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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Presentation on theme: "©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part."— Presentation transcript:

1 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS O RGANIZATIONS Chapter 12 Meiners, Ringleb & Edwards The Legal Environment of Business, 12 th Edition

2 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C HAPTER I SSUES o Major forms of business organizations o How businesses are created o Factors that may influence a businesss choice of its type of organization o Alternative business forms to apply to various circumstances o See Exhibit 12.1

3 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. S OLE P ROPRIETORSHIPS o A person doing business for him/herself (sole proprietor) o Usually the proprietor owns all of the business property o Responsible for control of the business o Responsible for management o Responsible for liabilities/debts o May hire agents – liable for them as well o Capital must come from the owners own resources or is borrowed o Profits from the business are taxed personally to the proprietor o Record keeping formalities are at the owners discretion

4 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. P ARTNERSHIPS Definition: An association of two or more persons to carry on business as co-owners for a profit Partners or General partners control the operations & profits Equal control unless agreed differently Under most state laws, a partnership may be sued as an entity. Most states have adopted the Uniform Partnership Act (UPA) and Revised Uniform Partnership Act (RUPA).

5 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. o No required to enter into a formal agreement for a partnership to exist at law o However, agreements are preferable, especially regarding finances, management and dissolution issues o If the Partnership Agreement is silent, the UPA governs (default rules). Each of the partners has a fiduciary duty to other partner(s) Latta v. Kilbourn: One partner may not use partnership assets for own benefit If the agreement does not state otherwise, the profits of the partnership are divided equally. P ARTNERSHIPS

6 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE Z HOU V. B ICKLEY Bickley worked at a Yamaha shop. Frequently ate lunch at a Chinese restaurant where Zhou and Zhang (Chinese immigrants) worked. Bickley told Zhou and Zhang that the Yamaha shop was going out of business. Suggested they help him open a new motorcycle repair shop. Three of them signed two-year lease on building for the shop. Zhou and Zhang paid security deposit & 1 st months rent. They helped pay for inventory; helped get the shop ready. Gave Bickley more money when he asked for it. Soon after Zhou and Zhang asked for keys to building; Bickley refused. Asked to see receipts and invoices; he refused. Asked to work at the shop; he refused. Demanded a written agreement; he refused. Attorney sent a demand letter on behalf of Zhou and Zhang; he ignored it. Suit was filed. Demanded return of funds expended. Bickley counterclaimed for breach of contract by his partners. Trial court held: No partnership, only a vague agreement to open a motorcycle repair shop. Bickley operated as a sole proprietor who borrowed money that he owed to Zhou and Zhang. Bickley appealed. (Continued)

7 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Mere fact parties called themselves partners and refer to business as a partnership, doesnt make them partners or a partnership. Zhou, Zhang and Bickley contributing money for expenses and signed a lease, is no binding contract, much less a partnership. A reasonable person could conclude that Zhou and Zhang simply intended to enter into a partnership agreement in the future. Bickley denied Zhou and Zhang access to building; denied them access to financial records; refused to let them participate in the operations of business. Such actions not consistent with a partnership. Affirmed: Parties did not intend to do things that would constitute a partnership. Intent to do things which constitute a partnership determines if parties are partners. C ASE C ASE Z HOU V. B ICKLEY

8 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. T ERMINATION OF THE P ARTNERSHIP Dissolution occurs when an event takes place to dissolve the partnership. Change of the composition of the partners Withdrawal of a partner Bankruptcy of a partner concerning the business Death of a partner Winding up of the partnership involves completing any unfinished business. If terminated, partnership must be reformed. Common: Partnership purchases life insurance on partners Proceeds used to buy back the interest of deceased partner from her estate

9 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. L IMITED P ARTNERSHIP Definition: 2 or more persons (partners) who have entered into an agreement to carry on a business venture for profit MUST have a written agreement that is filed with the state. Called Certificate of Limited Partnership. Puts 3 rd parties on notice that limited partners assets not available to satisfy claims against the LP General partners (at least one) Manage the business; Are personally liable to creditors; Have the duty to account to the limited partners Limited partners (at least one) are investors only Do not manage the business; Are not liable for debts beyond their contributions Limited partners BECOME general partners at law IF they participate in or manage the business (lose their limited liability). Most states use some form of the Uniform Limited Partnership Act (ULPA) or Revised Uniform Limited Partnership Act (RULPA).

