Lecture 17

1. Help investors create new businesses that employ people and pay taxes

2. Create clear rules that outline legal relationships between the people who own businesses and the people who run the business

3. Protect investors and counterparties from being exploited or taken advantage of

Goals of Business Organizations and Entites

1. Taxes

2. Liability

3. Fiduciary Obligations

Why it matters how you structure your business:

Tax

What type of business it is has significant tax implications for its owners

Liability

Is the owner personally liable if the business commits a tort and loses a big lawsuit

Can creditors take the business owner’s personal assets?

Liability for Others

Shareholders are liable for the misconduct of other partners

Respondeat Superior

Legal rule that says employers are usually liable for the negligent conduct of employees, which we discussed in torts

Fiduciary Duty

One of absolute loyalty to another person or entity

fiduciary duty

In every corporation, both corporate directors and officers owe a ___ to shareholders

fiduciary duty

In every partnership, each partner owes a ___ to the partnership (all the partners)

Sole Proprietorship

whenever one person owns business and there is no separate business entity

sole proprietorships

Most businesses in America are ___

directly to the owner

In a sole proprietorship, all profits go ___

Pros

1. The owner directly pays taxes (no double taxation)

2. Very easy to set up

Cons

1. Unlimited Personal Liability Risk

2. Difficulty Raising Capital

Pros and Cons of Sole Proprietorship

Pass-through entities

Entity does not pay income tax. Instead, the profits and losses of the partnership "pass through" to the individual partners, who report their profits or losses on their personal tax returns.

Orally, in writing, or inferred by the conduct

Creation of general partnerships

False; only required if the partnership is doing business under another name

T/F To create a general partnership, paperwork always needs to filed with the state

1. Two or more persons

2. Who agree (implied agreement is acceptable)

3. To be co-owners of a business for profit

Requirements to form a partnership:

Uniform Partnership Act (UPA)

What “fills in the gaps” not addressed in oral agreements for general partnerships

1. Joint (and equal) control of the partnership, AND

2. Joint (and equal) sharing of profits

Without a written agreement or clear oral agreement, the UPA says there is:

false; agency law applies

T/F Partners are not simultaneously agents and principals

False

T/F The partnership property belongs to individual partners

1. An individual partner cannot compete with the partnership

2. Doing business with the partnership is allowed but tricky because of the obvious conflicts of interest

3. Cannot exploit a partnership opportunity

4. Cannot secretly use or sell partnership assets

Fiduciary Duty in a partnership

False

T/F Partners cannot bind their fellow partners if they enter a contract, provided the partner was acting with authority

False

T/F When a partner transfers the rights to their share of profits, they also transfer the responsibilities that come with the partnership

True

T/F Each partner is liable for all the debt associated with a partnership

False

T/F If the partnership commits a tort, you can just withdraw to avoid being liable

creditor

If Partner A (on their own time) commits a tort against X and X sues Partner A personally and wins, X becomes a ___

Disassociate

Individuals may ___ from the partnership

Disassociation

Choosing not to be part of the partnership anymore

notice, Statement of Disassociation

When a partner disassociates, it’s important to file a ___ called __ with counterparties.

Dissolution

Legally ending the partnership

Wind Up

the process of settling the partnership’s affairs, including collecting revenues and paying debts.

1. Creditors paid first

2. Partners are then given:

   1. Their original contributions, then

   2. Remaining profits or losses are divided EQUALLY unless there is an agreement otherwise

Process of Winding Up

Limited Partners

People who just want to invest their money in a new business. They do not want to run the business and do NOT want the unlimited personal liability that comes with being a general partner

passive investors

Limited partners are referred to as ____

False

T/F Limited Partnerships do not need to be in writing because general partnerships do not need to be in writing

True

T/F Limited Partnerships must state they are LPs in all communications with others

False

T/F A limited partner owes a fiduciary duty to the partnership because they are a type of partner

Public Corporations/C Corporations

Most businesses (by dollar volume) in America is conducted by (for-profit)

have stock publicly traded on public stock exchanges like NASDAQ

False

T/F Public AND private corporations need to be audited (by law) to make sure their accounting is proper and properly reported to shareholders

Private Corporations

Number of shareholders is small (less than 500) and the shares of these corporations are not traded on open markets

