1. Choice of Business Entity: Governance
February 24, 2017
Corey C. Brown
Porter Hedges LLP
1000 Main Street, 36th Floor
Houston, Texas 77002
(713) Tel

2. Types of Business Entities in Texas
TX Bus. Org. Code
Texas Business Organizations Code (“TBOC”)
Consolidation of multiple prior laws
Effective for entities formed on or after 1/1/06
And LLPs filing or renewing registration on or after 1/1/06
Effective for existing entities 1/1/10
Procedures provided for early adoption

3. Types of Business Entities in Texas
Entities under TX Bus. Org. Code
Corporations (For profit and nonprofit corporations)
Limited liability companies
Partnerships (General, limited and limited liability partnerships)
Professional entities
Real estate investment trusts
Associations

4. Types of Business Entities in Texas
Choice of law for a business entity
For an entity doing business only in Texas, it is generally most efficient to organize the entity under Texas law
Avoids duplicate filing and registration fees (an out-of-state entity “doing business” in Texas must register here)
For entities doing business in multiple states, Delaware is a common choice
Delaware has well developed laws and knowledgeable judges

5. C Corporation Separate legal entity
Shareholders have limited liability
Tax treatment: Double taxation for C-corps
Entity level Federal income tax (15% - 35%)
Dividends to shareholders taxed
No flow-through of income, deductions or losses
Strict Charter Requirements: The Charter must include:
Nature of the business or purposes to be conducted or promoted
Number of authorized shares of each class of stock
The designations and the powers, preferences and rights, and the qualifications, limitations or restrictions of all classes of stock

6. C Corporation Governed by Charter, Bylaws and Shareholders Agreements
Management Generally
Formal management structure established by law
Limited ability of owners to contract “around” statutory requirements
Failure to observe formalities can result in loss of limited liability
Board of Directors
Elected by shareholders
Affairs managed under the direction of its Board
Officers appointed by Board

7. C Corporation Corporate Fiduciary Duties Duty of loyalty Duty of care
Duty of good faith
Self-dealing transactions
Corporate opportunity doctrine
To apply, the corporation must have a legitimate interest or expectancy in and the financial resources to take advantage of a particular business opportunity
TBOC and DGCL allow exclusions in Charter or by Board
Duty of candor/disclosure and confidentiality
Duty of care
Ordinarily prudent man would use under similar circumstances
Business judgement rule/entire fairness
Gross negligence/conscious indifference
TBOC and DGCL allow for the limitation of liability in Charter

8. Limited Liability Company
Separate legal entity
Members have limited liability
Tax treatment: Pass-through or double taxation
Company income, deductions or losses flow through to members
An LLC with two or more members is classified as partnerships for federal income tax purposes unless the LLC elects to be taxed as a corporation.
A single member LLC will be disregarded as an entity separate from its owner unless LLC elects to be taxed as a corporation
Limited Charter Requirements
In Texas, the Charter must include a statement of purpose and the managers, if applicable, or members, if no managers
No limitation on number or type of equity owners (subject to limitation on publicly traded status)
Most flexible capital structure; Series LLCs
Access to capital:
Limitation on publicly traded status
Flow through taxation may require special handling for tax exempt and foreign investors

9. Limited Liability Company
Management
Less formality than a corporation
Members have broad ability to govern by contract through the Company Agreement
Statute imposes “default” provisions
Can be member-managed or manager-managed
Managing members can operate through a Board or directly
Managers can operate through a Board or directly
Managers may be natural persons or entities
Can have officers vested with actual or apparent authority

10. Limited Liability Company
LLC Fiduciary Duties
TBOC does not specifically codify manager or member fiduciary duties
DLLCA provides that common law fiduciary duties apply unless modified by the Company Agreement
TBOC permits Company Agreements to expand or restrict the duties (including fiduciary duties) and liabilities of Members, Managers, officers and other persons to the company or to Members or Managers of the company
While DLLCA allows a Company Agreement to eliminate fiduciary duties (but not the contractual duty of good faith and fair dealing), the TBOC only permit a Company Agreement to “restrict” such duties, but allow the elimination of liability for breach of fiduciary duties (other than the duty of loyalty)
Bottom Line: Do not let courts define the parties’ duties

11. Limited Liability Company
State taxation
Texas – generally same as C corporation
Other – varies; most same as federal
Employment taxes
Single member LLC – same as sole proprietorship; all earnings = self-employment income
Multiple member LLC
Reasonable compensation subject to employment taxes

12. Limited Liability Company
Bottom Line
LLC is generally the preferred business entity
No special eligibility requirements
Full flow through taxation
Tax exempt and foreign investors often invest through a corporation (“blocker”)
Self-employment tax on residual earnings can generally be mitigated

13. Limited Partnership Separate legal entity
Limited partners have limited liability
Requires at least one general partner with unlimited liability
Corporate or LLC general partner can be used
Tax treatment: Pass-through
Limited Charter Requirements
No limitation on number or type of equity owners (subject to limitation on publicly traded status)
Transferability of interests: Can’t be “publicly traded”
Management vested in the general partner

14. Limited Partnership Fiduciary duties
General rule: General partner is a fiduciary
In Texas, the duties of care and loyalty and the obligation of good faith may not be eliminated by the partnership agreement, but may be modified by contract so long as not “manifestly unreasonable”
Delaware allows the limitation or elimination of partner fiduciary duties in the partnership agreement, but expressly does not allow the elimination of the implied contractual covenant of good faith and fair dealing

15. Limited Partnership Taxation
Number/type of equity owners: must be >1 owner; can’t be publicly traded (similar to multiple member LLC)
Can elect to be taxed as a corporation; rarely advisable
Federal income tax (default) – full flow through taxation
Same as multiple member LLC
State taxation
Texas – generally = C corporation, unless a “passive entity”
Other – generally same as federal
Employment tax – similar to S corporation

16. General Partnership Non-tax factors
No formal organizational requirements
No limited liability (joint and several liability)
No continuity of life – death or withdrawal of any GP terminates business (can reconstitute)
No free transferability of interests
Access to capital: limited
Management/governance –
No formal requirements
Any partner can bind the partnership

17. General Partnership Taxation
Number/type of equity owners: same as limited partnership
Can elect to be taxed as a corporation; rarely advisable
Federal income tax (default) – full flow through taxation
Generally no at-risk or passive activity limitations on losses
State taxation
Texas – taxable entity, except for “passive entities” and “general partnerships of all natural persons”
Other – generally same as federal
Employment tax – similar to sole proprietorship
Rarely advisable for a business entity, primarily due to joint and several liability

18. Limited Liability Partnership
Description and effect
Either a limited partnership or a general partnership that registers as an LLP. See TBOC
Partners have limited liability, except for negligence etc. of another partner where
The partner was supervising or directing the other partner
The partner was directly involved in the specific activity in which the negligence etc. was committed by the other partner
Tax effect: generally same as limited partnership

19. Professional Entities
Professional corporation or association
Definition:
Professional corporation: provides non-medical licensed professional services (e.g., architecture, law, accounting)
Professional association: provides medical services
Protects owners from entity debts and acts of other shareholders; entity has joint and several liability with owners (similar to LLP)
Taxation: generally same as a corporation with some special rules; can elect S corporation status
Professional limited liability company
Professional entity formed and taxed as a limited liability company

20. Disclaimers
This document is not intended to provide advice on any specific legal matter or factual situation, and should not be relied upon without consultation with qualified professional advisors.
Any tax advice contained in this document and any attachments was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under applicable tax laws, or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter.