Chapter McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Corporate Governance And Business Organizations.

11-2 Corporate Governance  How Business Organizations Are Operated, Led, Governed  How Law Provides Regulation Of Business Organizations  How Business Organizations Are Operated, Led, Governed  How Law Provides Regulation Of Business Organizations REGULATIONS

11-3 Size Of Ownership  Closely Held- Family And/Or Friends  Publicly Held- Traded On Public Stock Exchanges  Closely Held- Family And/Or Friends  Publicly Held- Traded On Public Stock Exchanges

11-4 Selecting a Form Sole Proprietorship Forms of Legal Organization of Business Entities Partnership Corporation General Partnership Limited Partnership Regular C Corporation Subchapter S Corporation Limited Liability Company Limited Liability Company Limited Liability Partnership Limited Liability Partnership

Starting a Business  Some Other Forms Joint Venture Joint Venture Strategic Alliance Strategic Alliance Franchise Franchise Cooperatives Cooperatives Master Limited Partnerships (M.L.P.) in some states, similar to L.L.Cs Master Limited Partnerships (M.L.P.) in some states, similar to L.L.Cs  Some Other Forms Joint Venture Joint Venture Strategic Alliance Strategic Alliance Franchise Franchise Cooperatives Cooperatives Master Limited Partnerships (M.L.P.) in some states, similar to L.L.Cs Master Limited Partnerships (M.L.P.) in some states, similar to L.L.Cs

Starting a Business  Sole Proprietorship Business is operated as own personal property Business is operated as own personal property Unlimited personal liability for all debts/obligations of the business Unlimited personal liability for all debts/obligations of the business Over 2/3 of U.S. businesses are sole proprietorships Over 2/3 of U.S. businesses are sole proprietorships They are usually small, about 99% have revenues of less than $1,000,000.00 per year They are usually small, about 99% have revenues of less than $1,000,000.00 per year Sole Proprietors are allowed to establish tax- exempt retirement accounts (e.g. Keough plans) Sole Proprietors are allowed to establish tax- exempt retirement accounts (e.g. Keough plans)  Sole Proprietorship Business is operated as own personal property Business is operated as own personal property Unlimited personal liability for all debts/obligations of the business Unlimited personal liability for all debts/obligations of the business Over 2/3 of U.S. businesses are sole proprietorships Over 2/3 of U.S. businesses are sole proprietorships They are usually small, about 99% have revenues of less than $1,000,000.00 per year They are usually small, about 99% have revenues of less than $1,000,000.00 per year Sole Proprietors are allowed to establish tax- exempt retirement accounts (e.g. Keough plans) Sole Proprietors are allowed to establish tax- exempt retirement accounts (e.g. Keough plans)

11-7 Sole Proprietorship Advantages  Ease of start/end  Be your own boss  Pride of ownership  Retain profit  No special taxes  Ease of start/end  Be your own boss  Pride of ownership  Retain profit  No special taxes Disadvantages  Unlimited liability  Limited financial resources  Difficulty in mgmt.  Time commitment  Few fringe benefits  Limited growth  Limited life span

Starting a Business  Partnership Voluntary Association Voluntary Association Between 2 or more legal competent persons Between 2 or more legal competent persons No Express Agreement Required No Express Agreement Required Typically governed by statutory law (e.g. Uniform Partnership Act, except Louisiana) Typically governed by statutory law (e.g. Uniform Partnership Act, except Louisiana) Sharing profits and losses = prima facie evidence of partnership Sharing profits and losses = prima facie evidence of partnership States differ on whether a partnership is viewed as a legal entity or aggregate of individuals for the purpose of participating in legal actions States differ on whether a partnership is viewed as a legal entity or aggregate of individuals for the purpose of participating in legal actions Extent and Nature of personal liability varies Extent and Nature of personal liability varies General v.Limited General v.Limited  Partnership Voluntary Association Voluntary Association Between 2 or more legal competent persons Between 2 or more legal competent persons No Express Agreement Required No Express Agreement Required Typically governed by statutory law (e.g. Uniform Partnership Act, except Louisiana) Typically governed by statutory law (e.g. Uniform Partnership Act, except Louisiana) Sharing profits and losses = prima facie evidence of partnership Sharing profits and losses = prima facie evidence of partnership States differ on whether a partnership is viewed as a legal entity or aggregate of individuals for the purpose of participating in legal actions States differ on whether a partnership is viewed as a legal entity or aggregate of individuals for the purpose of participating in legal actions Extent and Nature of personal liability varies Extent and Nature of personal liability varies General v.Limited General v.Limited

11-9 Types of Partnerships General GP GP GP GP Limited GP PassiveInvestor PassiveInvestor PassiveInvestor

11-10 Partnership AdvantagesDisadvantages   More financial resources   Shared mgmt.   Longer survival   Unlimited liability   Division of profits   Disagreements among partners   Difficult to terminate

11-11 Sharing Workload Sharing Financial Burden Sharing Emotional Burden Procuring Executive Talent Companionship Interpersonal Conflicts Dilution of Equity Dissatisfaction with Partner Absence of One Clear Leader Frustration of Not Calling Own Shots AdvantagesDisadvantages Advantages and Disadvantages of Partnerships

11-12 Small Business Management, 11th edition Longenecker, Moore, and Petty © © 2000 South-Western College Publishing An Opinion Survey About the Pros and Cons of Partnerships Why is a partnership good? Why is a partnership bad? Spreads the workload Spreads the emotional burden Buys executive talent not otherwise affordable Spreads the financial burden Makes company building less lonely Personal conflicts outweigh the benefits Partners never live up to one another’s expectations Companies function better with one clear leader Dilutes equity too much You can’t call your own shots 55 41 40 33 26 60 59 53 6 Question Perceived Pros and Cons Percentage Responding Source: “The Inc. Fax Poll: Are Partners Bad for Business?” Inc., Vol. 14, No. 2 (February 1992), p. 24.

Partnerships Choose your partners wisely!!! Choose your partners wisely!!! A partnership is like a marriage, easy to get into, sometimes difficult to maintain, and generally messy to get out of! A partnership is like a marriage, easy to get into, sometimes difficult to maintain, and generally messy to get out of! Choose your partners wisely!!! Choose your partners wisely!!! A partnership is like a marriage, easy to get into, sometimes difficult to maintain, and generally messy to get out of! A partnership is like a marriage, easy to get into, sometimes difficult to maintain, and generally messy to get out of!

Partnerships  A voluntary agreement by two or more persons to carry on, as co-owners, a business for profit.  “Persons” may be natural or artificial (e.g. corporations)  Requires intent to become partners (Tarnavsky v. Tarnavsky, 8th Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App. Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002)) Intent can be express or implied (based on words or actions) Intent can be express or implied (based on words or actions) Though their must be an intent to carry on a business “for profit” the business does not have to actually make a profit to be considered a partnership. Though their must be an intent to carry on a business “for profit” the business does not have to actually make a profit to be considered a partnership.  Partnership by estoppel may be found where one holds himself out as, creates a reliance upon, or fails to dispel a known misrepresentation  A voluntary agreement by two or more persons to carry on, as co-owners, a business for profit.  “Persons” may be natural or artificial (e.g. corporations)  Requires intent to become partners (Tarnavsky v. Tarnavsky, 8th Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App. Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002)) Intent can be express or implied (based on words or actions) Intent can be express or implied (based on words or actions) Though their must be an intent to carry on a business “for profit” the business does not have to actually make a profit to be considered a partnership. Though their must be an intent to carry on a business “for profit” the business does not have to actually make a profit to be considered a partnership.  Partnership by estoppel may be found where one holds himself out as, creates a reliance upon, or fails to dispel a known misrepresentation

Partnerships  Is There a Partnership?  A father and son each owned land and raised seed potatoes. They each used their own equipment. Each raised about the same amount of potatoes, and they were stored together and advertised for sale by Wilbur Kimm and Son. A loss arose. Issue: Are the father and son partners such that they must share this loss? Held: Yes. They were partners and must share the loss. Although intent of parties is a major factor, if facts bring arrangement within definition of a partnership, parties cannot escape liability incident to that relationship merely by saying that no such relationship exists. If intended action of parties creates a partnership in fact, what parties call their arrangement or intend their arrangement to be is irrelevant. The fact that the father and son split profits in a joint account that contained proceeds from their sale of seed potatoes was prima facie evidence that a partnership existed between father and son. Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 (Mont. 1984).  Is There a Partnership?  A father and son each owned land and raised seed potatoes. They each used their own equipment. Each raised about the same amount of potatoes, and they were stored together and advertised for sale by Wilbur Kimm and Son. A loss arose. Issue: Are the father and son partners such that they must share this loss? Held: Yes. They were partners and must share the loss. Although intent of parties is a major factor, if facts bring arrangement within definition of a partnership, parties cannot escape liability incident to that relationship merely by saying that no such relationship exists. If intended action of parties creates a partnership in fact, what parties call their arrangement or intend their arrangement to be is irrelevant. The fact that the father and son split profits in a joint account that contained proceeds from their sale of seed potatoes was prima facie evidence that a partnership existed between father and son. Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 (Mont. 1984).

Partnerships  Sharing in profits or losses is prima facie evidence of participation in a partnership but receipt of funds: in repayment of a debt or in repayment of a debt or as interest on a debt or as interest on a debt or as wages or as wages or as rent or as rent or as an annuity to heirs of a deceased partner or as an annuity to heirs of a deceased partner or as consideration for the sale of goodwill as consideration for the sale of goodwill  does not constitute evidence of participation in a partnership.  Sharing in profits or losses is prima facie evidence of participation in a partnership but receipt of funds: in repayment of a debt or in repayment of a debt or as interest on a debt or as interest on a debt or as wages or as wages or as rent or as rent or as an annuity to heirs of a deceased partner or as an annuity to heirs of a deceased partner or as consideration for the sale of goodwill as consideration for the sale of goodwill  does not constitute evidence of participation in a partnership.

Partnerships  Co-owners must register with the state.  Co-owners may need an occupational license.  Co-owners must register with the state.  Co-owners may need an occupational license.

Limited Partnerships  Partnership consisting of one or more general partners (who manage the business and are liable to the full extent of their personal assets for debts of the partnership) & one or more limited partners (who contribute only assets and are liable only up to the amount contributed by them).

Limited Partnerships  General Partner - In a limited partnership, a partner who assumes responsibility for the management of the partnership and liability for all partnership debts.  Limited Partner - In a limited partnership, a partner who contributes capital to the partnership but has no right to participate in the management and operation of the business. The limited partner assumes no liability for partnership debts beyond the capital contributed.  Note: Failure to comply with statutory requirements in forming a limited partnership results in the creation of a general partnership.  General Partner - In a limited partnership, a partner who assumes responsibility for the management of the partnership and liability for all partnership debts.  Limited Partner - In a limited partnership, a partner who contributes capital to the partnership but has no right to participate in the management and operation of the business. The limited partner assumes no liability for partnership debts beyond the capital contributed.  Note: Failure to comply with statutory requirements in forming a limited partnership results in the creation of a general partnership.

Limited Partnerships  The exercise of substantial control by a limited partner may result in his being declared a general partner.

Limited Partnerships  Not equal exercise of substantial control if only: Contractor for an agent or employee of the partnership Contractor for an agent or employee of the partnership Consulting/Advising Consulting/Advising Acting as a surety Acting as a surety Approving or disapproving an amendment to a partnership agreement Approving or disapproving an amendment to a partnership agreement Voting Voting  Not equal exercise of substantial control if only: Contractor for an agent or employee of the partnership Contractor for an agent or employee of the partnership Consulting/Advising Consulting/Advising Acting as a surety Acting as a surety Approving or disapproving an amendment to a partnership agreement Approving or disapproving an amendment to a partnership agreement Voting Voting

11-22 Partnerships  Partnership Agreements (Sometimes called Articles of Partnership)- An agreement listing and explaining the terms of the partnership. Critical for preventing and resolving potential disputes Critical for preventing and resolving potential disputes Should state (at least) Should state (at least)  Who will make final decisions.  What each partner’s duties are.  How much each partner will invest.  How profits and losses will be apportioned to each partner.  Methods for dispute resolution (e.g. arbitration)  How the partnership can be expanded or dissolved.  Partnership Agreements (Sometimes called Articles of Partnership)- An agreement listing and explaining the terms of the partnership. Critical for preventing and resolving potential disputes Critical for preventing and resolving potential disputes Should state (at least) Should state (at least)  Who will make final decisions.  What each partner’s duties are.  How much each partner will invest.  How profits and losses will be apportioned to each partner.  Methods for dispute resolution (e.g. arbitration)  How the partnership can be expanded or dissolved.

