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Business Associations/Corporations
University of Pennsylvania School of Law
Skeel, David A.

CORPORATIONS SKEEL FALL 2016
 
 
Overview: what form you choose as enterprise, attribute of corporation, limilited liability, pierce the veil, entity form (Hobby Lobby, Dodge Ford), Stock and debt (backed up in incentives), dividend, decision making in firms (the respective power of shareholders, directors – voting, meeting etc.) – not only Delaware voting rule, but also Federal proxy rule (voting rule is a field overlapped between Delaware and Federal), Fiduciary duty & Good faith (the heart of the class)- self dealing, controlling shareholders' case, corporate opportunities case, compensation case (there are variations of corporate oppoturnities like prohibit from competition with the company)
 
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FORM OF ENTERPRISE
Determination of a legal form depends on tax objectives, and on transaction costs
Partnership —-> LP (some limited liability) —–> get rid of all general liability—-> LLC/LLP
Corporation (limtied libiality + double taxation) —- get rid of tax —> LLC/S Corps
Forms evolves to get all the attributes
Sole proprietorship, Partnership are still in use (for simple, not need to file documents)
Limited partnership still in use (tax)
– Privately Held Enterprises – If an enterprise is not publicly held, choice of form is more complex;options include: close corporation, general partnership, limited liability partnership, limited partnership, or a limited liability company
– Publicly Held Enterprises –  If businesses whose ownership interests are to be held by members of the public, as opposed to owner-managers; corporation is traditionally the preferred choice of form for publicly held enterprises
Closed corporation: small amount of shareholders + managers etc. are the same person.
Publicly held corporation: stock is widely held (listed on national stock exchange, securities law applies).
**Form
sole proprietorship: one person with complete control. Simplest form
No documents to file with the states. Once you start the business, you are SP automatically (assuming there is no state restriction on type of business)
Flow-through taxation: income of the enterprise is treated as income of the owners, no tax at the enterprise, but tax at the personal leve.
You are personally liable for all debts of the enterprise
Does not have legal entity
 
General Partnership: more than one person, each called a general partner. Each partner will fully participate in the management of the partnership.
Format requirement (divide control, intending to make a profit and divide control among persons, you are automatically partnership, with or without a partnership agreement. e.g New Jersey case, employee and employer set a partnership but only the employer get the control, case law said this is not a partnership
In other word, You are partnerhsip in the eyes of the law even though you have not file any documemts. However for other entities, LP for example, are “non accidental entity”
GP is a creature of contract. You can vary responsibilities, management and profit percentages by contract (e.g one partner gets all the profits, one person get all the control) but not out of liability
Each partner is jointly and severally liable for the partnership's obligations. But you can contract around it to limit liability: (1) Indemnification agreement between partners, 2 partners agree to pay anything the 3rd partner liable for. (2) Insurance policy that the insurance company cover the liability (3) have customers/bank sign up liability waive
In practice, the bank will work in the opposite way: you are a limited partnership, or corporation but you need to give personal guarantee to the bank if you want a loan. [A way to force giving up limited liability] unless the company is big and clearly have assets.
Entity? Used to not be treated as an entity, but now the partnership is treated as an entity (has “entity status”), in that the partnership can sue and be sued by creditors of the partnership
Dissolved almost at will. One partner leaves the partnership is automatically dissolved, which doesn’t terminate the partnership, and there is still a winddown process when the partnership settles its debts. For example after dissolution, partnership's creditors will take before the partners' claim on capital. But it only makes sense when all the creditors are here and they have a claim right now.When the partnership and partners go bankruptcy?
Flow-through taxation: earnings at personal level, earnings of partnership are treated as individual earning of each of the partners
TREATEMENT OF PROPERTY — Tenancy in partnership
The partnership qua (as being) firm, rather than its individual partners, exercises true ownership rights over partnership assets that have priority over creditors of individual partners should the firm be liquidated. In other word, when the partnership falls, the property goes first to the creditors of the partnership, not the partners' creditors. A partnership holds the property, although the partners take personal liability
A partnership can be a trustworthy counterparty for its third party because:
You don't have to worry what's going on in the individual partner itself, you don't need to care how much the credibility of the partners. (reduce uncertainty and cost in transaction) —> one of the key innovation of corporate form in law, because it is impossible to do it by contracts.
Have similar effect as secured interest
Also very helpful to similar entity: (1) When a corporate buy a new business, is it better to set up as a separate corporate, or incorporate into our corporation? One of the advantage of keeping it separate is it simplified things for the creditor, so reduce cost (bargaining cost) (2) secured credit, you don't have to worry at all what the others are doing. You only have to worry about what your asset are
 
Limited Partnership: two kinds of partners: general partners and limited partners, typically among financial firms such as hedge funds, private equity firms and venture capital firms
General Partner treated like an ordinary partnership (full liable for obligation of the partnership)
In law, al limited partnerships have at least one general partner who incurs unl

LC, and main difference between is the restriction on share holders
Can S Corps become LLC? Delaware does not require a mergers to become LLC, but you can create LLC then merger S Corp into. LLC are unlikely be listed in national exchanged, even if they can. The practical reason is they will loss their tax benefits, so you might want to be S Corp—>because of tax
 
LLC Limited Liability Company: investors are called members, not shareholders. Traditionally there are two type: member-managed LLC, manager-managed LLC. But unlike LP, the members of LLC enjoy limited liability even when they exercise control over the business in much the same way that a general partner would
So you have all the merits of corporation (very similar to corporation):  pass through treatment and participation in control by members (without loss of limited liability)
Most modern smaller business and for some very large business with few owners end up being LLC, also popular in active investment companies, oil and gas ventures, real estate investment companies.
Articles of Organization/Operating Agreement is like the bylaws in corporation) to LLC.
Entirely contractual: Internal relatiosn among investors in LLC are governed as the LLC Agreement provides
Taxation of LLC: 1980-1997 pass through taxation unless it passes four-factor test: (1) limited liability for the owners of the business (2) centralized management (3) freely transferable ownership interests (4) continuity of life – the character of corporate, LLC have to fail at least 2 of the characters. Mostly by failing 3 and 4 since the LLC statute limits free transfer of interest. Statute did not make a limit lifetime, but the LLC itself is not perpetual (i.e.,: somebody die)
1997- “Check the box” regulation, abandon the game of define a de facto corporation and scrap the four factor test  —> allow all unincorporated business entities (GP, LP, LLCs, LLPs) to choose to taxed as partnerships or corporation
Exception: if your ownership are actively traded, then you get double taxation, even if you are not corporation. Same in LP, if the share of the partnership trade on open market, then apply double taxation
Except some special interest get permission like Real Estate LLC
LLC vs. S Corps: in the 90s, S Corps is popular for business like corporation because people are uncertain about how LLC will be treated. But LLC offers more tax advantage even compared to S Corps, such as ability to pass entity level debt through to members for income tax purposeetc.