Business Law Ch. 15,16

Taxation of C Corps

"C" corporations are considered a separate legal, taxable entity from the owners for income tax purposes. Therefore, corporations pay tax on their earnings and then tax is paid again if corporate earnings are distributed to shareholders in the form of dividends (known as double taxation).

This Relates to Court Jurisdiction

"The Delaware Court of Chancery is widely recognized as the nation's preeminent forum for the determination of disputes involving the internal affairs of the thousands upon thousands of Delaware corporations and other business entities through which a vast amount of the world's commercial affairs is conducted. Its unique competence in and exposure to issues of business law are unmatched."

Regular Partnership

-2 or more people/business organizations -Common business interest -Share profits/losses -Creation is simple -Each partner = equal voice -Continuity- dissolved when ownership changes -Liability- jointly & severally -Taxation- according to level of ownership

Limiting Director Liability

-A corporate board typically has several measures in place designed to limit their liability: *oversight committees to monitor executive management, and *consulting/outside professional firms to ensure validity of the information and data used by the board in their decision making.

Formation of a Corporation

-A corporation has the most formal filing and reporting requirements. -Document must state the corporation's name, purpose, number of shares issued, and address of the corporation's headquarters. -This document is known as the articles of incorporation.

Public Offerings

-A very complex and time-consuming process of converting the corporation from privately held to publicly held by engaging in an initial public offering (IPO). -At that point, the corporation may raise equity by selling its shares to the general public and to financial institutions.

Taxation of LLCs

-Another attractive advantage of an LLC is the various tax treatment alternatives. -Although many LLCs are typically treated as a pass-through entity, the LLC's members may also elect to be taxed as a corporation if they consider the corporate tax structure more favorable

Personal Guarantees

-Banks, landlords, and other creditors are fully aware of the limited liability provided by the corporate veil. -Thus, if a corporation is a start-up or has limited assets, these creditors will almost always require that the shareholders give a personal guarantee.

Initial Corporate Organizational Meeting

-Bylaws (rules by which corp. is run) -Board of directors and officers -Issuance of shares

Equity

-Corporations also sell equity to capitalize their operations. -For modest amounts of funding, corporations may turn to private investors or groups of investors. -Corporation will hire a registered broker-dealer to handle larger scale IPOs.

Capitalization of Corporations

-Corporations have the widest range of options when considering how to finance their operations. -They may be funded through debt or through the selling of equity in a variety of forms.

Limited Liability Partnerships (LLPs)

-Danger of being a general partner is the potential liability for acts of other general partners, debts, and liabilities of the partnership itself. -LLP statutes provide partnerships with the protective shield ordinarily only afforded to limited partners or corporate shareholders.

Types of Essay Questions

-Differences between LLC, LLP and Corporation *Details regarding each separate formation -Corporate opportunity and business judgment rule doctrines -Fiduciary duties of directors, officers, stockholders *Define each type of fiduciary duty and how the duties may be breached, leading to personal liability -Liability of promoter for a corporation

Dissolution of LLCs and Dissociation of Members

-Dissolution of an LLC is a liquidation process triggered by an event that is specified in the operating agreement. -Dissociation occurs when an individual member decides to exercise the right to withdraw from the partnership. -Generally, upon a dissociation the remaining members may either continue the LLC or wind it down.

Duties of LLC Members

-Duty of Loyalty -No self-dealing -Must act in good faith when dealing with LLC's business matters

Fiduciary Duties of Officers and Directors

-Duty of care and the duty of loyalty -Breaching these duties may result in personal liability for the officer or director.

Liability of LLPs

-General idea behind being an LLP is that all partners have liability protection for debts and liabilities of the partnership, but there may be conditions on these protections. -In cases where a partner has engaged in misconduct or tortious conduct (such as negligence), the LLP acts to shield the personal of assets of other partners—never the partner who committed the misconduct or negligence. -http://www.scstatehouse.gov/code/t33c041.php

Where is the corporation formed?

-In the state of its incorporation, a corporation is referred to as a domestic corporation. -A corporation that transacts business in a state other than its state of incorporation is known as a foreign corporation in the other state. -A corporation formed outside the United States that transacts business in the US is referred to as an alien corporation.

Capitalization of LLPs

-LLPs are capitalized in the same way as a regular partnership: through debt via private or commercial lenders or by selling partnership equity for ownership in the LLP itself. -Some LLPs have right to "call" for more money from each partner.

