Business organizations
Requirements to be a Sub-S Taxed Entity
1) Domestic entity, incorporated or organized in 1 of the 50 states or District of Columbia, 2) It has 100 or fewer owners, 3) All of its owners are individuals, estates, certain types of trusts, or tax-exempt organizations, 4) None of its owners are nonresident aliens; and 5) It has only one class of ownership interests outstanding (disregarding differences in voting rights) **An entity must continually meet the above criteria to qualify for Sub-S taxation. If one of requirements not met, it will no longer qualify for Sub-S taxation, and therefore its tax classification will immediately change to default classification for particular entity.
Partnerships: Governing Law: 3 Scenarios
1) Partners will agree upfront under which state's partnership laws they are forming the partnership, and this state statute will be specified in the partnership agreement 2) Partners have partnership agreement but do not specify which state governs- the CL rule is that the partnership law of the jurisdiction where the agreement was made governs 3) Partnership agreements DO NOT have to be written- with unwritten agreement, the law of the jurisdiction in which the partnership has its chief executive office governs relations among the partners and between the partners and the partnerships.
Formation: LLP
A partnership that has elected LLP status under the applicable provisions of its partnership statute (requires filing of "statement of qualification" with applicable Sec. of State) Statement of Qualification must include: 1) Name of Partnership 2) Street address of the Partnership's Chief Executive Office 3) Statement that partnership elects to be a limited liability partnership
Liability of a Principal for Agent Torts
A principal is subject to direct liability if, among other things, the principal was negligent in selecting or supervising the agent- it is the principal's own fault contributed to the agent's commission of the tort Respondent superior An employee acts within the scope of employment when performing work assigned by the employer or engaging in a course of conduct subject to the employer's control. An employee's act is not within the scope of employment when it occurs within an independent course of conduct not intended by the employee to serve any purpose of the employer.
Fiduciary Duties and Obligation of Good Faith and Fair Dealing: Limited Partnerships
Default Rule: LP does NOT owe fiduciary duties to the LP or any other partner solely by reason of being a limited partner. --Limited partner does not violate a duty or obligation under this Act or under the partnership agreement merely bc the limited partner's conduct furthers the limited partner's own interest. Limited partner does owe the limited partnership and partners an obligation of good faith and fair dealing, and this obligation cannot be eliminated in the partnership agreement. General partners of limited partnerships owe the limited partnership and its limited partners the duty of loyalty and care (cannot eliminate duty of loyalty or unreasonably reduce duty of care)
Management: Limited Partnerships
Default Rule: LP is managed by its general partner(s) and the limited partners have no rights to participate in control of the business. Default Rule: Consent of the limited partners is required to amend the partnership agreement or to sell, lease, or otherwise dispose of all, or substantially all, of the limited partnership's property, other than in the normal course of business
Transfer of Partnership Interests
Default Rule: Ownership interest is not freely transferable in its entirety. A partner can transfer his or her economic but not management rights. "Pick you Partner"- partners get to choose with whom they share management rights for the business (can be modified or eliminated by the partnership agreement- not in 103(b))
Transfer of Partnership Interests: Limited Partnerships
Default Rule: Partnership interest of a limited partnership is not freely transferable in its entirety. Transferable Interest- a partner's right to receive distributions Fairly common for a limited partnership agreement to override this default rule, given that limited partners generally have no say in management, so there is less concern by the other partners as to who becomes a limited partner
Fiduciary Duties: LLC
Courts have transferred DUTY OF CARE and LOYALTY (corporation concepts) to LLCs. William Peen Partnership v. Saliba -Del Ray, LLC was owned by the Penn Partnership (3/6 interest owned by 3 Lingos) and a 1/6 interest each to Saliba, Ksebe, and Hoyt. -Saliba and Ksebe had a falling out with the 3 Lingos. 3 Lingos enlist help of Hoyt to gain majority (4/6) and try to sell property the Lingos had 40% interest in. -Court used "Entire Fairness Test" • Lingos breached their obligation of fair dealing (how deal was structured) • Lingos breached their obligation of fair price (economic and financial aspects of deal)
Special Shareholder Meetings
held between annual meetings to have SH vote on a matter or matters that cannot wait until the next annual meeting. In NC, SHs can call a special meeting if the corporation receives a written request for one from SHs representing at least 10% of all shares entitled to vote. In NC, if the location of special meetings is not designated in the corporate bylaws, the meetings should be at the corporation's principal office. In NC, SH can participate in SHs' meetings via video conference if authorized by directors in the bylaws
Formation: Limited Partnerships
o Form a LP by filing a "certificate of limited partnership" with Sec. of State of the state in which LP is to be organized. o The name of the LP must contain the phrase "limited partnership" or abbreviation "LP"
Operating Agreement: LLC
o Most LLCs have a written operating agreement that tailors the applicable LLC statute's default rules to the specific needs and preferences of the LLC's members and managers. o LLC operating agreement is analogous to a partnership agreement if the LLC is to be member managed, or a combination of a corporate charter and bylaws if the LLC is to be manager managed. o Operating agreement can be oral or even implied. o In NC LLC statute, there is nothing that states how you can get rid of a manager run amuck. NC statute says to look at operating agreement => LLC can set up termination however it wants to
Annual shareholder meetings
regularly scheduled meetings held by a corporation each year so that SHs can vote on the election of directors. Corporations are required to hold annual meetings, unless the corporation's directors are elected by written consent (only in smaller businesses)
Entities with a Full Liability Shield:
-Corporations, -LLCs, -most LLPs, -Limited partners of limited partnerships o Therefore, corporations and LLCs provide the BEST PROTECTION for owners against inside liabilities
Entities with NO Liability Shield
-General partners of limited partnerships, -General partnerships, -Sole proprietorships
Factors considered in making determination whether partnership exists
-Parties' Intent -Profit Sharing -Obligations to Share Losses -Shared Ownership and control over partnership property/business -PR maintain power to administer business affairs -Agreement's language -Parties' conduct toward T -Parties' rights upon dissolution
Partnership agreements: Formation and types
-Adopting a partnership agreement ALWAYS requires unanimity. -Can change the default rules which govern the relationship among the partners -Can't change mandatory rules governing the relationship between the partnership and 3rd parties. A partnership falls under 1 of 3 categories: 1) Partnership for a definite term 2) Partnership for a Particular Undertaking (partnership agreement provides that the partnership ends upon completion of certain task) 3) Partnership at Will (partnership in which the partners have not agreed to remain partners until the expiration of a definite term or the completion of a particular undertaking.
