Business Law Chapter 31 - Corporations Questions
Why do venture capitalists sometimes prefer to invest in C corporations over LLCs?
- C corporations are easier to merge, sell, or take public - the law governing LLCs is still developing and is therefore less certain - LLCs involve arcane tax issues
What must a social enterprise balance the interests of when making business decisions?
- communities - environment - investors - stakeholders
What are the requirements for a company to qualify as an S corp?
- no more than 100 shareholders - only one class of stock - shareholders are U.S. citizens or residents - all shareholders agree that the company should be an S corp - no shareholders are partnerships or corporations
What are the disadvantages of a corporation?
- strict legal formalities - taxable entity - high formation costs
T/F: Although corporations were widely celebrated and encouraged when they were originally created centuries ago, they have been treated with growing suspicion since the stock market crash that led to the Great Depression.
False
The term "S Corporation" comes from _____
Internal Revenue Code
Jill owns a retail business by herself and was sued by a customer who fell in the store. The customer claimed the business was negligent in caring for its floors. What is Jill's potential liability?
Jill can be held personally liable to the customer since she is the owner.
Does a social enterprise register with the state as a nonprofit organization?
No
Is one of the characteristics of a closely held corporation that the shares are publicly traded?
No - the shares are not publicly traded
In many ways, a limited liability company can be thought of as a cross between _____.
a corporation and a sole proprietorship
Daniel, his parents, and three brothers own all the stock of their family farm corporation, and each person takes an active role in managing the enterprise. This corporation, which is taxed as a corporation, is most likely a(n) _____.
close corporation
The form of business ownership that is the MOST easily transferable is the _____
corporation
In National Franchisee Association v. Burger King Corporation, the court held that Burger King Corporation _____.
did not act in bad faith because there may well be a legitimate business reason to sell products below cost
When a partner leaves the partnership, whether it be voluntary or by expulsion, death or bankruptcy, it is called _____
dissociation
What form of organization is a compromise between starting one's own business as an entrepreneur and working for someone else as an employee?
franchise
What business form does not have limited liability?
general partnership
Charles and Ellen, an unmarried couple, run an ice cream store. The business is not incorporated, and they have filed no formation papers with the state. Their business is a _____.
partnership
Harold and Zack have pooled their money together to buy real estate but have filed no formal papers to form a business. Harold, a lawyer, handles all the legal matters and Zack, a real estate broker, finds buyers for the property they have subdivided. Harold and Zack are engaged in a _____
partnership
What constitutes a social enterprise's "triple bottom line"?
people, planet, and profits
What kind of existence do corporations have?
perpetual existence
Corporation's Protection
protects managers and investors from personal liability for the debts of the corporation and actions of others, but not against liability for their own negligence, torts, or crimes.
What kind of treatment are close corporations entitled to?
special treatment under state law
What federal agency requires that the seller of a franchise give the potential buyer a Franchise Disclosure Document (FDD) and audited financial statements?
the Federal Trade Commission (FTC)
Why do few corporations convert to LLCs even though it's legally possible?
the IRS would treat the change as a sale of corporate assets and tax the assets accordingly
Why are franchises appealing to franchisees?
they allow them to own their own business while also receiving the benefit of an established brand and support structure
What form of business are corporations?
they are a flexible form of business because they have stock that can be bought and sold easily.
Dissociation
when a partner leaves a partnership - the partnership can either buy out the departing partner and continue in business or wind up the business and terminate the partnership.
What typically must an enterprise do to become a socially conscious organization?
- obtain the approval of two-thirds of its shareholders. - agree to measure its social benefits using a standard set by an objective third party. - assess and report regularly on its website about the company's societal and environmental impact.
T/F: A corporation that registers for S corp status with the IRS is not necessarily treated as a close corporation under state law unless it complies with the state statute's particular requirements.
True
T/F: A joint venture is not its own legal entity. Rather, its participants retain their own separate identities and simply partner for a limited purpose, such as a specific project.
True
T/F: A limited liability company may go public, but once it does so it loses its status as a flow-through tax entity.
True
T/F: An advantage of a sole proprietorship is that it is very easy to form.
True
T/F: General partners have equal management rights in the partnership unless they agree otherwise.
True
T/F: In an S corporation, there can only be one class of stock.
True
T/F: In the past professional corporations were the only business formation other than general partnerships available to professionals, such as lawyers and accountants.
True
T/F: Operating agreements are not required but can be extremely helpful for LLCs.
True
T/F: Sole proprietors are personally liable for all of the debts incurred by their business.
True
T/F: Unlike charities, social enterprises can sell stock to investors.
True
Sole Proprietorship
a(n) unincorporated business owned by one person. It is the most common form of business.
Debra wanted to form a partnership with Lawrence. He agreed and they became co-owners in an equal partnership. This year, after expenses, the partnership had a profit of $200,000. How will the taxation of this profit be handled?