Formation of LLPs

-Limited liability partnerships are formed when members file a statement of qualification with the appropriate public official or state office. -Some states require LLP and individual partners carry and maintain liability insurance as a condition of formation

Different types of corporations

-Nonprofit corporations have no profit-seeking owners, but exist to perform some service to the public at large (e.g., charities, educational institutions). -Public corporations are those formed by a government body to serve the public at large, such as public mass transit. -Professional corporations are those where ownership is restricted to a particular profession licensed in that field, e.g. MDs.

LLC

-Nontaxable -Shareholders = "Members" -Often seen with professional company -Each state has its own statute re LLCs -Same liability protection afforded to principals of a corporation -But a member may become liable for the member's own acts or conduct -Pass-through tax treatment for its principals

"Business Judgment Rule"

-Officers and Directors are protected from liability as long as they *act in good faith* -Most courts define good faith by requiring directors/officers to clear three hurdles to obtain protection of the rule: *No private interest *Best information *Rational belief

Shareholders of Corportation

-Power to elect and remove directors -Power to veto fundamental changes to corporation, e.g. sale of all assets, mergers, issuing more capital stock, and issuing bonds -Shareholders also must approve any changes in the structure of the corporation through amending the articles of incorporation or bylaws.

Board of Directors

-Sets strategy and policies of the corporation, including payment of dividends -Also has important oversight functions -Most planning initiatives that result in a change to the corporation, such as an acquisition of another corporation's assets or stock, are overseen by the board prior to submitting the plan to shareholders for approval.

Breach of Fiduciary Duty Lawsuits by Shareholders

-Shareholders enforce their rights and fiduciary duties through the use of a lawsuit in the form of: -Shareholder's derivative action shareholder(s) bring lawsuit against insider in name of corporation, or -Shareholder's direct action. -Shareholder(s) bring lawsuit in own name(s)

Liability

-Shareholders, directors, and officers of a corporation are generally insulated from personal liability in case the corporation runs up large debts or suffers some liability. -This liability protection is often referred to as the corporate veil.

How to avoid liability for pre-inc debts

-Since promoters are liable for pre-incorporation debts of corps, take steps: -In agreement, specify "all pre-incorporation liabilities are liabilities of the corporation once the entity is formed OR -Form the corporation before promoter(s) sign(s) contract

Choice of State of Corp Incorporation

-Some significant advantages for large publicly held corporations may be gained by incorporating in Delaware; many shell companies set up in DE in order to avoid taxes in other states -However, most corporations are better served by incorporating in the state where they are headquartered.

When members of LLCs might incur liability

-State LLC statute might shields members and managers from liability solely by reason of being or acting as LLC members and managers -But individuals could be liable for breach of LLC's agreement if they: * assumed Liability on agreement or *for tortious acts that they committed, authorized, or ratified while acting for LLC

Operating agreement for an LLC

-Structure of governance and responsibility of members -Death, incapacity, and dissolution

Pre-incorporation Activity: Liability of Promoters

-Such activities include arranging for necessary capital through a loan, recruiting personnel, leasing property, and arranging to have the business incorporated -The individual who performs these activities is known as a promoter. -If the promoter makes a contract on behalf of a not-yet-formed corporation, she may have some degree of personal liability to perform under the contract.

Officers

-The corporation's officers are appointed by, and may be removed by, the board of directors. -The officers carry out the day-to-day operations of the corporation and execute the strategy and mandates set out by the board of directors

Management and Operation of LLPs

-The day-to-day operations and powers of the partners are spelled out in the partnership agreement. -The election procedures, qualifications, compensation, meeting times, and other organizational matters are typically addressed in the partnership agreement.

Privately Held vs Publicly Held

-The most common category is a privately held corporation. -Privately held corporations are those that do not sell ownership interests through sales via a broker to the general public or to financial institutions or investors.

Limited Liability Partnership (LLP) can be structured so that:

-one general partner controls the company's daily operations and is personally liable for business debts and -passive partners (limited partners) whose liability is capped at investment amount. -With professional LLPs, all are general partners

Corporations allocate power to:

-shareholders, -directors, and -officers.

Corporations

A corporation is fictitious legal entity that exists as an independent "person" separate from its principals.

Liability of LLC Members

Although LLC members are insulated from personal liability for any business debt or liability, creditors often require members of new and/or small LLCs to sign personal guarantees.

