparently carrying on the business of the LLC

  • manager-managed LLC → if management is by managers, each manager is an agent of the LLC & has the power to bind the LLC

voting strength & P/L allocations in an LLC

proportional to contributions in most states

transferability of ownership & rights for an LLC

member of an LLC may not transfer all of their interest in the LLC w/o the consent of all other members

• a member is free to assign their interest in distributions but isn’t free to assign any rights to manage the LLC

termination of an LLC

An LLC will dissolve upon:

1. exporiation of the period of duration stated in the articles

2. the consent of all members

3. the death, retirement, resignation, bankruptcy, incompetence, etc. of a member (these events dissociate the member)

4. a judicial decree or administrative order dissolving the LLC for violation of law

corporation

• a legal entity distinct from its SHs

  • C Corp

  • S Corp

• only the corporation is liable for corporate obligations

• owned by SHs, but managed by directors

• perpetual life

• freely transferable ownership unless otherwise agreed

• created under statute (Revised Model Business Corporation Act)

promoter

• promoters enter into contracts before the corporation is formed to obtain financing & things the corporation will need once formed

• personally bound on the contracts they make

• even if corp. adopts a promoter’s contract, promoter is liable unless there is a novation

articles of incorporation (corporations only)

includes anything the incorporators consider appropriate but must include:

• name of the corporation

• names & addresses of the corporation’s registered agent

• names & addresses of each of the incorporators

• # of shares authorized to be issued

purpose clause in articles of incorporation

• “Ultra Vires” Act

• optional!

• states the business purpose for which the corporation was formed

• if a business undertakes business outside the clause it is said to be acting “ultra vires”

bylaws

• not part of the articles of incorporation & aren’t required to be filed with the state

• adopted by the incorporates or the board of directors & may be repealed or modified by the board of directors

disregard of corporate entity (“piercing the corporate veil”

courts will generally pierce the corporate veil for any of the 3 reasons:

1. SHs commingle personal funds w/ corporate funds or use corporate assets for personal use

2. the corporation was inadequately (or “thinly”) capitalized at the time of formation (SHs must start the corp. w/ sufficient capital to reasonably meet the corp’s prospective liabilities)

3. the corporation was formed to commit fraud on existing creditors

financing the corporation

• debt securities (bonds)

  • secured mortgage bonds & unsecured debentures, convertible bonds

  • bondholders are creditors

• equity securities (stocks)

  • shares of the corp, stock warrants, stock options

  • stockholders are owners of the corporation

  • board of directors has discretion to issue stock @ any price it thinks is appropriate

shareholders rights → voting

• SHs have the right to vote to elect (usually annually) or remove directors

• also have the right to vote on whether to approval fundamental changes to the corporation

  • general rule: 1 share, 1 vote except-

  • cumulative voting: each share is entitled to 1 vote for each director position & the SH may cast the votes in any way, including casting all for a single candidate

shareholder rights → distributions

• generally don’t have a right to distributions (cash dividends & repurchases of shares) unless it’s declared by board of directors

• once board declares a distribution, SHs are treated as unsecured creditors of the corporation to the extent of the dividend

• distributions decrease corporation’s SE

shareholder rights → preferred shareholders

• corporation doesn’t need to give each SH an equal right to receive distributions; shares may be divided into classes w/ varying rights

  • noncumulative preferred shares: shares w/ a preference usually are entitled to a fixed amount of $ before distributions can be made w/ respect to non-preferred shares (won’t get paid until cumulative dividends for all years are paid)

  • cumulative preferred shares: dividends carry over to future yrs if not declared in a particular year

stock dividends

• issued from a corp’s own authorized but unissued shares

• no assets distributed; not a distribution of corporate assets

• SHs receiving the stock generally don’t owe tax on it

• solvency of the corp remains the same; no damage to creditors and SHs

preemptive rights

• when a corporation proposes to issue additional shares of stock, the current SHs often want to purchase shares in order to maintain their proportional voting strength

• common law granted SHs such a right, known as the preemptive right

• under the RMBCA, preemptive rights don’t exist unless the articles of incorporation provide for them

derivative action

when a corp has a legal cause of action against someone but refuses to bring the action, the SHs may have a right to bring a SH derivative action to enforce the corporation’s rights

