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Business Associations/Corporations
University of South Carolina School of Law
Burkhard, James R.

USC BUSINESS CORPORATIONS JAMES B OCONNOR

INTRO TO CORP. AND BUSINESS LAW- IN GENERAL
Corporations – artificial legal entities created under state law. To form a corporation you have to follow state requirements: File an application for charter or articles of incorporation and fill the fee with secretary of state. This gives you a bundle of rights only and the corporation is only on paper.
Choose a tax election:
Subchapter S – the corporation itself is not taxed, the owners are (treated like partnership for tax purposes)
Subchapter C – The Corporation is taxed as its own entity the owners are not so limited liability.
Get organized: Get board, issue shares, make by-laws, find capital, officers appointed from board, and the board of directors as the governing body.

Shareholders elect the board and the board runs the corporation and they elect officers. Usually there are so many shares that they cannot directly take over, elect or change the board so they use agencies (proxy – proxy holder). They send out info as solicitation to choose a person as their proxy (this is where securities law comes in). Shareholders really can’t remove officers or board members – the cost to get all the shareholders to do so is impossible and very expensive.

Institutional investors – an institution that invests – retirement pensions for example – because if they sold all their stock it would be detrimental to the company they are invested in so they have a great deal of influence – they also include mutual funds, they are “super share holders”.

Securities act of 1933 – selling securities to get investors requires they give detailed info to potential buyers – must be publicly available and certified by CPA. There are criminal penalties for not disclosing or giving half-truths (this was done in response to stock market crash and was partly responsible for it since they would get investors by lying to them).
Securities act of 1934 – SEC regulated with this act – financial reports must be given each year with financial statement and reported to SEC. Limited fraud provisions, solicitation are watched – all proxies must be forthcoming and only tell the truth.

Sole proprietorships – just a business owned by one individual – not taxed separately, no hidden benefits / drawbacks, no limitation on liability (changes if they hire somebody or take on help)
If sole proprietor hires somebody that is agency law – that person is an agent with some duties and authority to make contract on behalf of proprietor. They are liable in contract and tort – in tort liability the employer is liable thru vicarious liability.
Agent – subject to control of principle – does not include sub-contractors or independent contractors – if there is a separate contract for a particular result its not an agent. The issue of control tells us if it is an agent or not. Agents are fiduciaries – loyalty, good conduct, and confidentiality apply. (Officers, directors, and shareholders are all fiduciaries too).

ISSUES – always consider the rules of professional responsibility when dealing with client
What kind of company? How will you be taxed? What kind of liability will you have?

Partnerships –
1) Limited partnership (rare)
2) Limited liability partnership (LLP)
Company –
1) Limited liability company (LLC)
Corporation –
1) Closely held
2) General (publicly held)
3) Statutory close

South Carolina Corporation Act of 1988
33-2-103 Incorporation
(a) Unless a delayed effective date is specified, the corporate existence begins when the articles of incorporation are filed.
(b) The secretary of state’s filing of the articles of incorporation is conclusive proof that the incorporators satisfied all conditions precedent to incorporation except in a proceeding by the state to cancel or revoke the incorporation or involuntary dissolve the corporation.
33-2-104 Liability for pre-incorporation transactions
All person purporting to act as or on behalf of a corporation, when there has been no incorporation under chapters 1-20 of this title, are jointly and severally liable for all liabilities created while so acting, provided that any person so acting while believing in good faith that the articles have been filed shall not have any liability under this section.

TAX
1) Pass through taxation – corporation does not pay – tax consequences are to shareholders
2) C-Corp – where the corporation will be taxed federally as its own entity

Things to consider when determining what to recommend to business clients:
Tax status, # of people involved, control and management responsibilities, liability, raising capital, in case of death or bankruptcy of owner, expenses and formalities to start and run, profit and loss divisions.

