Business Structures
There are three steps for terminating (ie, ending) a partnership. To determine the amount (if any) to distribute to each partner, the following four procedures must be performed:
(1) Allocate gains and losses from asset sales based on partner profit and loss percentages (2) Partners with a resulting deficit capital account balance contribute cash to restore the balance to $0 (if they can) (3) Prorate any unrestored deficit balance among the remaining partners based on their profit and loss percentages. If there are no separately stated loss percentages, then use the profit percentages (4) Distribute the remaining cash to the partners in the amounts reflected in the final balance of each partner's capital account
Characteristics of a general partnership
-Two or more partners -For profit -Ease of formation (can be informal) -Limited or uncertain duration -Separate legal entity (state law): sue, be sued, own property -Partners have joint and several (ie, no limited liability)for partnership debts -Default entity when owners don't formally file as other entity(eg, corporation, limited partnership, LLC) -Nontaxable pass-through entity
There are no absolute requirements for how partnership debt will be apportioned among the partners.
Absent a contrary agreement among the partners, the debt will be apportioned in accordance with the partnership profit and loss percentages for each partner.
Types of General Partner Authority
Actual: partnership intends to give the partner authority, either: Express, explicitly stated (eg, partnership agreement) or Implied, for normal business tasks that require the authority to complete Apparent: partnership creates the impression that the partner has the authority Third party has reasonable, good faith assumption that the partner has authority Unauthorized but ratified: partnership ratifies the unauthorized action after the contract is made Partnership must be fully disclosed to the third party Contract details must be fully disclosed to the other partners Action must be ratified before the third party to the contract withdraws
Most states require limited partnership agreements to be in writing. There is no similar requirement for general partnerships. The only reason a general partnership agreement must be in writing is if the SOF applies.
An intention to own real estate is not enough to trigger the SOF when forming a partnership. If the purpose of the partnership is to buy a property, develop it and then sell it, the partnership agreement needs to be in writing under the Statute of Fraud. because it will take over one year to complete the partnership's purpose. GROSSE
Characteristics of a limited partnership
Formation Authorized by state law File certificate of limited partnership with state authority (eg, secretary of state) Must have at least one general partner and one limited partner Liability General partners have unlimited liability Only limited partners have limited liability Taxation Taxed as a pass-through entity Fiduciary duty General partners owe fiduciary duty to partnership Limited partners do not owe fiduciary duty to partnership
Preferred stock attributes
General preferences -Dividends: must be paid before common shareholders are paid dividends -Liquidation: receive liquidation proceeds before common shareholders Dividend preferences -Cumulative: dividends in arrears must be paid before common share dividends are paid -Participating: in addition to the fixed dividend payment, receive all or a portion of any surplus dividends declared
Shareholders have a right to inspect corporate books and records.
However, a shareholder must meet each of the following stipulations to inspect financial reports and accounting records (ie, corporate books): -The request is in good faith to protect shareholders' interest in the corporation (ie, for a proper purpose). -The request describes the purpose and the records to be inspected. -The requested records have a direct connection to such proper purpose. Note: It is possible for a shareholder to become a manager of the corporation; however, any additional rights are derived from the management position, not from being a shareholder.
Mergers and consolidations normally require approval by a majority of each corporation's board of directors and its shareholders.
However, most state laws don't require shareholder approval of short-form mergers (ie, 90%-or-more subsidiary merged with its parent).
Corporation characteristics
Limited liability - Shareholders are not responsible for corporation's debt Independent life - Shareholder death does not dissolve the corporation (ie, perpetual) Ease of transfer - Ownership is considered transferrable property Taxation - A corporation files and pays income tax Centralized management -A corporation is overseen by an internal group (ie, board of directors)
Activities that create nexus with a state include:
Maintaining a physical presence Having employees (eg, regional sales staff) in that state who also work there. Nexus depends on where employees perform services, not where they reside. Selling a significant, threshold amount of goods or services within that state. The threshold ranges from $100,000 to $500,000, depending on the state.
Certain activities do not create nexus. These activities usually involve minimal contact within another state and include:
Maintaining an account at a bank in that state Collecting debt from individuals who live in that state Hiring employees to work in one state even if they reside in another
The statute of frauds (SOF) requires written evidence supporting certain contracts (ie, the standards represented in GROSSE). A partnership agreement is a contract among the partners as to how the partnership operates.
Most states require limited partnership agreements to be in writing. There is no similar requirement for general partnerships. The only reason a general partnership agreement must be in writing is if the SOF applies.
Preferred stock is a form of equity that gives preferred shareholders priority over common shareholders for dividends and liquidation distributions. If preferred stock is cumulative, any prior year dividends that were declared but unpaid must be paid before common shareholders can receive dividends.
