Corporation- Overview
Five Basic attributes of a Corporation
– Separation of SH and manager makes the corp a breeding ground for conflicting interests- and opportunism (agency costs…)
– In some contexts, Corporate law assumes legal intervention is too costly and leaves the risk with SH: Such as, the judicially created Business Judgment Rule that gives the directors broad discretion
i. Other times, corp law regulates conflicts; a majority of SHs must approve the Bd’s decision to merge the corp with another corporation
Choice of Organizational Form
– Sole Proprietorship
– General Partnership: Partners are individually liable for partnership obligations; prevalent in service industries where trust must exist among the participants and capital needs are not great
i. Life Span
1. Does not require legal documentation (UPA §6; RUPA §202a). Created when two+ persons associate to carry on a biz as co-owners to share profits and control
2. Profit-sharing arrangement creates presumption of a partnership even if parties do not intend it (UPA §7, RUPA §202c3)
3. Without a definite term, a GP dissolves upon the withdrawal of any partner (UPA §31, RUPA §801a)
4. Absent agreement, the withdrawing partner may demand that the biz be liquidated and the net proceeds be distributed to the partners in cash (UPA §38(1), RUPA §807)
5. A partnership that seeks the liability shield created by LLP must file a statement of qualification or registration with state officials and adopt a name that identifies its LLP status (RUPA §1001)
ii. Financial Rights- Claims on Income Streams and Firm Assets
1. Unless agreed otherwise, partners share equally in profits/losses (UPA §18a, RUPA §401a)
2. A partner may enforce the rights to profits in an action for accounting (UPA §22, RUPA §405b)
3. Partners have no rights to compensation for their services, unless provided by agreement (UPA §18f, RUPA §401h)
4. On dissolution, after discharging partnership obligations, profits and losses are divided among the partners (UPA §40, RUPA §807)
iii. Firm Governance- Authority to Bind and Control the firm
1. Each partner is an AGENT of ALL other partners and can bind the partnership, either by transacting biz as agreed by the partners (actual auth’y) or by appearing in the eyes of Third Parties to carry on partnership biz (apparent auth’y) (UPA §9, RUPA§301)
2. UNLESS otherwise agreed, a majority vote of the partners decides ordinary partnership mattes, but anything that is extraordinary or contravenes the agreement requires unanimity (UPA §18h, RUPA §401j).
3. Partners have fiduciary duties to EACH other to act in good faith with due care and undivided loyalty (RUPA §404)
4. Partners must inform co-partners of material information affecting the partnership and share in any benefits from transactions connected to the partnership. (UPA §20, 21, RUPA §404b)
5. Breaches of fiduciary duty are actionable in court (UPA §22, RUPA §405b)
iv. Withdrawal and Transferability of Ownership Interests
1. A partner cannot transfer her interest in the partnership unless all the remaining partners agree or the partnership agreement permits it (UPA §18g, RUPA §401i)
2. A partner may transfer his financial interests in profits and distributions, entitling the transferee (often a creditor of the partner) to a charging order (UPA §28, RUPA §502)
v. Liability to Outsiders
1. GPs have unlimited liability. Their personal assets are at risk for all partnership obligations, whether they are contractual or arise because of misconduct (torts) of the partners or partnership employees (UPA §15, RUPA §306).
2. Under some statutes liability on partnership contracts is joint, so that partnership assets must first be exhausted (UPA §15a, RUPA §306a)
3. LLP statutes, which graft special limitations on liability into the GP statutes, limit the liability of partners for partnership obligations – unless the partner engaged in personal misconduct or, under some statutes, supervised another partner or agent engaged in misconduct (RUPA §306c)
– Limited Partnership: combine tax advantages and limited liability; general partners run the business and are fully liable for partnership debts, limited partners provide capital and are liable only to the extent of their investment
i. Life Span
1. Arises when a certificate is filed with a state official (RULPA §201).
2. Lasts as long as the parties agree or, absent agreement, until a GP withdraws (RULPA §801).
ii. Financial Rights
1. Limited and GPs share profits, losses, and distributions according to their capital contributions, absent a contrary agreement (RULPA §§503, 504).
