Business Law Test #3 (Ch. 36, 37, 38, 39, 40, 41, 42, 47)

Election of Directors in a Corporation

# of directors usually set forth in the articles of incorporation, term of office is generally 1 year **Removal of Directors: Directors can be removed for cause **Vacancies on Board: if director dies/resigns/new position created by the articles/bylaws

Potential problems for closely held corporations

***Separate status must be preserved 1. commingling of funds 2. no director meetings 3. shareholder use of corporate property

Franchise Contract

**MUST be in writing b/w franchisor and franchisee includes type of business entity including capital structure, sales quotas and record keeping, business premises leased/purchased, location of the franchise, quality control (a legitimate issue for franchisor because of good will, reputation, and trademark value) **Courts will not question franchisor's strict supervision but franchisor may be liable for torts of agents **Pricing arrangements: franchisor cannot set prices of goods sold

Dissolution of an LLC

*Dissociated member has no right to force the LLC to dissolve *Remaining members can choose to continue or dissolve *Operating agreement "trigger" events will cause dissolution

Rights of Partners

*In the absence of a partnership agreement (oral/written) state statutes govern the partner rights 1. Management: equal, each one vote, majority wins; need unanimous consent for some actions 2. Interest in the Partnership: equal profits, losses shared as profits shared 3. Compensation: no right to compensation partner's income takes the form of distribution of profits 4. inspection of the books: always a right; also can by done by representative of deceased partner 5. Accounting: when fraud, embezzlement, wrongful exclusion, etc. it is just and reasonable 6. Property rights: Property acquired by the partnership remains partnership property; an individual partner has no right to sell, mortgage, or transfer partnership property; each partner can use or possess property on behalf of partnership and assign her right to her share of the profits to another to satisfy individual debt

Attorney's Liability

*Liability for malpractice - when an attorney fails to exercise reasonable care and professional judgment she breaches the duty of care and can be held liable for malpractice (professional negligence)

Winding Up and Distribution of Assets

*partners have no authority except to complete already begun transactions, collect and preserve partnership assets, discharge liabilities, and provide an accounting *If liabilities are greater than assets partners bear losses in proportion in which they shared profits, unless agreed otherwise

LLC Operating Agreement

- Analogous to corporation's bylaws *Not required for LLC to exist, but strongly recommended the agreement be in writing stating: 1. Management and how future managers will be chosen 2. How profits will be divided 3. How membership interests may be transferred 4. Dissociation Procedures 5. Whether formal meetings will be held 6. How voting rights will be apportioned **State statute fills in the gaps where operating agreement is silent **If LLC statute is silent, courts may apply partnership principles

Consider when choosing a business entity

- Ease of Creation - Owners Liability - Tax considerations - Need for Capital

Management of an LLC

- Either member-managed or manager-managed *In member management all members participate in management and decisions *One member one vote - anything differential you have to specify *Managers and members owe fiduciary duties to the LLC and to each other

Accountant's Duty of Care

- must possess certain level skill and degree or care - must comply with GAAP and GAAS - must comply with IFRS - accountant is not required to discover every impropriety, defalcation, or fraud in a clients books - but if it goes uncovered b/c of negligence or failure to perform the accountant will be liable for any losses suffered by the client - audit - can be liable for failing to discover misconduct if a normal audit would have revealed it

Laws governing Franchising

- primarily governed by contract law - UCC Art. 2 governs franchises for sale of goods - Federal regulation of franchises: industry-specific standards: protect franchisee from unreasonable demands and bad faith termination; does not guarantee return on investment but will mandate disclosure on certain information *Franchise Rule: disclosure of material facts for informed decision - State Protection for Franchisees: protection from unfair trade practices and bad faith terminations; disclosure documentation including costs of operation, recurring expenses, profits earned, and substantiating of these figures; state law may prohibit termination without "good cause"

Potential Liability of Accountants under Securities Laws

- under section 11: civil liability for misstatements, standard of due diligence - under section 12(2): civil liability for fraud in relation to offerings/sales of securities; based on communications

Defenses to Accounting Negligence

1. Accountant was not negligent 2. if the accountant was negligent the negligence was not the proximate cause of the client's losses 3. the client was also negligent (depending on whether the state applies contributory negligence or comparative negligence)

SOX Requirements

1. Auditor Independence - unlawful to perform both audit and nonaudit services for the company at the same time - approval from issuer's audit committee - requires partner rotation - requires timely reports to audit committees of corporations 2. requirements for maintaining working papers used in an audit

Merger, Consolidation & Share Exchange Procedures

1. Board of directors of each corporation must approve the merger or share exchange plan 2. Majority of shareholders must approve 3. file plan with secretary of state

What is a security?