Debra and Lawrence must both pay tax on the business's profit.
Why do sole proprietorships work best for small businesses?
debt is generally the only source of working capital
Flow-through Tax Entity
does not pay income tax on its profits, but passes them through to its owners, who pay tax at their individual rates.
[Multiple Choice] A limited liability company _____. a. is regulated by a well-established body of law b. pays taxes on its income c. cannot have members that are corporations d. is a form of organization favored by venture capitalists e. can have an oral operating agreement
e. can have an oral operating agreement
An organization that does not pay income tax on its profits but passes it through to its owners who pay the tax at their individual rates is called a _____
flow-through tax entity
What does the Federal Trade Commission (FTC) require franchisors to do?
give prospective franchisees a franchise disclosure document at least 14 business days prior to the signing of a contract or payment of any money
Close Corporation
has a small number of shareholders whose stock is not publicly traded and who play an active role in management
If a court pierces the LLC veil it _____.
holds LLC members liable for the debts of the company
When may a court pierce an LLC's veil?
if members fail to provide adequate capital.
Most states require sole proprietors to register their business name if _____.
it is different from their own.
The phrase "piercing the company veil" applies to what type of organization?
limited liability company
What do Limited Liability Companies offer?
the best of both worlds: a flow-through tax entity and limited liability
Jane is in debt to Jack, and is also a partner in Mother Goose, LLP. Jane may transfer to Jack _____.
the value of her partnership interest in Mother Goose
The Federal Trade Commission (FTC) requires franchisors to provide the Franchise Disclosure Document (FDD) to franchisees prior to signing a franchise agreement _____.
to allow the franchisee to make an informed decision
Why were S corporations and close corporations created?
to encourage entrepreneurship
The corporate form of business _____
was first known and used by the Greeks and then spread through the Romans to England.
What are most franchisors and franchisees?
corporations or LLCs
[Multiple Choice] A joint venture is a(n) _____. a. association limited to no more than two persons in business for profit b. enterprise of numerous co-owners in a nonprofit undertaking c. corporate enterprise for a single undertaking of limited duration d. association of persons engaged as co-owners in a single undertaking for profit
d. Association of persons engaged as co-owners in a single undertaking for profit
What are the advantages of a sole proprietorship?
- Low-formation costs - flow-through tax entity
How may a partnership raise capital?
- contributions from partners - borrowing
What are the characteristics of LCCs?
- flow-through tax entity - different classes of stock permitted - members may be corporations, parternships or nonresident aliens - nontransferable interests
What are the features of professional corporations?
- limited liability - shareholders must be members of the same profession - strict legal formalities - complicated tax structure
Under what circumstances will a court hold LLC members personally liable for the liabilities of the LLC?
- members fail to provide adequate capital - members commit fraud - members fail to treat the LLC like a separate organization
Ned and Sarah formed an LLC to buy and renovate apartment buildings. They did not sign an operating agreement but they orally agreed that they would dissolve the LLC if they could not get along. The two owners argued repeatedly and Ned refused to meet with Sarah, although he was willing to take her phone calls. Ned continued to work on the renovation that was then underway. Sarah asked a court to dissolve the LLC. Under state law, an LLC without an operating agreement could only be dissolved if 1. the management of the entity is unwilling to reasonably promote the stated purpose of the entity or 2. continuing the entity is financially unfeasible. What result in Sarah's lawsuit? What is the moral of this story?
Laws relating to LLC vary by state and generally LLCs have a perpetual existence but this also varies from one state to another. In this case dissolving of the LLC will be determined as per the state law. From the facts of the case Ned is working on the renovation and so one of promoters of the LLC is willingly working for the stated purpose of the entity. Secondly there are no indications that the LLC is financially unfeasible. Thus the rule and law of the state will prevail and Sarah will not be able to dissolve the LLC. Result: The moral of this story is that when forming a LLC an operation agreement should be put in place if the founders want to dissolve the LLC on their own terms. Otherwise they will have to follow the rules of the State .
Corporations developed to encourage investors to contribute the capital needed to create large-scale manufacturing enterprises. But LLCs are often start-ups or other small businesses. Why do their members deserve limited liability? Is it fair that LLCs do not pay income taxes?
Limited Liability is necessary to ensure people are encouraged to entrepreneurship. This will help create jobs and improve disposable income in the hands of the public. As, LLC's are often start-ups or small businesses, they are given tax holiday/tax concessions precisely to encourage them to open new business and create jobs for the country, innovate advanced solutions to deal with various problems the country might be facing
Hortense and Gus are each starting a business. Hortense's business is an internet start-up. Gus will be opening a yarn store. Hortense needs millions of dollars in venture capital and expects to go public soon. Gus has borrowed $10,000 from his girlfriend, which he hopes to pay back soon. Should either of these businesses organize as an LLC? Strategy: Sole proprietorships may be best for businesses without substantial capital needs and without significant liability issues. Corporations are best for businesses that will need substantial outside capital and expect to go public quickly.
