Business Organizations Book Outline
Chapter 1: Introduction
1.02 The Menagerie of Business Associations
A. Brief Overview of Unincorporated Business Forms
Traditional Business Structures
1. Sole Proprietorships
No legal organization required;
An association of two or more persons, to carry on as co-owners a business, for a profit.
They don’t have to do anything else (file paperwork, etc), but they must operate under the assumption that they are a partnership. Can simply be an understanding.
Owners have personal liability for all obligations, voluntary and involuntary.
More than an informal business;
Creates a liability shield as a matter of the default rule, and has other attributes that are governed by corporate statutes.
Downfalls: expensive; double taxation.
Non-Traditional Business Structures
4. Limited Partnerships
5. Limited Liability Partnerships
6. Limited Liability Companies
Through state legislatures creating new forms via statute, there are new unincorporated associations that offer the limited liability aspect of a corporation.
Limited Liability helps companies get investors.
B. The Functions of Business Association Statutes
Firms can contract around most statutory provisions, even in the traditional corporate form.
Statutes provide “standard forms” in order to economize on contracting costs; however, forms are not statutes.
If the firm is relatively small, the forms can benefit by saving drafting costs.
Problem with forms is they are “off the rack” and not tailored to each individual business need.
C. Linking Statutory Forms
Courts battle with whether statutory rules should be “linked”.
i.e. General and limited partnership cases can apply to limited liability companies and limited liability partnerships.
Linkage may defeat the purpose of having separate forms.
D. Choice of Business Form
Firms must decide whether default rules fit its particular circumstances, taking into account how each business form will be taxed and regulated.
E. Choice of Law and Uniformity
Choice of form is closely related to choice of law.
State variations in law matter, especially with limited liability companies and limited liability partnerships where there is the most variation.
In contrast to corporations, partnerships and unincorporated firms could not always choose the applicable law so easily.
Choice of law was not much of an issue for partnerships because for most of the century state law has united around the Uniform Partnership Act (1914) and the Uniform Limited Partnership Acts (1916, 1976, 1985)—these acts now have 1997 and 2001 versions.
Limited Liability Company, Limited Liability Partnerships, and most limited partnership statutes now include specific provisions recognizing “foreign” firms of the same type and applying laws under which those firms are organized. The revised version of the UPLA includes a choice-of-law provision.
F. Business Associates as Aggregates and Entities
Corporations have traditionally been regarded as a separate legal “entity” that has rights, powers and liabilities separate from the owners.
Corporations also continue after the withdrawal or death of an owner. Ownership of property, prosecution and defense litigation is in the name of the corporation and not the owners.
Partnerships are “aggregates” of the owners.
Partners in partnerships are personally liable for the debts of the firm.
1.03 Tax Considerations
Partnerships are taxed in a “flow through” manner. Meaning income and perhaps losses are taxable directly at member level rather than first at the level of the firm.
Corporations are taxed double—taxed at the entity level and when they distribute dividends.
1.04 Attorney’s Role
When advising clients, attorneys want to consider: choice of law, tax implications, transaction costs, and interests of the parties, default rules, agency costs, etc.
To establish a default rule, consider what the parties would have agreed to without a law in place.
Chameleon Agreement is a broad shell to begin with when drafting.
Chapter 2: The Search for the Incorporated Partnership
LLCs have been the on the rise for the past 20 years.
General Partnerships are well suited for closely held firms, but LLCs offer limited liability.
Partnership statutes provide by default rules for owner-managers would ordinarily want including: direct member participation in management, equal allocation of financial rights, restricted transferability of management rights, and the ability to leave the firm via dissolution or buyout.
Can be easily altered by the partnership agreement to suit different variations.
Before the rise of LLCs, people received general liability by contracting under state corporate laws. Corporate shareholders are only at risk for what they’ve invested in the firm and not otherwise liable for corporate activities.
The problems between choosing a corporation or a partnership have led to the rise of “incorporated partnerships”—business forms that combine partner-type governance rules with limited liability. However, the “incorporated partnerships” didn’t solve all the problems.
2.02 Corporate Governance and The Closely Held Firm
A. Corporate Default Rules
Corporate statues aren’t good for closely held firms.
Closely held means firms that combine (1) owners direct participation in management; (2) restricted transferability of management rights; and (3) a lack of a public market for the firm’s shares.
Equal participation in management decisions.
Partners can delegate power to managers, but it is not typically the power that a board of directors has.
Managed by or under the board of directors. This extends to day-to-day activities as well as the ability to declare dividends.
Shareholders select the directors and make the important decisions, i.e., amending the articles of incorporation, merger, sale of all or substantially all of the corporation’s assets and dissolution.
Shareholders lack both actual and apparent authority to create corporate liabilities.
Shareholders don’t participate in the day-to-day activities.
Board of directors hires officers (P, VP, T, S, etc)
previous years. Shareholders that incur capital losses when selling their shares may be able to deduct these losses against their capital gains.
When Corporate and Capital gains taxes are low and personal tax rates are high, firms can “shelter” income by letting it build up in the corporation, while owners can cash the returned earnings by selling shares.
Subchapter S corporations can get some benefits of partnerships. Income and losses in a subchapter s corporation “flow through” to share holders almost like a partnership. Subchapter S corporations can only be filed in a limited amount of circumstances.
Profits are earned for tax purposes directly by the partners. Taxed only once a year, to the partners, at the partners individual tax rate, and not again when they are distributed to the partners.
Partners may be able to deduct partnership losses against their non-partnership income, a.k.a. sheltering income. This is become less easy. Partners cannot deduct passive losses that they incur from firms that they do not manage.
2.04 The Evolution of Unincorporated Limited Liability Firms
Erosion of tax restrictions helped revolutionize the choice between corporations or partnerships for firms that wanted the benefits of limited liability, but didn’t necessarily fit under the corporate structure.
Whether a business is taxed as a corporation or a partnership is usually determined by thefollowing definitions in the Internal Revenue Code:
– includes associations or businesses that resemble corporations even if they have not actually been organized pursuant to state corporate law.
Thus, a firm can’t claim to be a partnership and operate as a corporation to avoid taxes, they will be taxed as a corporation regardless of their form.
For many years, treaties determined what was an association via the Kitner Rules.(United States v. Kitner, IRS concerned with stopping what it believed were essentially partnerships from attaining certain tax advantages of incorporation, including the ability to shelter income in corporate pension plans.). see below
residual category which includes most of what is not “corporate,” trust, or estate.
Kitner Regulations: judged corporate resemblance in terms of what the IRS believed to be the distinguishing characteristics between corporations and partnerships. To be considered a corporation for tax purposes, the company had to have at least three of the following characteristics:
(1) continuity of life,
(2) corporate-type management,
(3) limited liability,
(4) free transferability of interests.