1. Common/preferred/treasury stocks, bonds, debentures, and stock warrants 2. stock options, put calls 3. notes, instruments of debt, certificates of interest and deposit 4. interest in oil, gas, or other mineral rights 5. investment contracts

Partnership termination (2 stages)

1. Dissolution (legal "death" of the partnership), and 2. Winding up and Distribution of assets (collecting and distributing partnership assets)

Types of Franchises

1. Distributorship (car or beer) - licensing; not forming anything at the governmental level; a contractual relationship 2. chain stores 3. manufacturing agreement - not as common; example: coca-cola

Duties of Directors and Officers

1. Duty of Care: Duty to make informed decisions, duty to exercise reasonable supervision when they delegate work; **Dissenting directors rarely held individually liable for a case of mismanagement 2. Duty of Loyalty: Subordination of personal interests to welfare of the corporation; no competition or conflicts of interest w/ corporation; No corporate opportunity; No insider trading; No transaction that is detrimental to minority shareholders

Duties of Partners

1. Fiduciary Duties: Partners are fiduciaries and general agents of one another and the partnership (TWO WAY FIDUCIARY DUTY) - Unless you agree otherwise duty of loyalty is to refrain from engaging in anything that conflicts with the partnership *Partners fiduciary duties cannot be waived/eliminated

Disadvantages of Franchises

1. Franchise Fee 2. Have to follow all corporate rules **Potential problem if too many rules are too rigidly enforced the franchisor could be liable under respondeat superior

Exempt Securities

1. Government issued 2. bank and financial institution securities 3. short term notes and drafts 4. securities of nonprofit, educational, and charitable organizations 5. securities issued by common carriers 6. any insurance, endowment, or annuity contract issued by a state regulate insurance company 7. securities issued in a corporate reorganization in which one security is exchanged for another 8. securities issued in stock dividends/splits

Advantages of the LLC

1. Limited Liability: liability of members limited to amount of their investments 2. Flexibility in taxation: an LLC of 2 or + members can choose to be taxes as either a partnership (pass through) or corporation - can avoid corporate "double taxation" ** Single member LLC treated like a sole proprietorship for tax purposes 3. Management and Foreign Investors: LLC's allow foreign investors to own LLC interests and flexible management

General characteristics of a partnership

1. Name if Entity 2. Owners = general partners 3. Partnership treated as an independent person under the law for being sued/suing 4. will hold title to property like a corporation

Advantages of sole proprietorship

1. Owner is in complete control and receives all profits (you are sole decision maker) 2. more flexible 3. easy to create/maintain 4. sole proprietor pays only personal income taxes on business profits b/c they are reported as personal income

Disadvantages of sole proprietorship

1. Owner is personally liable for all losses or liabilities incurred by the business enterprise 2. Personal assets at risk: creditors can pursue the owner's personal assets to satisfy any business debt 3. Lack of continuity after death of proprietor - when owner dies so does the business 4. debt is the only way to expand the business - difficult to raise financing

Liability of Directors and Officers

1. Personally liable for crimes and torts committed and for those committed by employees under their supervision 2. Shareholder derivative suits: shareholders perceive that directors are not acting in best interests of the corporation they may sue the directors

Rights of Corporate Directors

1. Right to participation 2. Right of inspection: access corporations books, records, facilities 3. right to indemnification: reimbursement for legal costs

Comparing Major Business Forms: Legal Position

1. Sole proprietorship - not a separate entity; owner is business 2. partnership: separate legal entity in most states 3. corporation: always a legal entity distinct from owners and legal person for purposes of owning property/being party to litigation

Comparing Major Business Forms: Method of creation:

1. Sole proprietorship: created at will by owner 2. Partnership: created by agreement of parties 3. Corporation: authorized by the state under the law

Comparing Major Business Forms: Liability

1. Sole proprietorship: unlimited liability 2. partnership: unlimited liability 3. corporation: limited liability of shareholders

Disadvantages of the LLC

1. State LLC statutes not uniform 2. Does not lend itself to easily having lots of owners/members 3. not a lot of case law 4. can't raise capital easily by selling member interest

Outsiders can be held liable for insider trading under Rule 10b-5

1. Tipper/Tippee Theory: tippees who acquire inside information as a result of a corporate insider's breach of fiduciary duty can also be liable ***Required breach of fiduciary duty to the corporation - Elements: 1) breach of duty, 2) disclosure made in exchange for personal benefit, 3) tippee knows or should have known of the breach and benefits from it 2. Misappropriation theory: holds an individual who wrongfully obtains inside information and trades on it for his personal gain liable

Shareholders' Powers

1. approve all fundamental changes to corporation 2. amend articles of incorporation/by laws 3. approval of mergers or acquisiion 4. sale of all corporate assets/dissolution 5. elect/remove B.O.D

Basic Elements of Fraud action under SEC Rule 10b

1. material misrepresentation 2. Scienter (wrongful state of mind) 3. reliance by the plaintiff on the material misrepresentation 4. an economic loss 5. causation - casual connection b/w misrepresentation and the loss ***Rule 10b prohibits use of any manipulative or deceptive device or contrivance in violation of SEC rules and regulations

