1. Chapter 18 Governance and Structure: Forms of Doing Business
Marianne M. Jennings
Business
Its Legal, Ethical, and Global Environment
10th Ed.
Chapter 18 Governance and Structure: Forms of Doing Business

2. Comparison of Business Organizations
Form
Formation
Funding
Management
Sole proprietorship
Partnership
Limited partnership
Corporation
S corporation or Subchapter S
Limited liability company (LLC)
Limited liability partnership
No formal requirements
Articles of partnership
Filing of articles of partnership
Formal filing of articles of incorporation
Same as above (special IRS filings)
Formal filing – articles of organization
Filing of articles of limited liability partnership
Individual provides funds
Capital contributions of partners
Capital contributions of general and limited partners
Debt (bonds)/equity (shareholders)
Same as above
Capital contributions of members
Individual
All partners or delegated to one
General partner
Board of directors, officers and/or executive committee
No centralized management; all members manage or delegate to one member

3. Comparison of Business Organizations
Form
Transfer Control
Taxes
Sole proprietorship
Partnership
Limited partnership
Corporation
S corporation or Subchapter S
Limited liability company (LLC)
Limited liability partnership
No transfer
Transfer interest but not partner status
Same as partnership (except RULPA)
Shares (with reasonable restrictions) are easily transferred
Restrictions on transfer to comply with S corporation
No transfer without consent of the majority
No admission without consent of majority
Individual pays on individual return
Partner takes profits and losses on individual return (flow-through)
Same as partnership
Corporation pays taxes; shareholders pay taxes on dividends
Shareholders pay taxes on profits; take losses
Flow-through treatment

4. Comparison of Business Organizations
Form
Termination
Liability
Sole proprietorship
Partnership
Limited partnership
Corporation
S corporation or Subchapter S
Limited liability company (LLC)
Limited liability partnership
Death; voluntary
Dissolution upon death; withdrawal of partner
Same as partnership
Dissolved only if limited in duration or shareholders vote to dissolve
Same as above
Dissolved upon death; bankruptcy
Dissolved upon death, bankruptcy
Individual
Partners are personally liable
General partner is personally liable; limited partners liable to extent of contribution
No shareholder personal liability unless
Watered or
Corporate veil
Limited liability – only liable to extent of capital contribution
Varies by state, but liability for acts of partners is limited in some way

5. Sole Proprietorships Formation Done by an individual
May have a fictitious name
Example: Ralph Jones d/b/a Spuds Brewery
No formal requirements for formation
May have to publish d/b/a name

6. Sole Proprietorships Sources of Funding
Loans
Government help
Liability: Full Personal Liability of Owner
Tax Consequences
Owner claims all income and losses
No separate filing requirement
Management and Control
All assets with one person

7. Sole Proprietorships Transferability of Interest
Business can be sold—property, inventory, and goodwill
Owner will usually sign a non-compete agreement

8. Partnerships Governed by the Uniform Partnership Act (UPA)
Adopted in 49 states
In absence of a partnership agreement, UPA controls
Revised Uniform Partnership Act (1994)—adopted in nine states

9. Partnerships Definition Formation
An association of two or more persons to carry on as co-owners, a business for profit
Can include corporations and natural persons
Formation
Voluntary formation: By agreement
Draw up articles of partnership
Involuntary formation

10. Information in Articles of Partnership
Minimum requirements
Names of the partners
Name of the partnership
Nature of the partnership’s business
The time frame of operation
Amount of each partner’s capital contribution
Managerial powers of partners
Rights and duties of partners
Accounting procedures for partnership books and records
Methods for sharing profits and losses
Salaries (if any) of the partners
Causes and methods of dissolution
Distribution of property if the partnership is terminated
Suggested provisions
Disability issues
Insurance coverage
Sale of interest
Divorce of one of the partners
Indemnity agreements
Noncompetition agreements
Leaves of absence

11. Partnership Formation
Involuntary Formation: By Implication
Sharing of profits
Constitutes prima facie evidence that a partnership exists
Exceptions—rent, wages, annuity to widow or estate, payment for goodwill

12. Partnership Formation
Case Byker v. Mannes (2002)
Was there a partnership created?
When did the relationship legally end?
Is Mannes liable to Byker?