• may only be brought to vindicate wrongs against the corporation

• direct action: SH seeks to vindicate the SH’s own rights against the corporation (corp is the defendant)

director rights

• not agents, no actual or apparent authority (may only work as a group)

  • election, removal, & supervision of officers

  • adoption, amendment, & repeal of bylaws

  • fixing management compensation & initiating fundamental changes to the corp’s structure

• has sole discretion to declare distributions to SHs including dividends (SHs have no power to compel a distribution)

• directors are fiduciaries of the corp & must act in the best interests of the corp

director rights → declaration of distributions

• board of directors has sole discretion to declare distributions to SHs including dividends

• directors who authorize a distribution in violation of law are personally liable to the extent the distribution exceeds what would’ve been lawful

director rights → fiduciary duties

• directors are fiduciaries of the corporation & must act in the best interests of the corp

  • directors aren’t insurers of the corp’s success

• directors will be liable to the corporation only for negligent acts or omissions

• entitled to rely on information, opinions, reports, or statements

• owe the corporation a duty of loyalty

• corporations are allowed to indemnify directors for expenses for any lawsuit brought against them in their corporate capacity

officer rights

• officers are individual agents (and employees) of the corp who ordinarily conducts it day-to-day operations

• officers are selected by the directors & can be removed by directors with/without cause (not elected)

• officers are corporate agents & agency rules determine their authority and power

• subject to fiduciary duties & must discharge their duties in good faith

• may also serve as directors

• not required to be SHs

fundamental changes

Fundamental changes that require SH approval:

Dissolution

Amendment to articles of incorporation that materially & adversely affect the SHs rights

Mergers, consolidations, & compulsory share exchanges

Sale of substantially all the corporation’s assets outside the regular course of business

general procedure for a fundamental change

1. majority of board of directors must adopt a resolution setting forth the proposal action & submitting it for a vote at a SHs meeting

2. corporation must notify all SHs even if they’re not entitled to vote

3. change must be approved by a majority of the shares voted at the meeting

4. a document setting forth the action (“articles”) must be executed by the corp & filed with the state

5. SHs who have a right to vote typically have a right to dissent/appraisal right (right to have the corp purchase their shares at a fair price)

merger

involves 1 or more corporations joining w/ another corporation

• 1 corp survives the merger & continues in existence

• the other merging corp ceases to exist after the merger

  • A + B = A

• both corps must follow the fundamental corporate change process unless a short-form merger

consolidation

involves 1 or more corporations joining together to form a new corporation

• each corp ceases to exist after the consolidation, only the new corp goes on

• new corp is liable for the debts of the old corp

  • A + B = C

• both corps must follow the fundamental corporate change process

share exchange

a transaction in which 1 corp acquires all of the outstanding shares of 1 or more classes of stock of another corporation

• both corps continue to exist as separate entities

  • A + B = A + B

• only the corp whose shares are being acquired needs to go through the fundamental change process

short-form merger

a parent corp owning 90% or more of a subsidiary corp may merge the subsidiary into the parent w/o the approval of the SHs of either corp or the approval of the subsidiary’s board

ways to fend off unwanted takeover attempts

• persuading SHs to reject the offer

• suing the person/company attempting the takeover for misrepresentation or omission & obtaining an injunction against the takeover

• merging w/ a white knight (company with which the directors want to merge)

• making a self-tender (offer to acquire stock from its own SHs & thus retaining control)

• paying greenmail (pay the person or company attempting takeover to abandon their attempt)

• locking up the crown jewels (give a 3rd party option to purchase the company’s most valuable assets)

• undertaking a “scorched earth” policy (sell of assets or take out loans that would make the company less financial attractive)

• applying shark repellent (amending the articles of incorporation/bylaws to make a takeover more difficult

termination of a corporation

• dissolution is a fundamental change & can be pursuant to a court order

• after dissolution the corp continues in existence for the purpose of winding up

• liquidation involves the process of collecting the corporate assets, paying expenses involved, satisfying creditor claims, & distributing net assets of the corp