Accountant Defenses toLiability to Section 11 of 1933 Act

1. no misstatements 2. misstatements were not material 3. misstatements had no causal connection to loss 4. plaintiff purchaser invested in the securities knowing of the misstatements

Events that cause dissociation

1. notice of intent to withdraw 2. triggering event 3. unanimous vote 4. court or arbitrator vote 5. partner's bankruptcy, assignment of interest, incapacity, or death

Factors the Lead Courts to Pierce the Corporate Veil

1. party is tricked/misled into dealing with the corporation rather than the individual 2. the corporation is set up never to make a profit or always to be insolvent or is too thinly capitalized; has insufficient capital at the time it is formed to meet potential debts/liabilities 3. the corporation is formed to evade an existing legal obligation 4. statutory corporate formalities such as holding required corporate meetings are not allowed 5. personal and corporate interests are commingled to such an extent that the corporation has no separate identity

Effects of Dissociation

1. rights in management ends (no authority in partnership) 2. partner's duty of loyalty ends 3. Liability to third parties: partnership bound for two years by acts of outgoing partner, unless proper notice given ---Broad public problem: take out an ad in the paper and post a notice in the paper and that is viewed as constructive notice to the public

Incorporation Procedures (basic steps)

1. select a state of incorporation 2. secure the corporate name (Trade Name Disputes: If a corporation does business under a name that is the same or as deceptively similar to an existing company name it may be liable for trade name infringement 3. prepare the articles of incorporation 4. file the articles of incorporation with the secretary of state

Essential elements of partnership

1. sharing of profits/losses 2. joint ownership of the business 3. an equal right to be involved in management of business **No partnership is profits were received as payment for: 1. debt by installments or interest 2. Wages of an employee 3. rent to a landlord 4. annuity to a surviving spouse or representative of a deceased partner 5. sale of a business or property's goodwill

Comparing Major Business Forms: Management

1. sole proprietorship: at owners discretion 2. partnership: each partner has equal voice in management 3. corporation: shareholders elect directors who set policy and appoint officers

Comparing Major Business Forms: Duration

1. sole proprietorship: determined by owner; dissolved on death 2. partnership: terminated by agreement but can continue even when one dissociates 3. corporation: perpetual existence

Comparing Major Business Forms:Transferability of Interest:

1. sole proprietorship: interest can be transferred but then proprietorship ends 2. partnership: can be assigned but not w/ full rights 3. corporation: shares of stock can be transferred

Comparing Major Business Forms: Taxation

1. sole proprietorship: owner pays personal taxes on business income 2. partnership: each partner pays pro-rata share of income taxes on net profits 3. corporations: double tacation

Defenses to Violating the 1933 Act

1. statement or omission was not material 2. plaintiff knew about the misrepresentation at time of purchase 3. defendant exercised due diligence in preparing the registration and reasonably believed at the time the statements were true

Exception to liability in purchase of assets - scenarios where corporations assume both assets and liabilities

1. when the purchasing corporation impliedly/expressly assumes the liabilities 2. when the sale transaction is a merger or consolidation of the two companies 3. when the purchaser continues the seller's business and retains the same shareholders, directors, and officers 4. when the sale is entered into fraudulently for the purpose of escaping liability **Also if you take the assets and continue in the same line of business you can be liable

C Corporation v. S Corporation

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Business Judgment Rule

A corporate officer/director will not be liable to the corporation or to its shareholders for honest mistakes of judgment and bad business decisions; applies as long as they: 1. took reasonable steps to become informed about the matter 2. had a rational basis for her decision 3. did not have conflict of interest AND MADE IN GOOD FAITH **Court will not require directors or officers to manage "in hindsight"

Nature of a Corporation

A corporation is a creature of statute, an artificial "person" Corporations can have one or more shareholders (people or businesses); owners = shareholders **Corporation is a legal "person" and enjoys the same rights and privileges as a natural person: access to courts, constitutional guarantees of free speech, due process, freedom from unreasonable search/seizures

1933 Securities Act

A disclosure and Anti-Fraud Statute: regulates the solicitation, buying and selling of securities: stocks and bonds 1. Defines securities 2. If a security does not qualify for an exemption it must be registered before it is offered to the public

Limited Liability Company (LLC)

A hybrid entity that combines the limited liability of a corporation and the tax advantages of a partnership *Governed by state statutes *owners are called "members" (not shareholders) and their ownership is called an "interest" (not shares) *You only need one member *Protects you from trade debts *An independent person, can sue and be sued and hold title to property

Tender Offer

A publicly advertised offer addressed to all shareholders of the target is called a tender offer *usually offer if higher than market price of the target's stock before the tender offer was announced *Frequently target corporation's management opposes the takeover (hostile takeover) - to resist a takeover a target company may self tender

