CORPORATIONS
PROFESSOR HAMANN
SPRING 2008
12j
text: Hamilton, Corporations (10th Ed. 2008).
Class overview
Two corporation types: closely held & public
Themes that overlap both types: Duties of Care, Loyalty, Business Judgment Rule & Conflict of Interest
Agency & Partnerships
Corporations are stale entities that need the Agents to make it work.
Board of Directors run the corporation; elected by the shareholders
vote on resolutions: e.g. to open bank account
shows bank that person has actual authority
Knowledge of business entity types to select the best form suitable for Client
Tax and liability variations
Partnership – default form of business w/o filing requirements
LP, LLC, etc. – all require document filing
Terminating a Partnership or Corporation
Partnership – winding up process
Corporation – shareholders control termination by majority vote
even if 2 parties have equal share, can’t – need majority
Corporations– its own entity owned by shareholders and control by board of directors
Pros – raise capital through stock, limited liability
Cons – double taxation (at corporate level & personal level through dividends), costly incorporation/reporting
A corporation under certain circumstances can elect to become a “S” Corporation, with similar taxation to a partnership. This election allows shareholders to treat earnings and profits as distributions and have them pass directly to their personal tax returns. The only catch is that if you are an employee, you have to pay yourself “reasonable compensation” for any work you perform for the company.
Sole Proprietorships – Controlled by one person
Pros – all control & profits, easy to form, less government restrictions
Cons – all losses & unlimited liability, difficult to acquire capital, may lack tax advantages
Commonly small business owners, but may have multiple investors as long as they are creditors instead of investors.
Partnerships – 2+ people share ownership & control
Pros – easy to form: written agreement not req., but recommended including job descriptions, profit/loss distributions, accepting/rejecting new/old partners, & dissolving the partnership; easier to raise capital
Cons – liability for other partners’ actions, dividing profits, disputes arising, death of a partner dissolves partnership à need agreement to keep alive (create an immediate new partnership)
Uniform Partnership Act (UPA-1914) sets standards. RUPA (1997) has not been too widely adopted (IL – has adopted with minor changes)
Limited Partnerships – filed with State; at least one general partner and limited partner
Pros – limited partners not subject to personal liability
Cons –
Presumed general partnership unless LP certificate filed with Secretary of State.
Limited Liability Partnerships (LLP) –
7/1/2003: Lawyers may operate as LLP – lawyers not liable for other attorney’s liability unless under direct supervision. Malpractice claims still held to the whole firm. Therefore, what defines “supervision” is still being explored by the Courts.
Limited Liability Limited Partnerships (LLLP) –
Pros –
Cons –
Limited Liability Companies (LLC) – limited liability of a corporation with control/tax advantages of a partnership
Pros – owners personal assets protected
Cons – strict IRS rules
A & B business startup scenario: A provides capital; B manages software co. (p.8)
defaults to a partnership relationship even w/o intent
B an agent of A?
B an agent of A (if sole proprietorship)
B an agent of AB partnership (if partnership)
B an agent of Software Corporation (if corporation)
BEST to enter into a partnership agreement à clearly establish A & B’s relationship
A & B hires C (truck driver) who gets in accident
V sues A, B, AB partnership & C if a partnership
V sues AB corp. & C if a corporation (A & B personal assets protected)
even with limited liability w/corp., still get insurance!
Corporation Map
Shareholders à Board of Directors à Officers
possible to have corporation with one person controlling every role
Federal Income Taxation of Business Entities
Which business form is best for me from a tax perspective?
Individual Rates – rate tables based on marital status; personal expenses cannot be deducted, only certain “important” expenses such as child care and mortgage interest payments.
progressive individual income tax tables p.164
Partnership Rates – partnerships do not pay taxes, rather included in personal income reports using the partnership’s net income divisible by the allotted partners’ investment.
Partnership files an informational tax return on who the partners are and who will be reporting the partnerships income.
Corporate Rates – corporations get to deduct most expenses: salaries, inventory, supplies
Marginal – calculation tax rate
Effective – final percentage of tax paid per dollar (what’s important!) p.162
50,000 à 15%
51,000à 7,500 + 25%x1,000 = 15.2% (marginal = 25%; effective = 15.2%)
C corporation – all corporations are C unless meet req. and file IRS S election form
S corporation – no corporate tax; taxed as a partnership
Major issue for small corporations: some start as S, then go to C.
Requirements:
75 or less shareholders (normally just one or several)
all shareholders U.S. citizens
one class of stock
Example: AB Software taxable income $200,000
no other income; even dist. partnership:
A & B both have 100,000 income
21,850 tax due à 78,150 net income (43,700 tax paid to Gov.)