General partnership may be appropriate for A, B and Phillips – consider tax

Partnership – always pass thru taxation in ANY partnership (general or limited)
Limited liability company – they have option of pass thru taxation or taxing the entity
If corporation – subchapter S (treated like partnership) or Subchapter C (entity taxed)
– Subchapter S – limited liability with pass thru taxation (requirements of having limited shareholders and other limitations)
– Limited partnership – limited partners have no personal liability – partners cant have their own names attached

Corporation characteristics partnership characteristics
Limited liability – not liable if one leaves, partnership dies
Centralized management Pass thru taxation
Free transferring of ownership / shares shareholders run it (management)
Continuity – if you pass shares it keep on can’t sell partnership freely – need unanimous decision
Taxpaying entity

Limited Liability Company – has limited liability, but everything else is like a partnership – free transfer, centralized management, continuity of existence (even if one sells interest it keeps going)

Partners are jointly and severally liable
Corporations – none of the shareholders have personal liability

Capital is either debt (loan) or equity (an investment in the company)
If corporation then you buy stock – common or preferred

Venture capitalists – those who might buy the company later will invest greatly if Delaware corporation.

Profits – you can either pay compensation or give shares of interest

C-Corps Concerns
Double taxation if you pay yourself – compensation (salaries) are considered ordinary business expense so if they make $1M, they pay $750,000 to themselves then it is deductible, then the 250 left is taxable income – only taxed once – then they may pay out dividends, but it is not deductible / or business expense, it will be taxed as a corporation because it is not deductible then when dividends are paid the owners / shareholders get taxed again.

Control of business – is the structure – decision-making process i.e.
Management – is the relationship of those invested – who has a say in how business is run

Principles and Agents Prior to Incorporation
Cargill Case – gave loan to Warren and by taking control of the company indirectly he became the principal and therefore jointly and severally liable to creditors. It came down to the question of control.
Fiduciary relationship that results from manifestation of consent by one person that the other shall act on his behalf and will be subject to his control and consent by the other so to act. Must be agreement but not always contract. Agency may exist even if not called agency and did intend it legally.
May be proved by circumstantial evidence by course of dealing – the principle must be shown to have consented to the agency since you cant be an agent without consent. A principle will be jointly liable if acting as principle.
A creditor who assumes control of his debtors business may become liable as principle for the acts of debtor in connection with business. Must be show a person has an independent business before he is considered not an agent.

Principal – proprietor usually, person on whose behalf action is to be taken
Agent – person acting on behalf of principal

FORMS OF BUSINESS ORGANIZATIONS
11 types of businesses – Sole proprietorship, general partnership (publicly held), limited liability partnership, limited partnership, partnership association (rare), general corporation, closely held corporation, limited liability company, business trust, unincorporated association, professional corporation, joint stock company (rare)

Management – participatory or centralized

Limited liability – owners not personally liable for company’s obligation beyond amount of original investment
Partnership – the business doesn’t pay taxes

Tarnowski – Agent acting for corporation – All profits made by agent belong to principal whether fruit of performance or from a violation of duties – doesn’t require actual injury. The aim is fidelity by agent and law won’t permit him to be tempted by private interests and disregard those of his principal.
Wrongdoer must pay for all consequences of tort likely to ensure that he could have reasonably foreseen and anticipated. REST 407 – if agent receives benefit from voluntary duty the principal may recover what he has received, its value or proceeds and damage caused. REST 910 – person injured by tort gets damages from him for all harm past, present, and prospective legally caused by the tort.

Partnership – a firm operated by a few members having a close, personal relationship. Company’s rights and obligation accrue to its owners and not business itself – half will pass if dead partner unless stated otherwise – not subject to tax, business is.
– Created through expressed agreement or circumstantial evidence.
– Limited partner – receives profit, doesn’t manage – not liable for more than invested
– Partners must participate in profits and share as principals of business not as compensation

Joint venture – is different and is less than a partnership – business is organized to complete a specific project – one piece of real estate development for example.

TEST if partnership formed
1) Intent – parties must clearly manifest their intent to associate themselves as a partnership
2) Contribution – each party must contribute something that promotes enterprise
3) Control – each party must have right of mutual control over subject matter of enterprise
4) Profit sharing – parties must agree to share the profits of enterprise

Partnership expressed / implied agreement
4 elements
1) Community interest in venture
2) Agree to share profits
3) Agree to share losses
4) Mutual control or management over enterprise

Holmes V. Lerner (nail polish case)
Partnership – an association of two or more persons to carry on as co-owners on business for profit
Profit sharing – the receipt by person of a share of profits of a business is prima facie evidence of a partnership – but it is not a required element, will only prove it.
REST 6 –
(Section 6) – Association with intent to carry on a business for profit – parties who expressly agree to associate as co-owners with the intent to carry on a business for profit have established a partnership.
(Section 7) – existence of partnership falls on the intent of parties in the agreement, conduct and surrounding circumstances.
(Section 18) – Rights and duties of partners subject to any agreement are determined by following rules:
a) Each partner shall share equally in profits and surplus remaining after all liabilities, including those to partners are satisfied

Financing the business
Partners provide capital and lend money to the partnership
– Obligations to creditors are in the liability category
– Value of ownership interest is in equity section
– Borrowing money raises liability of all partners
Business may require additional capital contributions – usually the agreement will have provisions dealing with contribution – with the agreement for a partner to contribute additional capital cannot be forced and a new partner can’t be added or partner shares cant be altered without unanimous consent

Meinhard V. Salmon – partnership for 20 years then one renegotiated contract after 20 years was up.
One partner may not appropriate to his own benefit a renewal of a lease, though its term is to begin at the expiration of the partnership – equity refuses to confine within the bounds of classified transactions its precept of loyalty that is undivided and unselfish – by the position he occupies as partner is bound by his obligation to his co-partners in such dealing not to separate his interest from theirs, but if he acquires any benefit to communicate it to them – thrust is the device through which performance of self is made subordinate to loyalty of others.

Partner’s liability to third person for partnership obligations
General partnership – extent of liability is full liability of each partner is one personal capacity even in limited partnership must be at least one general partner with full personal liability.
General partners are jointly and severally liable for torts and breach of trust committed by a partner within scope of business – jointly liable for all other partnership obligations.

Marshalling of assets – creditors must proceed against assets of firm before individuals – one partner is indemnified by others (unless it was wrong committed by him) –
303 – partnership may file statement of authority to grant or limit the authority of an individual partner.

Limited liability partnerships (physicians, attorneys, and accountants)
LLP – it protect other partners from the others. Partners remain liable for their own wrongdoing or negligence, may choose to be taxed as partnership or corporation. Citizens of each state where each partner is a citizen.

Corporations
1) Publicly traded (on security exchange) – Public – organized under general corporate codes – raises capital from many investors with very little management
2) Privately / closely held corporation – Private / close – can be organized under corporate codes or close corporation statutes

Corporate form – advantages
1) Limited liability of shareholders – corporation is solely responsible for obligations (shareholders assets are not) and the corporate veil may be pierced if corporation is a sham to protect shareholders – partners enjoy limited liability, but shareholders do not
2) Centralized management structure – corporations have authority to vary the structure as owners wish – consis

nd reserve it, establish capital structure, prepare stock subscription agreements, establish registered agent and office, determine statutory requirements for incorporators, officers and directors, prepare articles of inc and by laws, file articles with secretary of state and other government authorities with fees, file trade name registration and fees, and prepare draft of minutes of organization meeting or action to be taken at meeting.