Registration Process

A registration statement not effective until it has been reviewed and approved by the SEC 1. Prefiling Period: issuer cannot sell/offer securities 2. Waiting period: securities can be offered for sale but cannot be sold 3. post effective period: securities can be sold

Attorney's duty of care

ABA rules of professional conduct; owe duty to provide competent and diligent representation; investigate and discover facts that could materially affect client's rights

Restatement Rule

Accountants are subject to liability for negligence not only to their clients but also to the foreseen/known users of their reports or financial statements: - persons for whose benefit/guidance the accountant intends to supply the info or - persons whom the accountant intends the information to influence

Reasonably Foreseeable Users Rule

Accountants liable to any users whose reliance on statements/reports was reasonably foreseeable

Ultramares Rule - Near privity Rule

Accountants should be only liable to those with whom they are in privity or near privity of contract **Requirement of Privity (direct or very close contractual relationship) ***Liability to third party only if the 3rd party has sufficient "nexus" with an accountant

LLC Jurisdictional Requirements

An LLC is a legal entity separate from its owners For federal diversity jurisdiction the LLC may be treated differently than a corporation - citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions

Effect of Dissociation from an LLC

An LLC member has the power, but not the right to dissociate from the LLC at any time *Dissociation of an LLC is triggered by events similar to partnership Dissociating member loses the right to participate in the management and the right to act as an agent Member also has the right to have her interests bought out by other members **If the dissociation violates the operating agreement, it is wrongful and the member can be held liable for damages

Cooperative

Association organized to provide a not-for-profit service to members; not a business entity but a way to operate a business

SOX 2002

Attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for securities violations; applies to public companies - requires CEO's to take responsibility for accuracy of financial statements filed w/ SEC - Requires independent auditor report except for smaller companies of less than $75 million - PCAOB - internal controls and accountability - federal compliance

S corporations

Avoids federal "double taxation: of regular corporations at the corporate level; only dividends are taxed to the shareholders as personal income **Must meet certain requirements to qualify for S corporation status: Corporation is domestic, fewer than 75 stockholders, only one class of stock, no shareholder can be a non-resident alien **Taxed like a partnership so corporate income passes through to shareholders who pay personal income tax on it

Roles of Directors and Officers

B.O.D is ultimate authority *Corporation is governed by B.O.D elected by shareholders *Individual directors are not agents of corporation, only the board itself can act as a "super agent" and bind the corporation **A director can also be a shareholder, but no individual director can be an agent only as a group can they bind the corporation *Election of Directors - # of directors usually set forth in the articles of incorporation, term of office is generally 1 year

Promotional Activities

Before the corporation is formed; promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements **Promoters Liability: Promoter is PERSONALLY LIABLE for PRE INCORPORATION CONTRACTS on behalf of the corporation, unless 3rd party agrees to hold future corporation liable

State Securities laws

Blue Sky Laws Requires issues to comply with federal and state securities laws **Important to know your jurisdiction b/c laws vary

Who runs a corporation?

Board of directors - shareholders select the board, board selects the officers

Corporation by Estoppel

Business association holds itself out to others as being a corporation when it has made no attempts to incorporate **If it acts like a corporation, it cannot avoid liability by claiming that no corporation exists **Applies when a third party contracts with corporation but it has not filed articles of incorporation

Limited Partnership

Business organizational form that limits the liability of some of its owners; consists of one general partners (assumes management responsibility) and other limited partners *General Partners have a fiduciary obligation to Limited Partners Limited Partners have limited liability as long as they do not engage in management functions; liability is limited to amount invested General Partner assumes all management and personal liability

Partnership agreement

Can be written or oral, unless the statute of frauds requires a written agreement (If the partnership will acquire real property it must be in writing) *also called articles of partnership; can include almost any terms unless illegal or contrary to public policy/statute

Duration of the Partnership

Can specify the duration of the partnership (partnership of term) Partnership at will - means it can be dissolved at any time

Advantages of Franchises

Centralized management

Purchase of Stock

Common alternative to merger or consolidation *Purchase of controlling interest (51%) of a "target corporations" stock gives purchasing corporation controlling interest (TAKEOVER)

General Considerations for small business

Consider: - limitations on liability (consider insurance and conduct of owners) - tax: corporations (double taxation); partnerships, LLCs, LLPs, and S corporations (Pass through taxation) - continuity of life - legal formality and expense: LLP expensive to establish - Requirements for All business forms - converting an LLC to a Corporation: relatively easy, usually requires unanimous consent of members and then file articles of dissolution with the state - protecting intellectual property: trademarks: file or just create and use it

Franchise

Contract in which franchisor (owner of trademark, trade name or copyright) licenses franchisee to use the trade mark, trade name or copyright in the sale of goods or services *Can operate as an independent business person but still obtain the advantages of a regional or national organization

Ultra Vires Doctrine

Corporate Acts beyond the express or implied powers of the corporation *Articles of incorporation now adopt very broad purposes to prevent lawsuits against the corporation