10 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE E AGLES L ANDING D EVELOPMENT, L.L.C. V. E AGLES L ANDING A PARTMENTS, L.P. Eagles landing Development LLC (Eagles) contracted to build apartments for Eagles Landing Apartments, LP (ELA) for $1.4 million. ELAs general partner was Bluff City. Two limited partners, PNC, (a limited partnership) & Columbia (a corporation). Eagles completed work but still was owed $931,000. Agreement stated that Bluff Citys contribution wouldnt exceed net cash flow from rental of apartment. Cash flow was not good; no money there. All cash invested in ELA by partners was gone. Eagles sued for contribution by PNC and Columbia. Trial Court Held: ELA owed the $931,000. ELA appealed. (Continued)

11 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Columbia and PNC argue that if full developers fee is due under the Development Agreement, they were not parties to it. They were only limited partners Contend they cant be charged for any liability of partnership under Development Agreement. Court agreed. Unlike general partners, a Limited Partnership (LLP) protects partners registered as limited liability partnerships. Partner in a registered LLP is not liable. As partners in an LLP, neither Columbia nor PNC can be held liable for partnership debts. Trial court appeared to disregard PNC and Columbias status as LLPs. HELD: Affirm trial courts judgment and amount of $ owed. Reverse assessment of judgment to PNC and Columbia Remand to trial court for purpose of entering judgment against only the partnership, ELA. C ASE C ASE E AGLES L ANDING D EVELOPMENT, L.L.C. V. E AGLES L ANDING A PARTMENTS, L.P.

12 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. T ERMINATING A L IMITED P ARTNERSHIP o Similar to the termination of a general partnership o Death, insanity, withdrawal of a limited or general partner will terminate o Bankruptcy of a general partner = termination o Bankruptcy of a limited partner does not o Organization must wind up the business o Creditors are paid and profits are dispersed according to agreement

13 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ORPORATIONS o Legal entities/persons o Can sue & be sued o It has liability o It has constitutional rights Except the privilege against self-incrimination (only officers & employees have that right) o MUST meet formal requirements according to state statutes States issue corporate charter. o Liable for agents actions and contracts o Each state has its own corporation laws; federal government places very limited role

14 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C REATING A C ORPORATION o Articles of Incorporation and an application are sent to the appropriate state office Name & Address of corporation Name and Address of registered agent Purpose of business Class(es) of stock and par value Names & Addresses of incorporators o The state issues a Certificate of Incorporation o Incorporators hold a first organization meeting o At the first meeting Elect a Board of Directors Enact bylaws or rules that govern internal operations (bylaws cannot contradict the Articles of Incorporation) Issue the corporations stock

15 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. R ELATIONSHIP OF THE P ARTIES Important Separation Of ownership (the shareholders) AND of control (management & board of directors) Shareholders Owners of the corporation; no day-to-day control of activities Shareholder meetings need quorum (usually more than ½ total shares present) Most shareholders give their proxy to 3 rd parties to represent them. Shareholders elect Board of Directors No legal relationship to creditors Board of Directors Have management power over large decisions Can be removed from office by shareholders for cause (breach of duty/misconduct) Have fiduciary duty of loyalty to the shareholders Managers Appointed/hired by directors to manage day-to-day decisions Have broad duties of care & loyalty to directors Employees: Workers

16 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS J UDGMENT R ULE Makes directors & managers immune from liability WHEN problems result from honest mistakes in judgment IF there is a reasonable basis for their decisions IF they act in good faith

17 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE S TORETRAX. COM, I NC. V. G URLAND Gurland founded Storetrax.com – internet-based commercial real estate listing service in Maryland in Incorporated as a Delaware corporation in He agreed for a group of investors to buy majority share. Became president and member of the Board of Directors. Employment contract said that he had a years worth of pay in case he was fired. Two years later, he was removed as president, but stayed on the Board for another year. Requested severance pay, but was denied it. He sued. Board claimed he was not due severance pay because his job duties, title and salary changed. Also, as Board member, they claimed he breached a fiduciary duty by suing the company. Lower Court Held: For Gurland. Storetrax appealed. ( Continued)

18 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. o HELD: Affirmed. o There is a fiduciary duty of directors to the corporation. o However, situations arise where a corporate director may proceed with an individual interest that may conflict with those of the corporation on whose Board he sits. o When conflicts of interest arise, courts look closely if directors dealings are in good faith and fair dealing. If conflict arises, director can find a safe harbor by disclosing to the corporation the conflict and important facts to the remaining shareholders or directors. o Gurland had a conflict as an aggrieved former employer and his duty as director of the corporation. o Gurlands seeking $150,000 severance pay was not in corporations best interest, HOWEVER o Gurland notified Storetrax sufficiently of imminence of lawsuit. o Gurlands notification gives him the protections of safe harbor. o HELD: Gurland receives severance pay. C ASE C ASE S TORETRAX. COM, I NC. V. G URLAND

19 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. T ERMINATING THE C ORPORATION Voluntary Approval of the shareholders and the Board of Directors Articles of Dissolution are filed with the state Involuntary The state dissolves it Bankruptcy Wind up business to pay creditors and disburse profits to shareholders

