Corporations Outline
BASICS OF CORPORATIONS
- Closely held v. publicly held
- Closely held – 5 or fewer owners (overlap w/ control), no active mkt for shares
- Forming a Business Entity – Reasons:
- Liability for protection of owners.
- Set forth an understanding of management/rules.
- Establish change of control/exit/succession procedures
- Taxes & Investment/Raise Money – easier to do with an established model
- Ownership and profit issues
- Taxes – important in determining which business form to choose
- Basics
- Marginal rate (each add’l $ above threshold) v. average rate
- Capital Gains/Losses
- Long term, taxed at 15% v. short (up to 1 year), taxed at norm rate
- Long term and short term netted separately
- Losses may be carried to offset gains in future years
- Proprietorship – not a separate taxable entity from owner (Schedule C)
- Unincorp Business Entity – at least 2 owners/partnership – Subchapter K – pass through taxes to owners
- C-Corp – double taxed (if distribution made, shareholders taxed)
- S-Corp – created to deal with issue of double taxation. Req’s:
- Less than 100 shareholders
- No non-resident or non-individual shareholders
- Only 1 class of stock
- Internal Affairs Rule – foreign courts apply law of state of incorporation
GENERAL PARTNERSHIP
- Governed largely by state statute: Uniform Partnership Act; 1997 Revised UPA – adopted by 36states, DC, VI, and PR
- Formation
- Established by default where “2 or more ppl carry on as co-owners of a business for profit” – prima facie case if share profits.
- UPA and RUPA provide rules for assisting in determ of if established.
- Estab. whether there was intent or not.
- Creditors can give some business advice – if too involved, can be seen as partners
- Partnership Agreement
- RUPA – agreement may be written, oral, or implied – doesn’t have to be in writing
- If not in writing won’t reflect all expectations/understandings of partners.
- Only reason to have in writing is for statute of frauds issues (Gano v. Jamail)
- No analogous UPA provision.
- Default rules (of state statute) apply unless altered by agreement btwn partners.
- Profits – partners share equally in profits
- Management – each partner has equal right to participate in mngmnt.
- Unlimited personal liability.
- Liable for act depending on when you entered P-S in relation to when liability-creating event occurred – later/earlier partners not subj. to liability
- NOW – generally have an exhaustion requirement for partnership’s assets before going after partners personally; prev. did not have exhaustion req.
- Flow through taxation to partners – partnership preps statement for filing to inform of profits.
- Joint Venture – specific venture/specific undertaking – NOT general operation.
- Generally limited time and limited purpose
- Each must have equitable interest in profits; joint sharing of losses commonly regarded as essential
- Treated as “general partnership w/ limited purpose” – thus partnership laws generally govern
- Kessler v. Antinora (NJ 1995) – partnership profits
- K to provide funds to build house; A to build it – profit split, but silent on losses; house sold for a loss.
- Issue – what sort of entity is formed? Should A have to cover K’s losses?
- Holding – partnership (by default); Not required to cover losses – Cali Rule.
- General Rule – repay capital contribution first; if there is a loss, it should be split along lines that the profits were to be split (unless agreement specifies otherwise).
- If both parties put in capital, repayment is split into that proportion before reverting to the profit/loss rule.
- Might require one partner to pay cash to the other to reach that split
- CALIFORNIA EXCEPTION (Kovacic v. Reed) – if one party contributes only labor (and is not compensated for it), he does not have to compensate the capital partner.
- The labor investment is valued equally to the capital investment.
- Thus, labor investment is losing 100% of its value, while investing partner only losing a small percentage.
- If labor partner is compensated, default rule kicks in.
- Indemnification & Contribution
- INDEMNIFICATION – UPA S.18(b) & RUPA S.401(c) – partnership must indemnify partner for payments made and liab incurred in ordinary course of partnership’s business (unless altered by agreement)
- Obligation of the partnership
- CONTRIBUTION – if insuffic funds to pay obligations on dissolution, partners must make up the short fall.
- Creditor may go after indiv partners, but only liable up to their share (RUPA 307(d)
- AGENCY RELATIONSHIP
- Definition
- “Fiduc relationship which results by manifestation of consent by principal to agent to act on principal’s behalf and subject to his control; and agent consents to act”
- Manifestation by principal
- Agent’s acceptance of undertaking
- Understanding that principal is to be in control of relationship
- As long as legal def. met, agency is present even if parties did not intend one.