11-23 Partnerships  The Uniform Partnership Act, as enacted by a particular jurisdiction, has default rules covering matters not addressed in partnership agreements

Partnerships - Management/Authority  General rule giving equal voice to all partners in management (even if differing contributions) Can be altered by agreement Can be altered by agreement  Why alter?  In large/complex partnership may be cumbersome/inefficient  Decisions that significantly impact the nature of the partnership generally require unanimous consent  Partnerships are generally not liable for agreements of individual partners acting outside of scope of the partnership’s normal business, unless ratify, expressly or implicitly  General rule giving equal voice to all partners in management (even if differing contributions) Can be altered by agreement Can be altered by agreement  Why alter?  In large/complex partnership may be cumbersome/inefficient  Decisions that significantly impact the nature of the partnership generally require unanimous consent  Partnerships are generally not liable for agreements of individual partners acting outside of scope of the partnership’s normal business, unless ratify, expressly or implicitly

Partnerships  Partnership Property All property originally contributed to All property originally contributed to All property purchased on behalf of All property purchased on behalf of Purchasing property with partnership funds implies that it becomes partnership property (unless contrary intention can be proved) Purchasing property with partnership funds implies that it becomes partnership property (unless contrary intention can be proved) Any conveyance to the partnership by name Any conveyance to the partnership by name  Partnership Property All property originally contributed to All property originally contributed to All property purchased on behalf of All property purchased on behalf of Purchasing property with partnership funds implies that it becomes partnership property (unless contrary intention can be proved) Purchasing property with partnership funds implies that it becomes partnership property (unless contrary intention can be proved) Any conveyance to the partnership by name Any conveyance to the partnership by name

Partnerships  3 rules for liability in a partnership are: 1. Every partner is liable for his or her own actions. 1. Every partner is liable for his or her own actions. 2. Every partner is liable for the actions of the other partners (in course of business) 2. Every partner is liable for the actions of the other partners (in course of business) 3. Every partner is liable for the actions of the employees of the business (in course of business) 3. Every partner is liable for the actions of the employees of the business (in course of business)  3 rules for liability in a partnership are: 1. Every partner is liable for his or her own actions. 1. Every partner is liable for his or her own actions. 2. Every partner is liable for the actions of the other partners (in course of business) 2. Every partner is liable for the actions of the other partners (in course of business) 3. Every partner is liable for the actions of the employees of the business (in course of business) 3. Every partner is liable for the actions of the employees of the business (in course of business)

Partnerships  Distribution of partnership income How should the shares of partnership income be distributed? How should the shares of partnership income be distributed?  Pro-rata?  Based on financial contribution?  Based on work performed on behalf of? Usually determined by written agreement Usually determined by written agreement  Distribution of partnership income How should the shares of partnership income be distributed? How should the shares of partnership income be distributed?  Pro-rata?  Based on financial contribution?  Based on work performed on behalf of? Usually determined by written agreement Usually determined by written agreement

Partnerships  Creditors Rights Can obtain the debtor’s share of the income of a partnership, or in some cases can get the court to order the sale of the debtor’s share (Charging Order) Can obtain the debtor’s share of the income of a partnership, or in some cases can get the court to order the sale of the debtor’s share (Charging Order) This does not give the creditor a voice in the management of the partnership This does not give the creditor a voice in the management of the partnership This does not give the creditor the right to dissolve the partnership This does not give the creditor the right to dissolve the partnership  Creditors Rights Can obtain the debtor’s share of the income of a partnership, or in some cases can get the court to order the sale of the debtor’s share (Charging Order) Can obtain the debtor’s share of the income of a partnership, or in some cases can get the court to order the sale of the debtor’s share (Charging Order) This does not give the creditor a voice in the management of the partnership This does not give the creditor a voice in the management of the partnership This does not give the creditor the right to dissolve the partnership This does not give the creditor the right to dissolve the partnership

11-29 Partnership Duties  Duties Loyalty/Good Faith Loyalty/Good Faith Care in Partnership Care in Partnership To Inform/Account To Inform/Account  Note: However, partners can be compelled to sign confidentiality agreements (Madison Ave. Investment Partners, L.L.C. v. American First Real Estate Investment Partners, L.P., 2002 Del. Ch. LEXIS 97 (Del. Ch. New Castle 2002)  Duties Loyalty/Good Faith Loyalty/Good Faith Care in Partnership Care in Partnership To Inform/Account To Inform/Account  Note: However, partners can be compelled to sign confidentiality agreements (Madison Ave. Investment Partners, L.L.C. v. American First Real Estate Investment Partners, L.P., 2002 Del. Ch. LEXIS 97 (Del. Ch. New Castle 2002)

Partnerships - Dissolution  Dissolution methods Automatically after an agreed upon period of time Automatically after an agreed upon period of time Automatically when set objective has been attained Automatically when set objective has been attained By mutual agreement By mutual agreement By unilateral decision of any partner (if at will) By unilateral decision of any partner (if at will) By court order (including by Bankruptcy) By court order (including by Bankruptcy) By death or incompetence of a partner By death or incompetence of a partner By disability of a partner that substantially impairs his ability to carry on duties By disability of a partner that substantially impairs his ability to carry on duties By wilful breach of a partnership agreement By wilful breach of a partnership agreement By illegal acts of the partnership business By illegal acts of the partnership business  Dissolution methods Automatically after an agreed upon period of time Automatically after an agreed upon period of time Automatically when set objective has been attained Automatically when set objective has been attained By mutual agreement By mutual agreement By unilateral decision of any partner (if at will) By unilateral decision of any partner (if at will) By court order (including by Bankruptcy) By court order (including by Bankruptcy) By death or incompetence of a partner By death or incompetence of a partner By disability of a partner that substantially impairs his ability to carry on duties By disability of a partner that substantially impairs his ability to carry on duties By wilful breach of a partnership agreement By wilful breach of a partnership agreement By illegal acts of the partnership business By illegal acts of the partnership business

Partnerships - Dissolution  Dissolution of a partnership does not necessarily end the operation of a business (e.g. it may continue as a sole proprietorship, etc.)  The value of interests at dissolution is usually determined by settlement agreements  There are notice requirements upon dissolution (Phillip Lithographing Co. V. Babich, 135 NW.2nd 343 (Wis. 1965))  Dissolution of a partnership does not necessarily end the operation of a business (e.g. it may continue as a sole proprietorship, etc.)  The value of interests at dissolution is usually determined by settlement agreements  There are notice requirements upon dissolution (Phillip Lithographing Co. V. Babich, 135 NW.2nd 343 (Wis. 1965))

11-32 Distribution of Assets  Order/Priority Outside Creditors Outside Creditors Debts to Partners for Loans/Capital Advance Debts to Partners for Loans/Capital Advance Capital Contribution Capital Contribution Remaining Assets According to Partnership Agreement Remaining Assets According to Partnership Agreement  Order/Priority Outside Creditors Outside Creditors Debts to Partners for Loans/Capital Advance Debts to Partners for Loans/Capital Advance Capital Contribution Capital Contribution Remaining Assets According to Partnership Agreement Remaining Assets According to Partnership Agreement

11-33 Seven Trigger Points That Can Destroy a Partnership 1.A partner that is going through a divorce. 2.A partnership that is experiencing growing pains due to rapid growth. 3.A partner brings a spouse or a relative into the business. 4.A partner that wants to withdraw more money from the business. 5.A partner makes sexual advances toward another partner. 6.A partner experiences serious medical problems. 7.A partner begins doing business on the side with the partnership’s customers. Source: Used with permission, Inc. magazine, February 2001. Copyright 1998 by Gruner + Jahr USA Publishing, 38 Commercial Wharf, Boston, MA 02110. Inc. is a registered trademark of Gruner + Jahr Printing and Publishing.

Corporations  A legal entity formed in compliance with state statutory requirements. The entity is treated as a legal “person”, distinct from its shareholders.

Starting a Business  Corporation Separate Legal Entity Separate Legal Entity Ongoing Enterprise/Lifecycle Ongoing Enterprise/Lifecycle Limited Liability Limited Liability Close v.Public Close v.Public “C” v.“S” “C” v.“S” Profit v.Non-Profit Profit v.Non-Profit Domestic, Foreign, Alien Domestic, Foreign, Alien De Jure v. De Facto De Jure v. De Facto  Corporation Separate Legal Entity Separate Legal Entity Ongoing Enterprise/Lifecycle Ongoing Enterprise/Lifecycle Limited Liability Limited Liability Close v.Public Close v.Public “C” v.“S” “C” v.“S” Profit v.Non-Profit Profit v.Non-Profit Domestic, Foreign, Alien Domestic, Foreign, Alien De Jure v. De Facto De Jure v. De Facto

11-36 Corporation AdvantagesDisadvantages   More money for investment   Limited liability   Separation of ownership/mgmt.   Ease of ownership change   Perpetual life   Size   Initial cost   Paperwork   Two tax returns   Termination difficult   Double taxation

Corporations  A Corporation is “an artificial being, invisible, intangible, and existing only in the contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of creation confers upon it, either expressly or incidental to its very existence.” - Chief Justice Marshall, Dartmouth v. Woodard (1819)

Corporations  Historical Origins Roman royal fiat. Roman royal fiat. 17th century English Royal Charter. 17th century English Royal Charter. 1814, Francis Cabot Lowell, a Boston Merchant, founded the first publicly traded company in America, a textile company. Lowell had smuggled a plan for a power loom out of England and planned to compete with the British Lancashire Mills. Since he personally lacked the capital to build and install the machinery, he sold shares in the company to 10 other people. 1814, Francis Cabot Lowell, a Boston Merchant, founded the first publicly traded company in America, a textile company. Lowell had smuggled a plan for a power loom out of England and planned to compete with the British Lancashire Mills. Since he personally lacked the capital to build and install the machinery, he sold shares in the company to 10 other people. The publicly traded company model also played a key part in the financing of America’s railroads. The publicly traded company model also played a key part in the financing of America’s railroads.  Historical Origins Roman royal fiat. Roman royal fiat. 17th century English Royal Charter. 17th century English Royal Charter. 1814, Francis Cabot Lowell, a Boston Merchant, founded the first publicly traded company in America, a textile company. Lowell had smuggled a plan for a power loom out of England and planned to compete with the British Lancashire Mills. Since he personally lacked the capital to build and install the machinery, he sold shares in the company to 10 other people. 1814, Francis Cabot Lowell, a Boston Merchant, founded the first publicly traded company in America, a textile company. Lowell had smuggled a plan for a power loom out of England and planned to compete with the British Lancashire Mills. Since he personally lacked the capital to build and install the machinery, he sold shares in the company to 10 other people. The publicly traded company model also played a key part in the financing of America’s railroads. The publicly traded company model also played a key part in the financing of America’s railroads.

Corporations  Close corporation—a corporation whose stock is owned by a relatively few people and is not sold to the general public.  Public/Open corporation—a corporation whose stock is bought and sold on security exchanges and can be purchased by any individual.  Close corporation—a corporation whose stock is owned by a relatively few people and is not sold to the general public.  Public/Open corporation—a corporation whose stock is bought and sold on security exchanges and can be purchased by any individual.

Corporations  Types For Profit For Profit Non-Profit (e.g. Hospitals, Charities, Some Insurance Co.) - exempt from Corp. income tax Non-Profit (e.g. Hospitals, Charities, Some Insurance Co.) - exempt from Corp. income tax Municipal (e.g. Sewer Authority) (often have tax authority) Municipal (e.g. Sewer Authority) (often have tax authority)  Types For Profit For Profit Non-Profit (e.g. Hospitals, Charities, Some Insurance Co.) - exempt from Corp. income tax Non-Profit (e.g. Hospitals, Charities, Some Insurance Co.) - exempt from Corp. income tax Municipal (e.g. Sewer Authority) (often have tax authority) Municipal (e.g. Sewer Authority) (often have tax authority)

11-41 Close Corporations  Shareholders Few Few Live Near Each Other Know One Another & Skills Live Near Each Other Know One Another & Skills Active in Business Active in Business No Market for Shares No Market for Shares  Transferability of Shares Right of First Refusal Right of First Refusal Buy/Sell Agreement Buy/Sell Agreement Consent Restraint Consent Restraint  Shareholders Few Few Live Near Each Other Know One Another & Skills Live Near Each Other Know One Another & Skills Active in Business Active in Business No Market for Shares No Market for Shares  Transferability of Shares Right of First Refusal Right of First Refusal Buy/Sell Agreement Buy/Sell Agreement Consent Restraint Consent Restraint

11-42 Corporations Types by place of incorporation Types by place of incorporation  Domestic corporation - a business incorporated in a state  Foreign corporation—a business incorporated outside of the state.  Alien corporation—a business incorporated in a foreign country and operating in the United States. Types by place of incorporation Types by place of incorporation  Domestic corporation - a business incorporated in a state  Foreign corporation—a business incorporated outside of the state.  Alien corporation—a business incorporated in a foreign country and operating in the United States.