Veil Piercing: 2 Part Test
1) Was there such unity of interest and ownership that the separate personalities of the corporation and its shareholders, officers, or directors are indistinct or non-existent? • Factors: Undercapitalization, failure to observe corporate formalities, absence of corporate records, payment by the corporation of individual obligations • Implicit notion is that the corporation must have been used as the mere alter ego or instrumentality through which the defendant was conducting his or her personal business. 2) Would adherence to the fiction of separate corporate existence sanction fraud, promote injustice or inequitable consequences or lead to an evasion of legal obligations? • Factors: fraudulent misrepresentation by corporation directors, use of the corporation to promote fraud, injustice, or illegality.
Requirements for a shareholder meeting to be valid
1) a corporation must provide its SHs with notice of the meeting (subject to waiver) and 2) a quorum of shares must be present at the meeting. A quorum is the minimum number of shares that must be present at a SH's meeting (not the number of SHs that must be present, because SH voting is based on shares, not headcount). Normally, quorum is a majority by person or proxy, can could be changed by bylaws. **In NC, for a special meeting, the notice must include a description of the purpose or purposes for which the meeting is called. Additionally, the corporation must give notice no less than 10 days prior to nor more than 60 days before the special meeting. A corporation does not have to give notice to SHs who do not have voting rights. NC: If not otherwise fixed under G.S. 55-7-03 or G.S. 55-7-07, the record date for determining shareholders entitled to notice of and to vote at an annual or special shareholders' meeting is the close of business on the day before the first notice is delivered to shareholders.
Alternatives to shareholder voting at a meeting
A SH not attending the meeting can appoint a "proxy"- an agent appointed by a SH to whom the SH gives express actual authority to vote the SH's shares at a SH's meeting. A vote at a formal SH's meeting is not the only way a corporation can obtain SH approval of a matter. Corporate law statutes also provide for SH approval through written consent. The advantage to a corporation of using a written consent instead of holding a meeting is that no notice period is required for a written consent, so the SH approval can potentially be obtained much faster and without dealing with the logistics of holding a meeting. In most states, voting requires a majority of the quorum to pass an amendment. Example: 1,000,000 shares outstanding => 500,001 Quorum => 250,002 Majority needed to pass vote
Agency: Estoppel Definition
A business may be bound to a contract entered into on its behalf by an agent or other person lacking both actual and apparent authority under the doctrine of estoppel.
Doing Business in Other States: Corporations
A corporation operating in its state of incorporation is referred to in that state as a "domestic" corporation. A corporation operating in a state other than its state of incorporation is referred to in that state as a "foreign" corporation. Foreign corporation must "qualify to do business" in the state by also completing a filing of "certificate of authority" Qualifying to do business in a state has several consequences: 1) the foreign corporation will have to pay the annual fee/franchise tax charged by the state. 2) the foreign corporation will be subject to service of process in the state 3) the foreign corporation will have to file an annual report with the state Because of these consequences, many businesses try to get around filing by stating it is not doing business within the state.
Partnerships: Obligation of Good Faith and Fair Dealing
A partnership agreement cannot eliminate the obligation of good faith and fair dealing. The obligation of good faith and fair dealing is a contract concept, imposed on the partners because of the consensual nature of a partnership.
Ethical Issues During Incorporation Process: Who is the Client?
A single lawyer can and typically does represent all founders at incorporation, but such a joint representation implicates state ethical rules on conflicts of interest. In light of MRPC 1.7 (conflicts of interest), the standard practice is for a lawyer to get informed consent from each founder and have each sign a conflict waiver. A lawyer will typically discuss the various issues related to multiple representation at the initial meeting with the founders and, if the lawyer is well prepared, have conflict waivers prepared for them to sign on the spot. Once the corporation is formed, the standard practice is for the lawyer to then represent the corporation and not the individual founders
Fiduciary duties of partners: exceptions
A very broad provision in a partnership agreement in effect negating any duty of loyalty, such as a provision giving a managing partner complete discretion to manage the business with no liability except for acts and omissions that constitute willful misconduct, will not likely be enforced. Partnership agreements frequently contain provisions releasing a partner from liability for actions taken in good faith and in the honest belief that the actions are in the best interests of the partnership and indemnifying the partner against any liability incurred in connection with the business of the partnership if the partner acts in a good faith belief that he has authority to act. These types of provisions are intended to come within the modification authorized by RUPA 103(b)(4). On the other hand, absolving partners of intentional misconduct is probably unreasonable.