20 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C LOSE C ORPORATION VS. S C ORPORATION Close Corporation 20 states allow Distinguished from a closely held corporation (See Ch. 18) Limited # of shareholders – Shares not sold openly Shareholders must have agreement that governs affairs Not subject to formal rules regarding shareholder and director meetings (unlike regular corporations) S Corporation Regular C corporation can elect with IRS to be classified as S Corporation Have only one class of stock No more than 100 shareholders Only natural persons (U.S. citizens or legal residents) can be shareholders – not another corporation or partnership Primarily for tax considerations Profits/losses allocated to shareholders who pay income taxes Very popular in smaller businesses

21 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. P ROFESSIONAL C ORPORATIONS o Created by state laws o Owners of PC can only be professionals involved in the firm itself (i.e. MDs whose practices are tied together o Created to have limited liability for its members o Example: Doctors join to reduce liability risk for malpractice of a member-doctor o Stock usually not sold to outside investors o Has special tax treatment with IRS

22 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B ENEFIT C ORPORATION New Class of Corporation Voluntarily meets high standards of purpose, accountability and transparency. Characteristics (1) Corporate purpose to create a material positive impact on society and environment (2) Required to consider impacts of their decisions on shareholders, workers, community & environment (3) Required to make available to public annual benefit report assessing their overall social and environmental performance against a 3 rd party standard This entity gives its leadership greater leeway in making decisions that may not comport with traditional standard of maximizing financial interest of the firm.

23 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. L IMITED L IABILITY C OMPANIES LLC is treated like a corporation for liability purposes but like a partnership for federal tax purposes. State laws have procedures to create LLCs Filing a document: Articles of Organization State issues a Certificate to operate as an LLC Usually is formed by two or more members Members have a membership interest Limited liability of owners – the same as a corporation Members enter into an Operating Agreement Similar to bylaws of a corporation An LLC does NOT have perpetual life Death, resignation retirement, expulsion of member terminates LLC If remaining members give consent, LLC can continue (should be set out in Articles of Organization) Termination: There is a period of winding up, followed by payment of creditors and distribution of profits.

24 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE I N RE 1545 O CEAN A VENUE, LLC 1545 Ocean Avenue LLC formed for real estate project Owned by two companies (Ocean Suffolk & Crown Royal) Each company had membership certificate in Operating agreement had no dissolution provisions Two managers appointed to operate 1545: Crown Royal appointed King; Ocean Suffolk appointed Van Houten King and Van Houten argued; King announced Crown Royal would pull out King sued for work to stop and the LLC too be dissolved Trial court granted Kings requests Ocean Suffolk and Van Houten appealed. (Continued)

25 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LLCL 702 (New York LLC Law) states that court must examine the LLCs operating agreement Unilateral action of a single manager was permitted in Article 4.1 of 1545 LLC Operating Agreement Lets each manager to act autonomously to bind LLC in furtherance of business of the LLC Operating agreement was silent re: manger conflicts 1545 can only dissolved if cannot further purpose of LLC HELD: Lower Court ruling reversed; proceeding dismissed. Dissolution is not granted. C ASE C ASE I N RE 1545 O CEAN A VENUE, LLC

26 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. K EY O RGANIZATIONAL F EATURES o Limited liability o Control o Capital considerations o Taxation o Transferability of ownership interests o Method of creation o Entity as a distinct status separate from its owner o Each owner must make his/her own choice

27 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. L IMITED L IABILITY Allows a person to invest in a business without placing their personal wealth at risk. Allows investors to be passive toward internal management. Sole proprietors and general partners have unlimited personal liability for debts of business, including torts. Liability of limited partner is limited to capital contributed to limited partnership. Shareholders of corporation and members of limited liability companies risk only their capital investment if corporation fails – generally not personally liable for the business debts or torts.

28 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Piercing the corporate veil Affects limited liability organizations Prove corporation is a sham Owners actually intend to operate the business as a proprietorship or partnership Can involve fraud, undercapitalization or failure to follow corporate formalities Result: Owners are personally liable for all corporate liability – torts, contracts, debts See KC Roofing Center v. On Top Roofing, Inc. L IMITED L IABILITY

29 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE K.C. R OOFING C ENTER V. O N T OP R OOFING, I NC. Nugents owned a series of roofing companies. Russell and wife only shareholders, directors & officers 1977: Russell Nugent Roofing Inc. was incorporated; 1985: Corporation name changed to On Top Roofing; 1987: On Top Roofing ceased doing business; 1987: Nugents did business through new corporation RNR, Inc. 1988: Replaced by RLN Construction, Inc. 1989: RLN Construction was replaced by Russell Nugent, Inc. Business was run out of Nugents home In 1986 Nugents paid themselves salaries over $100,000 each Charged corporation $99,290 in rent for space in their home K.C. Roofing was owed $45,000 for roofing supplies sold to On Top Roofing, which no longer existed. (Continued)