Don’t need to quarterly reporting because government doesn’t see the need (few people are at risk and people who invest in private corporations are more sophisticated than ordinary investors)

Can pivot more rapidly than a publicly traded company

Advantages of Private Corporations

Pros

1. More Working Capital

2. Higher investor confidence in what is happening inside these corporations (because of audit)

Cons

1. Publicly traded corporations often come under extreme pressure and scrutiny if profits and growth lag

Pros/Cons of Public Corporations

Equity Financing

Issuing more stock

Debt financing

issuing bonds

Corporation

an artificial person. The law recognizes it as a “person” for most purposes. Indeed, corporations enjoy many of the same rights that people have, including:

1. Equal Protection of the laws

2. Access to courts

3. Due Process of law

4. Freedom of speech, including political speech

shareholders/stockholders, 1

Corporations are owned by their ___ and one share of stock means ___ vote.

to make money

The fundamental duty of a corporation is ___ for stockholder/owners

False; only insofar as the value of their equity decreases in response to corporate malfeasance

T/F Shareholders, since they own part of the company, are also liable for its actions

True

T/F You can’t sue a stockholder in a corporation for anything beyond what they hold in investment (for that corporation)

1. Single Economic Unit: Whether the corporation is merely an alter ego or instrumentality of the shareholders or directors. In sufficient corporate separateness. Siphoning money or commingling of funds.

2. Inadequate Capitalization: If the corporation was underfunded from the outset.

3. Lack of Corporate Formalities: Not following corporate formalities like holding regular board meetings or maintaining accurate financial records.

Fraud/Injustice/Inequitable Result: Accepting the separateness of the corporate entity, and thereby shielding the owner, would sanction or promote an injustice

Piercing the Corporate Veil Test

Corporate Governance

describes the overall control of a corporation

Bylaws

are the specific rules that regulate and govern the internal operations or corporations

1. Shareholders

2. Board of Directors

3. Management

Three main groups in every corporation

Shareholders

own the corporation but, ironically, have no role in the day-to-day management of the corporation.

Management

These are the people who run the corporation day to day

The Board of Directors

governs the corporation

1. The appointment, supervision, and removal of corporate officers, and setting their compensation.

2. Major financial decisions, like setting dividends, the issuance of new shares of stock, or stock buybacks (what's that?).

3. Authorize major corporate policy decisions (who should we take over next?) or (should we agree to be bought out?).

4. Like management, Directors owe a fiduciary duty to stockholders. To do this effectively, Board members must be informed and willing to exercise independent judgment.

Responsibilities of the Board of Directors

Business Judgement Rule

Honest mistakes or poor guesses will not lead to liability. In other words, as long as there was a reasonable basis for the business decision at the time, they are in the clear. The decision must be made in good faith and without any conflict of interest.

Limited Liability Company (LLC)

Best things about a corporation (no personal liability for shareholders) and best things about sole proprietorship (no double taxation) in one business

Pass Through

LLC Taxation

False

T/F Must have an operating agreement and be registered with the state, and the business MUST say LLC (or Limited Liability Company) in its name so the public is on notice of its status and knows it cannot sue the owners individually (unless they agree to, via a contract with a third party)

Member-managed

All members participate; majority members owe a fiduciary obligation to minority members (just like in a partnership)

Downside of LLC

Cannot easily transfer ownership interest (need consent of others), so it's not liquid like stock

Franchisor

7/11 Corporation

Franchisee

Old Indian Uncle running a 7/11 store

symbiotic

Franchisor-Franchisee relationship is ___

Distributorship

contractual business relationship where a distributor purchases products from a manufacturer (supplier) to sell, market, and distribute them within a specific territory, acting as an intermediary to retailers or consumers

Franchisors will fight back against attempts to change the original business model

S Corp

Limited number of shareholders (<100), one class of stock, natural person and US citizen or legal resident, pass-through taxation, no individual liability

Benefit Corporation

May write into their charter goals in additional to maximizing profits

Pass-Through Taxation

all profits/losses go directly to owner. owner then pays taxes on individual tax return

Double Taxation

Taxed as corporate income and then taxed again when shareholders receive dividends

Professional Corporations (PC)

Doctors/Lawyers

Each member has malpractice insurance; Individual practitioners are not liable for another professional’s misconduct

True (trademark law is federal)

T/F Franchises are run by both state and federal law

Dividends

Payouts to stockholders