Organization of the Corporation following incorporation
After incorporation, the incorporator needs to elect the corporation's board of directors. This is normally done by the incorporator signing a "written consent" Once the directors are elected, the board needs to complete the organization of the corporation by, at a minimum, adopting bylaws, appointing officers, and approving stock issuances.
Agency Law Definition
Agency law encompasses the legal consequences of the consensual relationships in which one person (the principal) manifests assent that another person (the agent) shall, subject to the principal's right of control, have power to affect the principal's legal relations through the agent's acts and on the principal's behalf.
Partnership agreements: Content and function
Agreements typically address management structure, allocation of profits and losses among the partners, partner taxation, admission and withdrawal of partners, and dissolution. It is through the partnership agreement that partners alter or opt out of default partnership statutory rules that do not meet the partners' needs or preferences. If a partnership agreement is silent on a particular issue addressed by a default statutory rule, the default statutory rule applies. Unanimous consent is needed to amend partnership agreement, but can be changed if partnership agreement specifies something else.
Creation of Agency Relationship
An agency relationship arises when: 1) a principal manifest assent to the agent and 2) the agent shall act on the principal's behalf and subject to the principal's control and 3) the agent manifests assent or otherwise consents to so act. (manifestation is written or spoken words or other conduct) o Most common way in which an agency relationship is created in the business organizations context: the business hires a person as an employee. o How the parties characterize the relationship (employee or independent contractor status), although relevant, is not controlling.
Dissolution: LLC
Can be dissolved voluntarily or judicially. o Haley v. Talcott Two Managers- 1 Manager putting up money wants to throw out 1 Manager running the business => conflict ensues. This is tough to do because need majority vote (with 2 managers, have 50-50 ownership) Remedy for deadlock situation => we dissolve LLC In hindsight, Talcott could have: • Retained majority interest in LLC • Could have made deal with bank to take other manager off guarantee • Every operating agreement should have an exit mechanism (Buy-Sell Agreement)- some way for owners to leave and get fair market value for their interest.
Shareholders automatic voting rights
Corporate law statutes provide SHs a vote on the following matters only: 1) Election and removal of directors 2) Amendments to the corporation's charter 3) SH (as opposed to board) initiated amendments to corporation's bylaws 4) dissolution of the corporation 5) A merger of the corporation, and 6) A sale of all (or substantially all) of the corporation's assets
Director's Terms
DEFAULT RULE: A director's term is generally one year. A corporation can instead choose to stagger, or classify, its board, meaning the terms of only a portion of its directors expire in a particular year. In such a case, each director may have a term for 3 years with 1/3 of the board coming up for election each year.
Directors: basics
DEFAULT RULE: Ultimate managerial authority resides in a corporation's board of directors. Typically, a corporation's bylaws dictate the size of the corporation's board or means for setting the size. A corporation is free to impose any qualifications for directors in its charter or bylaws
Agency Rules: Partnerships
DEFAULT RULE: each partner has actual authority to bind the partnership. - If the third party's belief that a partner has authority is not reasonable because the third party knew or had received a notification from the partnership that the partner lacked authority, the partnership is not bound. - RUPA specifies that a person has received a notification when it (1) comes to a person's attention or (2) is duly delivered at the person's place of business or at any other place held out by the person as a place for receiving communications. - Thus, if a partnership is worried about a partner entering into an unauthorized contract with a third party, the partnership can send to the third party a notification of a restriction on the partner's authority. As the statutory language indicates, such a notification is effective upon delivery, whether or not it actually comes to the third party's attention.
Agency: Ratification
DEFINITION: the affirmance of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority. A person ratifies an act: 1) by manifesting assent to be bound by the act, or 2) through conduct that justifies a reasonable assumption that the person so consents.
Inherent Agency Power
DEFINITION: the power of an agent which is derived not from authority, apparent authority, or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. • A business may be bound to a contract entered into on its behalf even in the absence of actual authority, apparent authority, or estoppel under the doctrine of inherent agency power. • Courts invoke inherent agency power when fairness dictates holding a principal liable on a contract even though the purported agent lacked authority and one or more estoppel elements is missing.
Agency: Estoppel Doctrine
DOCTRINE: A person who has not made a manifestation that an actor has authority as an agent and who is not otherwise liable as a party to a transaction purportedly done by the actor on that person's account is subject to liability to a third party who justifiably is induced to make a detrimental change in position because the transaction is believed to be on the person's account, if 1) the person intentionally or carelessly cause such belief -or- 2) having notice of such belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts. • Unlike apparent authority, finding estoppel does not require a manifestation traceable to the principal regarding the purported agent's authority, but does require detrimental reliance by the third party.