- Relationship is not limited to natural persons (partners to partnership)
- If not within scope of the business, there is no authority.
- Principal is liable to a 3d party when agent acts w/: actual, apparent, inherent auth.
- May also arise through estoppel or ratification.
- Cannot remove authority after the fact and invalidate liability to 3d party
- Except, if didn’t have authority, can quickly say “no” to avoid liab – needs to be before there is detrimental reliance.
- Actual Authority
- Stems from communication btwn principal and agent – is it reasonable for agent to believe he has authority to act?
- Can be revoked beforehand
- If after the fact – ratification/estoppel
- May be express or implied (from prior acts)
- If principals words/conduct would leave reasonable person in agent’s position to believe agent has authority to act, agent DOES have actual authority (hypo – principal left note on wrong desk to do act)
- Incidental Authority – authority for agent to engage in acts necessary to accomplish an authorized transaction.
- UPA S.9 – Partner Agent of Partnership as to Partnership Business
- Carrying on in usual way of P-S binds P-S, unless acting partner has no such authority AND 3d party knows he has no such authority
- If not w/in usual scope of business, BUT is within apparent course of business of other firms in same business, than still falls under S.9
- If not in usual business, doesn’t bind partnership unless authorized.
- Certain acts require no authority less than all partners – (see list)
- National Biscuit Co. v. Stroud (1959)
- S advised N it would not be responsible for more bread; F bought more
- Issue – Can acts of 1 partner bind partnership as a whole?
- Holding – YES, each partner has actual authority for the partnership
- Each GP has equal mngmnt authority, within scope of the partnership
- Other partner cannot restrict such authority by notifying 3d party
- To revoke, must dissolve partnership
- Holds unless partnership agreement states otherwise – RUPA S.303 (if agreement publicly filed) – no similar UPA provision.
- Outcome would be different if F had been
- Agent (rather than partner) – can revoke actual authority
- F might still have apparent auth, unless S notified Nabisco
- Apparent Authority
- Arises from manifestation of PRINCIPAL to 3d PARTY – if Principal’s words/conduct would lead a reasonable person in 3d party’s position to believe agent has such authority (cannot be created by agent)
- May be created through agent’s position/title – if not clearly estab, what is industry standard for such position/title.
- To dispel, principal must note that not authority exists to the 3d party
- Estoppel
- No affirmative representation made, but principal contributed to 3d party’s belief OR failed to dispel it.
- 3d party must have undergone a detrimental change in position.
- Fiduciary Duties
- UPA S.21 – Partner Accountable as a Fiduciary
- Every partner must account to P-S for any benefit
- Applies to all representatives of a deceased partner as well.
- Meinhard v. Salmon (NY 1928)
- Lease btwn G & S, S enters separate agreement with M – S to operate, M to pay ½ costs. Near end of lease, reversion enters into extended lease; S did not tell M.
- Issue – Does S have a duty to include M in the new lease?
- Holding – YES, related to their nexus of opportunity
- Those acting as partnership have undivided loyalty to one another
- New lease was incident of the enterprise, which S appropriated in secret, excluding M from chance to compete from opportunity arising from participation in partnership
- Should receive half of lease, with ~1share adjustment to account for S’ mngmnt interest
- JV/General Partnership distinction doesn’t seem to matter
- If G had approached capital partner instead, maybe a diff outcome – S has greater duty b/c of mngmnt role.
- Dissociation and Dissolution
- 3 stages: formal dissolution; winding down; termination
- Fiduc duties still exist - might even be heightened to avoid looting.
- Also continue to be personally liable during this period (unless altered by agrmnt)
- Except if P-S continues after dissolution, leaving partner not liab for future acts.
- Terminates actual authority (except that needed to wind down) – problem is apparent authority (key is to send notice to 3d parties)
- UPA S.29 – Dissolution
- Def – change in relation of the partners caused by any partner ceasing to be assoc in carrying on of the business (refers to personal rel. of the partners)
- Terminology
- At will – agreement has no specified definite term or undertaking (default)
- Term Partnership – implicit/explicit agreement by all partners that P-S shall have definite term for a particular undertaking.