Articles include:
Name of corp., # of types of shares corp. is authorized to issue, name and address of office and agent for service of process, name and address of incorporators, corp. purpose, name and address of initial board of directors, optional provisions concerning management of business and regulation of company affairs.
Model act 2.01 – 2.03 – for steps preparing articles and filing

4.3.2 – Mandatory charter provisions
A) Corporate name – must contain incorporated, corp., company, or limited. Can’t imply name that is not its purpose or purpose not permitted by 3.01 – must be distinguishable from others (check with trademark and trade name.
B) Capitalization – info on shares of stock corp. issues – what class to authorize and right to be provided for each class, # of shares, does it have par value.
C) Registered office and registered agent – must be on file with name and address
D) Incorporators name and address, sign charter
E) Regulations of corp. business and affairs – provisions and charter
F) Director – number of each and names and addresses
G) Duration – may be perpetual

Purposes and power clause (of charter / by-laws):
Purpose clause – designates type of business company may conduct and may only say the stated purpose of the lawful business to be engaged in
Powers clause – types of acts a corporation could engage in to achieve purpose (not always required). I.E. power to sue and be sued, acquire and convey real property, enter in to contracts, lend and borrow money.

Situation 3 – we have recommended they form a corporation and we represent all 3 at this point – under entered into a lease with property under the name of the corporation (as a promoter K) although it is not yet formed, for one year. The rental manager learned of the non-existence of Biologistics Inc. – Anderson may be personally liable if corp. is not formed.

Promoters K –
Promoters remain personally liable under K because to be enforceable at least one party has to be liable. The promoter signs on behalf of the to-be corp. If promoter were not bound there would be no K.
At time of contract a promoter acts on behalf of a non-existent principle – he is liable until the Corp. adopts the contract formally or informally, but corp. must be formed first. After all parties expect that corp. formed will be responsible for K performance but corp. has option to accept or reject the K – ratification of the contract occurs formally thru resolution or informally thru doing some act that shows acceptance.

Name of corp. – must have included in the name Inc., Corp., Company, Limited – cant imply name is not its purpose, must be distinguishable form others (must check with trademarks and trade names).
Should register it for use in other states – perhaps as trademark too.
Must reserve the name “Biologistics, Inc.”
Registered office is where registered agent is – anybody can do this technically and is used primarily for service of process and notices from the secretary of state (failure to pay taxes or fees for example)

File Articles:
Shares of stock should be issued, capitalization, date of incorporation, optional provisions, name / address / signature of incorporators (they just cause it to be filed).
Incorporators may also be directors if not listed, or name directors in the by-laws.
Shareholders don’t yet exist yet – board of directors for us are A, B and P
(They talk about bring a 4th person but undecided)

CAPITALIZATION
33-6-101-103. 6-210, 6-220, 6-400
Def – cash or assets put into corp. on long-term basis consists of equity or debt.
· Equity – contributed by shareholder in return for stock (ownership interest). Claims are paid on liquidation after all superior claims are satisfied.
· Debt – cash / assets borrowed – person is a creditor.
Equity
Represented by some form of security – typically stock. Holders are owner in proportion to number of shares.
a) Common stock – includes right to vote, right to share in profits, right to assets if liquidated, may be 2 classes (one with voting rights one without). Whatever is left over after issued to board owners –
b) Preferred Stock – always has priority over common stock to receive assets if corp. is dissolved. Right to profits in form of dividend before common stock. They do not share in profits beyond agreed level (limited by year and how much). But they are paid their full amount before common stock – not right to cove and directors can force preferred stock holders to sell their stock (price and one year dividends – it looks more like debt. K in nature / articles establish rights and preferences.

Warrants and rights – are options to purchase shares at fixed price during some period of time.
a) Warrants – transferable long term options – no voting or dividend rights
b) Rights – short term warrants expiring in one year – is with a dividend and raises capital

Issuing Equity Securities
Par value – in charter is dollar amount specified to value of stock (not used in SC)
Stock cant be issued for less than par value – is shown on books as capital – with that capital no dividends can be paid – fees / taxes are based on par value. May have two classes of stock – with par value and without.
Par stock – §152, §153 – par stock = capital, no par stock = stated capital