Allocation of Profits and Losses: Limited Partnerships
Default Rule for Distributions: distribution by a limited partnership must be shared among the partners on the basis of the value, as stated in the required records when the limited partnership decides to make the distribution, of the contributions the limited partnership has received from each partner No default rule for allocating profits and losses
Allocation of Profits and Losses
Default Rule: each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partner's share of the profits. --This per capita allocation may make sense if each partner contributed the same amount of capital to the partnership --Partnership agreements very often provide for a different allocation method --It is common for a partnership agreement to include a provision requiring the partnership to distribute to each partner sufficient funds to cover the partners' tax liabilities resulting from the allocation of the partnerships' earnings to the partners. --No specific default rule requiring partnership to distribute profits to its partners=> decision to allocate is governed by management provision s of partnership agreement or if agreement contains none, the default management rules. -NC Rules- -Default Rule Above Same- If Partnership Agreement only speaks to losses but not profits, profits are divided equally. If Partnership Agreement only speaks to profits but not losses, losses divided like profits.
Liability Shield: Direct Liability
Direct Liability: a liability shield does not protect a business owner from liability arising from the business owner's own actions or inactions.
Federal Income Tax Liability: Single-Member LLC
Disregarded* Sub-C Sub-S (if eligible)
Partnerships: Liability Exposure
Each partner is personally liable for the obligations of the partnership- liability is joint and several. This means that a judgment creditor of the partnership can recover the entire amount owed to it by the partnership from any partner or partners of its choosing. Exhaustion Rule: a creditor owed by the partnership has to try to get the money from the partnership before the creditor can levy execution against the assets of a partner to satisfy the judgment. A person who has to pay a judgment creditor of the partnership out of his or her pocket will have the right to recover some of this money from the other partners. Specifically, the partner will be entitled to indemnification, or repayment.
Whether the corporation is liable on the promotor contract following incorporation
GENERAL RULE: Corporation is not liable on a pre-incorporation contract unless the corporation adopts it. A corporation adopts a contract by manifesting assent to be bound by it. Adoption can only occur after the corporation is formed and is valid only if at the time of adoption the corporation has knowledge of all material facts concerning the contract. Adoption can be either be by express action or implied through conduct. Implied adoption may occur when a corporation receives the benefits of the contract or accepts goods or services under the contract with knowledge of the contract. It can also occur if the corporation makes payments under the contract or attempts to modify or enforce the contract- also known as adoption through acquiescence. Adoption does not relieve a promoter from liability on a contract unless the other party agrees to substitute the corporation for the promoter on the contract (novation). Absent a novation, both the corporation and the promoter will be liable on an adopted contract, although the promoter would likely be entitled to indemnification by the corporation if he has to pay out on the contract.
Liability Exposure: Limited Partnerships
General partners of limited partnerships are personally liable for the debts and obligations of the limited partnership, while limited partners are not. One Exception: Control Rule A limited partner that participates in the control of the LP's business will be personally liable for the obligations of the LP to persons who transact business with the LP while reasonably believing, based on the limited partner's conduct, that such limited partner is a general partner. --No specific definition of what constitutes "participating in the control of the business, but list activities that do NOT COUNT: Working for the LP or its general partner Guaranteeing LP obligations Attending Partner Meetings Voting on dissolving or selling partnership, changing nature of its business, admitting or removing general or limited partner, or amendment to partnership agreement.
Ensuring Authority: Agency
For significant transactions, the parties will conclude it makes sense to take some steps to ensure authority. These steps often include requiring the delivery of 2 documents at closing that address authority: a secretary's certificate and an opinion letter; and, if a partnership or LLC is involved, a party may also require the filing of a certificate of authority. secretary letter-Letter signed by entity's sectary guaranteeing everything. Opinion letter-from the attorney or law firm of one party to a transaction to the other party to the transaction that addresses various legal issues with respect to the transaction. Certificate of authority-filed with secretary of state
Limited Liability Companies (LLCs)
Formation Form LLC by filing a "certificate of formation" with Secretary of State of the state in which client wants LLC to be organized. Can apply for a certificate of existence OR if a foreign LLC, an application for a certificate of authority to transact business NC --In or during filing process must include the following: 1) Must clear name 2) Have "LLC" or "Limited Liability Company" in title 3) Have to have registered agent with street and mailing address of agent 4) Address and number of Principal Offices 5) Email Address 6) Need Organizer's (usually lawyer) sign off on Articles 7) May identify the initial members of the LLC
Liability Shield: LLC
LLC affords its members a full liability shield o Pepsi-Cola Bottling Co. v. Hardy Property is sold with environment problem Seller of property is then sued. • Seller states the LLC sold the property, so he was shielded with limited liability. Court said no shield for fraudulent actions/tortfeasors => no entity could protect wrongdoer with shield
Transfer of LLC interests
LLC interest is freely transferable but the assignee of a member's limited liability company interest shall have no right to participate in the management of the business and affairs of a limited liability company except as provided in a limited liability company agreement or, unless otherwise provided in the limited liability company agreement, upon the affirmative vote or written consent of all of the members of the limited liability company.
Governing Law: Limited Partnerships
LPs are governed by the LP statute of the state in which it is organized. Each state has its own LP statute based on some version of the Uniform Limited Partnership Act (or Revised ULPA).
Allocations Sub-S vs. Sub-K
Sub-S: Percentage Ownership Sub-K: Can be based on something other than percentage • Under both Sub-S and Sub-K, owners of a business are taxed on business income allocated to them even if the business did not distribute any money to them. • Allocating losses (and profits) on a basis other than percentage ownership is possible under Sub-K but not Sub-S.
No Default Buyout Right: Limited Partnerships
Limited partnership interest of a limited partner who dissociates before the termination of the limited partnership is essentially converted to a transferable interest owned by the dissociated limited partner
Allocation: Percentage Ownership
Losses based on ownership interest EXAMPLE: You have 60% in business without contributing anything. Aunt receives 40% of interest for $500,000 capital contribution. In first year, business has loss of $300,000. With percentage ownership basis, you would be allocated $180,000 in losses and aunt $120,000.
Two types of LLC management
Member Managed: similar to partnership or decentralized management- the statute vests the members (owners of LLC) with the authority to manage the LLC. Manager Managed: similar to corporate or centralized management- the statute vests management authority in a board of managers elected by LLC members. • NC- presumption is MANAGER MANAGED but can be changed by operating agreement o CAVEAT: In NC, all members by virtue of their status as a member are managers of the LLC • NC- Board of Managers make decisions based on majority vote without meeting and without notice. • If manager managed, the operating agreement should also state how the managers of the LLC will be chosen.
Agency: When a Principal Bound To a Contract?
The basic agency law rule is that a principal is bound to a contract made on the principal's behalf by an agent acted with actual or apparent authority.
expanding shareholder voting rights
The board may choose to put additional matters to a SH vote even though it is not required to under state corporate law. Furthermore, a corporation's charter or bylaws may specify additional matters on which SHs get to vote, but expanding the list is fairly uncommon except with respect to voting by holders of preferred stock.
Qualifications of Directors
NC GEN STAT § 55-8-02. Qualifications of directors. The articles of incorporation or bylaws may prescribe qualifications for directors. A director need not be a resident of this State or a shareholder of the corporation unless the articles of incorporation or bylaws so prescribe.
Formation: Limited Partnerships NC statutes
NCGS § 59-201. Certificate of limited partnership. (a) In order to form a limited partnership, a certificate of limited partnership must be executed and filed in the office of the Secretary of State and set forth: (1) The name of the limited partnership. (2) The address, including county and city or town, and street and number, if any, of the registered office and the name of the registered agent at such address for service of process required to be maintained by G.S. 55D-30. (3) If the limited partnership is to dissolve by a specific date, the latest date upon which the limited partnership is to dissolve. If no date for dissolution is specified, there shall be no limit on the duration of the limited partnership. (4) The name and the address, including county and city or town, and street and number, if any, of each general partner. (5) The address, including county and city or town, and street and number, if any, of the office at which the records referred to in G.S. 59-106 are kept, if such records are not kept at the registered office. (b) Unless a delayed effective date is specified in the certificate of limited partnership, a limited partnership is formed at the effective time and date of the filing of the certificate of limited partnership in the office of the Secretary of State if there has been substantial compliance with the requirements of this section.
Incorporation mechanics: name selection & articles of incorporation
Name Selection --> Need to clear the name first- states typically require that the name be distinguishable from all existing names on record with the secretary of state --> The fact that a secretary of state search indicates a particular name is available says nothing about whether the name has been registered as a trademark with the US Patent and Trademark Office. --> Can reserve a name for 60 days prior to incorporation.
Partnership: formation
No formalities are required to form a partnership Partnership formed when 1) 2 or more people associate to carry on as co-owners a business for profit, and 2) they do not file the paperwork to operate the business in some other form (UPA definition). If these elements are met, the people involved have created a partnership even if they had no idea they were doing so (INADVERTENT PARTNERSHIP)
Corporation by Estoppel Doctrine
One who contracts and deals with an entity as a corporation thereby admits that the entity is a corporation and is estopped to deny its incorporation in an action arising out of the contract or course of dealing. 3 Situations in which Corporation by Estoppel can be used: 1) An association, or its owners, having claimed corporate status in an earlier transaction with a third party, later denies that status in a suit brought by 3rd party. 2) The question of corporate status is raised by defendant in a suit brought by the would-be corporation. (plaintiff cannot sue in corporate name) 3) A 3rd party has dealt with a business as a corporation and seeks to impose personal liability on would-be SHs who in turn raise estoppel as a defense.
Dissolution: Winding up
Part of the winding-up process involves the settlements of accounts among partners. Default Rule: any amounts remaining after the partnership liquidates its assets and pays its creditors are divvied up among the partners based on each partner's capital account balance and, if any money remains, each partner's profit sharing percentage. If the surplus is less than the aggregate of the partners' capital accounts, the shortfall is allocated to the partners' capital accounts based on their loss sharing percentage. The partnership then pays each partner an amount equal to his capital accounting balance.
Deduction Limitations: Basis Limitation
caps the deduction a partner can take for partnership losses allocated to him or her in any particular year to the partner's adjusted basis in his or her partnership interest at the end of that year before taking into account a partner's share of the loss (adjusted basis cannot drop below $0) • A partner's adjusted basis equals his or her initial basis plus any of the foregoing increases and less any of the foregoing decreases. • You can "carry forward" your unused losses and deduct them in future years in which the adjusted basis in your partnership interest is greater than $0
Corporations: Potential consequences of a corporation doing business in state without filing
Potential consequences of a corporation doing business in state without filing: Corporation will not be allowed to maintain an action in any court of the state State may impose a monetary penalty on the corporation (Possibly) Voiding the contracts of unqualified corporations
Pre-incorporation activities: promoters
Promoter: a person who engages in pre-incorporation activities
Incorporation mechanics: articles of incorporation--Authorized Shares
Represents the maximum number of shares the corporation has the authority to issue. -->Par value is the minimum amount of consideration the corporation must receive when issuing a share. It has no impact on the price at which you could sell your 100 shares to someone else. -->Today it is customary to set par value at a nominal amount, such as one cent. Therefore, par value has little relevance today. -->You can set authorized shares at any number, but in some states the amount the corporation has to pay to file its charter and annual fee is based on the number of authorized shares it has. -->Many states simply charge a corporation a flat filing and annual fee.
Agency Rules: Corporations
SHs are not agents of the corporation Ultimate decision-making authority resides in a corporation's board of directors. An individual director cannot confer actual or apparent authority. Directors can only act collectively as a board. An individual director as such is not an agent of the corporation. In other words, the position confers no actual or apparent authority to bind the corporation. Of course, as with SHs, the corporation could confer actual or apparent authority to a director. Unlike SHs and directors, officers are by definition agents of the corporation. Usually, this is pursuant to a state's corporate law statute. It is typical for a corporation's bylaws to specify the authority of at least some of its executive officers. The board should adopt a resolution specifying the authority of any executive office it has created if such authority is not specified in the bylaws, as contemplated by the above statutory language. Included within an officer's authority is typically the authority to confer authority to bind the corporation on a subordinate, which conferral may authorize that subordinate to confer authority to a person below him or her in the hierarchy.
Limited Liability Limited Partnership (LLLP)
Simply a limited partnership that has elected LLLP status under applicable provisions of its limited partnership statute by including a line stating as such in its certificate of limited partnership Liability Exposure The primary distinction between a limited partnership and an LLLP is that the latter provides a full liability shield for all partners- a general partner of an LLLP is not personally liable for the obligations of the LLLP just because he or she is a general partner.
Partnership: Dissociation
Situation for when a partner departs a partnership. Default rule: unless a partner's dissociation triggers a dissolution of the partnership's business, the partnership is required to cause the dissociated partner to be bought out of his or her partnership interest for cash.
Federal Income Tax Liability: Corporation
Sub-C* Sub-S (if eligible)
Federal Employment Tax Liability
Sub-K • Self-Employment Tax on business income and wages paid Sub-S • Self-Employment Tax on FICA on Wages
Pass-through taxation
Sub-K and Sub-S provide for pass-through taxation, meaning that the entity calculates its income/loss for the tax year and then allocates it to each owner.
Federal Income Tax Liability: Limited Partnership
Sub-K* Sub-C * Default
Federal Income Tax Liability: Multi-owner Unincorporated entity Other than a limited partnership (general partnership, LLP, LLC)
Sub-K* Sub-C Sub-S (if eligible) * Default
Electing Directors: voting standards
The default rule under the MBCA and DGCL is that SHs elect directors using straight voting. Under straight voting, each SH can cast the number of votes he or she has (assuming one vote per share, this would correspond to the number of shares the SH owns) on her preferred candidates for the board seats up for election. Under straight voting, he or she who controls a majority of votes selects the entire board. In other words, a minority SH or SHs do not get to pick any of the board members. Versus Cumulative Voting: Each SH may multiply the number of votes he is entitled to cast (based on the number of shares held by him) by the number of directors to be elected by the voting group at the meeting and may cast the product for a single candidate or distribute the product among two or more candidates. Under both the MBCA and DGCL, a corporation opts into cumulative voting by including a provision to that effect in its charter. This makes it so that the majority can control the whole board. It allows for generally at least one minority board member.
Fiduciary duties of partners
The only fiduciary duties a partner owes to the partnership and the other partners are: (1) Duty of loyalty- duty to account to the partnership and hold as trustee for it any property, profit, or benefit derived from a use by the partner of partnership property-- (2) Duty of care- duty to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law in connection with partnership business.--
Dissolution definition and triggers: partnerships
The point at which the partnership begins the winding-up phase of its existence Triggered in a partnership at will whenever a partner notifies the partnership of his or her express will to withdraw as a partner. Triggered by the expiration of the term or completion of the undertaking or the express will of all the partners to wind up the business before the expiration or completion in a partnership for a definite term or particular undertaking. Court-ordered dissolution rules are mandatory rules and thus cannot be altered by a partnership agreement (appear on RUPA 103(b) list)
Deduction Limitations: At-Risk Limitation
caps the deduction a partner can take for partnership losses allocated to him or her to the amount the partner has "at risk" in the business. • Amount at risk can differ from adjusted basis bc of loan guarantees, stop-loss agreements, or nonrecourse loans • A partner can carry forward losses that are disallowed as a result of the at-risk rules and deduct them in future years in which the partner has a sufficient amount at risk.