13. Partnership Formation
Involuntary Formation: Partnership by Estoppel (or Ostensible Partner)
Results when someone allows the inference to be made that he/she is a partner
Allowing name to be used to get a loan

14. Partnership Funding Sources of Funding
Capital contributions of partners
Loans by partners
Outside loans

15. Partnership Liability
Mutual Principals and Agents
Partnership assets reachable by partnership creditors
Personal assets reachable by partnership creditors when partnership assets are exhausted
Case Vrabel v. Acri (1952)
Why wasn’t Mr. Acri a defendant?
Is Ms. Acri liable for the injuries?

16. Partnership Tax Issues Partnership does not pay taxes
Partnership files informational return
Partners report income and losses on their returns

17. Partnership Management
Partnership Control
Unless otherwise agreed, each has equal management authority
May delegate day-to-day authority to one partner
Each partner is mutual principal and agent of the others

18. Partnership Management
Borrowing—Done Routinely In Most Partnerships
Unanimous Consent Required for Confession of Judgment, Selling Goodwill, and Admission of Another Partner
No Compensation for Work Unless Agreed

19. Partnership Management
Fiduciary Duties
Mutual principals and agents
Each is to act in the best interests of the partnership
Partnership Property
Property contributed to the firm or purchased with partnership assets
Own property as tenants in partnership

20. Partnership Management
Transfers of Partners’ Interest
Partner’s interest is personal property
Can be pledged to creditors and transferred
Transferee does not become a partner

21. Partnership Management
Transfers of Partners’ Interest
Admission of new partner requires unanimous consent
Transferring partner is not relieved of liability
Some partnership agreements require partners to offer it first to remaining partners

22. Partnership Dissolution
One Partner No Longer Associated With the Partnership
Examples: Retirement, death
Can Just Be a Change in Structure or Can Proceed to Termination

23. Partnership Dissolution
Dissolution Methods
By agreement
By operation of law: Death of a partner, bankruptcy of partnership or partner
Court order
Termination
Assets are liquidated
Distribute in this order: outside creditors; partners’ advances (loans); capital contributions; profits

24. Limited Partnerships
Governed by Uniform Limited Partnership Act (ULPA)
Revised Uniform Limited Partnership Act (RULPA)
Recent revision adopted in nearly all states
Use ULPA or RULPA when no agreement
RULPA addresses the needs of the larger limited partnership

25. L.P.’s: Formation Structure Formation
Must have at least one general partner
Must have at least one limited partner
Liability of limited partner is limited to capital contribution
Liability of general partner is unlimited
Formation
Must meet statutory requirements; if not met a general partnership may be created

26. L.P.’s: Formation
Must File Certificate of Limited Partnership (see text for list of requirements and note differences between ULPA and RULPA)
RULPA is much briefer
Corrections Can Be Filed By Limited Partners

27. L.P.’s: Formation
Formation – the RULPA Requires the Following Information for Formation of a Limited Partnership
Name - must contain the words “Limited Partnership”
Address of principal place of business
Name and address of statutory agent for services process
Business address of general partner
Latest date for dissolution of partnership

28. L.P.’s: Funding Sources of Funding
Limited partners provide most of the financing
Limited partners can contribute services under RULPA
Loans are used—called advances when made by partners
Under RULPA, limited partners can use services already given as a contribution

29. L.P.’s: Liability
Limited Partners Have Limited Liability But Cannot Participate in Management
Under RULPA, Can Do the Following and Still Retain Limited Liability Status
Can be an employee
Can consult with and advise the general partner
Can act as a surety guarantor for the limited partnership
Can vote on amendments, dissolution, sale of property, and debt assumptions

30. L.P.’s: Tax Issues Taxed the Same as General Partnerships
Partners Report Profits and Losses on Individual Returns
Limited Partners Get Direct Tax Benefits With Limited Liability
IRS Scrutinizes to be Certain it is a Partnership and Not a Corporation

31. L.P.’s: Profits
Partner Relationships: Management is Responsibility of General Partner
Profits and Distributions
Authority belongs to general partner to make decisions here
Profits and losses are allocated on the basis of capital contributions
RULPA requires agreement for splitting profits and losses to be in writing