Corporate Criminal Acts

Corporation can be held liable for criminal acts of agents/employees provided that the punishment is one that can be applied to a corporation (can't be imprisoned, can be fined) **Under the "responsible officer" doctrine corporate officers may go to prison

Alter Ego Theory

Corporation is "alter ego" of majority shareholder and personal and corporate interests are commingled such that the corporation has no separate identity

By laws

Corporation's internal rules of management adopted by the corporation at its first organizational meeting

Winding Up in Involuntary Dissolution

Court will appoint a receiver to wind up the corporate affairs and liquidate corporate assets - liquidated assets first used to pay creditors - remaining assets are distributed to shareholders according to stock rights

Importance of Good faith and fair dealing

Courts usually try to balance rights of both parties; if franchisor arbitrarily or unfairly terminates a franchise, franchisee may be able to sue for wrongful termination Most courts will not consider the termination "wrongful" if: 1. Franchisor's decision to terminate was made in normal course of business, and 2. reasonable notice of termination was given to franchisee

Securities Exchange Act of 1934

Deals with the sales of securities in resale market; also is an anti-fraud statute; does not matter whether securities have been registered or not **Created the SEC an independent federal regulatory agency that administers federal securities laws ****Applies to companies with $10 million in assets and 500 or more shareholders

Director's Duties in a Take Over

Defense tactics must be reasonable and directors must not breach their fiduciary duties **Actions judged by the business judgment rule

Rights of Shareholders

Depends on articles and bylaws but generally: 1. Stock certificates: evidence of ownership 2. Preemptive Rights: Existing shareholders have first opportunity to buy new stock (meant to prevent dilution and maintain proportional control - important in close corporations) 3. Stock Warrants: right to buy stock at a stated price by a specified date 4. Dividends: distribution of corporate profits/income ordered by the board; Illegally paid dividends must be returned but board is surety for the return and in some cases shareholders can use court to compel directors to declare a dividend in their failure 5. Inspection Rights: a limited right 6. Transfer of Shares 7: Dissolution rights: after debts and creditor claims satisfied, assets distributed to shareholders in portion to the percentage of shared owned 7. Shareholder's Derivative Suit: Can file when they believe directors are not acting in corporations best interest

Federal Securities Laws

Designed to protect investors from deceptive, unfair and manipulative practices when buying/selling securities

Partnership Buy-Sell Agreements

Determines in advance of an "event" how remaining partners will buy-out partners' interest

Dissolution of a Corporation

Dissolution is the legal death of the artificial person of the corporation - 1. winding up - liquidated assets

Classifications of corporations

Domestic: does business within its state or incorporation Foreign: corporation in X state does business in Z state Alien: formed in another country Public corporation: formed by gov. to meet some political/governmental purpose Publicly held corporation: publicly traded shares in securities market private corporations: for profit Non-profit: hospitals, educational institutions, charities close corporation: shares held by family members, small # owners

First Corporate Organizational Meeting

During it Shareholders should approve the bylaws, elect directors, hire officers, and ratify preincorporation contracts and activities

Corporate Powers

Express Powers: Found int he corporation's articles of incorporation, the laws of the state, and in the state and federal corporations **Corporate by laws may also grant or limit a corporations express powers Implied Powers: All acts reasonably necessary to accomplish corporate purposes; a corporate officer can bind a corporation in contract in matters connected with the ordinary business affairs of the enterprise

Conflicts of Interest

Fiduciary duty requires them to make a full disclosure of any potential conflicts of interest that might arise in any corporate transaction *Requires full disclosure of any potential conflicts of interest and abstain from voting on an y transaction that may benefit the director/officer personally; however, if transaction is fair/reasonable it can be approved by majority of disinterested directors

Formation of LLC

File articles of organization with the secretary of state's office *Articles include: name, address, agent info, member's name, and how LLC will be managed

Professional Liability for fraud

Fraud Elements: 1. Misrepresentation 2. Intent to deceive 3. justifiable reliance 3. to obtain damages - actual injury to innocent party occurred Actual Fraud: 1. she intentionally misstates a material fact to mislead a client 2. the client is injured as a result of justifiably relying on the misstated fact **Can be liable for constructive fraud (grossly negligent in performing duties) whether or not he acted with fraudulent intent

Uniform Partnership Act

Gap Filler; governs the operation of partnerships in the absence of express agreement

Corporate Formation

Generally involves two steps: 1. Preliminary and Promotional Activities 2. The Legal Process of Incorporation ** Many start as sole proprietorships/partnerships and converted to corporate entities as businesses grow

Liability of Attorney's to Third parties

Generally not liable to a non-client unless the attorney committed fraud; restatement may apply to attorney's

Wrongful Termination

Generally termination provisions favor the franchisor who owns the trademark

Corporation Shareholders

Have limited liability - generally shareholders are not personally liable for corporate acts; BUT in certain situations, the corporate "Veil" of limited liability can be PIERCED, holding the shareholders personally liable; liability is initial investment ALWAYS