Director meetings: regular v. special
There are two types of meetings Regular: the dates for regular meetings are specified in corporation's bylaws Special: those meetings held between regular meetings The default rule under the MBCA and NC is that directors must be provided at least 2 days' notice of a special meeting, but this period can be, and normally is, reduced by a bylaw provision. In NC, unless bylaws state differently, president or two directors may call special director meeting.
Director voting
There must be a quorum present at a meeting for a board to act. Under the default rule, the presence of a majority of directors constitutes a quorum (a director participating by phone or similar means is considered present). Both the MBCA and DGCL allow a corporation to lower the board meeting quorum requirement through a bylaws provision to as little as 1/3 of directors. An item must receive the affirmative vote of a majority of directors present at the meeting to pass. o A board can also act through written consent. In NC, director consents have to be unanimous (statute trumps bylaws)
Promoter personal liabiliy on pre incoporation contracts
Two legal Issues related to promoter contracts: 1) Whether the promoter is personally liable on a pre-incorporation contract GENERAL RULE: promoter is personally liable on pre-incorporation contracts even after the corporation is formed. Analysis varies on how promoter signed contract: If promoter signs contract in his or her own name, the promoter is personally liable under basic principles of contract law- by signing the contract the promoter has manifested an intent to be bound. If promoter signs contract in the name of yet-to-be-corporation knowing the corporation has not been formed and the other party is unaware that the corporation has not been formed, the promoter is personally liable under the agency law rule that the agent who acts on behalf of a nonexistent principal is personally liable. If promoter signs his name and indicates he is a promoter, the case is murky. Courts have held that a promoter is not liable on a contract if he or she can prove that the other party agreed to look solely to the corporation on the contract. Courts look to the facts and circumstances surrounding the making of the contract.
Allocation of Profits and Losses; Distributions: LLC
Typically, an LLC agreement will tie ownership interests in an LLC to contributions. In other words, if you contribute cash to an LLC equal to 60% of total contributions received by the LLC, you will get a 60% ownership interest. Thus, as a general matter, you can think of the default allocation and distribution rules as being based on the ownership interests (or percentages) of an LLC's members.
Liability Exposure: Limited Liability Partnerships
Unlike partners in a general partnership, partners in an LLP are not personally liable for the obligations of the LLP just bc they are partners.
Shareholder voting: election of directors, class voting
When it comes to the election of directors, the default voting standard is plurality. In this context, plurality means that the director candidates who receive the largest number of votes are elected, up to the maximum number of director slots for election. Because under a plurality standard, the candidates receiving the most votes win, regardless if fewer than a majority, there will be no failed elections even if the number of nominees greatly exceeds the number of seats up for election. Class Voting: depends on the type of stocks issued (common, preferred) and what preferences the preferred stock holders have. -Classes vote separately but each class has to approve it.
Veil Piercing: General Rule
a corporation will be looked upon as a legal entity separate and distinct from its shareholders, officers, and directors unless and until sufficient reason to the contrary appears, but when the notion of a legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, then sufficient reason will exist to pierce the corporate veil.
De Facto Corporation Doctrine
a de facto corporation exists if the following 3 elements are met: 1) there is a law under which a corporation with the power assumed might be incorporated 2) there has been a bona fide attempt to organize a corporation in the manner prescribed by the statute; and 3) there has been an actual exercise of corporate powers. The burden of establishing de facto corporate status is on the party seeking to rely upon it.
NC Articles of organization requirements: LLC
a) The articles of organization must include the following information: 1) Name of the Organization 2) The name and address of each person executing the articles of organization and whether the person is executing the articles or organization in the capacity of a member or an organizer. 3) The street address, and the mailing address if different from the street address, of the LLC's initial registered office, the county in which the initial registered office is located, and the name of the LLC's initial registered agent at that address. 4) The street address, and the mailing address if different from the street address, of the LLC's principal office, if any, and the county in which the principal office, if any, is located. 5) If the LLC is to render professional services and is subject to relevant statutes as a professional limited liability company, the professional services to be rendered by the LLC. b) The articles of organization may include any other provision that is or may be included in an operating agreement.
Allocation: Special Allocation
allocation of profits (losses) other than Percentage Ownership
Deduction Limitations: Passive Activity Loss Limitation
allows a taxpayer to deduct losses from "passive" activities only to the extent of the taxpayer's passive income from his or her other passive activities for that year. • Passive Activities include: 1) Ownership of a business in which taxpayer does not materially participate during year and 2) rental activities, even if taxpayer materially participates in them, unless taxpayer is a real estate professional. • Generally, a taxpayer materially participated in a business for a tax year if he or she was involved on a regular, continuous, and substantial basis in its operations. • A taxpayer may carry forward unused passive losses to deduct against future passive income. (up to 20 years)
Agency: Actual Authority
• An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act. • The focus is on communication by the principal to the agent, and the agent's reasonable interpretation of that communication. • Actual authority can be express or implied. Implied actual authority includes authority to do acts necessary or incidental to achieve the principal's express objective. Implied actual authority can also arise from manifestations by the principal that reasonably lead the agent to believe he or she has authority to take a particular action.
Disregarded Entity
• An entity "that is treated as an entity not separate from its single owner for income tax purposes" => taxed essentially the same as a sole proprietorship • Owner reports net income or net loss from business on his or her personal federal income tax return. • **Single-member LLC cannot elect to be taxed under Sub-K => only available to unincorporated entities with 2 or more owners.