Corporations- “S” Corp  “S” Corporation A Federal Tax Election A Federal Tax Election Owners have limited liability, but are taxed as if the firm were a partnership Owners have limited liability, but are taxed as if the firm were a partnership  “S” Corporation A Federal Tax Election A Federal Tax Election Owners have limited liability, but are taxed as if the firm were a partnership Owners have limited liability, but are taxed as if the firm were a partnership

Corporations- “S” Corp  “S” Corporation Requirements Firm has 75 or fewer owners Firm has 75 or fewer owners All stockholders must be individuals, estates, or certain trusts (not other corporations) All stockholders must be individuals, estates, or certain trusts (not other corporations) Only one class of stock outstanding Only one class of stock outstanding Must be a domestic corporation Must be a domestic corporation Must operate on a calendar year basis Must operate on a calendar year basis No nonresident alien stockholders No nonresident alien stockholders All shareholders must consent to having the corporation taxed as a partnership All shareholders must consent to having the corporation taxed as a partnership  “S” Corporation Requirements Firm has 75 or fewer owners Firm has 75 or fewer owners All stockholders must be individuals, estates, or certain trusts (not other corporations) All stockholders must be individuals, estates, or certain trusts (not other corporations) Only one class of stock outstanding Only one class of stock outstanding Must be a domestic corporation Must be a domestic corporation Must operate on a calendar year basis Must operate on a calendar year basis No nonresident alien stockholders No nonresident alien stockholders All shareholders must consent to having the corporation taxed as a partnership All shareholders must consent to having the corporation taxed as a partnership

Corporations- “S” Corp  Tax Reasons for “S” Corp. Corporation is losing money- Valuable to have losses flow through to individual tax return, but only valuable if have other personal income to offset against. Losses are limited to basis. Basis is stock investment and loans to corporation Corporation is losing money- Valuable to have losses flow through to individual tax return, but only valuable if have other personal income to offset against. Losses are limited to basis. Basis is stock investment and loans to corporation Corporation is highly profitable - Although double taxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since no corporate level tax Corporation is highly profitable - Although double taxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since no corporate level tax  Tax Reasons for “S” Corp. Corporation is losing money- Valuable to have losses flow through to individual tax return, but only valuable if have other personal income to offset against. Losses are limited to basis. Basis is stock investment and loans to corporation Corporation is losing money- Valuable to have losses flow through to individual tax return, but only valuable if have other personal income to offset against. Losses are limited to basis. Basis is stock investment and loans to corporation Corporation is highly profitable - Although double taxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since no corporate level tax Corporation is highly profitable - Although double taxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since no corporate level tax

Corporations- Preincorporation  Promoters (also called Preincorporators) - persons who bring the corporation into being by pre- incorporation actions Has personal liability for pre-incorporation contracts (corporations may later adopt same) Has personal liability for pre-incorporation contracts (corporations may later adopt same) Not agents of corporation or shareholders Not agents of corporation or shareholders But have fiduciary duties to both (e.g. full disclose, dealing in good faith, etc.) But have fiduciary duties to both (e.g. full disclose, dealing in good faith, etc.) May be paid for reasonable charges May be paid for reasonable charges May be paid with shares May be paid with shares  Promoters (also called Preincorporators) - persons who bring the corporation into being by pre- incorporation actions Has personal liability for pre-incorporation contracts (corporations may later adopt same) Has personal liability for pre-incorporation contracts (corporations may later adopt same) Not agents of corporation or shareholders Not agents of corporation or shareholders But have fiduciary duties to both (e.g. full disclose, dealing in good faith, etc.) But have fiduciary duties to both (e.g. full disclose, dealing in good faith, etc.) May be paid for reasonable charges May be paid for reasonable charges May be paid with shares May be paid with shares

Corporations-Preincorporation  Incorporators - those who sign the articles of incorporation and deliver them to the state May be a single person May be a single person May be an attorney May be an attorney  Incorporators - those who sign the articles of incorporation and deliver them to the state May be a single person May be a single person May be an attorney May be an attorney

Corporations-Preincorporation  Shareholder Agreements should address: Conflicts of Interest Conflicts of Interest Key Man (e.g. Life Insurance) Key Man (e.g. Life Insurance) Buy/Sell (e.g. Right of First Refusal to Purchase Shares) Buy/Sell (e.g. Right of First Refusal to Purchase Shares) Profit Allocation Profit Allocation Indemnification Indemnification  Shareholder Agreements should address: Conflicts of Interest Conflicts of Interest Key Man (e.g. Life Insurance) Key Man (e.g. Life Insurance) Buy/Sell (e.g. Right of First Refusal to Purchase Shares) Buy/Sell (e.g. Right of First Refusal to Purchase Shares) Profit Allocation Profit Allocation Indemnification Indemnification

11-49 Incorporation  Steps Select Where to Incorporate Select Where to Incorporate Prepare Articles Prepare Articles Sign/Authenticate Articles Sign/Authenticate Articles File Articles File Articles Receive Certificate Receive Certificate Hold Initial Meeting Hold Initial Meeting  Steps Select Where to Incorporate Select Where to Incorporate Prepare Articles Prepare Articles Sign/Authenticate Articles Sign/Authenticate Articles File Articles File Articles Receive Certificate Receive Certificate Hold Initial Meeting Hold Initial Meeting

11-50 Corporations-Incorporation  Where to incorporate Businesses can incorporate in any state they choose. Businesses can incorporate in any state they choose. Some states offer fewer restrictions, lower taxes & fees, and other benefits to attract businesses to incorporate with their state. Some states offer fewer restrictions, lower taxes & fees, and other benefits to attract businesses to incorporate with their state. Internet businesses present a sales tax collection problem for states in which these businesses have no physical presence. Internet businesses present a sales tax collection problem for states in which these businesses have no physical presence.  Where to incorporate Businesses can incorporate in any state they choose. Businesses can incorporate in any state they choose. Some states offer fewer restrictions, lower taxes & fees, and other benefits to attract businesses to incorporate with their state. Some states offer fewer restrictions, lower taxes & fees, and other benefits to attract businesses to incorporate with their state. Internet businesses present a sales tax collection problem for states in which these businesses have no physical presence. Internet businesses present a sales tax collection problem for states in which these businesses have no physical presence.

11-51 Corporations-Incorporation  Issues to Consider when Selecting a State of Inc. How many incorporators are required by the state, and whether the incorporator itself can be a corporation. How many incorporators are required by the state, and whether the incorporator itself can be a corporation. The minimum number of people required to form the corporation. The minimum number of people required to form the corporation. The minimum capital requirement, if any. The minimum capital requirement, if any. The state's fees for filing the articles of incorporation. The state's fees for filing the articles of incorporation. The state's annual corporate franchise tax. The state's annual corporate franchise tax. The state's corporate income tax and whether earnings from operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these taxes should not be an issue. The state's corporate income tax and whether earnings from operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these taxes should not be an issue.  Issues to Consider when Selecting a State of Inc. How many incorporators are required by the state, and whether the incorporator itself can be a corporation. How many incorporators are required by the state, and whether the incorporator itself can be a corporation. The minimum number of people required to form the corporation. The minimum number of people required to form the corporation. The minimum capital requirement, if any. The minimum capital requirement, if any. The state's fees for filing the articles of incorporation. The state's fees for filing the articles of incorporation. The state's annual corporate franchise tax. The state's annual corporate franchise tax. The state's corporate income tax and whether earnings from operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these taxes should not be an issue. The state's corporate income tax and whether earnings from operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these taxes should not be an issue.

11-52 Corporations-Incorporation  Issues to Consider when Selecting a State of Inc. (Cont.) Whether the corporation is allowed to keep its books and records outside the state. Whether the corporation is allowed to keep its books and records outside the state. The state's court system's reputation of fairness in business cases. The state's court system's reputation of fairness in business cases. Whether the corporation is allowed to have its principal place of business outside the state. Whether the corporation is allowed to have its principal place of business outside the state. Whether there is a state inheritance tax on non-resident shareholders. Whether there is a state inheritance tax on non-resident shareholders. Disclosure/privacy - whether the state requires public disclosure of the names of shareholders. Disclosure/privacy - whether the state requires public disclosure of the names of shareholders. Whether the state requires a corporate bank account in that state (Delaware does not). Whether the state requires a corporate bank account in that state (Delaware does not).  Issues to Consider when Selecting a State of Inc. (Cont.) Whether the corporation is allowed to keep its books and records outside the state. Whether the corporation is allowed to keep its books and records outside the state. The state's court system's reputation of fairness in business cases. The state's court system's reputation of fairness in business cases. Whether the corporation is allowed to have its principal place of business outside the state. Whether the corporation is allowed to have its principal place of business outside the state. Whether there is a state inheritance tax on non-resident shareholders. Whether there is a state inheritance tax on non-resident shareholders. Disclosure/privacy - whether the state requires public disclosure of the names of shareholders. Disclosure/privacy - whether the state requires public disclosure of the names of shareholders. Whether the state requires a corporate bank account in that state (Delaware does not). Whether the state requires a corporate bank account in that state (Delaware does not).

11-53 Corporations-Incorporation  Delaware- Delaware often is the preferred state of incorporation. Initially, Delaware gave management better rights in the event of a takeover, so in the 1940's and 1950's many corporations moved there. Delaware set up a court system that has expertise in commercial transactions and well-developed corporate law (equals predictability). Other states improved their corporate legal systems, but virtually every corporate attorney is familiar with Delaware law. Delaware also has the Delaware Asset Protection Trust, which permits one to set up a trust that cannot be touched by creditors but that allows one to get one's money. Most other states require irrevocable trusts that prevent one from accessing one's money once it is in the trust. The state of Alaska responded with a similar trust, but added spouses and children to the list of creditors that could not get at the money in the trust. Delaware responded likewise.

11-54 Corporations-Incorporation  Delaware v. Nevada- Taxes on corporate earnings: Delaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned. Taxes on corporate earnings: Delaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned. Annual franchise tax: Delaware and most other states have an annual franchise tax on corporations. Nevada does not. Annual franchise tax: Delaware and most other states have an annual franchise tax on corporations. Nevada does not. Annual disclosure: Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person. Annual disclosure: Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person. Protection of officers and directors: Nevada provides broader protection against personal liability of officers and directors than does Delaware. Protection of officers and directors: Nevada provides broader protection against personal liability of officers and directors than does Delaware.  Delaware v. Nevada- Taxes on corporate earnings: Delaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned. Taxes on corporate earnings: Delaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned. Annual franchise tax: Delaware and most other states have an annual franchise tax on corporations. Nevada does not. Annual franchise tax: Delaware and most other states have an annual franchise tax on corporations. Nevada does not. Annual disclosure: Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person. Annual disclosure: Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person. Protection of officers and directors: Nevada provides broader protection against personal liability of officers and directors than does Delaware. Protection of officers and directors: Nevada provides broader protection against personal liability of officers and directors than does Delaware.

11-55 Corporations-Incorporation  Delaware v. Nevada- (Cont.) Shareholder disclosure: Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate. Shareholder disclosure: Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate.  Delaware v. Nevada- (Cont.) Shareholder disclosure: Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate. Shareholder disclosure: Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate.

11-56 Corporations-Incorporation  Delaware v. Nevada (Cont.) Disclosure to IRS: Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business purposes. Disclosure to IRS: Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business purposes. Note: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it at least is worth considering. Note: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it at least is worth considering.  Delaware v. Nevada (Cont.) Disclosure to IRS: Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business purposes. Disclosure to IRS: Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business purposes. Note: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it at least is worth considering. Note: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it at least is worth considering.

11-57 Corporations-Incorporation  Advantage of Incorporating in One's Own State If the company does not plan to obtain venture capital funding, it may be best to incorporate in the state in which the company plans to do business. Doing so has the following advantages: If the company does not plan to obtain venture capital funding, it may be best to incorporate in the state in which the company plans to do business. Doing so has the following advantages: Local attorneys are familiar with the local law Local attorneys are familiar with the local law One can have an intrastate securities law exemption. One can have an intrastate securities law exemption. There is the convenience of geographical proximity. There is the convenience of geographical proximity. The corporation does not need to register as a "foreign" corporation in the state of operation if it is incorporated there. The corporation does not need to register as a "foreign" corporation in the state of operation if it is incorporated there.  Advantage of Incorporating in One's Own State If the company does not plan to obtain venture capital funding, it may be best to incorporate in the state in which the company plans to do business. Doing so has the following advantages: If the company does not plan to obtain venture capital funding, it may be best to incorporate in the state in which the company plans to do business. Doing so has the following advantages: Local attorneys are familiar with the local law Local attorneys are familiar with the local law One can have an intrastate securities law exemption. One can have an intrastate securities law exemption. There is the convenience of geographical proximity. There is the convenience of geographical proximity. The corporation does not need to register as a "foreign" corporation in the state of operation if it is incorporated there. The corporation does not need to register as a "foreign" corporation in the state of operation if it is incorporated there.

11-58 Articles of Incorporation- Contents  Mandatory Elements Name of Corporation Name of Corporation # Shares of Capital Stock Authorized to Issue # Shares of Capital Stock Authorized to Issue Address of Registered Office/Name Registered Agent (for service of process) Address of Registered Office/Name Registered Agent (for service of process) Name/Address of Incorporator Name/Address of Incorporator  See N.C. Blank Form  Generally should keep to a minimum because must file amendments to change  Mandatory Elements Name of Corporation Name of Corporation # Shares of Capital Stock Authorized to Issue # Shares of Capital Stock Authorized to Issue Address of Registered Office/Name Registered Agent (for service of process) Address of Registered Office/Name Registered Agent (for service of process) Name/Address of Incorporator Name/Address of Incorporator  See N.C. Blank Form  Generally should keep to a minimum because must file amendments to change

Corporations - Incorporation  Other Requirements Meetings Meetings Corporate Seal Corporate Seal Bylaws Bylaws  Other Requirements Meetings Meetings Corporate Seal Corporate Seal Bylaws Bylaws

Corporations - Defective Incorporation  De Jure v. De Facto Substantial compliance with all steps of the incorporation process = De Jure Substantial compliance with all steps of the incorporation process = De Jure If serious defect, but good faith effort and exercise of powers, may be found to be De Facto. If serious defect, but good faith effort and exercise of powers, may be found to be De Facto.  De Jure v. De Facto Substantial compliance with all steps of the incorporation process = De Jure Substantial compliance with all steps of the incorporation process = De Jure If serious defect, but good faith effort and exercise of powers, may be found to be De Facto. If serious defect, but good faith effort and exercise of powers, may be found to be De Facto.

