Business Organizations Outline
Prof Wade – Spring 2013
Introduction
I. Types of Business Organizations
A. Sole proprietorship: one person owns the business, one person manages the business, and one person conducts the business
1.BLD: A business in which one person owns all the assets, owes all the liabilities, and operates his/her personal capacity
2.Sole proprietorship can be incorporated.
B. General partnership: 2 or more people plan to share profit/losses and share ownership/control. DO not need to file anything to get general partnership.
1.BLD: A partnership in which all partners participate fully in running the business and share equally in profits & losses (though the partners’ monetary contributions may vary)
C. Limited partnership (LP): Need to file form with Secretary of State stating that you intend to form LP.
1.BLD: A partnership composed on one or more persons who control the business and are personally liable for the partnership’s debts (called general partners), and one or more persons who contribute capital and share profits but who cannot manage the business and are liable only for the amt of their contribution (called limited partners).
a. General partner can be corp or real person
2.Characteristics:
a. Investors have limited liability. Limited partner will not lose his/her personal assets but, instead, will lose the person’s investment into corp.
b. Need at least 1 general partner, who agrees to incur personal liability.
D. Limited Liability Partnership (LLP): Need to file a form with Secretary of State stating that u intend to form LLP. (LLP is growing form of bus org)
1.Difference b/w LLP & LP: NO general partner is need for LLP, but is required for LP. Partners in LLP are limited partners
2.Advantage that LP has over LLP: More established law dealing with LP, so u know the roles and responsibilities of LP more clearly than with LLP.
E. Corporations: are artificial creations that are formed to make money for the people who own the corp. Corporations form to avoid liability
1.BLD of corporation: An entity (usually a business) having authority under law to act as a single person distinct from the shareholders who own it and having rights to issue stock and exist indefinitely
2.Corporation is a separate person (stemmed from 14th A DPC)
a. People apply for a charter to get corp & that corp acts legally as a person. When corp goes for charter, it is state that gives corp power; thus, people of US are ones giving corps power they hold. After filing, corp will get certificate of incorporation. Then, 1st organizational meeting will be held & Bd of Directors will appoint officers & draft constitution establishing internal relationships with Bd of Directors & shareholders & internal relationship with Bd of Directors & officers, & other rules, such as how many bd of directors, how often will bd of directors meet, etc.
b. Corps can borrow $, can sue in ct, can enter Ks, own prop b/c corp is a separate person.
c. Corp is special person b/c corp is ONLY designed to make profits for shareholders.
3.4 characteristics of corporations (Corps MUST have ALL 4 characteristics to be corp)
a. Limited liability: Shareholders have limited liability, which means that shareholders are ONLY liable to extent that he/she invested w/in corp. Shareholders are NOT held personally liable in breach of K or tort cases.
b. Free transferability of shares: shares are freely transferable; this means there is a market for transferring of the shares.
i. 2 situations where corporate shares are NOT completely transferable:
1.If there is a small closely held corp, there would be no market for these shares AND
2.If P holds shares that are not profitable, but could have been profitable if corp was run better. (remember: Board of Directors manages corp-> centralization of management).
c. Continuity of existence: NO matter what happens, corp will continue to exist until it is orally dissolved and state corp law provides for process of dissolution.
i. Thus, even if there is a small corp with one person and that one person dies, the corp will continue to exist because the corporation, itself, is an individual person. Death of owners/shareholders does NOT terminate entity, since shares can be transferred.
d. Idea of centralized management: NOT everybody gets to manage corp & management of corp is centralized. Management is centralized with officers & directors. Each is charged by law with specific duties to corp & its shareholders
4.Doc of birth for corp: article of incorporation
5.Once corp is born, doc called bylaws is drafted which governing rights of parties
6.People who invest in corp=shareholders
7.Interest investors purchase in corp=stock
F. Limited Liability Company (LLC): new bus org that is a limited company (most comparable to corp)
1.LLC investor=member. Members have limited liability (liable only to the extent of percentage of interest in company)
2.LLC provides limited partners with limited liability & 1 person is elected as general partner, who will incur personal liability.
a. Note: General partner can either be real person or corp
3.LLC may have 2 characteristics of corporation BUT NO more than 2 of these characteristics. This, LLC can have:
a. Limited liability only
b. Limited liability + free transferability of shares
c. Limited liability + continuity of existence
d. Limited liability + idea of centralized management
4.Doc of birth for LLC: article of organization
5.Once LLC is born, doc called operating agreement is drafted which governing rights of parties.
6.People who invest in LLCs= members
7.Interest investors purchase in LLC=LLC interest
8.Types of LLC
a. Manager managed LLC: have bd of managers who does management. Management is centralized as does corp. Most analogous to corps.
b. Member managed LLC: Most analogous to general partnership. Each member can participate in management.