- Statement that goal of partnership is to recoup investment not suffic to constitute a “term”
- Rightful Dissolution – w/o violation of the agreement
- Wronful – in contravention of terms of agreement
- Dissolving partner must pay damages, for breach of contract.
- Formal Dissolution – Step 1
- Req’s a formal event.
- P-S to end on set date
- Partner walks away
- Death/Bankruptcy
- Court Order – Key reasons:
- Breach of agreement/partner conducts self unreasonably
- P-S can only carry on at a loss
- Indiv partner capable of performing function
- Lunatic
- Partnership can continue after dissolution event
- Have to give accounting to leaving partner – either then or later
- If later, accounting = amount of share (valued at time of dissolution) + (interest on capital OR returns gained from capital)
- Partners choice – encourage P-S to make accounting when leaving
- Equitable Rule – allows reasonable efforts to make acct’g – can’t find partner, so put money into escrow/trust
- Generally not made when leaving, b/c ppl for get or it isn’t much at the time (eg: FaceBook)
- Winding Down – Step 2
- Close any transactions; distrib assets:
- Creditors, partners (non capital contrib), capital contrib, profits
- Partners personally responsible for contribution to satisfy liabilities
- Selling assets can be piecemeal or as a going concern
- Authority/Agency still exists in a limited way.
- Termination – Step 3
- Collins v. Lewis (Texas 1955)
- C puts up money, L operates cafeteria – goes way over cost
- Issue – May court dissolve partnership?
- Holding – NO, L hasn’t done anything wrong; but C may walk away
- Partners have inherent power of dissolution, but not the right
- Court will not assist in braking of partnership where partner not fully or fairly performed agreement – courts as a policy don’t like breaking up P-S
- C did not perform when he stopped his payments to L (no finance cap in agreement)
- L could perform his role (mngmnt) but for C’s stopping payment.
- L not dissolving b/c no incentive
- He has a set cash flow
- Cali Rule won’t apply b/c receiving compensation for his labor, so would have to repay losses.
- C could potentially bring suit later, arguing P-S not possible to carry on for any profit – but that might have to be awhile to avoid appearing as if trying to scuttle the P-S
- Case heard under Texas Law, but outcome largely the same under UPA
OTHER BUISINESS FORMS
- Change to a diff structure does not affect liab for acts while done under prev. structure
- Some states may say that after certain time, that is no longer the case.
- Main Partnership/Corporation trade-off is taxes v. liability.
- LP
- State statutes generally explicitly link to general partnership law.
- Formation – req’s filing with the state
- Real details of rights/duties/operation is in the partnership agreement (non-public)
- Can withdraw w/o notice, triggering dissolution.
- Statute does not explicitly grant/deny mngmnt rights to LP, but cases hold that LP may not participate in mngmnt – agreements also tend to deny mngmnt rights.
- LP participates in control, loses LP status: “control rule liability”
- Generally no voting rights, except for major transactions
- LLP
- General partnership law applicable, when not explicitly altered
- All partners have right to participate in mngmnt w/o risking loss of limited liability – provides “peace of mind” insurance for innocent partners
- Supervisory liability – only liability for acts you engage in and wrongful acts of ppl you supervise.
- Formation – must fall w/in general def. of partnership, and meet certain formalities (such as filing with the state and carrying specified insurance funds)
- LLLP
- Allows for an LP to register as an LLLP.
- The Control Rule – lmt’d partner has no liability for debts of venture beyond initial investment, but can lose that protection if they participate in mngmnt.
- Signif litigation on how much activity is necessary
- Each progression of LP statute, control rule has become more protective of LP – last version eliminated control rule
- Gateway Potato Sales v. GB Investment Co (AZ 1991)
- S (GP) told Gateway that GBI (LP) providing the financing and was actively involved in the management – GBI never confirmed, and took it at face value
- Issue – Is GBI liable as a general partner, even though Gateway did not directly know of GBI’s mngmnt acts?
- Holding – YES, can be (remanded for determination of liability)
- Threshold question is whether there is authority for the transaction
- Actual authority – yes, GP’s role to manage affairs
- Apparent authority – no – agent cannot create authority, must come from partnership (principal)
- Is there liability? 3 rules, under 2 statutes
- If LP’s participation in control is not substantially the same, then must have actual knowledge of participation in control
- If there is no actual knowledge of participation, then LP’s control must be substantially the same as GP’s.