Formation of LLC

An LLC is formed by filing: Articles of organization (also called certificates of organization) with the state public filing official

Piercing the Corporate Veil

Corporate shield usually protects personal assets of principals from corporate debts UNLESS: -Inadequate capitalization -Evidence of fraud or wrongdoing -Failing to follow corporate formalities

Corporate Debt

Corporations often borrow money from commercial lenders (such as banks) to fund day-to-day operations. For larger projects, corporations may also use more sophisticated forms of debt such as issuing bonds or debentures.

Protection offered by BJR

Directors and officers have protection from liability for their decisions under the *business judgment rule* as long as they've exercised good faith judgment and met fiduciary obligations.

Case Questions: 15.2

Facts: Chargois and Ernster (C&E) were individuals who formed and registered a limited liability partnership to operate their law practice in 2002. In an attempt to solicit business, C&E developed a Web site in June 2003 which included a link using Dillard Department Stores's corporate name and trademarked logo. Dillard's sued C&E for trademark infringement, but during the litigation, Chargois and Ernster executed a separation agreement that provided for dissolution of the partnership. C&E's registration as an LLP was not renewed with state authorities and their registration expired later that same year. The court entered a final judgment ordering "Chargois & Ernster, L.L.P." to pay Dillard's $143,500.

Case Question : 16.3

Facts: McCall and other shareholders brought a derivative suit against Scott and all other officers and directors of Columbia, a healthcare corporation, alleging breach of fiduciary duty claims. -The shareholders claimed that the board had intentionally and/or recklessly disregarded fraudulent activities of senior management, including management's attempt to improperly boost revenue through systematic overbilling for a period of two years. The directors defended by citing a limited liability provision in their corporate charter that limited the liability of the directors in the case of an allegation of the breach of duty of care so long as they did not act in bad faith.

How Did the Court Rule?

Issue: Are Chargois and Ernster personally shielded from any partnership liability or debt by the state LLP statute? Ruling: No. Chargois and Ernster were personally liable for the judgment owed to Dillard's. The court found that the debt was incurred when the judgment was entered on November 2, 2004, at which time the LLP had lost its liability-limiting attributes and no longer protected Chargois and Ernster.

How Did the Court Rule?

Issue: Is Columbia's limited liability provision valid given the circumstances? Ruling: No. Limited liability provisions in corporate charters are unenforceable in the face of gross, ongoing negligence by the directors to notice or investigate the illegal conduct of the corporation's officers.

Capitalization of LLCs

LLCs are capitalized primarily through debt via private lenders or commercial lenders, or by selling equity ownership in the LLC itself. *LLCs may sell equity ownership or obtain loans to capitalize

Taxation of LLPs

LLPs are treated as pass-through entities. They are not subject to tax; any income is taxed only when it is distributed to the LLP's partners.

Management and Operation of LLCs

Most states distinguish between: A member-managed LLC, and A manager-managed LLC (only person with authority to bind the LLC)

New Type of Corporation: B

Over 26 states allow Benefit Corporations Certification requires annual audits: governance, employment practices, community performance, environment Generally mission must include attacking social and environmental problems. Examples: Method cleaning products, Green Mountain Power (VT), Plum Organics

Duty of Care of Officers & Directors

Requires that there is no: -Negligence -Failure to act with diligence -Rubber stamp

Taxation of S Corps

Subchapter S: Do not pay corporate taxes They transfer income, losses, deductions to shareholders via distributions reported on K-1 Forms -Avoids double taxation. Requirements in states that recognize them: -Single class of stock. -No non-resident alien shareholders. -No more than 100 shareholders.

Duty of Loyalty of Officers & Directors

The duty of loyalty is primarily focused on providing protection to shareholders in cases where a transaction occurs where the possibility of self-dealing is present.

Privately Held becoming Publicly Held

When a privately held corporation wishes to fund capitalization through the sale of ownership interest to the general public and commercial investors, the principals pursue an Initial Public Offering (IPO) and then continue their corporate existence as a publicly held corporation

Corporate Opportunity Doctrine

When a related opportunity is off limits to insiders unless and until they disclose it to the corporation: -Did the corporation have a current interest or expected interest in the opportunity? -Is it fair to the corporation's shareholders to allow another to usurp a certain interest? -Is the opportunity closely related to the corporation's existing/prospective business activities? If Board rejects opportunity, insider may pursue it