De Jure Corporation

If a corporation has substantially complied with all conditions precedent to incorporation the corporation is said to have de jure (rightful and lawful) existence **All substantial statutory requirements are met; cannot be attacked by state or 3rd parties *If the Defect is NOT substantial

Appraisal Rights

If a shareholders disapproves a merger/consolidation but is outvoted the dissenting shareholder will not be forced to become an unwilling shareholder in a corporation **Gives dissenting shareholders a statutory right to be paid the fair value of the share's they held on the date of the merger/consolidation; has the right to be "bought out"" of his or her shares **Dissenting shareholders looses voting rights

De Facto Corporations

If the Defect IS SUBSTANTIAL; EX: corporation didn't hold organizational meeting to adopt bylaws **Statutory requirements not met, but promoters made good faith effort to comply with corporate law; can only be attacked by the state

Debt/Liability for an incoming partner

If they lie to you about what your actual debts are (what your liability for the debt is) your investment is always at risk; even if you didn't participate in the act that rendered the liability, but no personal liability

Piercing the Corporate Veil

In certain situations, courts will pierce the corporate veil and hold shareholders personally liable in the interests of justice and fairness

Compensation of Corporate Directors

Inside Director: officer of the corporation - has a managerial position and receives compensation Outside Director: Does not hold a management position **Often the same person is both an officer and director and receives compensation as an officer

Violations of 1933 Act

Intentional or negligent defrauding of investors by misrepresenting or omitting material information if the registration statement or prospectus - criminal penalties - civil sanctions

Registration statement

Issuing corporation must file w/ the SEC and provide all investors with a prospectus (document describing security and financials of issuing corporation) **designed to provide investors w/ sufficient information to make informed decisions

Method of creation for LP, LLC, LLP

LP - agreement to carry on business for profit, must has atleast one general partner LLC - agreement of members, file articles of organization LLP - agreement

Legal position of LP, LLC, LLP

LP - legal entity LLC - legal entity LLP - treated same as general partnership (separate legal entity)

Liability of LP, LLC, LLP

LP - unlimited for all general partners, limited partners only liable to capital contributions LLC - limited to capital contributions LLP - liability of a partner for acts committed by another is limited, still liable for trade debts

Shareholders' Meetings

Must occur at least annually; voting requirements and procedures require: 1. notice of meetings 2. proxies 3. shareholder proposals

Are individual directors on the board agents of a corporation?

No

Private Equity Capital

Obtain capital from wealthy investors; ultimately the company may sell shares in an IPO

Dissociation

Occurs when a partner ceases to be associated in the carrying on of the partnership *Allows partner to have her interest purchased by the partnership and terminates voting interest in the partnership **Although a partner always has the power to dissociate from the firm she may not have the right

Winding Up

Occurs when an LLC is dissolved *To wind up members must collect, liquidate, and distribute the LLC's assets *After all assets are sold, proceeds distributed to pay creditors, then capital contributions, then remaining $ distributed pro-rata *Members who did not wrongfully dissociate may participate in the winding up process

Primary Governing Document of LLC

Operating Agreement

Agency Concepts and Partnership Law

Partnerships governed by common law and statutory laws Partners are AGENTS and FIDUCIARIES of each other

Cumulative Voting

Process designed to ensure that minority shareholders have some membership on the board

Corporate Earnings and Taxation

Profits can either be kept as retained earnings or passed on to shareholders as dividends Corporations can be taxed twice, first to corporation and then to shareholders via dividends (Double taxation) Holding Companies (parent company): company whose business activity consists of holding shares in another company; meant to reduce or defer U.S. income taxes; usually held off shore

Exempt Transactions

Regulation A Offerings: do not exceed $5 million in securities during any 12 month period; issue must file a notice w/ SEC an offering circular; companies allowed to test the waters without selling any; and some have sold securities via the internet Regulation D Offerings: 1. Rule 504: up to 1 million during 12 months to accredited investors only 2. Rule 505: up to 5 million during 12 months to both accredited and unaccredited investors 3. Rule 506: unlimited if no general solicitation and notice to SEC; max of 35 unaccredited investors Resales and Safe Harbor Rules: generally, most securities can be resold without registration - Rule 144: 505/506 securities trigger registration requirements unless sale complies with all 144's conditions;

Partnership by Estoppel

Representation by partners to a third party; Occurs when a person who is not a partner holds himself out to third parties and the third party relies to her detriment; the "non-partner" is an agent whose acts are binding on the partnership; or when a partner represents expressly or impliedly that a non-partner is a member of the firm

Extraordinary Corporate Matters

Requires Super Majority

Corporate Personnel

Responsibility for management of company rests with board of directors (elected by shareholders) *Board of directors makes policy decisions and hires officers to run corporation on a daily basis * Shareholders can sue corporation and be sued by corporation and bring a derivative suit on behalf of the corporation in some instances

