1. Organizing a Corporation (CC&G 1-17, 17-34, 796-824)
a. Types of Organizations
i. Sole Proprietorship
ii. Partnership (General or Limited)
iii. Joint Venture
iv. Corporation (C or S)
v. Professional Corporation
vi. LLP
vii. LLLP
viii. S-Corporations
1. Must be domestic
2. Have only one class of stock (but may have voting and non-voting stock)
3. May not have over 100 shareholders (may only be domestic individuals, estates, or certain trusts)
4. Operate on calendar year
5. May not have terminated an s-election within 5 years
ix. LLC (limited liability company)
1. Check the box regulation – yes, we’re an LLC!
2. Taxed as a partnership
3. Downsides: not yet certainty of law for LLCs; not as easy to raise capital as in a corp.; if you are publically traded, you are automatically a Corporation; no uniformity of law among states for LLCs; no pass-through taxation, but some states may add taxes
x. LAW FIRMS
1. Sole proprietorships- owner/attorney will be liable for all obligations incurred in connection with the practice, both those arising out of professional services and other obligations.
2. Partnerships-
a. General Partnership-common when two or more individuals come together to carry on a business for profit
i. Because of common law, no formal requirements
ii. No protection from liability
b. Limited Partnerships- Created by statute
i. General partners are fully liable for all obligations of the limited partnership and the acts of other general partners
ii. Limited partners are not liable for obligations of the partnership or the acts of general partners, but they may not participate in management of the partnership.
c. LLP-
i. A form of general partnership, but partners are not liable for the obligations of the partnership or the actions of copartners
d. LLLP-
i. A form of limited partnership, but general partners are not liable for obligations of the partnership or actions of copartners.
e. NOTE: there are no tax consequences to convert to an LLP or LLLP; can be created from day 1 or existing partnerships may convert later; provide very flexible capital structures
b. Factors Driving Decision As To Form
i. Tax Implications
1. Corp- not so good b/c both the Corporation AND the shareholders (who are taxed on dividends) are taxed- called “double taxation”
a. Way around this? S-corps use pass-through taxation and are taxed like partnerships (only at partner level)
2. Neat trick- to avoid taxes, make employees shareholders, pay them a salary. This is an expense, which is deducted BEFORE taxes. (avoids double taxation)
ii. Start-up and ongoing costs/ legal fees
1. Partnerships better here- no requirements to become a partnership
2. Corporations must file docs with the appropriate state office
a. Corporate existence begins with the filing of corporate docs. (unless you have delayed the effective date of those articles)(YOU MAY NEVER POST-DATE!)
iii. Limiting liability
1. Corps- shareholders have no liability for corporate obligations/actions
2. General Partnership- partners fully liable
3. Limited Partnership- limited partners not liable; general partners fully liable
4. LLP- some states give full liability protection, some only give partial protection
a. May still be liable for debts of corp, but not negligence or misconduct
5. LLLP- all partners have full liability protection
iv. Centralized vs. non-centralized
1. Corps required to have centralized management (Directors & Officers)
a. S-Corp may contract around this.
2. Partnerships can be centralized or non-centralized
v. Transferability of Interest
1. Corp- shares freely transferrable w/o restrictions
a. Closely held corps- transferrable, but may be some restrictions (also smaller mkt. for shares)
2. Partnership- interests not transferrable- if one partner leaves, partnership dissolves (this is the DEFAULT rule- you can contract around)
vi. # of Participants
1. S-Corps limited to 100 or less
2. Everything else can have as many as they like
vii. Continuity of Existence
1. Corporations last in perpetuity (good)
2. Partnership -agreements may stipulate the length of the partnership, but may be amended at end of term; States have default rules if agreement is silent as to term.
viii. Capital Flexibility
1. Corporations, because shares are fully transferrable, have a bit more capital flexibility.
ix. Convertibility
1. It’s easier to switch into the corporate form than out of it.
x. Certainty of Laws
1. Corporate law more certain than partnership law
2. Delaware. (everyone incorporates there b/c their law is well known and favorable to corps)
3. Default rules- don’t need to be negotiated b/c there’s an off-the-rack set of rules that can be used without having to state anything.
