2 Sole ProprietorshipA person doing business for himself/herself (sole proprietor)Usually the proprietor owns all of the business propertyResponsible for control of the businessResponsible for managementResponsible for liabilities/debtsMay hire agents – liable for them as wellCapital must come from the owner’s own resources or is borrowedProfits from the business are taxed personally to the proprietorRecord keeping formalities are at the owner’s discretionSee Exhibit 13.1.
3 PartnershipsDefinition: An association of two or more persons to carry on business as co-owners for a profitPartners or General partners control the operations & profitsEach of the partners has a fiduciary duty to the other partner(s)Latta v. Kilbourn: One partner may not use partnership assets for own benefitUnder state laws, a partnership may be sued as an entityMost states have adopted the Uniform Partnership Act (UPA) and Revised UPANo need to enter into a formal agreement for a partnership to exist at lawHowever, agreements are preferable, esp. regarding finances, management and dissolution issuesIf the Partnership Agreement is silent, the UPA governs (default rules)If the agreement does not state otherwise, the profits of the partnership are divided equally
4 Termination of General Partnership Dissolution occurs when an event takes place to dissolve the partnershipChange of the composition of the partnersWithdrawal of a partnerBankruptcy of a partner concerning the businessDeath of a partnerWinding up of the partnership involves completing any unfinished businessIf terminated, partnership must be reformedCommon: Partnership purchases life insurance on partnersProceeds used to buy back the interest of deceased partner from her estate
5 Limited PartnershipDefinition: 2 or more persons (partners) who have entered into an agreement to carry on a business venture for profitMust have a written agreement filed with the stateCalled Certificate of Limited PartnershipPuts 3rd parties on notice that limited partners assets not available to satisfy any claims against the limited partnershipGeneral partners (at least one)Manage the businessAre personally liable to creditorsHave the duty to account to the limited partnersLimited partners (at least one) are investors onlyDo not manage the businessAre not liable for debtsLimited 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
6 Corporations Legal “entities”/”persons” Can sue & be sued It has liabilityIt has constitutional rightsMUST meet formal requirements according to state statutesLiable for agents’ actions and contractsEach state has its own corporation laws; federal government places very limited roleClose corporation: Shares held by only one or small group of shareholders; stock not traded on a stock exchangePublic corporation: Stock is traded on a stock exchange; is likely to have many shareholders
7 Ironite Products Co. v. Samuels 1972: Irwin Fox and Alvin Samuels established Ironite.Articles of incorporation set out guidelines for operation.Irwin and Alvin orally made decisions about company; shared equally.Later they formed Sweet Gas – ran under same rules.1989: Invited their sons, Richard Fox and Mark Samuels, to join them – sons would eventually take control. Richard drafted new bylaws. Alvin made hand-written changes and all agreed to new bylaws.1993: Irwin died and Richard took over his ½ of the company.Outsider invited to join Board of Directors for independent tie breaker vote.Fights began over who should be paid how much and who should control what. Richard and independent director voted to pay Richard more than Mark.
8 Ironite Products Co. v. Samuels Mark sued Richard, Ironite, and Sweet Gas.Said original agreement of equal shares applied.Defendants said new bylaws would determine compensation, not old oral agreement.Trial court held that proceeds from operations would be shared equally by terms of the original agreement.Richard and companies appealed.HELD: Reversed.1972 Oral Agreement contradicts terms of the bylaws.Oral agreement violated the parol evidence rule and evidence must be ignored.Written documents clearly state that compensation for the officers is at the discretion of the Board of Directors.Bylaws Article III, Section I clearly allows Board to manage affairs of the companies, absent proof of wrongdoing.No allegation that Board perpetrated fraud or made an irrational business judgment. Richard, Ironite and Sweet Gas win.SWEET GAS
9 Creating A Corporation Articles of Incorporation and an application are sent to the appropriate state officeThe state issues a Certificate of IncorporationSee Exhibit.13.2Incorporators hold a first organization meetingAt the first meetingElect a Board of DirectorsEnact bylaws or rules that govern internal operations (bylaws cannot contradict the Articles of Incorporation)Issue the corporation’s stock
