Business Associations Hillman Fall 2014
I. Introduction
A. Principal Forms of Doing Business
Corporation – a fictitious being, independent of its owners that can conduct business in its own name
1) Publicly-Held Corporation
i. Wide disbursement of stock – in the thousands, usually no single stockholder that controls the corporation
ii. Managers not usually owners – owners are passing investors, easy exit. Sell stock on the market problems with accountability to owners
2) Close Corporation
i. Handful of owners (1-5): shares held by limited numbers of individuals
§ Stocks not traded on a market
§ Stock has restrictions on transferability
ii. Managers are owners
§ Creates problems of oppression, control
iii. Advantage: flexibility in close corporation statutes
3) Legal characteristics
i. Legal entity separate from owners
ii. Formed through formalities – files articles with a state officer (as opposed to partnerships, joint ventures)
iii. Shares reflect ownership / transferability: ownership interest is characterized by ownership of stock, alienable by “chunks”
iv. Centralized management: shareholders have no right to manage; rather, stockholder elect board of directors, which appoints Officers
§ Board of directors: responsible for overall management of corporation
§ Officers: responsible for day-to-day actions of corporation
§ Close corporation: majority control person elects officers
v. Perpetual existence: potentially unlimited life, even at death of owners or change of management.
vi. Limited liability: shareholders are not responsible for debts of corp. b/c corp is legal person, creditors cannot pursue personal assets of owners, shareholders’ risk is limited to amount in their investment.
§ Advantages: facilitates diversification, encourages investment, decrease need to monitor wealth of co-owners, permit optimal management decisions
§ Disadvantages: creditors will evaluate their risk according to liability type and might demand personal guarantees if you are limited liability
§ Rationale: since shareholders have no right to participate in management, they should not have unlimited liability for corporate obligations.
vii. No uniformity of Law: each state has its own corporate code, which can vary significantly from state to state. Model Business corp. Act adopted by trivial states – CA, NY, TX, DE have their own corp code
viii. Certain Shareholder relationships are mandatory (not contractual): corporate law sets the framework and shareholders cannot change the rules dictating governance of the corp.
§ Shareholders cannot negotiate to remove the board… governance dictated by corporate law.
§ Modern view – there’s some room for departure. In close corps, you can vote to get rid of the BoD; you can contract certain SH relationships.
ix. Double taxation – corporations are taxed on its income, the dividends given to shareholders are taxed then as well
§ Trigger: distribution of profits (dividends) by the corporation. If the corp doesn’t pay dividends but reinvests the money in itself, that income is taxed at the single corp tax rate.
§ Solution: pay money as a salary, gets noted as an expense and lowers the net income of the corp, which lowers the tax rate
· Only works for close corps where shareholders are also employed by the corp.
· Can’t pass the tax loss to the shareholders for them to offset taxable personal income, if the corporation can’t use the tax loss, no one can.
§ S-Corp – subchapter S of tax code – passthrough corps – certain close corporations can elect not to be taxed for certain purposes.
· Requirement
o No more than 35 SHs,
o One class of stock
o No-nonresident SH’s
o Not member of affiliated group of corporations
o No large corporations qualify
· Disadvantage – SHs claim a pro rata share of the corporations losses, which can’t be passed through the corp, losses are subtracted from the SHs income.
Partnership – association of 2 or more people as co-owners to carry on a business for profit
1) General Partnership – Legal characteristics
a. Not a legal entity (for most purposes): since it’s an association, the relationship is the focus
b. No limited liability: partners personally liable for claims, potential unlimited liability or joint and several liability
i. Overstatement of risk: this risk could be overstated in many cases since it’s customary for business to insure against their liabilities, can’t normally insure against K liability
ii. Joint and several liability – under UPA but not RUPA, partnership cannot be sued, only individual partners
1. Torts and breaches of trust – jointly and severally liable
2. Contract obligations – only jointly liable.
c. No statutory formalities to create: can have an accidental partnership found to exist by conduct
i. Intent to form not required, just need 2 or more persons who intend to associate for the purpose of carrying on a business for profit.
