Corporations Final Outline – Fall 2017
Introduction
Purpose of business = profit
Various business players – many different interested parties: owner/ operator (can be > 1), employees, directors, customers (output), suppliers (input), regulators (gov’t), public market, lenders
Integration – 2 business models:
Vertical integration: company expands by gaining control of their entire supply chain
All in house (ex: buy lemon groves vs. buy lemons from lemon supplier)
Pro: better cost and quality control
Con: loss of flexibility and resilience
Horizontal integration: company acquires or merges with other companies that do the same thing
Merge to create a bigger, more robust company
Pro: allows a company to expand into new territories without the high expense of building from scratch, because an existing, profitable business is usually less expensive than the total cost of starting a new business
Con: usually takes the form of a merger or acquisition, and these actions tend to be perceived as greedy or aggressive. As a result, the final company may suffer from a poor reputation and decreases in consumer goodwill
Original form of business was a Partnership
2 people operating a business – partner A and partner B:
Problem: If partner B died à partnership died. Had to distribute assets btwn A and B’s heirs – NOT convenient for a continuing business.
Problem: Liability! Unlimited personal liability for owners of a business. Ex: if partner A poisoned the lemonade partner B is liable too
Entity formation
Most important feature: Entity has a life apart from the owners!
Limited liability for owner of the entity for the obligations and debts of that entity
Issues to advise client on wen forming an entity. Business planning issues:
What is the deal? What did they agree to? (To decide how to structure)
Control issues (ownership sharing and profit sharing)
What assets and liabilities the new partnership is going to have
Transferability issues (if die, become disabled, etc.)
Where want to form (what state – some say DE is best, but more expensive)
What form – LLC, LLP, C-Corp, S-Corp, etc.
Timing (how long going to last)
Role of the corporate lawyer:
Transactional practice as opposed to a litigation practice
Works on deals, not cases: M&A, securities offerings, bank financings, routine Ks (supply, services, leases, etc.) business start-ups
Advises the client as to the best way to structure a deal, negotiates the legal terms of the deal, and negotiates the Ks, etc. to document the deal
Deals with matters prospectively, not retrospectively. It’s your job to worry about what can go wrong w/ an agreement. Client views you as insurance policy, so you have to be the risk-adverse party.
Ask clarifying questions that reveal what they were not aware of.
Counselor: advising the client on best day to structure deal
NOT giving business advice
Clients care about money, risk, and liability – corporate lawyer is the risk averse party (client can ignore, but must advise client of risks)
Figure out what is material to client – what rises to a level of importance that requires advising client
Figure out what business model is re: integration
Deal w/ relationship btwn owners and management
Facilitator: basically the project manager. Drafts and negotiates the Ks
Know what your bargaining position is (ex: if client wants to get into Walmart understand you have 0 leverage so don’t be too aggressive in your mark-up)
But have to be cautious about being driven ONLY by profit (ex: if have to have jeans made in sweat shops to get at price point for Walmart – good outcome from business side because of huge profit, but realize the social/ideological issues)
Conciliator of disputes – write letter to other side (and client control)
Guardian of the public: most controversial b/c of attorney client privilege. Supposed to be on guard to public BUT not supposed to divulge client information
Prefatory Matters
Chapter 1: Business Forms Overview
(1) Sole Proprietorship
Business owned by a single person who has not opted into (i.e. filed paperwork) a different form
Default form for a single owner business
No legal distinction btwn owner and business
All of the assets of the business are owned by the individual in the same way that the individual owns his or her non-business assets (house, car, boat, etc.)
One person operating a business
Governing Law:
Single owner w/ complete management authority
Management:
Sole proprietor entitled to make all business decisions
No formalities involved (meetings, votes, etc.)