Corporations - Duties  Ultra vires doctrine: shareholders could sue managers for embarking on projects contrary to the corporate purpose.  However this doctrine is in decline because of the broad interpretation of the Business Judgement Rule which shields some managerial actions from substantive review by courts (especially in Delaware)  Ultra vires doctrine: shareholders could sue managers for embarking on projects contrary to the corporate purpose.  However this doctrine is in decline because of the broad interpretation of the Business Judgement Rule which shields some managerial actions from substantive review by courts (especially in Delaware)

11-62 Corporations- Dissolution  Types of Voluntary Dissolution End at specified time found in Articles End at specified time found in Articles Written consent of all shareholders Written consent of all shareholders Majority Vote of shareholders at a special meeting Majority Vote of shareholders at a special meeting Merger or consolidation Merger or consolidation Vote of majority of incorporators if corporation has not begun business Vote of majority of incorporators if corporation has not begun business  Types of Voluntary Dissolution End at specified time found in Articles End at specified time found in Articles Written consent of all shareholders Written consent of all shareholders Majority Vote of shareholders at a special meeting Majority Vote of shareholders at a special meeting Merger or consolidation Merger or consolidation Vote of majority of incorporators if corporation has not begun business Vote of majority of incorporators if corporation has not begun business

11-63 Board of Directors  Powers/Duties General General Actions Requiring Initiative Actions Requiring Initiative  Online Communications  Powers/Rights of Director as an Individual  Compensation  Powers/Duties General General Actions Requiring Initiative Actions Requiring Initiative  Online Communications  Powers/Rights of Director as an Individual  Compensation  Election Number Number Qualifications Qualifications Nomination Nomination Term Term Vacancies Vacancies  Removal  Meetings

Board of Directors  In most jurisdictions, the board acting alone can: Declare a dividend Declare a dividend Establish the price for sale of shares Establish the price for sale of shares Elect and remove officers Elect and remove officers Fill vacancies on the Board Fill vacancies on the Board Sell, lease or mortgage assets outside the normal course of business Sell, lease or mortgage assets outside the normal course of business  In most jurisdictions, the board acting alone can: Declare a dividend Declare a dividend Establish the price for sale of shares Establish the price for sale of shares Elect and remove officers Elect and remove officers Fill vacancies on the Board Fill vacancies on the Board Sell, lease or mortgage assets outside the normal course of business Sell, lease or mortgage assets outside the normal course of business

Board of Directors  Actions by Board Initiative are regarded as proposals for shareholder approval  Shareholders must all approve certain extraordinary actions such as amendment of articles, mergers, sale or lease of substantially all assets or dissolution  Actions by Board Initiative are regarded as proposals for shareholder approval  Shareholders must all approve certain extraordinary actions such as amendment of articles, mergers, sale or lease of substantially all assets or dissolution

Board of Directors  Recent statutes in many jurisdictions now allow directors to communicate and conduct business electronically. But, not allow electronic board meetings But, not allow electronic board meetings  Why the distinction?  Recent statutes in many jurisdictions now allow directors to communicate and conduct business electronically. But, not allow electronic board meetings But, not allow electronic board meetings  Why the distinction?

Board of Directors  There are statutory and/or bylaw requirements for qualification, nomination, election, term, vacancy filling, removal or directors and officers as well as for meeting frequency, notice, formality, quorum

Board of Directors  Is it realistic to expect directors to “manage” the corporation, or should their role be viewed as one of more of monitoring/evaluating the actions of corporate officers?

Board of Directors  The Board only has authority to act for the corporation as a group  Most state law mandates directors must act in the best interests of the corporation and its shareholders Courts have generally interpreted this to mean maximizing share price. Courts have generally interpreted this to mean maximizing share price. Is what’s best for the share price always what’s best for the company? Is what’s best for the share price always what’s best for the company?  The Board only has authority to act for the corporation as a group  Most state law mandates directors must act in the best interests of the corporation and its shareholders Courts have generally interpreted this to mean maximizing share price. Courts have generally interpreted this to mean maximizing share price. Is what’s best for the share price always what’s best for the company? Is what’s best for the share price always what’s best for the company?

11-70 Officers of Corporation  Powers  President/Chairman- ex officio  Vice President  Corporate Secretary  Treasurer  Powers  President/Chairman- ex officio  Vice President  Corporate Secretary  Treasurer

Officers  Ex-officio authority = authority by virtue of office  Often a good idea to have an Assistant Treasurer and/or Assistant Secretary for reasons of expediency  Ex-officio authority = authority by virtue of office  Often a good idea to have an Assistant Treasurer and/or Assistant Secretary for reasons of expediency

11-72 Duties Directors/Officers  Act Within Authority  Due Care and Diligence Prudent Person Prudent Person Business Judgment Business Judgment Increased Director Liability Increased Director Liability  Act Within Authority  Due Care and Diligence Prudent Person Prudent Person Business Judgment Business Judgment Increased Director Liability Increased Director Liability  Loyalty/Good Faith Self-Dealing Self-Dealing Usurp Usurp Freeze-Outs, etc. Freeze-Outs, etc. Inside Information Inside Information  Right to Dissent

11-73 Duties Directors/Officers  Optional limitations on liability Charter Option Statute (breach of duty) Charter Option Statute (breach of duty) Self-Executing Statute (willful or reckless) Self-Executing Statute (willful or reckless) Cap on Money Damages Cap on Money Damages  Why should the law permit any of these?  Optional limitations on liability Charter Option Statute (breach of duty) Charter Option Statute (breach of duty) Self-Executing Statute (willful or reckless) Self-Executing Statute (willful or reckless) Cap on Money Damages Cap on Money Damages  Why should the law permit any of these?

11-74 Duties Directors/Officers  Indemnification Mandatory (acting in good faith, pre- existing agreement) Mandatory (acting in good faith, pre- existing agreement) Permissible (good faith, believed best interest, unaware illegal, disinterested agree) Permissible (good faith, believed best interest, unaware illegal, disinterested agree) Impermissible (liable or bad faith or violate fed. Securities law) Impermissible (liable or bad faith or violate fed. Securities law)  Indemnification Mandatory (acting in good faith, pre- existing agreement) Mandatory (acting in good faith, pre- existing agreement) Permissible (good faith, believed best interest, unaware illegal, disinterested agree) Permissible (good faith, believed best interest, unaware illegal, disinterested agree) Impermissible (liable or bad faith or violate fed. Securities law) Impermissible (liable or bad faith or violate fed. Securities law)

Corporate Governance  “Directors can be out of touch with a company's business and can fall prey to the temptation to simply be polite to a chief executive while Rome is burning. A code of silence develops in the boardroom. By the time someone is willing to speak up, the company is in deep trouble.” - Bill George, Former CEO, Medtronic Corp. in "Authentic Leadership: Rediscovering the Secrets to Creating Lasting Value," Jossey-Bass/Wiley, 2003.

Corporate Governance  The Board of Directors of Worldcom reportedly allowed CEO Bernie Ebbers to rule “practically unchecked”, generally “rubber-stamping” his decisions. Their audits “rarely scratched below the surface” and they approved multibillion dollar mergers and acquisitions “with little discussion.” (Report: Worldcom board passive, Jim Hopkins, USA Today, June 10, 2003, p. 3B)

Corporate Governance  First Board usually appointed by incorporators  Who nominates/elects the board thereafter? Typically the Executive Officers by Proxy Elections Typically the Executive Officers by Proxy Elections  First Board usually appointed by incorporators  Who nominates/elects the board thereafter? Typically the Executive Officers by Proxy Elections Typically the Executive Officers by Proxy Elections

11-78 Make-up of Corporate Boards  Retired officer of another firm89%  CEO at another company87%  Major company shareholder73%  Ex-government official53%  Academicians50% Corporate boards average 11 Directors. Most Directors by percentage are:

Corporate Governance  But, on April 14, 2003, the SEC said it would review rules that make it tough for shareholders to nominate directors to corporate boards. SEC Chairman William Donaldson asked staffers to come with recommendations to make it easier for shareholders to run their own candidates. Changes may be adopted in time for the 2004 proxy season.

Corporate Governance  Criteria for Who should sit on the Board of Directors? Competence? Competence? Knowledge of/Experience in, the industry? Knowledge of/Experience in, the industry? General business knowledge/experience? General business knowledge/experience? Note: One of the requirements of Sarbanes- Oxley is that a company must have individuals who are certified financial experts on the board. Note: One of the requirements of Sarbanes- Oxley is that a company must have individuals who are certified financial experts on the board.  Criteria for Who should sit on the Board of Directors? Competence? Competence? Knowledge of/Experience in, the industry? Knowledge of/Experience in, the industry? General business knowledge/experience? General business knowledge/experience? Note: One of the requirements of Sarbanes- Oxley is that a company must have individuals who are certified financial experts on the board. Note: One of the requirements of Sarbanes- Oxley is that a company must have individuals who are certified financial experts on the board.

Corporate Governance  Independence? Inside vs. Outside Inside vs. Outside  Self-Interest (Good or Bad?)  Some corporate bylaws require board members to be shareholders  Should the company maintain a certain % of independent directors? If so, what %?  Independence? Inside vs. Outside Inside vs. Outside  Self-Interest (Good or Bad?)  Some corporate bylaws require board members to be shareholders  Should the company maintain a certain % of independent directors? If so, what %?

Corporate Governance  Independence? In Britain, the 1992 Cadbury Committee report recommended that boards of directors of public companies include at least 3 outside directors as members and that the CEO and chairman posts be held by different individuals. In Britain, the 1992 Cadbury Committee report recommended that boards of directors of public companies include at least 3 outside directors as members and that the CEO and chairman posts be held by different individuals.  Independence? In Britain, the 1992 Cadbury Committee report recommended that boards of directors of public companies include at least 3 outside directors as members and that the CEO and chairman posts be held by different individuals. In Britain, the 1992 Cadbury Committee report recommended that boards of directors of public companies include at least 3 outside directors as members and that the CEO and chairman posts be held by different individuals.

Corporate Governance  Should There be Pluralism on Board (interest group reps. e.g. Labor, Environmental, Consumer Watchdogs, etc.)? e.g. Volkswagon’s “Group Works” Council e.g. Volkswagon’s “Group Works” Council  Should There be Pluralism on Board (interest group reps. e.g. Labor, Environmental, Consumer Watchdogs, etc.)? e.g. Volkswagon’s “Group Works” Council e.g. Volkswagon’s “Group Works” Council

Corporate Governance  Ethical Orientation? - C-bridge, a rapidly emerging leader among Internet-based business solution providers, appointed to Joseph L. Badaracco, Jr., Professor of Business Ethics at the Harvard Business School to its Board.

Corporate Governance  Should a Chairman of the Board & CEO be the same person? In the UK, the role of chairman of the board and CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman. In the UK, the role of chairman of the board and CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman. However, recent studies suggest that companies in which the chairman and CEO positions are held by two different people perform no better than companies in which the roles are combined. In other words, it’s no guarantee against future scandals. However, recent studies suggest that companies in which the chairman and CEO positions are held by two different people perform no better than companies in which the roles are combined. In other words, it’s no guarantee against future scandals.  Should a Chairman of the Board & CEO be the same person? In the UK, the role of chairman of the board and CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman. In the UK, the role of chairman of the board and CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman. However, recent studies suggest that companies in which the chairman and CEO positions are held by two different people perform no better than companies in which the roles are combined. In other words, it’s no guarantee against future scandals. However, recent studies suggest that companies in which the chairman and CEO positions are held by two different people perform no better than companies in which the roles are combined. In other words, it’s no guarantee against future scandals.

Executive Compensation  Is CEO Compensa tion Fair?

Executive Compensation  The traditional argument is that executive responsibilities and skills call for higher salaries (e.g. Michael Capellas recently received judicial approval for “scaled down” $20 million 3 year pay package. This was 23% below originally proposed package. The judge called the package “fair and eminently reasonable”. The company had difficulty attracting candidates. Capellas will make less than could have earned elsewhere.)

Executive Compensation  According to the judge, the package was “Quite startling in its magnitude but reasonable for a management challenge that was unprecedented. The challenge, to save tens of thousands of jobs and satisfy tens of millions of customers.”

Executive Compensation  According to Richard Lambert, Accounting Professor at Wharton Business School, if the level of executive compensation is put in the context of overall company finances, it seems less of a problem. Compared with the value of most public companies, the amount of money being given to executives is not that large. “Even if you cut the CEO’s salary in half, the effect on shareholder wealth would be very small.”

Executive Compensation  If a company does well or poorly, to what extent is the CEO responsible for this? It's clear that CEOs' pay has risen far faster than the corporate profits they're paid to generate. Profits rose 78% in the last decade, much less than the 212% increase in CEO pay over the same period. It's clear that CEOs' pay has risen far faster than the corporate profits they're paid to generate. Profits rose 78% in the last decade, much less than the 212% increase in CEO pay over the same period.  If a company does well or poorly, to what extent is the CEO responsible for this? It's clear that CEOs' pay has risen far faster than the corporate profits they're paid to generate. Profits rose 78% in the last decade, much less than the 212% increase in CEO pay over the same period. It's clear that CEOs' pay has risen far faster than the corporate profits they're paid to generate. Profits rose 78% in the last decade, much less than the 212% increase in CEO pay over the same period.

Executive Compensation  The chief executives at 23 corporations under investigation for improper accounting pocketed $1.4 billion, or an average of $62 million each, in the last three years. Meanwhile, their companies' stock values plunged $530 billion, or about 73% of their total value, and their companies laid off a total of 162,000 workers.

Executive Compensation  The Financial Times recently reported on a study of what they called “The Barons of Bankruptcy” – a privileged group of top business leaders who made extraordinary fortunes even as their companies were heading for disaster. They examined the largest 25 business collapses since the start of last year and, according to their figures, the executives and directors of these doomed companies walked away with over $3.3 billion in compensation and proceeds from stock sales.

Executive Compensation  Revenue at Tyco's electronics unit fell from $13.6 billion in fiscal 2001 to $10.5 billion in the following year. Nevertheless, division president Juergen W. Gromer earned a bonus of almost $3.4 million. Gromer's salary was increased by $35,500, to $695,500. In the previous year, Gromer earned a bonus of $6.85 million.

