1. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning Chapter 21 Forms of Doing Business Its Legal, Ethical, and Global Environment MARIANNE M. JENNINGS 7 th Ed.

2. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 2 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.

3. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 3 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.

4. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 4 Transferability of Interest: –Business can be sold—property, inventory, and goodwill. –Owner will usually sign a non-compete agreement. Sole Proprietorships

5. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 5 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. Partnerships

6. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 6 Partnerships Definition: –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 

7. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 7 Partnership Formation Case 21.1 Byker v. Mannes (2002). –Was there a partnership created? –When did the relationship legally end? –Is Mannes liable to Byker?

8. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 8 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.

9. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 9 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.

10. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 10 Partnership Funding Sources of Funding: –Capital contributions of partners. –Loans by partners. –Outside loans.

11. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 11 Partnership Liability Mutual principals and agents: –Partnership assets reachable by partnership creditors. –Personal assets reachable by partnership creditors when partnership assets are exhausted. Case 21.2Vrabel v. Acri (1952). Why wasn’t Mr. Acri a defendant? Is Ms. Acri liable for the injuries?

12. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 12 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. Partnership Management

13. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 13 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.

14. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 14 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. Partnership Management

15. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 15 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.

16. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 16 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. Partnership Management

17. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 17 Partnership Tax Issues: –Partnership does not pay taxes. –Partnership files informational return. –Partners report income and losses on their returns.

18. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 18 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.

19. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 19 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. Partnership Dissolution

20. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 20 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. Limited Partnerships

21. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 21 Structure: –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. L.P.’s: Formation

22. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 22 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. L.P.’s: Formation

23. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 23 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.

24. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 24 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. L.P.’s: Funding

25. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 25 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. L.P.’s: Liability

26. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 26 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. L.P.’s: Profits

27. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 27 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. L.P.’s: Partner Authority

28. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 28 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. L.P.’s: Transferability

29. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 29 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. L.P.’s: Tax Issues

30. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 30 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. L.P.’s: Dissolution

31. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 31 If termination is elected, assets are distributed as follows: –Outside creditors. –Partners’ distributions. –Return of capital contributions. –Remainder split according to agreement. L.P.’s: Dissolution

32. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 32 Characteristics of a Corporation: –Legal existence. –Unlimited duration. –Free transferability of interest. –Limited liability. –Centralized management. –Can hold legal title to property. –Can sue and be sued. Corporations

33. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 33 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. Types of Corporations

34. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 34 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. The Law of Corporations: Model Business Corporation Act (MBCA). –Liberal statute. –One-third of the states have adopted. –Revised in 1984. Types of Corporations

35. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 35 Must comply with statutory requirements. File articles of incorporation: –Name. –Names and addresses of all incorporators. –Capital structure of the corporation. –Types of stock. Corporate Formation

36. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 36 Corporate Formation File articles of incorporation: –Classes of stock. –Rights of shareholders. –Voting rights. –Statutory agent.

37. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 37 Where to incorporate: –Status of state’s corporation laws. –State tax laws. –Ability to attract employees. –Incentives. Corporate Formation

38. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 38 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. Corporate Formation

39. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 39 Corporate Formation Must hold initial meeting after incorporation: –Elect new directors. –Adopt bylaws (day-to-day procedures). –Issue Stock. –Ratify Pre incorporation contracts.

40. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 40 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. Corporate Capital

41. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 41 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. Liability Issues. –Must make full payment for shares—if not, there is liability (water stock). Not paying par value.

42. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 42 Liability Issues: –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. –Reasons for piercing: Inadequate capitalization—must put in enough money to meet the risks of doing business Alter ego theory—separate nature of corporation is disregarded. Corporate Liability

43. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 43 Reason for Piercing the Veil: –No formalities—personal and corporate properties are mixed together. –Ignoring corporate formalities - elections, meetings. –Forming to perpetrate a fraud on creditors. Corporate Liability

44. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 44 Piercing the Veil Case 21.3U.S. v. Best Foods, 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?

45. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 45 Corporate Directors Election of Directors. –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.

46. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 46 Case 21.4Grobow v. H. Ross Perot (1988). –Why is director independence important? –How does the business judgement rule apply in the repurchase? Director Liability

47. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 47 Corporate Liability Officer liability. –Increasing personal liability. –Increasing prosecutions. –Particularly when environmental laws are violated.

48. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 48 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.

49. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 49 Voting shareholders: –Elect the board. –The Proxy. –Vote on critical corporate issues. –Pooling agreement. –Voting trust. Shareholder Rights

50. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 50 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.

51. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 51 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.

52. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 52 Shareholders have access to books and records. –Under revised MBCA, no ownership requirements. –Must have proper purpose. Generally share in a corporation are freely transferable; however sometimes transfers are restricted. Shareholder Rights

53. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 53 Shareholder Rights Transfer restrictions. –Must be noted or referenced on stock certificates. –Must serve a necessary purpose. –Must be reasonable.

54. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 54 Voluntary. –Board resolution. –Shareholder approval. Involuntary. –Forced by court or state agency. –Example: Fraud. Corporate Dissolution

55. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 55 Corporation pays tax. –Shareholders pay tax on dividend income. Subchapter S or S corporation. –Corporate liability protection with partnership tax status. Corporate Tax Issues

56. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 56 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.

57. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 57 Articles of organization. Filed centrally. Name must disclose status - L.L.C. or LLC. LLC: Formation

58. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 58 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. Limited Liability Companies

59. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 59 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. Limited Liability Companies

60. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 60 Dissolution and Termination: –Generally withdrawal, death or expulsion of members will dissolve company. –Some state permit judicial dissolution. –All state permit voluntary dissolution. Limited Liability Companies

61. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 61 Formation: Must file to create. Funding: Capital contribution from partners. Tax Consequences: Tax reporting entity not tax paying. Limited Liability Partnership

62. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 62 Limited Liability Partnership Management & Control: partners can participate in management without personal liability for partnership debts. Transferability: transfer must be restricted. Dissolution & Termination: similar to limited partnership.

63. Copyright ©2006 by West Legal Studies in Business A Division of Thomson Learning 63 Joint Ventures Increasing. –Joint ventures with countries themselves. –Business structure varies. Example: Germany and differing board structures. International Issues