ii. FOUR ELEMENTS – evidence of a partnership
1. Agreement to share profits;
2. Agreement to share losses
3. Mutual right of control or management in the business
4. Community of interest in the venture
d. Ownership interest not transferable: rationale – joint and several liability
i. See dissolution of partnership
e. Limited life / Fragile continuity of existence – partnership does not survive a change in the membership of the partnership.
f. Relationship is contractual / law is permissive: partners are free to structure their relationship in contradiction to statutory norms. (contrast… corporate law is mandatory)
g. No centralization of management: partners are the agents of each other and of the business. Each partner has the right to bind other partners.
i. A large partnership will create an executive lawyer of partners through contract.
ii. Corporations are centrally managed by statute.
h. Substantial uniformity of law: UPA (1914) adopted by 49 states (not LA); RUPA (1990) adopted by most states with variations between Jx.
i. No double taxation: no separate entity to be taxed. All tax losses pass through to the individual partners, they can use the losses to offset personal taxable income
i. Disadvantage: income is automatically taxed regardless of whether the business distributes the money to the individual. Still taxed on profits reinvested into the partnership.
2) Limited Partnerships
a. Two classes of partners: must have at least one of each
i. General partner: manages the business, unlimited liability
ii. Limited partner: passive in the business, limited liability
1. Permissible activities: may be an officer or employee of limited partnership or the corporate general partner; may consult with general partner; may vote on removal of general partner
b. Advantages: tax benefits of a partnership + limited liability
c. Formal Creation: only by filing cert of limited partnership with secretary of state, no accidents.
d. Centralized management: limited partners provide money, general partners provide expertise
e. Corporate general partner: possible to have a corporation as the general partner, creates limited liability at each level. But creditors might want to assess the capitalization of the corporate general partner.
3) Limited Liability Partnership
a. Special ty
Most of its activity – means at least: ½ assets in state; ½ of SHs located in state.
2. Vantage Point v. Examen (DE 2005)– DE and CA law conflicted on necessary voting requirements for a certain issue (majority of each class v. majority of all classes). Delaware court held that the internal affairs doctrine supersedes CA 2115… only the law of the state of incorporation governs and determines issues relating to internal affairs. Cited 14th amd due process concerns.
3. NY has a similar provision
2) DE is the Jx of Choice
a. WHY?
i. Rich body of case law, developed legal infrastructure
ii. Superb specialized judiciary
iii. Public corps like the permissiveness and predictability of DE’s courts.
iv. Theory – race to the bottom
b. Who does the DE corp code pander to?
i. Management v. SHs: Management
1. Managers pick the place of incorporation.
2. Subtle bias – can’t be too manager driven, will drive down stock prices. Need to appear to represent the SHs too.
ii. Majority SHs v. minority SHs: Majority
1. Majority SHs make decisions, including picking directors.
2. But CA is more friendly to minority SHs
iii. SHs v. creditors: SHs
1. In liquidation scenarios, close cases regarding SH v. creditor claims to corporate assets, DE tends to side with SHs
3) Close corporations: will not necessarily incorporate where PPoB is; while there are few owners, the business itself can be very large economically.
a. Benefits of incorporating at PPoB
i. Cheaper to incorporate in-state
1. HILLMAN: this is dead wrong
a. Filing fees needed to incorporate in any state – not a deterrent towards incorporating anywhere
b. Local lawyer can incorporate in DE in minutes
ii. Tax purposes (franchise fee)
iii. Flexibility
b. Statutory close corporations: Special provisions in many state codes allow SH’s in close corporations to dispense with certain corporate formalities.
i. Fewer than 50 shareholders
ii. Elects to be a statutory close corporation in its articles.
4) LLC: file to form LLC in the same state as incorporation.
C. Incorporation process and design of capital structure
1) Process of Incorporation Overview
a. Steps
i. File articles of incorporation – (DE: certificate of incorporation) w/ Secretary of State
1. Person who files is the incorporator
2. Must include name of corp, number, and type of shares to be issued, address of registered office, name of registered agent at office, and each incorporator’s name/address
3. May include brief statement of purpose (required only by some states; if not stated, corp. may engage in “any lawful purpose”), names/addresses of initial board of directors, “par value” shares of stock, extent and conditions of personal liability of SHs for corporate debts.