Executive Compensation  Former Kmart CEO Charles Conaway received nearly $23 million in compensation during his 2-year tenure. When Kmart filed for bankruptcy in 2002, 283 stores were closed and 22,000 employees lost their jobs. Their total severance pay: $0.

Executive Compensation  In 2002, the total compensation of CEO Scott McNealy of Sun Microsystems, rose 31% to $31.7 million while his shareholders’ return plunged 74.7%, according to Equilar, an independent provider of compensation data.

Executive Compensation  At Honeywell, CEO David Cote made $68.5 million, about 80% of which was a sign-on bonus for taking over the top job in February 2002. Meanwhile, Honeywell shareholders saw the value of their investments slide by 27.3%.

Executive Compensation  Steve Jobs of Apple Computer, pulled in $78.1 million while his investors’ return slumped by 34.6%.  In 2002, while the S&P 500 plunged 22%, median CEO compensation rose 14%.  Bottom Line: There is little correlation between pay and performance, no linkage  Steve Jobs of Apple Computer, pulled in $78.1 million while his investors’ return slumped by 34.6%.  In 2002, while the S&P 500 plunged 22%, median CEO compensation rose 14%.  Bottom Line: There is little correlation between pay and performance, no linkage

Executive Compensation  Executive vs. Worker Pay Disparity 20 years ago the CEO got about 40 times what the average worker did. It's now, according to them, 541 times. 20 years ago the CEO got about 40 times what the average worker did. It's now, according to them, 541 times. The earnings of CEO's have grown 10 times faster than those of the average worker. The earnings of CEO's have grown 10 times faster than those of the average worker.  Executive vs. Worker Pay Disparity 20 years ago the CEO got about 40 times what the average worker did. It's now, according to them, 541 times. 20 years ago the CEO got about 40 times what the average worker did. It's now, according to them, 541 times. The earnings of CEO's have grown 10 times faster than those of the average worker. The earnings of CEO's have grown 10 times faster than those of the average worker.

Executive Compensation  Executive vs. Worker Pay Disparity Among Fortune 500 companies CEOs earn more than 100 times the average employee’s salary. Among Fortune 500 companies CEOs earn more than 100 times the average employee’s salary. Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions. Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions. 60% of managers recently surveyed said CEOs make too much. 60% of managers recently surveyed said CEOs make too much. 64% of respondents to a recent SHRM online poll indicated that they did not believe that executive pay in their organization was in line in comparison to pay in the rest of the organization. 64% of respondents to a recent SHRM online poll indicated that they did not believe that executive pay in their organization was in line in comparison to pay in the rest of the organization.  Executive vs. Worker Pay Disparity Among Fortune 500 companies CEOs earn more than 100 times the average employee’s salary. Among Fortune 500 companies CEOs earn more than 100 times the average employee’s salary. Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions. Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions. 60% of managers recently surveyed said CEOs make too much. 60% of managers recently surveyed said CEOs make too much. 64% of respondents to a recent SHRM online poll indicated that they did not believe that executive pay in their organization was in line in comparison to pay in the rest of the organization. 64% of respondents to a recent SHRM online poll indicated that they did not believe that executive pay in their organization was in line in comparison to pay in the rest of the organization.

Executive Compensation  Executive vs. Worker Pay Disparity Hershey CEO Richard Lenny was paid more than $22 million last year. An average union worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensation could support 598 of these average workers. Hershey employees went on strike earlier this year when management doubled the cost of co-payments for health care. Hershey CEO Richard Lenny was paid more than $22 million last year. An average union worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensation could support 598 of these average workers. Hershey employees went on strike earlier this year when management doubled the cost of co-payments for health care.  Executive vs. Worker Pay Disparity Hershey CEO Richard Lenny was paid more than $22 million last year. An average union worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensation could support 598 of these average workers. Hershey employees went on strike earlier this year when management doubled the cost of co-payments for health care. Hershey CEO Richard Lenny was paid more than $22 million last year. An average union worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensation could support 598 of these average workers. Hershey employees went on strike earlier this year when management doubled the cost of co-payments for health care.

Executive Compensation  Executive vs. Worker Pay Disparity Gaps between exec/worker increasing. Gaps between exec/worker increasing. The growing disparity between executive compensation and that of other employees is leading to a trust gap, which threatens to seriously impair morale. The growing disparity between executive compensation and that of other employees is leading to a trust gap, which threatens to seriously impair morale. Bottom Line: When executive pay increases faster than the economy other people's share decreases. Bottom Line: When executive pay increases faster than the economy other people's share decreases.  Executive vs. Worker Pay Disparity Gaps between exec/worker increasing. Gaps between exec/worker increasing. The growing disparity between executive compensation and that of other employees is leading to a trust gap, which threatens to seriously impair morale. The growing disparity between executive compensation and that of other employees is leading to a trust gap, which threatens to seriously impair morale. Bottom Line: When executive pay increases faster than the economy other people's share decreases. Bottom Line: When executive pay increases faster than the economy other people's share decreases.

Executive Compensation  Perks/Other non-salary compensation Stock Options Stock Options  Options allow executives to buy their company's stock in the future at the current price.  After less than six months on the job, Tyco International Ltd.'s chief executive Ed Breen earned $49 million in paper profits just in his Tyco stock options, according to the company's proxy statement.  Perks/Other non-salary compensation Stock Options Stock Options  Options allow executives to buy their company's stock in the future at the current price.  After less than six months on the job, Tyco International Ltd.'s chief executive Ed Breen earned $49 million in paper profits just in his Tyco stock options, according to the company's proxy statement.

Executive Compensation  Qwest's CEO Joseph Nacchio, cashed out $300 million in stock options while the company's stock dropped from $51 a share to $8. At the same time he fired 17,000 employees and shut down a $25 million charity program.

Executive Compensation  Life insurance, pension plan, IRA, club memberships, car allowances, stock options.  Jack Welch from GE got luxury apartment, entertainment and a private jet.  “Golden parachutes”  Life insurance, pension plan, IRA, club memberships, car allowances, stock options.  Jack Welch from GE got luxury apartment, entertainment and a private jet.  “Golden parachutes”

Executive Compensation  Under his current contract, if Home Depot CEO Robert Nardelli is fired he will receive an $82 million severance package (Fortune Magazine)

Executive Compensation  SERP (supplemental executive-retirement plan) is a steroid-enhanced version of the traditional defined- benefit pension plan, in which a company sets aside a given % of an executive's pay every year to produce a guaranteed payout. SERPs are now offered by about 1/2 of all big publicly traded companies, usually only to the CEO and the next dozen or so officers. And while the combination of a collapsing stock market and low interest rates have placed pension plans for ordinary Joes in jeopardy that's not the case for top execs. In fact, now that the stock market bubble has burst, compensation experts predict that companies will actually increase their use of SERPs to pick up the slack. ” (Fortune, April 28, 2003)

Executive Compensation  How did this happen? Who usually decides on compensation packages? Who usually decides on compensation packages?  Compensation Committees of Corporate Boards Based on what? Based on what?  Fair Market Value as demonstrated by disclosed information, recommendations of executive search firms and “other” factors.  How did this happen? Who usually decides on compensation packages? Who usually decides on compensation packages?  Compensation Committees of Corporate Boards Based on what? Based on what?  Fair Market Value as demonstrated by disclosed information, recommendations of executive search firms and “other” factors.

Executive Compensation  Collusion? When most big companies name outside directors they tend to draw from a familiar pool of corporate luminaries close to home. When most big companies name outside directors they tend to draw from a familiar pool of corporate luminaries close to home. A University of Michigan Business School study determined that there is about 4.6 degrees of separation on average on corporate boards. Business is run by the “connected few”. A University of Michigan Business School study determined that there is about 4.6 degrees of separation on average on corporate boards. Business is run by the “connected few”.  Collusion? When most big companies name outside directors they tend to draw from a familiar pool of corporate luminaries close to home. When most big companies name outside directors they tend to draw from a familiar pool of corporate luminaries close to home. A University of Michigan Business School study determined that there is about 4.6 degrees of separation on average on corporate boards. Business is run by the “connected few”. A University of Michigan Business School study determined that there is about 4.6 degrees of separation on average on corporate boards. Business is run by the “connected few”.

Executive Compensation  What about the shareholders, the supposed “owners” of the corporations? Vodafone recently put executive compensation up for a shareholder vote. Vodafone recently put executive compensation up for a shareholder vote. Good idea? Good idea? This is highly unusual. This is highly unusual.  What about the shareholders, the supposed “owners” of the corporations? Vodafone recently put executive compensation up for a shareholder vote. Vodafone recently put executive compensation up for a shareholder vote. Good idea? Good idea? This is highly unusual. This is highly unusual.

Starting a Business  Limited Liability Company (L.L.C.) A hybrid form of business enterprise that offers the limited liability of the corporation but the tax advantages of a partnership A hybrid form of business enterprise that offers the limited liability of the corporation but the tax advantages of a partnership 47 States permit (including N.C.) 47 States permit (including N.C.) Separate Legal Entity like corporation Separate Legal Entity like corporation Require filing Articles of Incorporation Require filing Articles of Incorporation All investors able to share in management All investors able to share in management No restrictions on number or types of members No restrictions on number or types of members No one member has liability for wrongful acts of others (makes attractive to doctors, lawyers, etc.) No one member has liability for wrongful acts of others (makes attractive to doctors, lawyers, etc.)  Limited Liability Company (L.L.C.) A hybrid form of business enterprise that offers the limited liability of the corporation but the tax advantages of a partnership A hybrid form of business enterprise that offers the limited liability of the corporation but the tax advantages of a partnership 47 States permit (including N.C.) 47 States permit (including N.C.) Separate Legal Entity like corporation Separate Legal Entity like corporation Require filing Articles of Incorporation Require filing Articles of Incorporation All investors able to share in management All investors able to share in management No restrictions on number or types of members No restrictions on number or types of members No one member has liability for wrongful acts of others (makes attractive to doctors, lawyers, etc.) No one member has liability for wrongful acts of others (makes attractive to doctors, lawyers, etc.)

Starting a Business  Limited Liability Partnership (L.L.P.) Similar to L.L.C., but designed for professional groups who normally do business as partners Similar to L.L.C., but designed for professional groups who normally do business as partners Started to shield uninvolved professionals’ personal assets from malpractice claims Started to shield uninvolved professionals’ personal assets from malpractice claims Must maintain adequate professional liability insurance Must maintain adequate professional liability insurance  Limited Liability Partnership (L.L.P.) Similar to L.L.C., but designed for professional groups who normally do business as partners Similar to L.L.C., but designed for professional groups who normally do business as partners Started to shield uninvolved professionals’ personal assets from malpractice claims Started to shield uninvolved professionals’ personal assets from malpractice claims Must maintain adequate professional liability insurance Must maintain adequate professional liability insurance

Starting a Business  Joint Venture A joint undertaking of a specific commercial enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958) A joint undertaking of a specific commercial enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958) A joint venture is normally not a legal entity and is treated like a partnership for federal income tax purposes A joint venture is normally not a legal entity and is treated like a partnership for federal income tax purposes Normally lasts until venture is completed or becomes impossible to complete Normally lasts until venture is completed or becomes impossible to complete  Joint Venture A joint undertaking of a specific commercial enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958) A joint undertaking of a specific commercial enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958) A joint venture is normally not a legal entity and is treated like a partnership for federal income tax purposes A joint venture is normally not a legal entity and is treated like a partnership for federal income tax purposes Normally lasts until venture is completed or becomes impossible to complete Normally lasts until venture is completed or becomes impossible to complete

Starting a Business  Strategic Alliance A strategic alliance is an organizational relationship that links two or more independent business entities in a common endeavor A strategic alliance is an organizational relationship that links two or more independent business entities in a common endeavor  Strategic Alliance A strategic alliance is an organizational relationship that links two or more independent business entities in a common endeavor A strategic alliance is an organizational relationship that links two or more independent business entities in a common endeavor

Starting a Business  Franchise Business owner (franchisor), usually a corporation, allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Business owner (franchisor), usually a corporation, allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Each franchise operates as an independent business. Each franchise operates as an independent business. Franchise Agreements are often viewed as one- sided or “Contracts of Adhesion” (Body Shop Example) Franchise Agreements are often viewed as one- sided or “Contracts of Adhesion” (Body Shop Example) Clayton Act “tie-in sales” questions Clayton Act “tie-in sales” questions Sherman Act price control questions Sherman Act price control questions  Franchise Business owner (franchisor), usually a corporation, allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Business owner (franchisor), usually a corporation, allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Each franchise operates as an independent business. Each franchise operates as an independent business. Franchise Agreements are often viewed as one- sided or “Contracts of Adhesion” (Body Shop Example) Franchise Agreements are often viewed as one- sided or “Contracts of Adhesion” (Body Shop Example) Clayton Act “tie-in sales” questions Clayton Act “tie-in sales” questions Sherman Act price control questions Sherman Act price control questions

Starting a Business  Franchise (Cont.) Government disclosure requirements Government disclosure requirements Law of state of franchisor typically controls in contract disputes (e.g. Burger King, Florida) Law of state of franchisor typically controls in contract disputes (e.g. Burger King, Florida) Often “turn-key” operations Often “turn-key” operations Typically owned by a sole proprietor. Typically owned by a sole proprietor. Examples (McDonald's, Dairy Queen) Examples (McDonald's, Dairy Queen) Advantages - Proven management style, Name recognition, Strong marketing resources, Often involve financial support Advantages - Proven management style, Name recognition, Strong marketing resources, Often involve financial support Beware, overblown or “fly-by-night” franchises! Beware, overblown or “fly-by-night” franchises!  Franchise (Cont.) Government disclosure requirements Government disclosure requirements Law of state of franchisor typically controls in contract disputes (e.g. Burger King, Florida) Law of state of franchisor typically controls in contract disputes (e.g. Burger King, Florida) Often “turn-key” operations Often “turn-key” operations Typically owned by a sole proprietor. Typically owned by a sole proprietor. Examples (McDonald's, Dairy Queen) Examples (McDonald's, Dairy Queen) Advantages - Proven management style, Name recognition, Strong marketing resources, Often involve financial support Advantages - Proven management style, Name recognition, Strong marketing resources, Often involve financial support Beware, overblown or “fly-by-night” franchises! Beware, overblown or “fly-by-night” franchises!