AB as Corporation:
200,000 taxable income – 61,250 tax = 138,750 left for A&B to share
69,380 to each A&B in dividends x 15% (dividend rate tax) = 10,407
A&B each get ~57,000 net income (~86,000 tax paid to Gov.)
A has 500,000 other income: (better for A to have Corp., B to have partnership)
A 600,000 B 100,000 incomes (partnership)
A pays 206,000 tax
A 557,000 B 57,000 incomes (corporate)
A pays
“Zeroing out corporate income” – salaries paid to partners deductible to corporation
A&B get 90,000 salaries à 200,000 – 180,000 = 20,000 taxable income
3,000 tax paid = 17,000 net income not paid out on dividends à 17,000 becomes retained earnings and is not taxed (carried over into next year)
However, A only an investor/no salary!
select S corporation status instead of “zeroing out”
“Accumulation and Bailout”
Corporate income only taxed when paid out in dividends. Therefore, corporations can accumulate a lot of money that will be taxed eventually!
Can’t pay dividends to only one shareholder and not another. Two main ways to get money out of a corporation is salaries and dividends.
A owns business hires B; 500,000 capital investment in business
A gets 500,000 stock in business
year 1: 100,000 taxable income – 22,500 tax = 77,500 retained earnings
A has plenty other income so wants to accumulate income
after 10 years of the same: 775,000 total retained income
A sells 500,000 in stock + 775,000 = 1,275,000
1,275,000 – 500,000 basis = 775,000 capital gain taxed at 15%
benefit to A even though paying ~110,000 tax in one year
How to Incorporate
States typically have General Incorporation statutes.
Delaware – won the state race to generally have the best factors, BUT not necessarily for all corporations.
e, but doesn’t mention D will then be released from liability.
BOP on promoter to show intent of the 3rd party to release promoter.
Best solution!? = form the corporation FIRST!
Summary
Promoter always liable on the K unless released
Corporation only liable on the Ks the corporation chooses to adopt or those Ks that the corporation has benefited from.
Defective Incorporation
Robertson v. Levy – Seller transferred the assets of a business and assigned a lease to an association that had submitted articles of incorporation and was doing business in a corporate name. After the transfer and assignment were completed a certificate of incorporation was issued and one payment was made on the installment note for the assets. When the association ceased doing business the seller brought suit for the balance of the note and the damages incurred in settling the lease. Ct. – Certificate of incorporation was conclusive evidence of corporate existence, eliminating the concept of corporations by estoppel, and it was immaterial that the seller believed he was dealing with a corporation. The association’s subsequent incorporation had not relieved it of personal liability.
A de jure corporation results when there has been conformity with the mandatory conditions precedent, as opposed to merely directive conditions, established by the statute. A de jure corporation is not subject to direct or collateral attack either by the state in a quo warranto proceeding or by any other person.
A de facto corporation is one which has been defectively incorporated and thus is not de jure. The requisites for a corporation de facto are: (1) a valid law under which such a corporation can be lawfully organized; (2) an attempt to organize thereunder; (3) actual user of the corporate franchise. Good faith in claiming to be and in doing business as a corporation is often added as a further condition. A de facto corporation is recognized for all purposes except where there is a direct attack by the state in a quo warranto proceeding.
A corporation comes into existence only when the certificate has been issued. Before the certificate issues, there is no corporation de jure, de facto or by estoppel.
Frontier Ref. v. Kunkel’s – P provides gas to station run by D. D defaults and P goes after all parties.
What type of business exists here?
Partnership – Fairfield, Beach & Kunkel OR
Sole Prop. of Kunkel loaned $ by Fairfield & Beach
Evidence in memo by P’s employee makes business appear to be partnership à P sues all
Ct. – Kunkel was sued by P in another case individually as the sole station owner = oops! Otherwise, this case could have easily gone the other way.
805 ILCS 5/2.15
IL only requires filing of the Articles of Incorporation: filing = “conclusive evidence” “except as against the State”
MBCA 2.03 – filing is “conclusive proof” unless
Disregard for the Corporate Entity
Piercing the Corporate Veil
Fraud doctrine: if corporate entity was used to defraud/deceive someone, then PCV
(See Securities, 10b-5). Will also allow direct damages.
Undercapitalization theory: was there enough money when corporation began? Subjective
loans from S/H do not count
courts are more willing to come to aid of tort victim rather than contract creditor
In addition to the alter ego or instrumentality doctrine, second major way. Though in Walkovsky insurance met minimum statutory standard, sometime assets are