Once a dividend is declared, the shareholders are considered unsecured creditors for that amount. However, shareholders have no creditor claim on dividends until they are declared, even on cumulative stock.
Voting trust: A voting trust is an arrangement by which all or part of a corporation's stock is transferred to a trustee. The trustee then owns the stock as a fiduciary and votes at shareholder meetings on behalf of the original owner(s). Voting trusts are typically used for shares in issuers (ie, publicly traded companies). Cumulative voting: Cumulative voting is a method concentrating voting power that allows a shareholder to cast all the shareholder's votes for one BOD candidate rather than vote on each open BOD seat
Proxy: A proxy is a shareholder's authorization of an agent to vote that shareholder's stock at shareholder meetings. Proxies must be in writing and are revocable. Shareholder agreement: A shareholder agreement is a contract that specifies the rights and duties among the shareholders (eg, restrictions on transferring shares). Shareholders may agree in advance to vote in a specified manner for any matter subject to shareholder approval, such as electing a specific person to the board of directors (BOD). Shareholder agreements are typically used in closely held corporations.
A dividend distribution that contains a return of capital and is not approved by the shareholders is considered an illegal dividend.
Shareholders must repay illegal dividend payments they received from an insolvent corporation regardless of whether they knew the distribution was illegal.
Shareholders have the right to vote on significant, corporate-wide matters such as liquidating dividends and electing the board of directors (BOD).
The BOD votes on regular dividends, acquiring the corporation's stock (ie, treasury stock), and stock issuances.
General partners have unlimited liability for the partnership's debts.
There are no requirements for filing a certificate of formation with the partnership's home state or how partners will apportion debt. Partnerships are pass-through entities that do not pay or remit taxes.
Directors and officers must act with duty of care and loyalty
They must not: -Compete with the corporation -Use corporate opportunity for personal gain -Have a conflict of interest with the corporation -Engage in insider trading -Authorize transactions detrimental to minority shareholders -Sell their control over the corporation (eg, kickbacks, bribes)
General partners have a fiduciary duty to the limited partnership (LP) and partners.
This means that a general partner must not have a conflict of interest with the LP, compete with the LP, or conduct LP business in a manner that is reckless, grossly or intentionally negligent, or knowingly violates the law.
Much like the managers of a corporation, general partners have a fiduciary duty to the LP and other partners.
This means that a general partner must not: -Compete with the LP -Use the LP's business opportunities for personal gain -Have a conflict of interest with the LP -Conduct LP business in a manner that is reckless, grossly or intentionally negligent, or knowingly violates the law
When one party (Ward) purchases a partner's (Lark's) interest in a partnership, the other, nonselling partners must unanimously approve the purchasing party as a new partner.
Unanimous consent is required because each partner has authority to bind the partnership to contracts. The existing partners are entitled to make sure they trust the prospective partner before allowing that person to become a partner.
A limited partner does not have a fiduciary duty to the LP or the other partners
and may conduct business with the LP in the same manner as a third party
An LP is managed by one or more general partners who are jointly
and severally liable for the obligations of the LP
When determining the amount to distribute to each partner in a partnership termination,
any deficit balance that will not be restored by the deficit partner must be allocated (pro rata) to the other partners' capital accounts. The ending balances equal the amount of cash distribution to each partner.
BOD functions include
approving stock issuances and repurchases (ie, treasury stock) and declaring "regular" dividends
When there is a sale of a partnership interest,
the new partner is not required to make a contribution to the partnership.
If other partners in a limited partnership do not consent to a new partner,
then that person would be only an assignee and therefore entitled only to a share of the partnership's profits and, in the event of the partnership's termination, partnership's net assets.
Courts will hold shareholders personally liable for a corporation's liabilities (ie, pierce the corporate veil) for situations such as
undercapitalization shareholder fraud ignoring corporate formalities, and commingling assets.
One characteristic of a corporation that distinguishes it from other entities is that the ownership interest (ie, shares) is freely transferrable. A shareholder is not required to seek approval from the other shareholders to sell or transfer shares.