II. DEFINITIONS AND TERMS:
a. Public sector: government
b. Private sector: companies
9.Private sector within private sector=public corporation
a. Public corporation is a type of corporation where the shares are sold amongst the public and has public shareholders. Public corps are part of the private sectors.
a. Insiders: work for corp & serve as directors
10. Inside directors: serve on bd and work for bd as officers
b. Outsiders are bd members but do NOT work for co
11. Outside directors: ONLY serve on bd and do NOT work for corp (NOT officers). NOT all outside directors are independent. Might have outside director that does bus with corp or serves as consultant. If there is some relationship b/w corp and outside director, then not independent
c. Independent: No relationship with co
d. Interested: Interested is more narrow than independent. Asks: Does this person have financial interest in the transaction
12. Self interest: direct financial interest or control
e. Leverage buyout: a purchase of co financed by relatively small amt of equity (common stock) & large amt of debt, which provides leverage. Often, assets of co are sold to pay off part of debt.
f. Market value of co: price of each share of stock
g. Stock: equity in co. Stockholder is ONLY paid when co makes profit. Interest depends on future of co.
13. Different classes of stock: Class A stock will have certain rights that favor Class A stock over Class B stock.
h. Notes & bonds: promises to the corp where they agree to give specific amt of money at specific date. Bond diametrically opposes the idea of equity & stock. Notes & bonds are a kind of debt.
i. Preferred Stock: hybrid of equity & debt. Once co is dissolved & upon that liquidation, debt holders are paid first, then preferred stockholder, and lastly, common stockholders are paid. Preferred stockholders are still NOT debt holders. Stockholder w/ preferred stock is preferred over common shareholder/stockholder, but NOT as preferred as debt holders.
14. Ex: preferred stockholders in Benihana case
15. Preferred stockholders do NOT usually have voting rights unless something happened, such as they have not been paid dividends from time after time. Sometimes, terms will allow preferred to gain voting rights.
16. Preferred shareholders receive income in form of dividends.
j. Common stockholder: shareholders typically with the voting rights. Common stockholders are the last ones to receive assets/funds from liquidation.
k. Conversion: Idea that one security can be exchanged fo
. RULE: Corp may consider all those affected, including non-shareholder groups, but must ultimately serve needs of shareholders (most maximize shareholders’ profits).
IV. LLCs and Corporations
1. Limited Liability Companies
Formed under state statute
“Members” have the right to participate in management
Members enjoy limited liability (members are not personally liable for debts of the LLC; they are only liable to the extent of their investment in the LLC)
2. Difference between LLCs and Corporations
IRS ruled that business entities that have more than two of the following 4 corporate attributes will be subject to corporate taxation:
i. Limited liability;
ii. Free transferability of interests;
iii. Continuity of life;
iv. Centralized management
Role and Purposes of Corporations
I. What is the role and purposes of corporations?
The role and purposes of corporations is profit maximization.
1. Charitable Donations:
a. A.P. Smith v. Barlow
Facts: Shareholders challenged a charitable donation of $1,500 made by the corporation to Princeton University. Corporation brought suit for declaratory judgment that the donation was permissible under law. Shareholders claimed that the donation did not fulfill the corporate purpose of short-term profit maximization. Managers claimed that the donation would be good for the corporation’s long-term profitability, and that managers can engage in conduct for the corporation’s long-term profitability
Holding: The court held for the corporation, inasmuch as charitable donations were good and allowable under NJ statute, which applied retroactively.
Rule: Corporations have the power to make charitable donations so long as such donations are (1) not to a pet charity of the CEO’s, board members’, etc., (2) reasonable in amount, and (3) beneficial to the corporation, even if indirect or tenuous (i.e., serves the purpose of profit maximization, or maximizes the profitability of the corporation for the shareholders).
Rationale: Charitable donations are good for neighborhood, good for world, and therefore good for corporation’s profitability. Corporations should behave as good citizens by giving charitable donations. Corporations hold most of the wealth so individuals won’t make charitable donations. Corporations have power to make donations, but their purpose is to make profit. Thus, they should use their power to accomplish the purpose of profit maximization.
Counterargument against charitable donations: CEOs are donating other people’s money! Usually give to elitist charities like Princeton.
b. Cali/NY statutes:
Corporations have a right to make charitable donations regardless of benefit to corporation
c. Delaware statute:
Corporations have a right to make charitable donations provided the corporation reaps some benefit, whether direct or indirect/tenuous
d. Pennsylvania statute:
Not limited to charitable donations; mentions stakeholders explicitly affected by corporate activity
Deal with not just charitable donations, but any activity of board of directors vis-à-vis impact on shareholders and stakeholders
Shareholders need not go before all others in PA; corporations may consider interests of others first [communitarian view]