30 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. K.C. asked court to pierce the corporate veil and hold Nugents personally liable. District held for K.C. Nugents Appealed. HELD: Affirmed. Nugents must pay K.C. When corporation is used for an improper purpose... to perpetuate injustice and avoid its legal obligations, corporate veil is pieced. Here: 1. Nugents had control of all aspects of business; 2. Control was used to commit fraud or wrong or other positive legal duty, including an unjust act; 3. Breach of duty caused unjust loss or injury to plaintiff Nugents were avoiding debts to plaintiffs. Refused On Tops obligations to creditors. This is unfair, unjust and inequitable to allow Nugent to hide behind corporate shield and avoid legal obligations to plaintiffs. C ASE C ASE K.C. R OOFING C ENTER V. O N T OP R OOFING, I NC.

31 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. T RANSFERABILITY OF O WNERSHIP I NTERESTS Refers to ability of an owner in a business to sell or pass interest to others Nontraded Entities In sole proprietorship, selling the business ends the existing proprietorship. Price is FMV to be determined. If a partner sells or assigns interest in the partnership, the partnership continues, but the new person doesnt automatically become a partner. New person is just entitled to receive the share of profits the partner would have received, But cant participate in management of partnership or right to P-ship information without permission of other partners

32 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duration: Refers to ability to continue to operate in event of death, retirement or incapacity of owner of business Sole proprietorship terminates with death or incapacity of proprietor. At common law partnerships and LLCs are dissolved by death, retirement or incapacity of a partner, but are not necessarily terminated. (Can reform) Unless, articles of incorporation provide for period of duration, corporation has perpetual existence. Death or retirement of shareholder(s) does not bring termination of the corporation. (In fact, usually does not have any impact on operations of the business.) D URATION

33 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Three types: 1.Product distributorships (i.e. Ford Dealership) 2.Trademark/trade-name licensing (i.e. Coca-Cola) 3.Business format franchising (i.e. McDonalds) Franchisor grants a right to sell goods or services to a franchisee in return for payment of a franchise fee Uniform product or services and the use of a trademark help the franchisee establish quickly in the market See Exhibit 12.4 F RANCHISES

34 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Laws are still developing Federal & state laws protect investors FTC Franchise Rule: Franchisor is required to give an offering circular (disclosure statement) to potential franchisees FTC v. Wealth Systems,Inc.: FTC alleged that 3 entities violated Section 5 in selling home-based Internet business opportunity by misrepresenting purchases will earn substantial income. When violations occur, the result is usually that promoted activity is closed down. o Some states have laws to regulate franchises as well – for example, California. o Many states have business opportunity disclosure filing requirements. o Most states use the Uniform Franchise Offering Circular (UROC) as basis of reporting. o State agencies have authority to investigate franchise fraud and other bad business practices. o Some franchisees given extra protection by state laws: o Example: auto dealers and gas stations – often have extra rights over other franchises F RANCHISES

35 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The franchise agreement sets forth rights and obligations of the parties, i.e. territorial rights, fees and royalties, termination, etc. Termination Through explicit events that bring about franchises termination Fixed expiration time Franchisors right to termination re: occurrence of events – Inspection problems or violations of franchisee Bankruptcy of franchisor F RANCHISES

36 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. C ASE C ASE D UNKIN D ONUTS F RANCHISED R ESTAURANTS V. S ANLIP o Three individuals owned Sanlip, Inc, which was Dunkin Donuts franchisee. o Operated two donut shops in Norcross Georgia o Dunkin said defendants breached franchise agreements: Failed to remodel their shops; Failed to participate in mandatory system-wide programs; Failed to attend required training; Failed to prepare immigration forms for new employees o Dunkin also said defendants transferred significant part of franchise w/o Dunkins knowledge in violation of franchise agreement. o Sanlip did not dispute claims. o Protested that Dunkin was not allowing owners reasonable chance to sell franchise. o Dunkin entered into settlement agreement. o Allowed Sanlip time to try to find buyer. (Continued)

37 ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sanlip submitted proposed sale agreement. Dunkin refused to accept the buyer. Asked court to order Sanlip to return shops to Dunkin. Sanlip counterclaimed: Dunkin had rejected a reasonable proposal from buyer to take over shop. HELD: Summary Judgment in favor of Dunkin Donuts. Defendants must pay attorneys fees & costs. Dunkin may not unreasonably reject proposed sale agreement. Dunkin analysis: If store will lose money. If so, Dunkin rejects proposed sale agreement. Also looks at financial condition of the buyer if it decides store may break even. This is firmly-established policy by Dunkin and reasonable. Dunkin has right to terminate the agreement. Lease agreements provide Dunkin may terminate lease if franchise agreement for shop is terminated for any reason. C ASE C ASE D UNKIN D ONUTS F RANCHISED R ESTAURANTS V. S ANLIP


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