Decision-making authority can be delegated to employees though
Liability Exposure:
Proprietor/owner is personally liable for all obligations of the business in same way and to same extent that sole proprietor is liable for personal obligations
Taxation:
Business income/losses reported on owner's personal federal income tax return
Indistinguishable from individual
Reported differently than wages but still reported on individual tax return
Usually by attaching Schedule C to his or her Form 1040
Business does not file a federal income tax return nor does it pay federal income tax
Legal Name:
Official legal name is the sole proprietor’s legal name (i.e., “Robert B. Smith”)
If operating under a different name, include “DBA” (doing business as): “Robert B. Smith, DBA AAA Plumbing”
Why use this form? Advantages:
Low risk of being sued
“Judgment proof” i.e. don’t have enough assets to want to protect them
(2) Partnership (General Partnership)
Business (for-profit) owned by 2 or more owners that has not opted into a different form
Default form for a multi-owner, for-profit business
Governing Law:
Governed by state's partnership statute (of state in which it is organized)
Each state has its own partnership statute based either on the Uniform Partnership Act (UPA) or revised UPA (RUPA) aka Uniform Partnership Act (1997)) w/ the exception of the Louisiana statute
Majority of states: repealed UPA-based partnership statutes and replaced with RUPA-based statutes (most not adopted verbatim, states are free to make changes or adopt ULC amendments)
If you don't choose it, it will be imposed on you – if you don’t indicate what state you are incorporated in, it will be imposed on you
Partnership owns the property, and you own an interest in the partnership. If you bought the car for the partnership, you own it. If the car is bought by partnership money, the partnership owns it.
Partnership Agreement:
Most partnerships have a written partnership agreement that overrides various default rules
Typically addresses management structure, allocation of profits and losses among the partners, partner taxation, admission and withdrawal of partners, and dissolution
Partnership statutes are composed largely of default rules that a partnership can alter or opt out of through appropriate langue in its partnership agmt
Partnership agmt allows the partners to tailor the rules to their specific needs and preference
Tailoring is undoubtedly necessary b/c it its highly unlikely that all of the default rules will correspond w/ what the partners want
Default rule under both UPA and RUPA: partners share profits equally (ex: 50/50 if 2 partners)
Does not have to be in writing, but going w/ an oral agreement is inadvisable
Most partnerships have a written partnership agreement that overrides various default rules
So first step for providing advice to a partnership on partnership law issues is usually a review of the partnership agmt not the statute (although statute still relevant b/c some rules partners cannot K around)
Management: (specified in partnership agreement)
Owners called “partners” and they own partnership interests
Common approach: partners select a managing partner generally vested w/ the authority to make all decisions
Note: Partnership agmt will typically require a partnership vote on matters outside of the ordinary course of business ex: admitting a new partner or selling the business
Default rule for partnership management (if partnership agmt is silent): each partner has equal rights in the management of the partnership business
Liability Exposure:
Each partner is PERSONALLY LIABLE for the obligations of the partnership – complete liability (big concern)
Joint and several liability: If you're 70% partner, you can be sued for 100% of liability
We look THROUGH the partnership for liability purposes.
Partnership Federal Income Taxation:
Most partnerships taxed under Subchapter K of the IRC (Sub-K) which is comprised of provisions specifically designed for the taxation of a business organized as a partnership
Partnership itself not required to pay federal income tax – allocates profits and losses to its partners pursuant to the partnership agreement
Income (loss) is allocated to the partners who include it on their personal income tax returns (usually by attaching Schedule E to his/her Form 1040) and pays any resulting tax liability (pursuant to the partnership agmt or the applicable partnership statute if there is no agmt or provision allocating income)
Called “pass-through” taxation b/c partnership’s income (loss) is PASSED THROUGH to the owners’ tax returns
This is a FAVORABLE attribute b/c partnership does not pay tax on profit, only partners.
IRS requires partnership to file an annual info return (Form 1065) specifying the partnership's income and deductions and each partner's allocation of profits/losses
Ex: $100k profit in bank, money is allocable to partners à on individual tax return, must report your portion
NOTE: Difference btwn allocation and distribution
Allocation: how the profits are allocated – what each partner has to pay taxes on
Problem from partner’s standpoint: $500 of addt'l income to report so each have to pay $200 to IRS but don’t have access to partnerships cash
Often provisions saying give me enough distributions to pay taxes on my allocation of partnership income
Default rule: 50/50 allocation & distribution BUT doesn't mean the money must be distributed at end of the year
NOTE: It is possible for a general partnership to opt out of Sub-K taxation and into Sub-C or S taxation
Partners’ Rights:
Default rules: Equal rights to management & equal rights to profit
Can contract around these terms though
If you own these partnership interests 50/50, you have right to allocation of profit and loss
Some partnership agreements say no distributions until both partners agree. You then pay tax on your allocable income but partnership hasn’t made any distributions
Most partnerships make sure you’re distributed enough money to pay taxes
Why Form Partnership?