An interest in a general partnership is not freely transferrable. Certain actions that are outside the normal course of business or significantly affect each partner's liability require all partners' unanimous consent. For example, unanimous consent is required to transfer ownership to a new partner because the existing partners are entitled to decide if they trust the new partner and want to share partnership profits with that person. For the same reasons, the transfer of ownership to a new limited partner of a limited partnership requires the approval of all partners
Shareholders have the right to vote at shareholder meetings on certain significant matters affecting the corporation, such as:
BOD assignments liquidating dividends dissolving the corporation mergers or consolidations amendments to the corporation's articles of incorporation loans to directors
Items included in articles of incorporation
CNN RIC T Corporation's name Nature and purpose Name and address of each incorporator Registered agent in the state Initial board members Capitalization (ie, equity structure) Term of the corporation (or indefinite duration)
Prior to forming a new corporation, a promoter enters into contracts on behalf of the future corporation. The promoter is personally liable for these contracts because the corporation is not yet in existence. The corporation becomes liable for the contracts by expressly adopting them in its bylaws or accepting the contract benefits. Releasing the promoter from liability requires agreement of all three parties. (promoter, corporation and third party)
However, neither of these actions relieves the promoter of personal liability. Instead, the promoter can be relieved of personal liability through novation. Novation occurs when a new party (ie, new corporation) is substituted for an original party (ie, promoter) to a contract, then the new party assumes (ie, steps into) the obligations of that original party, and then all three parties (ie, the two original parties and the new party) agree to the novation. When this happens, the promoter is released from liability under the contract. The corporation and the remaining original party start a contractual relationship using the original contract.
Dissolution of a partnership is the first of a three-step process that culminates in a partnership's termination.
If a partner dies during that process, the remaining partners have the option of continuing with the termination process or canceling the termination and restarting the partnership business. Under the Revised Uniform Partnership Act (RUPA), a partner's withdrawal does not automatically cause dissolution or termination of the partnership or an acceleration of the termination process
Members of a limited liability company (LLC) can elect how the LLC is treated for tax purposes. If a multiple-member LLC makes no election, it is treated as a partnership.
If a single-member LLC makes no election, it is treated as a disregarded entity (eg, sole proprietorship).
An LLC may be member-managed or manager-managed. A manager-managed LLC is operated only by managers who are authorized by the LLC to be managers and is more like a corporation.
In a corporation, only properly elected directors and officers are authorized to operate the business and therefore owe fiduciary duties to the corporation. Shareholders of a corporation do not owe any fiduciary duties to the corporation. In a manager-managed LLC, the managers owe fiduciary duties to the LLC; however, members do not.
A limited liability partnership (LLP) provides protection to partners from their other partners' torts. Generally, partners in an LLP are personally liable for their own torts.
In addition, supervising partners (eg, a managing partner) are personally liable for the torts of those they supervise.
Once the new partner is admitted, that partner has the right to participate in management of the partnership's business.
In addition, the new partner has joint and several liability for partnership debts arising after being admitted, but not liabilities that arose before being admitted
Once a new partner is admitted to a partnership by unanimous consent of the other partners, that new partner has the right to participate in management of the partnership's business.
In addition, the new partner has joint and several liability for partnership debts arising after being admitted, but not liabilities that arose before being admitted.
A general partnership can be created formally (eg, a written agreement) or informally (eg, a rock band).
In either case there is no requirement to file a certificate of formation with the partnership's home state. Corporations, limited liability companies, and limited partnerships require a more formal process for creation (eg, formation documents, state filing fees).
Issuing a liquidating dividend is a significant event for a corporation because it usually occurs when the corporation is going out of business.
In liquidation, shareholders have a right to a return of their capital contributions, subject to payment for priority claims (eg, creditors). Because liquidating dividends is a return of shareholder capital, shareholders retain the right to vote on it.
Courts hold shareholders personally liable for the corporation's liabilities (ie, pierce the corporate veil) for actions such as
Undercapitalization - This occurs if the capital the shareholders contributed to form the corporation is inadequate to meet the corporation's reasonable financial needs. Shareholder fraud - shareholders create a corporation with the intent to commit fraud (eg, a Ponzi scheme). This is not to be confused with ultra vires acts (eg, unauthorized acts) by directors and officers, which do not result in shareholder liability Ignoring corporate formalities - occurs when shareholders don't follow legal formalities, such as electing a board of directors and holding shareholder and board meetings. Commingling assets - if shareholders consistently treat corporate assets as if they were the shareholders' personal assets, using them for personal purposes (eg, paying a home mortgage).
Limited partnerships (LPs) are pass-through entities that are not subject to taxation.
Unlike a general partnership, an LP provides limited liability to its limited partners.
Shareholders have the right to:
Vote on corporate-wide matters (eg, changes to corporate structure) Transfer shares (ownership) freely Receive declared dividends Inspect books and records (for proper purposes) Have stock appraised Sue on corporation's behalf - a derivative lawsuit (eg, against directors) Receive equity capital upon liquidation (subordinate) Preemptive right - prevent dilution of ownership Limited liability - unless corporate veil is peirced