2. Pre-dissolution distributions are by agreement, as is compensation of the GP (RULPA §601).
iii. Firm Governance
1. GPs have auth’y to bind the partnerships as to ordinary matters (RULPA §403).
2. Limited partners have voting auth’y over specified matters, but cannot bind the partnership (RULPA §302)
3. GPs have fiduciary duties akin to those of partners in a GP
iv. Withdrawal and Transferability of Ownership Interests
1. A GP cannot transfer her interest in the partnership unless all the remaining partners agree or the partnership agreement permits it (RULPA §401i)
2. Limited partner interests are freely assignable (RULPA §702)
3. limited and general partners can assign their rights to profits and distributions (RULPA §703).
v. Liability to Outsiders
1. At least one partner must be a GP, with unlimited liability. Limited Partners are liable only to the extent of their investment so long as they do not “participate in control” of the business (RULPA §303)
2. Older statutes did not define “participation”, and courts construed the term broadly. Limited partners were said to participate in control if they shared in operational decisions, retained control of financial matters, and decide the GP’s tenure (see Holzmann)
3. Modern statutes clarify that some activities do not constitute participation in control. Limited partners do not lose their LL merely by being officers, directors, or SHs of a corp GP, voting on major biz matters, or advising the GP (RULPA §303).
4. LLP statutes limit the liability of the GP, creating an LP with the essential attributes of a manager-managed LLC
– Limited liability Company: hybrid entity btwn a corp and partnership. Members of the LLC provide capital and manage the biz according to their agreement; their interests are not freely transferable. Members are not personally liable for debts of the entity
i. Life Span
1. Arises with the filing of a certificate or articles of org with a state official (ULLCA §202)
2. man
Partnership’s income flows through to the partners even if retained in the biz, but it is taxed only once
ii. Corp: taxed when it earns income. The tax on the SH is deferred until the income is distributed or when they sell their shares after appreciation; double tax is unavoidable
c. Business loses money
i. Partnership: Losses flow through to the partners, who can deduct them against from other income (or “shelter” their income)(Limitations on an inactive partner’s losses, passive losses)
ii. How long does it last? Perpetual existence, regardless of what investors and directors come and go
iii. Who manages the investment? Locus of corp power is the Bd of directors (they often delegate power to officers to act and bind the corp)… In doing so the Board is subject to fiduciary duties… SH has very limited governance role (only voting power to elect directors, approve fundamental corp changes, and initiate limited reforms)
iv. What’s the return? SH are last in line, receive dividends if declared at discretion of board, and only have residual claims at dissolution
v. How can investors get out? SH’s interests are freely transferable
vi. What are investors’ responsibilities to others? Corporation is liable for its own obligations, but otherwise creates a “nonrecourse” structure
1. Exceptions of course; close corps, for instance; corporations are largely malleable set of default rules that specifies the terms of the parties’ relationship unless they agree otherwise… places a premium on lawyer’s role as a creative planner
– A Corporation is a convenient legal entity that can enter in contracts, own property and be a party in court; comes in different sizes (publicly held multinational conglomerate and one-person businesses)
– Corp’s existence arises from state-enabling statutes which give business participants significant freedom to choose their own customized relationships
i. Many gaps; filled by judicial norms
ii. Other gaps, such as those involving disclosure to investors, are filled by Fed Sec Laws
– Ultimately: Corporation is an investment vehicle for the pooling of money and labor- a grand capitalist tool
i. Money Capital: from SHs and Creditors, Human capital: from executives and employees
1. Both expect a return on their investment; corporations define their legal relationships and mediates the conflicting interests
ii. Corp: Corp can deduct ordinary biz losses only against income the biz generates. Sometimes, if there is insufficient income in a year, the losses can be carried forward or back to other tax years. SH can deduct losses only by selling their shares at a loss and deducting capital losses