Often inadvertent – just happens w/o thinking about it – no planning, or chosen w/o counsel – acting as partners
Or decide to do business together and say partners/partnership w/o looking at consequences
Don’t need to file – as soon as start acting like a partnership that is enough
rgeable to the partnership arising from negligence, wrongful acts, or misconduct committed while the partnership is registered as a LLP and in the course of the partnership business by another partner, or an employee, agent, or representative of the LLP.”
Partial shield: liability protection afforded to partners extends only to malpractice liabilities, leaving the partners exposed to contractual claims against the partnership
As contract creditor, prefer this b/c it could be read as an exhaustive list not including Ks so presumably, you could still sue
Provision B: “An obligation of a partnership incurred while the partnership is a LLP, whether arising in K, tort, or otherwise, is solely the obligation of the partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner”
Full shield: liability protection afforded to partners extends to all claims against the partnership, whether based on malpractice, breach of contract, or general tort liability
As a partner, you prefer this – doesn’t matter how it arises or what the cause of the obligation is, the partner is not liable
As a tort creditor, you’d prefer neither. But if had to choose, you’d pick A
(4) Limited Partnership (LP)
Partnership w/ 1 or more “general partners” AND 1 or more “limited partners” that has filed a “certificate of limited partnership” with state's SOS office
General partners have management rights but NO liability shield (unlimited liability – i.e. personally liable for the debts and obligations of the LP)
Limited partners have NO management rights but DO get a liability shield (i.e. generally not liable for the debts or obligations of the limited partnership)
Limited partners can feel confident that they won’t be sued, but get no management rights
As management rights increase, liability increases
Structure: general partners & limited partners à LP
Limited partners: purely passive parties that give cash
Kick in $. Give up management rights. Limited liability.
vs. General partners: the managers
Complete control. Unlimited liability.
BUT can protect themselves from liability by forming a separate entity for the GPs – like an LLC – have the individual GPs above that form
Individual GPs put some $ into a LLC à now all of the individual GPs other assets are protected – creditors can only get to the LLC not individual GPs anymore
OR could separate assets under different entities (don’t place them into one entity) – want to segregate assets/operations to insulate GPs and the business from liability. That way, if one entity goes bankrupt, that’s fine but you can’t get to entity B or C, nor to the general partner
Governing Law:
Governed by state’s limited partnership statute (of the state in which it is organized)
Each state has own LP statute based on some version of Uniform Limited Partnership Act (except Louisiana)
Limited Partnership Agreement:
Written agreement signed by each partner that addresses the rights and obligations of the limited partners
Composed largely of default rules
Compensation, allocation, and distribution all fleshed out in partnership agreement
Management:
Managed by general partners. Limited partners having no rights to participate in control of business
Liability Exposure:
General partners personally liable for debts and obligations of the LP, while limited partners are not
Taxation:
Same as general partnerships
Sub-K of the IRC à general partnership not required to pay federal income tax; allocates profits and losses to its partners pursuant to the partnership agreement
Most partnerships are taxed under Sub-K: partnership itself doesn’t pay federal income tax
Income (loss) allocated to partners who then include it on their personal income tax returns
“Pass-through” taxation: partnership’s income (loss) passed through to owners’ tax returns
Why form an LP?
Often used for real estate investment firms or investment funds/private equity funds
No good reason to use over LLCs
LPs are largely superseded by LLCs
Form an LP then LPs give money and sign limited partnership agmt to get x% for kicking in $ which goes into bank the acct of LP. Then GPs are subject to all creditors of the LP
Risk: if LPs take too much control of biz
Separate those w/ the most information and control from those with the money