- Participate in control in substantially the same way and signal it to creditor – saying the LP provides funding not suffic b/c that is the LP’s role.
- AZ adopts rules 1 and 2.
- Under current law, when “substantially the same” test is met, direct contact not req’d. If test not met, then direct contact is req’d.
- LLC
- Combines benefits of corporation and partnership – lmt’d liability and pass-thru tax
- Large freedom to arrange internal operations of venture
- Members can appoint managers – members don’t have authority
- Can also be “member-managed” – all members have authority
- Most states allow LLC to be formed by 1 person
- Can unilaterally disassociate at any time, but dissolution req’s a vote.
CORPORATIONS
- Formation of a Closely Held Corporation
- Where to Incorporate – appraisal of 2 factors: cost of incorp and law of state of incorporation
- Usually comes down to state conducting business w/in and Delaware
- How to Incorporate
- File w/ state – 4 req’s: agent, #shares, corp name, name of incorporators
- Permissive provisions
- Opt-in (must be put into charter to apply) – lmt’d liab of directors
- Opt-out – purpose of court
- Then must create bylaws (not publicly filed)
- Restated (articles redone – only need to check one copy)
- Amended – only certain parts redone (need to check all versions)
- Signif issue – what to put into articles – trend toward simplification, only put in what is req’d
- MBCA provisions
- S 2.02 – Articles of Incorp
- Must contain – corp name, # shares, street address of office and name of agent, name and address of each incorporater
- May contain – name and address of initial directors, purpose of corp, defining powers of managers/directors/shareholders, imposition of personal liab for shareholders, director liability and indemnification
- S 2.03 – Incorporation: effective when docs filed (concl. proof of proper existence)
- S 2.05 - Org of Corp
- After incorp, initial dir must appoint managers and create bylaws
- S 2.06 – Bylaws: may contain any provision for managing the business
- Ultra Vires
- Ashbury Railway v. Riche – beginning of doctrine
- Corp NOT liable to contrast RR b/c it was “beyond power of corp” – which was to “make or sell, lend, hire”
- Doesn’t matter that corp’s shareholders agreed
- Articles of Incorp are public record and should be looked at when doing trans
- Some courts avoided ultra vires by construing purpose clauses broadly or finding implied purposes – could also use estoppel, unjust enrichment, waiver
- 711 Kings Highway Corp v. F.I.M.’s Marine Repair Service (NY 1996) – diminish UV
- Casea arguing ultra vires should be dismissed for failure to state a claim
- People weren’t checking public record (undermines reason for UV)
- NY Bus Corp Law S.203 – no act of a corp shall be invaled by fact it was w/o capacity or power to do such act
- Except:
- Act brought by shareholder to enjoin corp act
- Act by corp against incumbent or former officer
- Act brought by state AG
- Sullivan v. Hammer (DE 1990) – Chartable Donations
- Financial support for museum to be named after corporation’s founder – settlement for court approval
- Allows settlement to go through – in making determ, Court should look at fairness of the case, considering:
- Probable validity of claims
- Difficulties in enforcing claims through court
- Collectability of judgment
- Delay, expense, and trouble of litigation
- Amount of compromise
- Views of parties involved
- No personal benefit, lack of indep, or gross neg shown – so get BJR
- If this is UV depends on how purpose clause written – “any lawful purp”
- Defense – gift contributes to goodwill of the corp – speculative at best, but doesn’t matter b/c of BJR protection
- What considerations matter? – geography, entity donated to, indiv’s name in relation to the corp
- State statute – allows for reasonable contrib to charity
- CL – reasonableness interp and ultra vires.
- Citizens United
- UV arg for corp making political donations didn’t work
- Promoters
- “Person who directly/indirectly takes initiative in founding/organizing” firm – could be a promoter w/o knowing it
- Owes signif fiduc duty to others in corp – corp may bring suit v. promoter after corp control transfers to subsequent investors.
- Default Rule – promoter liable for contracts made when no corp exists – unless there is an agreement to look to some other entity for liability.
- Where performance called for before corp existence, inference promoter intended to be personally liable, and corp not liable on contract unless it explicitly/implicitly adopts contract (McArthur v. Times Printing Co)
- Yaki v.