CHAPTER 22 Business Organizations SOLE PROPRIETORSHIP Simplest form

CHAPTER 22 Business Organizations

SOLE PROPRIETORSHIP § Simplest form of business entity. § The owner is the business. § The owner owns all the assets of the business and is personally liable for all obligations. § Usually uses a fictitious name. 2

GENERAL PARTNERSHIP § Created with two or more persons. § Partners usually share profits and losses equally. § Each partner has right to manage and is an agent of the partnership. § Each partner is personally liable for obligations. § Partners own property as tenants in common. § Treated as a “pass through” tax entity. 3

JOINT VENTURE § Joint ventures : – – share a common business interest; have the mutual right to direct and govern; share the partnership’s profits and losses; and combine their property, money, efforts, skill, or knowledge in the undertaking. § Terminates when venture is completed. 4

LIMITED PARTNERSHIP § Consists of at least one general partner and one limited partner. § Limited partner has no right to manage. § Liability is limited to amount of investment. § Attractive to investors. 5

CORPORATIONS § Created by state statute. § Separate legal entity with constitutional rights. § Owned by shareholders who have limited liability up to their investment. § Managed by Board of Directors with day-to-day operations by Officers. 6

“S” CORPORATIONS § Treated as a “pass through” entity, where shareholders are treated as partners for tax partners. § Limited to 35 shareholders, with no foreign investors. § Status is elected with the IRS. 7

CLOSE CORPORATIONS § Few shareholders, usually members of a family. § Flexible, may dispense with corporate formalities. § Popular for small businesses. 8

LIMITED LIABILITY COMPANIES § Owners are called “members. ” § Members’ liability limited to amount of investment. § LLC’s are generally “pass through” entities for tax purposes. § Members can participate in management without liability. 9

LIMITED LIABILITY PARTNERSHIPS § Statutory entity designed for professionals. § Professionals are insulated from a partner’s malpractice. 10

INCOME TAX CONSIDERATIONS § Comparing Separate Taxable Entities with Pass-Through Entities. – Property Transfers—taxable to a corporation. – Cash Distributions—double taxation to corporations. – Operating Losses—recognized at the corporate level. 11

INCOME TAX CONSIDERATIONS § Comparing Separate Taxable Entities with Pass-Through Entities (Cont’d): – Allocation of Losses. – Ability to Raise Venture Capital. 12

AGENCY AND LIABILITY Case 22. 1 Synopsis. Water, Waste & Land, Inc. v. Lanham. WWL was a land development and engineering company doing business under the assumed name of “Westec. ” Lanham and Clark were managers and members of Preferred Income Investors, L. L. C. (PII), an LLC. Clark contacted Westec about the possibility of hiring Westec to perform work for PII. Clark gave his business card to representatives of Westec. The business card listed PII as the business and included Lanham’s address, which was also the address listed as P. I. I. ’s principal office and place of business in its articles of organization filed with the secretary of state. There was no indication what P. I. I. meant or that P. I. I. was a limited liability company. Westec never received a signed contract from Lanham but received verbal authorization from Clark to begin work. Westec completed the engineering work and sent a bill for $9, 183. 40 to Lanham. No payments were made on the bill. 13 CONTINUED

AGENCY AND LIABILITY Westec filed a claim in county court against Clark and Lanham individually as well as against P. I. I. The county court found in favor of Westec. The district court reversed and held that Lanham was not personally liable. The court reasoned that Westec was put on notice that it was dealing with an LLC, because the business card contained the letters “P. I. I. ” and Section 7 -80 -208 of the LLC Act provides that the filing of the articles of organization serves as constructive notice of a company’s status as a limited liability company. ISSUE : May a member of a limited liability company claim protection for amounts owing for services rendered if the existence of the limited liability company was not disclosed at the time the services were requested or performed? HELD: For WESTEC. Clark and Lanham were personally liable for the monies owed by P. I. I. because under the common law of agency, an agent is liable on a contract entered on behalf of a principal if the principal is not fully disclosed. In other words, an agent who 14 negotiates a contract with a third party can be sued for any breach

PARTNERSHIP MECHANICS § Formation of General Partnership – Mutual Agency Relationship. – Without a Partnership Agreement, state law governs. – Written Agreements usually include: term, capital division of profits and losses, name of the partnership, and consequences of death, incapacity, or 15 sale of a partnership interest.