Liability of Shareholders

Shareholders are generally not liable for the contracts or torts of the corporation **If the corporation fails they generally cannot lose more than their investment 1. Watered Stock: Worth less than fair market value; Shareholder is personally liable for the difference 2. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control; in breach the minority shareholder can sue for damages

Shareholder Voting

Shareholders exercise ownership control through the power of their votes **Quorum Requirements: shareholders representing more than 50% of shares must be present to conduct business 1. Voting List: record of stock ownership 2. Cumulative Voting: allows minority shareholders to get a board member elected ****Has to appear in bylaws for it to be applicable

Voluntary Corporate Termination

Shareholders or the board can initiate dissolution by submitting a proposal to the shareholders *Must file articles of dissolution w/ the state and notify creditors

What debt is a security

Short term debt is treated as a security long term debt is not

Share Exchange

Some or all of the shares of one corporation are exchanged for some or all of the shares of another corporation **If one corporation owns all the shares of another corporation it is the parent corporation and the wholly owned company is the subsidiary corporation

Venture Capital

Start up businesses and high risk enterprises need start up and expansion capital; the start up typically gives a share of its stock

Involuntary Dissolution

State can dissolve a corporation for failure to comply with state regulations Court can dissolve a corporation if there is a deadlock, acts of directors that are fraudulent, misapplied corporate assets, shareholders are deadlocked and failed to elect directors

Corporate Financing

Stocks: ownership/equity, dividends, voting rights, paid last Bonds: debt, fixed ROI, priority over stock; normally have maturity date - when principal investment is returned to investor

Directors can only act as a unit, cannot act alone

TRUE

Poison Pill Takeover Defense

Te target corporation issues to its stockholders rights to purchase additional shares at low price when there is a takeover attempt; this makes the takeover undesirably or even prohibitively expensive for the acquiring corporation

Purchase of Assets in Mergers/Take Overs

The acquiring corporation extends its ownership and control over the physical assets of another company; *Does not usually require shareholder approval; however, selling all your assets might require approval **US DOJ and FTC have guidelines that significantly constrain and often prohibit mergers that could result from a purchase of assets **Generally, the purchasing corporation is not automatically responsible for the liabilities of the selling company (there are exceptions)

LP v. LLLP

The difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment **Most states do not allow for LLLP's

On corporate formation who makes the selection for directors?

The incorporators

Dissolution for Limited Partnerships

The limited partner is entitled to return of capital contributions

Quorum

The min. number of members of a body of officials needed to be present for business to be validly transacted **Unless otherwise specified a majority of the board of directors is needed

Authority of Partners

UPA affirms general principles of agency law; Partners have unconstrained authority in scope of business but partner may be able to subject partnership to tort liability; *If a partner acts within scope of authority partnership is bound; partners generally do not have authority to make charitable contributions

Corporate Torts

Under Respondeat Superior liability for torts committed by agents within the course and scope of their employment

Potential Liability to Clients

Under common law professionals may be liable to clients for breach of contract, negligence, fraud

Liability of Partners

Unlimited; Partners are personally liable for the debts of the partnership; If a partner is sued for partnership debt, partner has right to insist that other partners be sued with her Joint and several: third party has the option of suing all the partners together (jointly) or one or more of the partners separately (severally)

Termination

Usually a franchise agreement sets our conditions of termination *Notice requirements - reasonable time to "wind up" business *give franchisee opportunity to cure an ordinary, curable breach within a certain time period *Constructive discharge claim

LLC Liability under the Alter-ego theory

When a corporation is deemed to be merely an alter ego of the shareholder-owner a court will pierce the corporate veil and hold that person personally liable **Piercing the veil allows you to directly hold members liable

Wrongful Dissociation

When a partner has power to dissociate but lacks right to do so *Liable to partnership and to others for damages caused by dissociation

Joint Venture

When two or more entities combine efforts or property for a single transaction or project; owe same fiduciary duty to each other as partners do (If one of the ventures secretly buys land that was to be acquired by the joint venture the other JV may be awarded damages) **Single purpose/limited purpose partnerships - it is presupposed that there are outside interests Unless agreed otherwise, JV's share profits and losses equally **Common in international transactions **There are similarities to partnership: resembles and is taxed like a partnership with equal rights of management **Differences from a partnership: limited in time/scope where as a partnership is an ongoing business; members have less implied and apparent authority than partners ***Death of a Joint Venture member does not terminate Joint Venture ***Joint venture terminates when project is completed

Are officers agents of a corporation?