10 Relationship of Parties of A Corporation ShareholdersOwners of the corporation; no day-to-day control of activitiesShareholder meetings need quorum (usually more than ½ total shares presentMost shareholders give proxy to 3rd parties to represent them.Shareholders elect Board of DirectorsNo legal relationship to creditorsSee Storetrax.com v. GurlandBoard of DirectorsHave management power over large decisionsCan be removed from office by shareholders for cause (breach of duty/misconduct)Have fiduciary duty of loyalty to the shareholdersManagersAppointed/hired by directors to manage day-to-day decisionsHave broad duties of care & loyalty to directorsEmployeesWorkers
11 Business Judgment Rule Makes directors & managers immune from liabilityWhen problems result from honest mistakes in judgmentIf there was a reasonable basis for their decisionsIf they acted in good faith
12 Professional Corporations (PCs) Created by state lawsOwners of PC can only be professionals involved in the firm itself (i.e. MD’s whose practices are tied togetherCreated to have limited liability for its membersExample: Doctors join to reduce liability risk for malpractice of a member-doctorStock usually cannot be sold to outside investorsHas special tax treatment with IRS
13 Limited Liability Companies (LLC) LLC is treated like a corporation for liability purposes but like a partnership for federal tax purposes.State laws have procedures to create LLC’sFiling a document: Articles of OrganizationState issues a Certificate to operate as an LLCUsually is formed by two or more membersMembers have membership interestsLimited liability of owners – the same as a corporationMembers enter into an Operating AgreementSimilar to bylaws of a corporationAn LLC does NOT have perpetual lifeDeath, resignation, retirement, expulsion of member terminate LLC unless otherwise providedBut, if remaining members give consent, LLC can continue (should be set out in Articles of Organization)Termination: Period of winding up, followed by payment of creditors and distribution of profits.
14 In re 1545 Ocean Avenue, LLC1545 Ocean Avenue LLC formed to develop real estateOwned by two companies (Ocean Suffolk & Crown Royal); each company had membership certificate in 1545Operating agreement had no dissolution provisionsTwo managers appointed to operate 1545Crown Royal appointed KingOcean Suffolk appointed Van HoutenKing and Van Houten argued; King announced Crown Royal would pull outKing sued for work to stop and the LLC too be dissolvedTrial court granted King’s requestsOcean Suffolk and Van Houten appealed.
15 In re 1545 Ocean Avenue, LLC, cont. LLCL 702 (New York LLC Law) states that court must examine the LLC’s operating agreementUnilateral action of a single manager was permitted in Article 4.1 of 1545 LLC Operating AgreementLets each manager act autonomously to bind LLC in furtherance of business of the LLCOperating agreement was silent about manger conflicts1545 can only dissolved if cannot further purpose of LLCHELD: Lower Court ruling reversed and proceeding dismissed.Dissolution is not granted.
16 Business &Taxation Corporate profits are taxed at corporate tax rate. Dividends are taxed at each individual shareholder’s tax rate.In effect this is “double taxation” of the same profits.The Supreme Court has held: There is no “double taxation” under the law, since “two separate entities” (corporations and shareholders) are taxed only once each.Partnership pays no income taxesIncome passes to parties who pay tax on their share of incomeLimited Liability CompanyTreated like a corporation for liability purposesTreated like a partnership for federal tax purposes
17 Factors That Influence the Choice of a Business Organization Limited liabilityControlCapital considerationsTaxationTransferability of ownership interestsMethod of creationEntity as a distinct status separate from its ownerEach owner must make his/her own choice
18 Limited Liability (Protecting Personal Financial Risks) Allows person to invest in business without placing all wealth at risk.Allows investors to be passive toward internal management.Sole proprietors have unlimited personal liability for debts of business, including torts.Liability of limited partner is limited to capital contributed to LP.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.
19 Piercing The Corporate Veil Owner treats corporation as an “alter ego”Co-mingling fundsNo separate recordsLoans money without loan papersNo reimbursement for expensesResult: Shareholders are personally liable for all corporate liability – torts, contracts, debtsSee KC Roofing Center v. On Top Roofing, Inc.