PARTNERSHIP MECHANICS § Operation of a General Partnership: – Each partner is liable for partnership debts if made with the scope of a partner’s duty. – Each partner has a fiduciary duty to the other. 16

PARTNERSHIP MECHANICS Case 22. 2 Synopsis. Bohatch v. Butler. Bohatch questioned the billing practices of another partner in the law firm. The client had no problem with the billing. Bohatch was asked to leave by the other partners. When she filed suit for, inter alia, breach of fiduciary duty, the partners voted to expel her from the firm. The trial court found for Bohatch. The appeals court reversed because the partners only had a duty not to 17 expel her in bad faith. CONTINUE

PARTNERSHIP MECHANICS Case 22. 2 Synopsis. (Cont’d). ISSUE: Can a partnership expel a whistleblowing partner merely for reporting in good faith the alleged misconduct of another partner? HELD: AFFIRMED. The Texas Supreme Court stated there was no whistleblowing exception to the at-will nature of partnerships; therefore, the partners were free to expel Bohatch and were not to liable for damages for doing so. 18

PARTNERSHIP MECHANICS § Decision Making in a General Partnership—unless stated otherwise, decisions must be unanimous on all non-routine matters. § Dissolution and Winding Up of the General Partnership—settling and liquidating to terminate the partnership. § Termination of the General 19

LIMITED PARTNERSHIP REQUIREMENTS § Formal Requirements: Certificate filed with state with designation of limited partners. § LP interests are securities and regulated by the state. § Limited Participation—no management activity. § Not recognized until certificate of Limited Partnership is filed. 20

INCORPORATION § Where to Incorporate—any state. § Costs and state laws must be factored. § Some states are favorable to corporations (e. g. , Delaware). § Delaware permits broader limitations on directors’ personal liability. § Almost 60% of Fortune 500 corporations are incorporated in 21 Delaware.

INCORPORATION § How to Incorporate: – One or more incorporators file certificates or articles of incorporation with the state. – Bylaws voted on at the organizational meeting. 22

INCORPORATION § Defective Incorporation. – De Jure Corporation—substantial compliance with statutes; corporation by right; cannot be challenged. – De Facto Corporation—corporation in fact as long as incorporators were unaware of defect and made a good faith effort to comply with statutes. – Corporation by Estoppel—if a third party treats a business as a corporation, the third party cannot deny it is a corporation and try to reach shareholders personal assets. 23

PIERCING THE CORPORATE VEIL § “Alter Ego” Theory— business not a distinct entity from the owners. 1. Domination by Controlling Shareholder. 2. Commingling of Assets 3. Bypassing Formalities—in a close corporation shareholders must agree 24 to bypass formalities.

PIERCING THE CORPORATE VEIL § Undercapitalization Theory: – Insufficient amount placed at risk in corporation – That will anticipate reasonable corporate liabilities. 25

PIERCING THE CORPORATE VEIL Case 22. 3 Synopsis. Walkovszky v. Carlton. Plaintiff was injured when he was run down by a taxi owned by Seon Cab Corp. Carlton was a shareholder of ten corporations, of which Seon was one. Each corporation owned two taxis, and each had the minimum required liability coverage. Walkovszky sought to pierce the corporate veil to reach Carlton personally for his injuries. ISSUE: May the corporate veil be pierced solely because the corporation is undercapitalized? HELD: No. In New York, the veil will not be pierced solely for undercapitalization reasons. 26

MANAGEMENT OF THE CORPORATION § Directors—members of the Board of Directors; if also an officer, she is an inside director; if she is not an officer, then she is an outside director. § Officers—agents hired, fired, and compensated by the Board. § Shareholders—owners of the company who elect the directors 27

SHAREHOLDER VOTING § Shareholders of record can vote for themselves or have another vote for them as a proxy. § Cumulative Voting—number of votes is equal to the number of shares owned times the number of directors 28

SHAREHOLDER RIGHTS § Shareholders have a common law right to inspect the books and records § This right can be lost if not used in good faith. 29

SHAREHOLDER RIGHTS Case 22. 4 Synopsis. State Ex Rel. Pillsbury v. Honeywell, Inc. (1971). Pillsbury sought to stop Honeywell’s production of fragmentation bombs because he did not like them produced in his own community. Pillsbury sought shareholder lists and other records from Honeywell after purchasing 100 shares of Honeywell refused. Pillsbury sued. 30

SHAREHOLDER RIGHTS Case 22. 4 Synopsis. ISSUE: Does a shareholder who desires to change a corporate policy, even if motivated by social/political concerns, have the proper purpose required to gain access to a shareholder list? HELD: NO. All courts found Honeywell within its rights to refuse Pillsbury’s requests because it was not a properly motivated interest of a shareholder. 31

SHAREHOLDER RIGHTS § Shareholder Proposals. 1. Human Rights. 2. Environmental Conditions. 3. Corporate Governance. 32

STRUCTURAL CHANGES § Merger—combination of two or more corporations into one; the disappearing corporation(s) is (are) part of the survivor. § Sale of Assets—if all or substantially all of the corporation’s assets are being sold, then the sale must be approved by both the shareholders and the boards. § Appraisal Rights—right to receive fair cash value of their shares when voted against a transaction. 33

OWNERSHIP CHANGES § Tender Offers—public offers to all shareholders of the “target” to buy shares at a stated price. § Leveraged Buyouts—stock purchase financed by debt. 34