Result: An LLC is not the best choice for either of these businesses. Venture capitalists will insist that Hortense's business be a corporation, especially if it is going public soon. A yarn store has few liability issues, and Gus can always buy insurance. Furthermore, he does not expect to have any outside investors. Hence, a sole proprietorship would be more appropriate for Gus's business.
If you were to look online for a description of a professional corporation, you might find websites stressing that, in a PC, shareholders are still responsible for their own wrongdoing. For example: "In some states, these professionals can form a corporation, but with the distinction that each professional is still liable for his or her own wrongful professional actions." Why is this statement at best unnecessary and at worst misleading?
Result: In every organization, the professional is responsible for his or her own wrongful acts.
Alan Dershowitz, a law professor famous for his prominent clients, joined with other lawyers to open a kosher delicatessen, Maven's Court. Dershowitz met with greater success at the bar than in the kitchen—the deli failed after barely a year in business. One supplier sued for unpaid bills. What form of organization would have been the best choice for Maven's Court? Strategy: A sole proprietorship would not have worked because there was more than one owner. A partnership would have been a disaster because of unlimited liability. They could have met all the requirements of an S corporation or an LLC.
Result: In this situation, most entrepreneurs would choose an LLC because it would be easier than forming an S corp and registering with the IRS. However, they really should have a good operating agreement.
Leonard, an attorney, was negligent when he represented Anthony. In settlement of Anthony's malpractice claim, Leonard signed a promissory note for $10,400 on behalf of his law firm, an LLC. When the law firm did not pay, Anthony filed suit against Leonard personally for payment of the note. Is a member personally liable for the debt of an LLC that was caused by his own negligence?
Result: No, regardless of his actions, Blum cannot be personally liable for this debt.
Huma and Zuma want to start Spring High, a business that would take high school students on safe, educational trips during spring break. Eventually, they hope to seek venture capital money and expand the business nationally. After reading up on the legal issues online, Huma thinks Spring High should be a close corporation, while Zuma proposes that it be a S corporation. Neither thinks they should choose an LLC. Who is right? Strategy: At the moment, they could qualify as a close corporation because they only have two shareholders. As long as neither of them is a nonresident alien, Spring High could also be an S corporation. Although Spring High could be an LLC, it is not a form favored by venture capitalists. They are both right. Spring High should not be an LLC because that would discourage venture capital investment. The enterprise should probably be both a close corporation and an S corp. In some states, they would qualify for close corporation status without having to elect it. In any event, there is little downside to such an election. An S corporation is also a reasonable choice because, for now, it makes sense to limit their tax liability. Should they expand to the point that they no longer meet all the S corp requirements, it would be easy to become a C corporation.
Result: They are both right. Spring High should not be an LLC because that would discourage venture capital investment. The enterprise should probably be both a close corporation and an S corp. In some states, they would qualify for close corporation status without having to elect it. In any event, there is little downside to such an election. An S corporation is also a reasonable choice because, for now, it makes sense to limit their tax liability. Should they expand to the point that they no longer meet all the S corp requirements, it would be easy to become a C corporation.
According to the company's website, "d.light is a global leader in delivering affordable solar-powered solutions designed for the two billion people in the developing world without access to reliable energy." It is a for-profit enterprise. What form of organization makes the most sense for this business. Why?
Result: d. light is a benefit corporation. It is for profit but uses its profits to provide light to people in the developing world.
Why is Costello and Giordano personally liable to Ridgaway's estate in Ridgaway v. Silk?
Ridgaway's death is attributable to Costello and Giordano's own negligence, recklessness, or tortious conduct
What is the liability of an S corp shareholder regarding the debts of the business?
an S corp shareholder would not be personally liable for the debts of the business
General Partnership
an unincorporated association of two or more owner/co-owners who carry on a business for profit - each owner is a general partner
[Multiple Choice] A limited liability partnership _____. a. protects partners from liability for their own misdeeds b. protects the partners from liability for the debts of the partnership c. must pay taxes on its income d. both A and B e. A, B, and C are all correct.
b. protects the partners from liability for the debts of the partnership
[Multiple Choice] A sole proprietorship _____. a. must file a tax return b. requires no formal steps for its creation c. must register with the secretary of state d. may sell stock e. provides limited liability to the owner
b. requires no formal steps for its creation
What are the most common forms of So-Called social enterprises?
benefit corporations and low profit limited liability companies
[Multiple Choice] Assuming all other requirements are met, a corporation may elect to be treated as an S corporation under the Internal Revenue Code if it has _____. Strategy: Review the list of requirements for an S corporation. a. both common and preferred stockholders b. a partnership as a stockholder c. 100 or fewer stockholders d. the consent of a majority of the stockholders
c. 100 or fewer stockholder An S corporation can have only one class of stock. A partnership cannot be a stockholder, and all the shareholders must consent to S corporation status.