Starting a Business  Types of Franchises Distributorship- Dealer is allowed to sell a product produced by a manufacturer. Distributorship- Dealer is allowed to sell a product produced by a manufacturer. Chain-Style Business - Firm is allowed to use the trade name of a company and follows guidelines related to the pricing and sale of the product. Chain-Style Business - Firm is allowed to use the trade name of a company and follows guidelines related to the pricing and sale of the product. Manufacturing Arrangement- Firm is allowed to manufacture a product using the formula provided by the franchisor Manufacturing Arrangement- Firm is allowed to manufacture a product using the formula provided by the franchisor  Types of Franchises Distributorship- Dealer is allowed to sell a product produced by a manufacturer. Distributorship- Dealer is allowed to sell a product produced by a manufacturer. Chain-Style Business - Firm is allowed to use the trade name of a company and follows guidelines related to the pricing and sale of the product. Chain-Style Business - Firm is allowed to use the trade name of a company and follows guidelines related to the pricing and sale of the product. Manufacturing Arrangement- Firm is allowed to manufacture a product using the formula provided by the franchisor Manufacturing Arrangement- Firm is allowed to manufacture a product using the formula provided by the franchisor

Starting a Business  Cooperatives Group of 2 or more independent persons that cooperate for a common objective (e.g. farmers pooling produce for sale) Group of 2 or more independent persons that cooperate for a common objective (e.g. farmers pooling produce for sale)  Cooperatives Group of 2 or more independent persons that cooperate for a common objective (e.g. farmers pooling produce for sale) Group of 2 or more independent persons that cooperate for a common objective (e.g. farmers pooling produce for sale)

Starting a Business  Factors in Selecting a Form Liability Liability Tax Treatment Tax Treatment Formalities/Complexity Formalities/Complexity Access to Funds/Financing Access to Funds/Financing Distribution of Profits/Losses Distribution of Profits/Losses Management/Control Management/Control Lifecycle Lifecycle Liquidity/Ease of Transfer Liquidity/Ease of Transfer Privacy Privacy Fringe Benefits Fringe Benefits  Factors in Selecting a Form Liability Liability Tax Treatment Tax Treatment Formalities/Complexity Formalities/Complexity Access to Funds/Financing Access to Funds/Financing Distribution of Profits/Losses Distribution of Profits/Losses Management/Control Management/Control Lifecycle Lifecycle Liquidity/Ease of Transfer Liquidity/Ease of Transfer Privacy Privacy Fringe Benefits Fringe Benefits

Starting a Business  Liability Why Limit Liability? Why Limit Liability?  Incentive to Invest  Lawsuits Can’t insurance cover liability? Can’t insurance cover liability? Personal Guarantees/Co-Signing Can Expand/Reimpose Liability (Often required by lenders, especially with new, small companies) Personal Guarantees/Co-Signing Can Expand/Reimpose Liability (Often required by lenders, especially with new, small companies)  Liability Why Limit Liability? Why Limit Liability?  Incentive to Invest  Lawsuits Can’t insurance cover liability? Can’t insurance cover liability? Personal Guarantees/Co-Signing Can Expand/Reimpose Liability (Often required by lenders, especially with new, small companies) Personal Guarantees/Co-Signing Can Expand/Reimpose Liability (Often required by lenders, especially with new, small companies)

Starting a Business  Liability Sole Proprietor Sole Proprietor  Sole and complete unlimited liability General Partnership General Partnership  Joint liability for debts and contracts (“in the ordinary course of business”, Help instill v. Regions Bank, Texas Court of Appeals, 2000, 33 S.W.3d 401)  Joint and several unlimited liability for torts (unless “marshalling” requirement Marshalling = liabilities first paid out of the partnership assets Marshalling = liabilities first paid out of the partnership assets  Liability Sole Proprietor Sole Proprietor  Sole and complete unlimited liability General Partnership General Partnership  Joint liability for debts and contracts (“in the ordinary course of business”, Help instill v. Regions Bank, Texas Court of Appeals, 2000, 33 S.W.3d 401)  Joint and several unlimited liability for torts (unless “marshalling” requirement Marshalling = liabilities first paid out of the partnership assets Marshalling = liabilities first paid out of the partnership assets

Starting a Business  Partnership Liability  Orel Koelling was a partner in a partnership that employed Martin Martinez. Mr. Martinez died as the result of an accident which occurred in the course of the partnership's business. Mrs. Martinez filed suit against Koelling to recover for her husband's death. Koelling moved for summary judgment on the grounds that the partnership was the employer and liable, if anyone was. Issue: Should Koelling be dismissed from this litigation? Held: No. Partners are jointly and severally liable for the actions of the partnership. Thus, Koelling, as a partner, was a proper defendant. Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).  Partnership Liability  Orel Koelling was a partner in a partnership that employed Martin Martinez. Mr. Martinez died as the result of an accident which occurred in the course of the partnership's business. Mrs. Martinez filed suit against Koelling to recover for her husband's death. Koelling moved for summary judgment on the grounds that the partnership was the employer and liable, if anyone was. Issue: Should Koelling be dismissed from this litigation? Held: No. Partners are jointly and severally liable for the actions of the partnership. Thus, Koelling, as a partner, was a proper defendant. Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).

Starting a Business  Liability (Cont.) Limited Partnership Limited Partnership  Some partners have personal liability that is limited to the cash or property they invested in the firm. One or more general partners who actively manage the business, receive a salary, share in profits and losses, have unlimited liability. Limited Liability Partnership Limited Liability Partnership  Unlimited liability for general obligations, limited for malpractice Corporation, S Corporation, Limited Liability Corporation Corporation, S Corporation, Limited Liability Corporation  Liability limited to the assets of the Corporation  Liability (Cont.) Limited Partnership Limited Partnership  Some partners have personal liability that is limited to the cash or property they invested in the firm. One or more general partners who actively manage the business, receive a salary, share in profits and losses, have unlimited liability. Limited Liability Partnership Limited Liability Partnership  Unlimited liability for general obligations, limited for malpractice Corporation, S Corporation, Limited Liability Corporation Corporation, S Corporation, Limited Liability Corporation  Liability limited to the assets of the Corporation

Starting a Business  Taxation Sole Proprietor Sole Proprietor  Reports profits on personal income tax return Partnership/”S”Corp./L.L.C./L.L.P. Partnership/”S”Corp./L.L.C./L.L.P.  Pass through (not taxed at business entity level) - Personal earnings received from the partnership are subject to personal income taxes. “C” Corporation “C” Corporation  “Double Taxation” - Corporation pays tax on its income and Shareholders pay income tax on dividends (Possible solution: Don’t pay dividends. Profits can be paid out as salary or other forms of deductible compensation) “Income Splitting” “Income Splitting”  Always good idea to seek advice of Accountant or Tax Attorney on this!  Taxation Sole Proprietor Sole Proprietor  Reports profits on personal income tax return Partnership/”S”Corp./L.L.C./L.L.P. Partnership/”S”Corp./L.L.C./L.L.P.  Pass through (not taxed at business entity level) - Personal earnings received from the partnership are subject to personal income taxes. “C” Corporation “C” Corporation  “Double Taxation” - Corporation pays tax on its income and Shareholders pay income tax on dividends (Possible solution: Don’t pay dividends. Profits can be paid out as salary or other forms of deductible compensation) “Income Splitting” “Income Splitting”  Always good idea to seek advice of Accountant or Tax Attorney on this!

Starting a Business  Formalities/Complexity Sole Proprietor Sole Proprietor  Least formalities/complexity Partnership Partnership  Formalities/complexity varies  Formalities/Complexity Sole Proprietor Sole Proprietor  Least formalities/complexity Partnership Partnership  Formalities/complexity varies

Starting a Business  Formalities/Complexity (Cont.) Limited Partnership, L.L.P., S Corporation, L.L.C., Corporations Limited Partnership, L.L.P., S Corporation, L.L.C., Corporations  All have statutory requirements and require written agreements. Corporation has the most required formalities/complexity (Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834) Corporation has the most required formalities/complexity (Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834) Limited Partnerships covered under N.C.G.S. 59 Limited Partnerships covered under N.C.G.S. 59 L.L.C.s are covered under N.C.G.S. 57C L.L.C.s are covered under N.C.G.S. 57C Corporations covered under N.C.G.S. Chapter 55 (Professionals under, 55B Non-Profits, under 55A) Corporations covered under N.C.G.S. Chapter 55 (Professionals under, 55B Non-Profits, under 55A)  Formalities/Complexity (Cont.) Limited Partnership, L.L.P., S Corporation, L.L.C., Corporations Limited Partnership, L.L.P., S Corporation, L.L.C., Corporations  All have statutory requirements and require written agreements. Corporation has the most required formalities/complexity (Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834) Corporation has the most required formalities/complexity (Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834) Limited Partnerships covered under N.C.G.S. 59 Limited Partnerships covered under N.C.G.S. 59 L.L.C.s are covered under N.C.G.S. 57C L.L.C.s are covered under N.C.G.S. 57C Corporations covered under N.C.G.S. Chapter 55 (Professionals under, 55B Non-Profits, under 55A) Corporations covered under N.C.G.S. Chapter 55 (Professionals under, 55B Non-Profits, under 55A)

Starting a Business  Access to Funds/Financing Sole Proprietor Sole Proprietor  Generally has the least access to funds/financing Partnership Partnership  Generally has a greater access to funds/financing than Sole Proprietorship L.L.P’s, S Corporations L.L.P’s, S Corporations  Generally somewhat better access to funds  Access to Funds/Financing Sole Proprietor Sole Proprietor  Generally has the least access to funds/financing Partnership Partnership  Generally has a greater access to funds/financing than Sole Proprietorship L.L.P’s, S Corporations L.L.P’s, S Corporations  Generally somewhat better access to funds

Starting a Business  Access to Funds/Financing Limited Partnerships and L.L.C.s Limited Partnerships and L.L.C.s  Generally better access to funds  Note: Limited Partnerships often offer the best tax shelters for investors! Corporation Corporation  Generally has greatest access to funds/financing (e.g. Can sell equity/debt securities (stocks & bonds),, limited liability encourages investors, stock can be offered as collateral, etc.)  Access to Funds/Financing Limited Partnerships and L.L.C.s Limited Partnerships and L.L.C.s  Generally better access to funds  Note: Limited Partnerships often offer the best tax shelters for investors! Corporation Corporation  Generally has greatest access to funds/financing (e.g. Can sell equity/debt securities (stocks & bonds),, limited liability encourages investors, stock can be offered as collateral, etc.)

Starting a Business  Distribution of Profits/Losses Sole Proprietor Sole Proprietor  Gains all profits, suffers all losses Partnership Partnership  Distribution of profits and losses generally set by agreement or pro-rata Corporation Corporation  Distribution of profits determined by management/market, received as dividends or increased value of stock.  Distribution of Profits/Losses Sole Proprietor Sole Proprietor  Gains all profits, suffers all losses Partnership Partnership  Distribution of profits and losses generally set by agreement or pro-rata Corporation Corporation  Distribution of profits determined by management/market, received as dividends or increased value of stock.

Starting a Business  Management/Control Sole Proprietor Sole Proprietor  Sole & complete management/control Partnership Partnership  Management/control determined by agreement  Partnership books and records must be kept accessible to all partners  Management/Control Sole Proprietor Sole Proprietor  Sole & complete management/control Partnership Partnership  Management/control determined by agreement  Partnership books and records must be kept accessible to all partners

Starting a Business  Management/Control (Cont.) Corporation Corporation  Nature of control/management determined by bylaws, actual persons in control determined by vote.  Corporate shareholder have no management authority unless elected to board or as officer  “Freeze-outs” are a common problem in Close Corporations L.L.P. L.L.P.  Management shared unless altered by agreement  Purchasing an existing members interest does not automatically confer managerial authority. Other partners must unanimously agree to.  Management/Control (Cont.) Corporation Corporation  Nature of control/management determined by bylaws, actual persons in control determined by vote.  Corporate shareholder have no management authority unless elected to board or as officer  “Freeze-outs” are a common problem in Close Corporations L.L.P. L.L.P.  Management shared unless altered by agreement  Purchasing an existing members interest does not automatically confer managerial authority. Other partners must unanimously agree to.