Sub-C Taxed Entity
• An entity taxed under Subchapter C is treated as separate taxpayer. • If a Sub-C entity distributes money to its owners (such a distribution is normally referred to as a dividend), the owners must include the distribution in their taxable incomes.
Angel investors
• Angel investors are wealthy individuals who directly invest in emerging growth companies (as opposed to investing through a VC fund), typically prior to a VC investment. o Can invest in S-Corps and more open to investing in pass-through taxation entities. o Angel investors typically invest in a business with the expectation that VC funds will provide later rounds of financing • BOTTOM LINE: business needing to raise money from angel investors and VCs should probably organize as a corporation with Sub-C taxation.
Agency: Apparent Authority
• Apparent authority is the power held by an agent or other actor to affect a principal's legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations. • Focus here is on communication by the principal and the reasonable interpretation of this communication by the third party. • For a principal to be bound by an agent's action, the principal must take some affirmative step, either to grant the agent authority or to create the appearance of authority. An agent's actions, standing alone and without some action by the principal, cannot create authority to bind the principal. • Some courts have a reliance element to apparent authority- the third party must rely on its belief that the agent had authority. Although a number of courts impose a reliance requirement, the Restatement of Agency does not. • The appointment of an agent by a principal to a particular position or office constitutes a manifestation by the principal. Thus, if a third party knows an agent is in a particular position and this knowledge is traceable to the principal, the agent has apparent authority to do what a person in the agent's position would customarily have authority to do. • Apparent authority of an agent can be broader than his or her actual authority. • Apparent authority and actual authority often coincide as well.
Fiduciary Duties of the Agent
• Duty of Loyalty and obedience • Duty to use skill, care and diligence • Duty of full disclosure • Duty of accounting In light of the fact that agent fiduciary duties end upon termination of the agency relationship, it is common for a business to essentially extend portions of them beyond termination by contract. Specifically, many businesses routinely have at least their upper-level employees sign an agreement containing some provisions such as: - Non-Competition Covenant - Covenant Not to Solicit Customers - Covenant Not to Solicit Employees - Injunctive Relief: included in a contract to make it more likely that a court will conclude that money damages are inadequate.
Incoporation mechanics: Articles of Incorporation basic requirements
• Information that is needed on the "articles of incorporation" include: o Name Selection o Authorized Shares o Name and Address of Registered Agent o Name and Address of Incorporator (In NC, can have more than one incorporator) o Signature of Incorporator GENERAL RULE: only include in the charter required provisions and desired optional provisions that the statute requires to be set forth in the charter. Everything else you put in the bylaws- this is because a corporation's charter is a public document and is more difficult and costly to amend than its bylaws.
Defective Incorporation
• Occasionally, a business decides to go with the corporate form, gets up and running, but because of an unknown foul-up with its secretary of state paperwork, the corporation does not actually get incorporated. Once the mishap is discovered, its easy enough to fix. Upon refilling, the corporation then formally adopts any contracts someone entered into on its behalf before it existed and everyone goes about their business. • Sometimes, a dispute arises concerning a contract signed by the business in the name of the corporation when, because of a foul-up, the corporation did not actually exist. The other side then discovers the defective incorporation and thus agrees that the person signing on behalf of the nonexistent corporation is personally liable. It will likely also argue that the business is by default a partnership and thus the non-signing owners are personally liable too.
Outside Liability Exposure
• Outside liability exposure refers to the extent to which the creditors of the individual owners of a business operated in a particular legal form can recover against the business's assets. • Unincorporated entities are generally SUPERIOR to corporations in this regard • Corporation: creditor can reach and get your business interest/stock • LLCs: Outcome is different than scenario under corporations. Plaintiff would not be able to seize your ownership interest in the business. Instead, the plaintiff will get a "charging order", which entitles him to any distributions made by the LLC until the judgment is paid off (no management rights transferred) • -CAVEAT: Single Member LLCs- handled like Corporations • Reverse Veil Piercing: Creditors of a business owner may also be able to reach the assets of a business under the doctrine of reverse veil piercing, which applies to all limited liability entities (corporation, LLC, LLP, etc.) • -2 Part Test and Factors are the SAME as traditional Veil Piercing
Prevalence of Sole Proprietorships
• Sole proprietorships are by far the most common form of business in the US. • **Remember: Liability insurance and not a liability shield is typically the first line of defense for a business, at least with respect to tort liability.
Special Allocation: "substantial economic effect"
• Valid for tax purposes only if it has "substantial economic effect"- it has to at least appear that the partners agreed to it for economic reasons rather than to merely minimize the partners' tax obligations. • If IRS determines an allocation does not have substantial economic effect, it will disregard it and generally tax each partner based on his or her percentage ownership.
Venture Capitalists
• Venture Capitalists specialize in investing in emerging growth and other development-stage companies with great potential but high risk. o As general rule, VCs only invest in businesses organized as corporations and taxed under Sub-C (want preferred stock, don't like passing through companies and tax implications with that) o VCs cannot invest in Sub-S bc an S-Corp cannot have an entity as an investor • BOTTOM LINE: business needing to raise money from angel investors and VCs should probably organize as a corporation with Sub-C taxation.