20 K.C. Roofing Center v. On Top Roofing, Inc. Nugents owned a series of roofing companies1977: Russell Nugent Roofing Inc. was incorporatedRussell and wife only shareholders, directors & officers1985: Corporation name changed to On Top Roofing1987: On Top Roofing ceased doing business1987: Nugents did business through new corporation RNR, Inc.1988: RNR ceased to exist1988: Replaced by RLN Construction, Inc.1989: RLN Construction was replaced by Russell Nugent, Inc.Business was run out of Nugent’s homeIn 1986 Nugents paid themselves salaries over $100,000 eachCharged corporation $99,290 in rent for space in their homeK.C. Roofing was owed $45,000 for roofing supplies sold to On Top Roofing, which no longer existed (Continued)
21 K.C. Roofing Center v. On Top Roofing, Inc., cont. 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 business2. 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 plaintiffNugents were avoiding debts to plaintiffs.Refused On Top’s obligations to creditors.It is unfair, unjust, and inequitable to allow Nugent to hide behind corporate shield and avoid legal obligations to plaintiffs.
22 Transferability of Ownership Interests Refers to ability of business owner to sell or pass interest to othersNontraded EntitiesIn sole proprietorship, selling the business ends the proprietorship. Price is FMV to be determined.If a partner sells or assigns interest in the partnership, the partnership continues, but the new person doesn’t automatically become a partner.New person is just entitled to receive the share of profits the partner would have received, but can’t participate in management of partnership or right to its business information.Sale of close corporation is like a sole proprietorship sale as price of shares is not determined on a stock exchangeMust determine the market value of the close corporation and its shares. May need specialists to determine value.Publicly Traded CorporationsPublic corporation stock may be traded on stock exchange.Price is known and therefore no specialists need to be hired to determine market value.
23 DurationDuration refers to ability to continue to operate in event of death, retirement or incapacity of owner of businessLimited Life:Sole proprietorship terminates with death or incapacity of proprietor.At common law partnerships and LLC’s are dissolved by death, retirement or incapacity of a partner, but are not necessarily terminated. (Can reform)Perpetual Existence: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.)Close corporation or LLC with few members – death of a shareholder may impact the business.
24 Franchises Three types: 1) product distributorships (i.e. Ford Dealership)2) trademark/trade-name licensing (i.e. Coca-Cola)3) business format franchising (i.e. McDonald’s)Franchisor grants a right to sell goods or services to a franchisee in return for payment of a franchise feeUniform product or services and the use of a trademark help the franchisee establish quickly in the marketSee Exhibit 13.4
25 Franchises Federal & state laws protect investors FTC Franchise Rule: Franchisor is required to give an offering circular (disclosure statement) to potential franchiseesFTC v. Wealth Systems: FTC alleged that 3 entities violated Section 5 in selling home-based Internet business opportunity by misrepresenting purchases will earn substantial income.Also failed to give purchasers a complete disclosure document and failed to provide purchasers with earnings claims documents and did not comply with Franchise Rule’s general media claims requirements.When violations occur, the result is usually that promoted activity is closed down.Some states have laws to regulate franchises as well – for example, California, Illinois and New York.Some franchisees given extra protection by state laws: auto dealers and gas stations – often have extra rights compared to most franchises
26 FranchisesThe franchise agreement sets forth rights and obligations of the parties, i.e. territorial rights, fees and royalties, termination, etc.TerminationThrough explicit events that bring about franchise’s terminationFixed expiration timeFranchisor’s right to termination re: occurrence of events –Inspection problems or violations of franchiseeBankruptcy of franchisor
27 Dunkin’ Donuts Franchised Restaurants, LLC v. Sanlip, Inc. Three individuals owned Sanlip, a Dunkin’ Donuts franchisee.Operated two donut shops in Norcross GeorgiaDunkin’ said defendants breached franchise agreementsFailed to remodel their shopsFailed to participate in mandatory system-wide programsFailed to attend required trainingFailed to prepare immigration forms for new employeesDunkin’ said defendants transferred significant part of franchise w/o Dunkin’s knowledge in violation of franchise agreement.Sanlip did not dispute claims.Protested that Dunkin’ was not allowing owners reasonable chance to sell franchise.Dunkin’ entered into settlement agreement.Allowed Sanlip time to try to find buyer (Continued)
28 Dunkin’ Donuts Franchised Restaurants, LLC v. Sanlip, Inc. Sanlip submitted proposed sale agreement. Dunkin’ refused to accept the buyer. Asked court to order Sanlip to return shops to Dunkin’.Sanlip counterclaimed: Dunkin’ rejected reasonable proposal.HELD: Summary Judgment for Dunkin’ plus attorneys’ fees & costs.Dunkin’ may not “unreasonably” reject proposed sale agreement.Dunkin’ analysis:If store will lose money 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 provides Dunkin’ may terminate lease if franchise agreement for shop is terminated for any reason.