Starting a Business  Liquidity Sole Proprietorship Sole Proprietorship  Poor liquidity Limited partnership Limited partnership  Interest sales are technically easy, but generally not particularly attractive General partnership General partnership  Interest sales are difficult, requiring agreement of other partners  Liquidity Sole Proprietorship Sole Proprietorship  Poor liquidity Limited partnership Limited partnership  Interest sales are technically easy, but generally not particularly attractive General partnership General partnership  Interest sales are difficult, requiring agreement of other partners

Starting a Business  Liquidity (Cont.) “S” Corporation “S” Corporation  Fair liquidity, but it may be restricted Corporation Corporation  Easy transfer, sell shares (note: minority interest shares less attractive in close corporation) L.L.C. L.L.C.  Transfer restrictions  Liquidity (Cont.) “S” Corporation “S” Corporation  Fair liquidity, but it may be restricted Corporation Corporation  Easy transfer, sell shares (note: minority interest shares less attractive in close corporation) L.L.C. L.L.C.  Transfer restrictions

Starting a Business  Lifecycle Sole Proprietorship Sole Proprietorship  Often ends with the death or incapacity of the sole proprietor Corporation Corporation  Continues to function unless/until formally dissolved, voluntarily or involuntarily, regardless of the death or incapacity of individual shareholders (makes easier to preserve goodwill) L.L.C. L.L.C.  Often required to have a stated duration  Lifecycle Sole Proprietorship Sole Proprietorship  Often ends with the death or incapacity of the sole proprietor Corporation Corporation  Continues to function unless/until formally dissolved, voluntarily or involuntarily, regardless of the death or incapacity of individual shareholders (makes easier to preserve goodwill) L.L.C. L.L.C.  Often required to have a stated duration

Starting a Business  Lifecycle General Partnerships, L.L.P.’s, L.L.C.’s  Often dissolved by loss of any member, but remaining members can unanimously agree to continue operations Limited Partnerships Limited Partnerships  Often dissolved by loss of a general partner, but remaining members can unanimously agree to continue operations  Life Insurance, especially for a “key man” can be a key factor in maintaining operations!  Lifecycle General Partnerships, L.L.P.’s, L.L.C.’s  Often dissolved by loss of any member, but remaining members can unanimously agree to continue operations Limited Partnerships Limited Partnerships  Often dissolved by loss of a general partner, but remaining members can unanimously agree to continue operations  Life Insurance, especially for a “key man” can be a key factor in maintaining operations!

Starting a Business  Privacy Sole Proprietorships, Partnerships and Close Corporations Sole Proprietorships, Partnerships and Close Corporations  Have very limited requirements for disclosure of private/financial information. Public Corporations Public Corporations  Have extensive requirements for disclosure of private/financial information.  Privacy Sole Proprietorships, Partnerships and Close Corporations Sole Proprietorships, Partnerships and Close Corporations  Have very limited requirements for disclosure of private/financial information. Public Corporations Public Corporations  Have extensive requirements for disclosure of private/financial information.

Starting a Business  Fringe Benefits Historically, fringe benefit laws have favored “C” corporations Historically, fringe benefit laws have favored “C” corporations  For example, generally, health insurance is fully deductible for a “C” corporation, partially deductible for sole proprietor, not deductible for partners or for an “S” corporation  Fringe Benefits Historically, fringe benefit laws have favored “C” corporations Historically, fringe benefit laws have favored “C” corporations  For example, generally, health insurance is fully deductible for a “C” corporation, partially deductible for sole proprietor, not deductible for partners or for an “S” corporation

11-137 Organizational Choices TypeCreationContinuityControlLiabilityTax Proprietorship Do It! ProprietorProprietorUnl’dSingle PartnershipAgreementEasilyDissolved(Buy/Sell)EqualAmongPartnersUnl’dSingle LimitedPartnership Agree & Register GeneralPartnerGeneralPartner Gen’l- Unl’d Ltd.- Ltd. Single LLP Articles & RegistrationEasilyDissolvedEqualPartnersLimitedSingle LLC RegistrationDissolved (90 Days) EqualMembersLimitedSingle S Corporation Articles (<75 People) Perpetual (Ease Of Transfer) ShareholdersDirectorsOfficersLimitedSingle Corporation Articles Of IncorporationPerpetual (Ease Of Transfer) ShareholdersDirectorsOfficersLimitedDouble

11-138 Basic Forms of Ownership  Sole Proprietorship  Partnership  Corporation NumberSales 74%5% 8%5% 18%90%

11-139 Basic Forms of Ownership

11-140 Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S. Sole proprietorships 16,955,000 73.0% Corporations 4,631,000 19.9% Partnerships 1,654,000 7.1% Sole proprietorships, the most widespread form of business ownership, are most common in retailing, agriculture, and the service industries. Source: U.S. Bureau of the Census, Statistical Abstract of the United States, 119th ed., Washington, D.C., 1999, p. 545.

Changing Popularity of Business Forms

Corporations

Some Form Trends  Historically, maximum individual tax rate > than maximum corporate rate created incentive to keep income in corporate form  1986 Tax Act made maximum individual rate < maximum corporate rate & companies became ” S” corps in droves  But 1993 Tax Act increased individual rates, thus, “S” corps no longer as advantageous  New kid on block - L.L.C., more flexible than “S” Corp and better that L..L.P. in that not require a general partner  Historically, maximum individual tax rate > than maximum corporate rate created incentive to keep income in corporate form  1986 Tax Act made maximum individual rate < maximum corporate rate & companies became ” S” corps in droves  But 1993 Tax Act increased individual rates, thus, “S” corps no longer as advantageous  New kid on block - L.L.C., more flexible than “S” Corp and better that L..L.P. in that not require a general partner

Naming a Business  Some Key Questions Statutory requirements? Statutory requirements? Is your proposed business name available? Is your proposed business name available? Will your business name receive trademark protection? Will your business name receive trademark protection? If your business will have a website, is a similar domain name available? If your business will have a website, is a similar domain name available?  Some Key Questions Statutory requirements? Statutory requirements? Is your proposed business name available? Is your proposed business name available? Will your business name receive trademark protection? Will your business name receive trademark protection? If your business will have a website, is a similar domain name available? If your business will have a website, is a similar domain name available?

Naming a Business  If you're starting a corporation, LLC or limited partnership, you must comply with statutory requirements for naming your business  Naming Convention for Corporations (Incorporated, Inc., Corporation, Corp., Company, Co.)  L.L.P. or L.LC. (Limited or Ltd..)  Fictitious/Assumed/Trade Name (or dba)  If you're starting a corporation, LLC or limited partnership, you must comply with statutory requirements for naming your business  Naming Convention for Corporations (Incorporated, Inc., Corporation, Corp., Company, Co.)  L.L.P. or L.LC. (Limited or Ltd..)  Fictitious/Assumed/Trade Name (or dba)

Naming a Business  Name available? Corporate/L.L.C./Limited Partnership Name Search – Secretary of State Corporate/L.L.C./Limited Partnership Name Search – Secretary of State Fictitious/Assumed Name Search – Register of Deeds Fictitious/Assumed Name Search – Register of Deeds Trademark Search – U.S. Patent Office Trademark Search – U.S. Patent Office  Basic Concerns Is it the same? Is it the same? Is it similar enough to cause confusion? Is it similar enough to cause confusion?  Name available? Corporate/L.L.C./Limited Partnership Name Search – Secretary of State Corporate/L.L.C./Limited Partnership Name Search – Secretary of State Fictitious/Assumed Name Search – Register of Deeds Fictitious/Assumed Name Search – Register of Deeds Trademark Search – U.S. Patent Office Trademark Search – U.S. Patent Office  Basic Concerns Is it the same? Is it the same? Is it similar enough to cause confusion? Is it similar enough to cause confusion?

Naming a Business  Trademark A trademark (sometimes called simply a "mark") is any word, phrase, design or symbol used to market a product or service. A trademark (sometimes called simply a "mark") is any word, phrase, design or symbol used to market a product or service. Technically, a mark used to market a service, rather than a product, is called a service mark, though the term "trademark" is commonly used for both types of marks because they refer to the same group of legal protections. Technically, a mark used to market a service, rather than a product, is called a service mark, though the term "trademark" is commonly used for both types of marks because they refer to the same group of legal protections. Owners of trademarks have rights under both federal and state law that give them the power in many cases to prevent others from using the same or confusingly similar trademarks. Owners of trademarks have rights under both federal and state law that give them the power in many cases to prevent others from using the same or confusingly similar trademarks.  Trademark A trademark (sometimes called simply a "mark") is any word, phrase, design or symbol used to market a product or service. A trademark (sometimes called simply a "mark") is any word, phrase, design or symbol used to market a product or service. Technically, a mark used to market a service, rather than a product, is called a service mark, though the term "trademark" is commonly used for both types of marks because they refer to the same group of legal protections. Technically, a mark used to market a service, rather than a product, is called a service mark, though the term "trademark" is commonly used for both types of marks because they refer to the same group of legal protections. Owners of trademarks have rights under both federal and state law that give them the power in many cases to prevent others from using the same or confusingly similar trademarks. Owners of trademarks have rights under both federal and state law that give them the power in many cases to prevent others from using the same or confusingly similar trademarks.

Naming a Business  Trademark (Cont.) When picking a business name, take care to choose a name that will be likely to receive trademark protection When picking a business name, take care to choose a name that will be likely to receive trademark protection There are specific steps to protect your business name as a trademark There are specific steps to protect your business name as a trademark Document first & continuous use Document first & continuous use Aggressively warn/sue potential infringers (see Victor’s Little Secret case) Aggressively warn/sue potential infringers (see Victor’s Little Secret case)  Trademark (Cont.) When picking a business name, take care to choose a name that will be likely to receive trademark protection When picking a business name, take care to choose a name that will be likely to receive trademark protection There are specific steps to protect your business name as a trademark There are specific steps to protect your business name as a trademark Document first & continuous use Document first & continuous use Aggressively warn/sue potential infringers (see Victor’s Little Secret case) Aggressively warn/sue potential infringers (see Victor’s Little Secret case)

Naming a Business  Trademark (Cont.) On the flip side, to make sure your business name won't step on someone else's rights to an existing trademark, you'll have to do a trademark search. On the flip side, to make sure your business name won't step on someone else's rights to an existing trademark, you'll have to do a trademark search. If your business is anything but a small, local service business or retailer, such as a dry cleaners or a fabric store, you'll probably want to take advantage of trademark protection. If your business is anything but a small, local service business or retailer, such as a dry cleaners or a fabric store, you'll probably want to take advantage of trademark protection.  Trademark (Cont.) On the flip side, to make sure your business name won't step on someone else's rights to an existing trademark, you'll have to do a trademark search. On the flip side, to make sure your business name won't step on someone else's rights to an existing trademark, you'll have to do a trademark search. If your business is anything but a small, local service business or retailer, such as a dry cleaners or a fabric store, you'll probably want to take advantage of trademark protection. If your business is anything but a small, local service business or retailer, such as a dry cleaners or a fabric store, you'll probably want to take advantage of trademark protection.

Naming a Business  Trademark (Cont.) Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in the marketplace. Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in the marketplace. By allowing just one company to use a name, trademark law helps that company to build customer trust and goodwill. By allowing just one company to use a name, trademark law helps that company to build customer trust and goodwill. Any business name you use to market and identify your products or services is a potential trademark. For example, McDonald's uses its business name to market its hamburgers. Any business name you use to market and identify your products or services is a potential trademark. For example, McDonald's uses its business name to market its hamburgers. To qualify for trademark protection, your business name should be what trademark law considers "distinctive." To qualify for trademark protection, your business name should be what trademark law considers "distinctive."  Trademark (Cont.) Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in the marketplace. Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in the marketplace. By allowing just one company to use a name, trademark law helps that company to build customer trust and goodwill. By allowing just one company to use a name, trademark law helps that company to build customer trust and goodwill. Any business name you use to market and identify your products or services is a potential trademark. For example, McDonald's uses its business name to market its hamburgers. Any business name you use to market and identify your products or services is a potential trademark. For example, McDonald's uses its business name to market its hamburgers. To qualify for trademark protection, your business name should be what trademark law considers "distinctive." To qualify for trademark protection, your business name should be what trademark law considers "distinctive."