4. Internal Affairs Doctrine- your jurisdiction of incorporation gets to regulate your corporate internal affairs (common law doctrine)
2. Corporate Behavior and Goals (CC&G 34-53; RMBCA § 3.01-3.04)
a. Corporate form separates owners (shareholders) from managers (officers)
i. Shareholders delegated their authority to the Officers, creating a fiduciary duty owed by officers to shareholders
ii. CONFLICTING INTERESTS- these two groups often have opposing interests. (e.g., management’s salaries)
1. Solution? Granting stock options can help align shareholder and managerial interests
a. Stock option- an option to buy stock at a discounted rate below market price.
i. if an option is for a price below the market, the stock is “underwater”
b. Corporate Social Responsibility
i. Shareholder Primacy Model- The sole corporate objective is wealth maximization for shareholders. Maximize profits!!!
1. Dodge v. Ford Motor Co. (p. 34) illustrates a violation of this rule.
a. Ford was making so much that they reduced the cost of cars
b. They were not acting in the shareholders’ best interestsà Ford lost.
ii. Statutes- some say managers can take into account other ethical considerations (permissive but not mandatory)
iii. Nexus of Contracts theory- managers should think about everyone who comes into contact with the company when making decisions
1. Creditors; employees; contractors; suppliers; etc.
c. Effects of Insolvency on Corporate Constituency (not enough $$ to cover corporate debts)
i. Many states have laws dictating what corporations must do when they near insolvency
1. Managers’ duty shifts to creditors
2. Creditors paid first, preferred shareholders second, common shareholders last (if there’s anything left. Why? b/c shareholders have nothing to lose, they may be willing to take larger corporate risks which makes the company more profitable than creditors would
3. Forming the Corporation (233-241)
i. Delaware GCL- How Corporation Formed (§101) (S
i. No. ¶ never presented evidence of injustice or unfairness.
3. Factors for whether parent and subsidiary operate as a single economic entity:
a. 1) whether the corporation was adequately capitalized for the corporate undertaking;
b. 2) whether the corporation was solvent;
c. 3) whether dividends were paid, records kept, officers and directors functioned properly, and other formalities were observed;
d. 4) whether the dominant shareholder siphoned corporate funds; and
e. 5)whether the corporation functioned as a façade for the dominant shareholder
i. Other factors from Steven (p. 267) 1) parent owns all or most of subsidiary’s shares; 2) parent and subsidiary have common directors or officers; 3) parent finances subsidiary; 4) parent subscribes to all subsidiary’s shares or otherwise causes its incorporation; 5) parent pays subsidiary’s expenses; 6) parent uses subsidiary’s property as its own; 7) directors or executives of subsidiary do not act independently but take orders from parent in its interest; 8) subsidiary has substantially no business except with parent or no assets except those conveyed by parent; 9) in parent’s papers or in its officers’ statements, subsidiary is described as a department or division of parent, or its business or financial responsibility is referred to as the parent’s own.
4. Court said business practices were reasonable.
a. Plaintiff failed to present evidence of injustice or unfairness.
c. Statutes & Cases:
i. Defective Incorporation
1. Don Swann Sales Corp. v. Echols (p. 246)
2. Delaware GCL- Defective Organization as a Defense (§329)(p. 248)
3. RMBCA- Liability for Preincorporation Transactions (§2.04)(p. 248)
4. Sulphur Export Corp. v. Caribbean Clipper Lines, Inc. (p. 249)
5. Ohio GCL- Liability for Nonpayment of Stated Capital (p. 250)
ii. Disregarding the Corporate Entity (PIERCING THE VEIL)
1. Texas BCA- Liability of Shareholders (p. 261)
2. Bartle v. Home Owners Cooperative (p. 275)
3. Stone v. Eacho (p. 277)
a. Disregarded corporate form of subsidiary corp., consolidated with bankruptcy proceeding of parent corp.
b. The claims of a parent corporation against a subsidiary should be thus postponed where the subsidiary, as here, has in reality no separate existence, is not adequately capitalized, and constitutes a mere instrumentality of the parent corporation.
4. Deep Rock Doctrine
a. Involves bankruptcy and reorganization of corporations whose sole or controlling shareholder seeks to enforce claims against it as a general creditor
b. Instead of holding the shareholder liable for the bankrupt corporation’s debts, the doctrine permits subordination of the shareholder’s claims not only to claims by outside creditors, but also to claims of preferred shareholders of the bankrupt.
5. Pre-Formation Transaction by Promoters (CC&G 281-298; MBCA (1984) § 2.04)
i. Promoter- someone who helps set up a corporation prior to its formation (although generally the FIRST thing you do is form a corporation).
b. Promoter liability
i. Basics
1. GENERAL RULE: promoters are liable for obligations they undertake on behalf of the corporation prior to its existence.
2. Corporate Existence begins at the time of the filing of the corporate documents with the State.
3. What if a promoter wanted to contract on behalf of a corporation not yet formed?