32. L.P.’s: Partner Authority
General partner has same authority as in general partnership
Can restrict by agreement
Consent of limited partners required for
Admitting a new general partner
Admitting a new limited partner (can give authority in the agreement)
Extraordinary transactions (selling assets)
Limited partners have right to inspect books and records

33. L.P.’s: Transferability
ULPA Allows Transfer of Interests
May have significant restrictions on transfer to prevent liability under federal securities laws
The more easily an interest can be transferred, the more likely the IRS is to label it a corporation
Transfer of a limited partner’s interest does not dissolve the partnership
Under RULPA, Assigning Limited Partner Can Be Given the Authority to Make the Assignee a Limited Partner

34. L.P.’s: Dissolution RULPA Provides for the Following Means
Expiration of time period in agreement or event as provided in agreement
Unanimous written consent of all partners
By court order
Withdrawal of general partner

35. L.P.’s: Dissolution
If Termination is Elected, Assets are Distributed as Follows
Outside creditors
Partners’ distributions
Return of capital contributions
Remainder split according to agreement

36. Corporations Characteristics of a Corporation Unlimited duration
Free transferability of interest
Limited liability
Centralized management
Legal existence
Can hold legal title to property
Can sue and be sued

37. Types of Corporations For Profit Not For Profit
Domestic—in the State of Incorporation
Foreign—Everywhere Else
Government Corporations—Like FNMA
Professional Corporations—Limited Liability on Everything Except Professional Malpractice

38. Types of Corporations
Close or Closely Held Corporations: Limited Number of Shareholders, Subject to Less Formality
Subchapter S or S Corporation
IRS election to be treated as partnership for tax purposes
Still have limited liability
Limits on size for this election

39. Types of Corporations
The Law of Corporations: Model Business Corporation Act (MBCA)
Liberal statute
One-third of the states have adopted
Revised in 1984

40. Corporate Formation Must Comply With Statutory Requirements
File Articles of Incorporation
Name
Names and addresses of all incorporators
Capital structure of the corporation
Types of stock

41. Corporate Formation File Articles of Incorporation Classes of stock
Rights of shareholders
Voting rights
Statutory agent

42. Corporate Formation Where to Incorporate
Status of state’s corporation laws
State tax laws
Ability to attract employees
Incentives

43. Corporate Formation Incorporators Idea people—also called promoters
Will be personally liable for contracts entered into before incorporation
Corporation can ratify contracts—promoter is secondarily liable
Corporation can enter into a novation with the third party—promoter or incorporator is released from liability

44. Corporate Formation Must Hold Initial Meeting After Incorporation
Elect new directors
Adopt bylaws (day-to-day procedures)
Issue stock
Ratify pre-incorporation contracts

45. Corporate Capital Capital and Sources of Corporate Funds
Debt Financing—The Bond Market
Short-term financing—loans from banks
Bond market
Benefits of debt financing
Interest is tax deductible
Debt holders get paid first
Limitation: too much debt renders corporation financially unstable

46. Corporate Capital Equity Financing—Shareholder
Common stock: Has voting rights, receives dividends when paid
Preferred stock: Receiver preference over common stock can be cumulative or noncumulative

47. Corporate Liability Liability Issues
Must make full payment for shares—if not, there is liability (water stock); not paying par value
Shareholders’ liability generally limited to amount of investment
If corporate veil is pierced, there is shareholder liability. Means corporate immunity from liability is set aside

48. Corporate Liability Reason for Piercing the Veil
Inadequate capitalization—must put in enough money to meet the risks of doing business
Alter ego theory—separate nature of corporation is disregarded
No formalities—personal and corporate properties are mixed together
Ignoring corporate formalities—personal elections, meetings
Forming to perpetrate a fraud on creditors

49. Piercing the Veil Case 18.3 U.S. v. Bestfoods, Inc. (1998)
Is there a special CERCLA rule for piercing the corporate veil?
What must be shown to hold a parent liable for the action of a subsidiary?