Yes

Shareholders

acquisition of shares grants an equitable ownership interest in a corporation; generally have no right to manage daily affairs of the corporation but do so indirectly by electing directors **Controlling shareholders owe a fiduciary duty to minority shareholders

Limited Liability Partnership (LLP)

allows a partnership to continue as a pass through entity for tax purposes but limits personal liability *relatively easy to convert a partnership to LLP *UPA makes all partners jointly and severally liable for another partner's tort including personal assets **LLP allows professionals to avoid personal liability for the malpractice of other partners ***Only protects you from professional malpractice, does not protect you from trade debts ***Formed through the government - filing the articles of limited liability partnership with the secretary of state for the state All big 4 firms are LLP's

Disclosure Under SEC Rule 10b-5

any material omission or misrepresentation in connection w/ the sale or purchase of security may violate the rule; examples of material facts calling for disclosure include: - dividend change - fraudulent trading in the company stock by broker- dealer - contract for sale of corporate assets - new discover, process, product - significant change in firm's financial condition - potential litigation against the company

Partnership

association of two or more persons to carry on a business for profit *treated as an entity for most purposes; can sue or be sued, hold title to real or personal property in its name rather than in the names of individual partners

Dissolution

can be brought by acts of the partners, operation of law, or judicial decree *Partnerships can agree to dissolve *By Operation of Law - Death of a partner - Bankruptcy of a partner - Bankruptcy of partnership - Illegality *By Judicial Decree - Insanity - Incapacity - Business Impracticality - Improper conduct **Good faith is required when dissolving a partnership

Family Limited Liability Partnership

for when partners are related to each other *Used in agriculture

Insider Trading

goal of 10b and 10b-5 is to prevent purchase or sale of securities on basis of information that is not available to the public

Well-Known Seasoned Issue (WKSI)

has issues $1 billion in securities during the last 3 years or $700 million outstanding stock in public hands **Can file registration statement the same day they announce

Preferred Stock

has priority over common stock as to dividends and payment on dissolution of the corporation; may or may not have voting rights

Corporate Officers

hired by the Board of Directors; rights are defined by employment contracts but usually can be removed at any time; have fiduciary duties to the company

Howey Test

investment contract is any transaction in which a person: 1. Invests 2. in a common enterprise 3. reasonably expecting profits 4. derived primarily or substantially from others managerial/entrepreneurial efforts

Violations of the 1934 Act

may lead to both criminal and civil liability **Requires Scienter for civil or criminal penalties under 10b and 10b-5 - violator must have had intent to defraud or knowledge of her misconduct; can be proved using false statements made, failure to disclose, or consciously reckless to truth of statements **Scienter not required for section 16b violations Criminal Penalties: 10b/b-5 a person faces $5 million and 20 years in prison; 25$ million for partnership/corporation; SOX says 25 years in prison if willful Civil Sanctions: Both SEC and private parties can bring actions against violators under insider trading and securities fraud enforcement act for 10b/b-5, except for 16b only a corporation or shareholders by derivative can bring action

Tax treatment of partnerships

pass through entity - a business entity that has no tax liability; income is passed through to the owners of the entity who pay income taxes on it; pass through on a pro-rata basis to the partners *tax reporting entity; only responsible for filing an information return with the IRS to figure out what owners need to pay **When a partnership has an excess of revenue over expenses it doesn't show a profit for tax purposes

SEC Rule 10b-5

prohibits the commission of fraud in connection with the purchase or sale of any security **Applies to all cases concerning securities trading, on exchanges, OTC, or private

Corporate Governance

relationship b/w corporation and shareholders; attempts to align officers and shareholders (through stock options) The goal is to promote accountability: 1. audited reporting of financial conditions to evaluate managers 2. legal protections for shareholders so violators can be punished/victims can recover losses *Board of Directors - responsible to ensure all corporate officers are operating in best interests of shareholders *Compensation Committee: assess performance and design fair compensation system

Insider Reporting and Trading SEC Section 16b

requires recapture of all short swing profits by insiders to a corporation who earn 10 percent of more; applies to stocks, warrants, options, and securities **A fall back statute; plaintiff is the corporation itself; designed to prevent insider short swing profits/losses **Strict liability statute

Short-Form Mergers

simplifies procedures for a merger of a substantially owned subsidiary corporation into its parent corporation (Parent-subsidiary merger) **Shareholders do not have to approve it **Can only be used when parent corporation has at least 90 percent of each class of stock of the subsidiary **Board of parent corporation approves and new articles are filed w/ secretary of state

Merger

the legal combination of two or more corporations. After a merger, only one corporation continues to exist. A and B merge and A or B emerge as surviving corporation **Surviving corporation inherits pre-existing legal rights

Sole Proprietorship

the owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship * No entity so no filing with the state * No distinguishing from you and the business

Articles of incorporation

the primary document needed to incorporate a business, serves as a primary source of authority for its future organization and business functions. Generally must include: 1. name of the corporation 2. Number of shares the corporation is authorized to issue 3. Name/Address of corporations agent/office 4. name and address of each incorporator 5. duration and purpose and internal organization

Consolidation

two or more corporations combination in such a way that each corporation ceases to exist and a new one emerges; A and B consolidate to form C **inherits all rights and liabilities of both predecessors