50. Corporate Tax Issues Corporation Pays Tax
Shareholders pay tax on dividend income
Subchapter S or S Corporation
Corporate liability protection with partnership tax status

51. Corporate Directors Election of Directors Director Liability
Elected by shareholders to make corporate policy
May operate by committee
Hire officers of corporation and set officers’ salaries
Director Liability
Protected by the Business Judgment Rule. Directors and Officers must act in good forth and with prudence to avoid personal liability
Can consult experts but must study issues

52. Control By Board of Officer Pay
Dodd-Frank Requirements on Independence of Compensation Committee and Pay Votes
Shareholder “say on pay” vote every three years
Independent compensation committee
Claw-back provisions in compensation for executives if there is fraud or other illegality

53. Director Liability Case 18.4 Brehm v. Eisner (2000)
Who made the decision to terminate Ovitz?
Was hiring Ovitz just a HUGE mistake?
Why is there no liability on the part of the directors?

54. Corporate Liability Officer Liability Increasing personal liability
Increasing prosecutions
Particularly when environmental laws are violated

55. Sarbanes-Oxley Act Liability for Officers and Directors
Prohibitions on Loans to Officers
Code of Ethics for Financing Reporting
Lawyer’s new duties to company and officers
Board Membership – majority must be independent

56. Sarbanes-Oxley, Dodd-Frank, and Boards
Majority of Independent Directors
Only Independent Directors on Audit and Compensation Committees
No Loans to Officers
Codes of Ethics for Financial Reporting
Legal Counsel’s Role
Must investigate issues raised
Must notify CEO of investigation
Must report material violations to CEO
Must go to independent directors if problem is not resolved

57. Shareholder Rights Voting Shareholders Elect the board The Proxy
Vote on critical corporate issues
Pooling agreement
Voting trust

58. Shareholder Rights
Shareholders Have Right to Vote on Mergers, Consolidations, and Sale of All Assets, Not on Acquisition
Procedure
Board of Directors adopts resolution in favor of combination or sale
Resolution with notice of meeting sent to all shareholders
Shareholders vote on resolution at meeting

59. Shareholder Rights Dissenting Shareholders
Shareholders not voting in favor of the combination can force corporation to purchase their shares for cash – called appraisal rights
Corporation May Use Freeze-Out to Defeat Dissenters’ Rights

60. Shareholder Rights Shareholders Have Access to Books and Records
Under revised MBCA, no ownership requirements
Must have proper purpose
Generally Shares in a Corporation are Freely Transferable; However Sometimes Transfers are Restricted

61. Shareholder Rights Transfer Restrictions
Must be noted or referenced on stock certificates
Must serve a necessary purpose
Must be reasonable

62. Corporate Dissolution
Voluntary
Board resolution
Shareholder approval
Involuntary
Forced by court or state agency
Example: Fraud

63. Limited Liability Companies
History: In Existence Internationally For Some Time
GMBH—Europe
Limitada—South America
LLC—U.S.
Nature
Aggregate organization
Liability shield
Income flows through

64. LLC: Formation Articles of Organization Filed Centrally
Name Must Disclose Status – L.L.C. or LLC

65. Limited Liability Companies
Funding: Members Contribute Capital
Liability
Members stand to lose capital contributions, but their personal assets are not subject to attachment
Tax Consequence
Income passes through to members
LLC does not pay taxes

66. Limited Liability Companies
Management and Control
Operating Agreement—specifies voting rights
One member or an outside consultant can have operating authority delegated to him or her
Transferability of Interest
Interest can be transferred
Transferee does not become a member unless majority of remaining members approve

67. Limited Liability Companies
Dissolution and Termination
Generally withdrawal, death or expulsion of members will dissolve company
Some state permit judicial dissolution
All state permit voluntary dissolution

68. Limited Liability Partnership
Formation: Must File To Create
Funding: Capital Contribution From Partners
Liability: Limited Liability For All
Tax Consequences: Tax Reporting Entity Not Tax Paying

69. Limited Liability Partnership
Management and Control
Partners can participate in management without personal liability for partnership debts
Transferability
Transfer must be restricted
Dissolution and Termination
Similar to Limited Partnership

70. International Issues Joint Ventures Increasing
Joint ventures with countries themselves
Business structure varies
Example: Germany and differing board structures