Naming a Business  Distinctive Names Examples of Distinctive Names (likely to receive trademark protection): Xerox, Amazon.Com Examples of Distinctive Names (likely to receive trademark protection): Xerox, Amazon.Com Not: Joe’s Hardware Not: Joe’s Hardware One Theory - Make a new word One Theory - Make a new word  Distinctive Names Examples of Distinctive Names (likely to receive trademark protection): Xerox, Amazon.Com Examples of Distinctive Names (likely to receive trademark protection): Xerox, Amazon.Com Not: Joe’s Hardware Not: Joe’s Hardware One Theory - Make a new word One Theory - Make a new word

11-153 Agency Duties  Loyalty  Keep Principal Informed  Obey Instructions  Account For Money  Partnership Liability- Each Partner Is Agent And Principal  Loyalty  Keep Principal Informed  Obey Instructions  Account For Money  Partnership Liability- Each Partner Is Agent And Principal

11-154 Creation of Agency  Nature of Agency- One Party (Agent) Acting for Another (Principal) Usually formed by contract, but may be oral Usually formed by contract, but may be oral  Nature of Agency- One Party (Agent) Acting for Another (Principal) Usually formed by contract, but may be oral Usually formed by contract, but may be oral

11-155 Creation of Agency De facto agency may be found by court even where no intent to create De facto agency may be found by court even where no intent to create  Keys: Indication/manifestation of consent by principal Indication/manifestation of consent by principal Agent acceptance to act on behalf of principal Agent acceptance to act on behalf of principal Understanding of principal control Understanding of principal control  Evidence: Word’s, Actions, Circumstances De facto agency may be found by court even where no intent to create De facto agency may be found by court even where no intent to create  Keys: Indication/manifestation of consent by principal Indication/manifestation of consent by principal Agent acceptance to act on behalf of principal Agent acceptance to act on behalf of principal Understanding of principal control Understanding of principal control  Evidence: Word’s, Actions, Circumstances

11-156 Creation of Agency  Capacity to Be Principal Generally same capacity to act as principal Generally same capacity to act as principal  Capacity to Be Agent Generally unrestricted Generally unrestricted  Capacity to Be Principal Generally same capacity to act as principal Generally same capacity to act as principal  Capacity to Be Agent Generally unrestricted Generally unrestricted

11-157 Duties of Agents  Some Duties of Principal may be non- delegable (e.g. provide safe work environment, etc.)  Loyalty Honesty Honesty Full disclose Full disclose Notification and surrender of special compensation Notification and surrender of special compensation No seizure of principal opportunities No seizure of principal opportunities  Some Duties of Principal may be non- delegable (e.g. provide safe work environment, etc.)  Loyalty Honesty Honesty Full disclose Full disclose Notification and surrender of special compensation Notification and surrender of special compensation No seizure of principal opportunities No seizure of principal opportunities

11-158 Duties of Agents  Loyalty Conflict of Interest Avoidance Conflict of Interest Avoidance  Even in re: the appearance of a conflict  Dual role generally o.k. with full consent & disclosure  Loyalty Conflict of Interest Avoidance Conflict of Interest Avoidance  Even in re: the appearance of a conflict  Dual role generally o.k. with full consent & disclosure

11-159 Duties of Agents  Those Specified by Contract, if any  Fiduciary Strongly enforced by courts Strongly enforced by courts  Obey Instructions Reasonable Belief Exception Reasonable Belief Exception  Exercise Care and Skill Gratuitous Agent Factor (reduced expectations) Gratuitous Agent Factor (reduced expectations)  Communicate “Relevant” Information Affecting a “Material Interest”  Protect Confidential Information  Not Perform Illegal Acts  Those Specified by Contract, if any  Fiduciary Strongly enforced by courts Strongly enforced by courts  Obey Instructions Reasonable Belief Exception Reasonable Belief Exception  Exercise Care and Skill Gratuitous Agent Factor (reduced expectations) Gratuitous Agent Factor (reduced expectations)  Communicate “Relevant” Information Affecting a “Material Interest”  Protect Confidential Information  Not Perform Illegal Acts

11-160 Duties of Agents  Account for Funds/Property Keep Accurate Records Keep Accurate Records Permit Inspection Permit Inspection Not Commingle Funds Not Commingle Funds Not embezzle Not embezzle Not convert for own use Not convert for own use  Account for Funds/Property Keep Accurate Records Keep Accurate Records Permit Inspection Permit Inspection Not Commingle Funds Not Commingle Funds Not embezzle Not embezzle Not convert for own use Not convert for own use

11-161 Duties of Principals  Compensate Contingent Compensation (e.g. Contingency Fee or Commission) Contingent Compensation (e.g. Contingency Fee or Commission) Procuring Cause - when agent primary cause Procuring Cause - when agent primary cause Duration of Employment - Where no set time, “reasonable time” to recover costs Duration of Employment - Where no set time, “reasonable time” to recover costs Real Estate Commissions - Received at “closing” Real Estate Commissions - Received at “closing” Insurance Commissions - On premiums paid Insurance Commissions - On premiums paid  Compensate Contingent Compensation (e.g. Contingency Fee or Commission) Contingent Compensation (e.g. Contingency Fee or Commission) Procuring Cause - when agent primary cause Procuring Cause - when agent primary cause Duration of Employment - Where no set time, “reasonable time” to recover costs Duration of Employment - Where no set time, “reasonable time” to recover costs Real Estate Commissions - Received at “closing” Real Estate Commissions - Received at “closing” Insurance Commissions - On premiums paid Insurance Commissions - On premiums paid

11-162 Duties of Principals  Reimburse/Indemnify - for expenses on behalf of Principal, where no fault  Keep Accounts  Reimburse/Indemnify - for expenses on behalf of Principal, where no fault  Keep Accounts

11-163 Enforcement of Liabilities  Breach of Duty by Agent may reduce/eliminate compensation may reduce/eliminate compensation may be grounds for termination of agency may be grounds for termination of agency  Breach of Duty by Principal May create basis for lien of held property or cause for legal action May create basis for lien of held property or cause for legal action  Breach of Duty by Agent may reduce/eliminate compensation may reduce/eliminate compensation may be grounds for termination of agency may be grounds for termination of agency  Breach of Duty by Principal May create basis for lien of held property or cause for legal action May create basis for lien of held property or cause for legal action

11-164 Termination of Agency  By Will of Parties - As specified per agreement  Agency at Will- Power by either to terminate at any time Exceptions: Exceptions:  Agency Coupled With Interest - power given as security  Legislative Restrictions  By Will of Parties - As specified per agreement  Agency at Will- Power by either to terminate at any time Exceptions: Exceptions:  Agency Coupled With Interest - power given as security  Legislative Restrictions

11-165 Termination of Agency  By Operation of Law Death or insanity Death or insanity Bankruptcy affecting Bankruptcy affecting Illegality Illegality Impossibility Impossibility Destruction of subject matter Destruction of subject matter Material change in business conditions Material change in business conditions  By Operation of Law Death or insanity Death or insanity Bankruptcy affecting Bankruptcy affecting Illegality Illegality Impossibility Impossibility Destruction of subject matter Destruction of subject matter Material change in business conditions Material change in business conditions

11-166 Termination of Agency  Notice to 3 rd Persons Actual Actual Constructive (e.g. in newspaper of general circulation in the area) Constructive (e.g. in newspaper of general circulation in the area) Failure may = apparent authority Failure may = apparent authority  Notice to 3 rd Persons Actual Actual Constructive (e.g. in newspaper of general circulation in the area) Constructive (e.g. in newspaper of general circulation in the area) Failure may = apparent authority Failure may = apparent authority

11-167 Agent’s Authority to Bind Principal  Actual Authority Express- Specifically Described Express- Specifically Described  Attorney-in-Fact if Power of Attorney (General or Limited) (Statutory Limitations) Implied- Necessary to Complete Task (Custom, Justifiable Belief of Agent, Emergency) Implied- Necessary to Complete Task (Custom, Justifiable Belief of Agent, Emergency)  Actual Authority Express- Specifically Described Express- Specifically Described  Attorney-in-Fact if Power of Attorney (General or Limited) (Statutory Limitations) Implied- Necessary to Complete Task (Custom, Justifiable Belief of Agent, Emergency) Implied- Necessary to Complete Task (Custom, Justifiable Belief of Agent, Emergency)

11-168 Agent’s Authority to Bind Principal  Apparent Authority- Reasonable Belief/Perception by 3 rd Party Based on conduct of principal Based on conduct of principal Justifiable Belief of 3rd Party Test Justifiable Belief of 3rd Party Test Duty of 3 rd Persons Duty of 3 rd Persons  Apparent Authority- Reasonable Belief/Perception by 3 rd Party Based on conduct of principal Based on conduct of principal Justifiable Belief of 3rd Party Test Justifiable Belief of 3rd Party Test Duty of 3 rd Persons Duty of 3 rd Persons

11-169 Agent’s Authority to Bind Principal  Apparent Authority  The shareholders of a closely held family corporation filed suit to set aside a mortgage on certain real property. Held: The corporate president had apparent authority to mortgage the property of the corporation, and the bank relied on that authority. The mortgage was proper because the family corporation had left the president in a virtually unfettered managerial position of control. Their actions caused the bank to believe that the president had authority to bind the corporation. Lettieri v. American Sav. Bank, 437 A.2d 822 (Conn. 1980).  Apparent Authority  The shareholders of a closely held family corporation filed suit to set aside a mortgage on certain real property. Held: The corporate president had apparent authority to mortgage the property of the corporation, and the bank relied on that authority. The mortgage was proper because the family corporation had left the president in a virtually unfettered managerial position of control. Their actions caused the bank to believe that the president had authority to bind the corporation. Lettieri v. American Sav. Bank, 437 A.2d 822 (Conn. 1980).

11-170 Ratification  Could be where exceeded authority or no authority  Intent may be express or implied by words or actions  Requirements Principal must have had legal capacity both when act occurred and ratified Principal must have had legal capacity both when act occurred and ratified Affirm Act in its entirety Affirm Act in its entirety Knowledge of All Material Facts (Though not necessarily understanding) Knowledge of All Material Facts (Though not necessarily understanding)  Effect - Releases Agent of Liability to 3rd Party  Could be where exceeded authority or no authority  Intent may be express or implied by words or actions  Requirements Principal must have had legal capacity both when act occurred and ratified Principal must have had legal capacity both when act occurred and ratified Affirm Act in its entirety Affirm Act in its entirety Knowledge of All Material Facts (Though not necessarily understanding) Knowledge of All Material Facts (Though not necessarily understanding)  Effect - Releases Agent of Liability to 3rd Party

11-171 Principal’s Contractual Liability  Liability for Agent Representation- Limited by Exculpatory Clause  Liability for Notice/Payment to Agent Generally Notice to Agent = Notice to Principal, wherein scope of agent’s authority Generally Notice to Agent = Notice to Principal, wherein scope of agent’s authority Generally Payment to Agent = Payment to Principal Generally Payment to Agent = Payment to Principal A conflicts of interest may negate a principal’s liability A conflicts of interest may negate a principal’s liability  Liability for Agent Representation- Limited by Exculpatory Clause  Liability for Notice/Payment to Agent Generally Notice to Agent = Notice to Principal, wherein scope of agent’s authority Generally Notice to Agent = Notice to Principal, wherein scope of agent’s authority Generally Payment to Agent = Payment to Principal Generally Payment to Agent = Payment to Principal A conflicts of interest may negate a principal’s liability A conflicts of interest may negate a principal’s liability

11-172 Principal’s Liability for Acts of Subagents  Agent’s Authority to Appoint Subagents - Implied unless expressly excluded Agent ultimately liable Agent ultimately liable  Agent’s May Have Employees- Ministerial Acts - Principal bound Concept: Liable as if agent had performed Concept: Liable as if agent had performed  Agent’s Authority to Appoint Subagents - Implied unless expressly excluded Agent ultimately liable Agent ultimately liable  Agent’s May Have Employees- Ministerial Acts - Principal bound Concept: Liable as if agent had performed Concept: Liable as if agent had performed

11-173 Agent’s Contractual Liability Only If:  Unauthorized Actions Implied Warranty of Authority Implied Warranty of Authority Intent, Knowledge & Good Faith of Agent Immaterial Intent, Knowledge & Good Faith of Agent Immaterial  Nonexistent/Incompetent Principal  Agreement to Assume Liability Agent Should Fully Disclose I.D. of Principal Agent Should Fully Disclose I.D. of Principal Agent Should Clearly Indicate Capacity as Agent Agent Should Clearly Indicate Capacity as Agent  Undisclosed/Partially Disclosed Principal Frequently used in controversial real estate/stock acquisitions Frequently used in controversial real estate/stock acquisitions Creates expectation of liability Creates expectation of liability  Unauthorized Actions Implied Warranty of Authority Implied Warranty of Authority Intent, Knowledge & Good Faith of Agent Immaterial Intent, Knowledge & Good Faith of Agent Immaterial  Nonexistent/Incompetent Principal  Agreement to Assume Liability Agent Should Fully Disclose I.D. of Principal Agent Should Fully Disclose I.D. of Principal Agent Should Clearly Indicate Capacity as Agent Agent Should Clearly Indicate Capacity as Agent  Undisclosed/Partially Disclosed Principal Frequently used in controversial real estate/stock acquisitions Frequently used in controversial real estate/stock acquisitions Creates expectation of liability Creates expectation of liability

11-174 Liability for Torts  Direct Liability vs. Respondeat Superior (Let the master respond, i.e., master is responsible for servant.) = vicarious liability  Employee vs. Independent Contractor Within actual or apparent scope of employment Within actual or apparent scope of employment  Focus on words/actions/consent of principal “mere deviation” not take outside of scope “mere deviation” not take outside of scope Degree of Control over “Methods” Degree of Control over “Methods” Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer or other depends upon degree of control Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer or other depends upon degree of control  Direct Liability vs. Respondeat Superior (Let the master respond, i.e., master is responsible for servant.) = vicarious liability  Employee vs. Independent Contractor Within actual or apparent scope of employment Within actual or apparent scope of employment  Focus on words/actions/consent of principal “mere deviation” not take outside of scope “mere deviation” not take outside of scope Degree of Control over “Methods” Degree of Control over “Methods” Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer or other depends upon degree of control Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer or other depends upon degree of control

11-175 Liability for Torts  Intentional Torts by Agent - Generally = not within scope of employment, unless encouraged by principal  Agent Generally Still Liable even if acting with scope (though may be indemnified)  Intentional Torts by Agent - Generally = not within scope of employment, unless encouraged by principal  Agent Generally Still Liable even if acting with scope (though may be indemnified)

11-176 Employee vs. Independent Contractor Employee  Works For  Receives Payment From  Controlled Working Conditions/Methods  Employer Liable for  Acts  Omissions Independent Contractor  Works For  Receives Payment From  Uncontrolled Working Conditions/Methods  Employer Not Liable

11-177 Liability for Crimes  Agent -Liable  Principal - Old rule, hard to impose liability, but changing in some jurisdictions Foreign Representatives (varies with jurisdiction) Dependent Agents - greater liability Dependent Agents - greater liability Independent Agents - lesser liability Independent Agents - lesser liability  Agent -Liable  Principal - Old rule, hard to impose liability, but changing in some jurisdictions Foreign Representatives (varies with jurisdiction) Dependent Agents - greater liability Dependent Agents - greater liability Independent Agents - lesser liability Independent Agents - lesser liability

Chapter McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Corporate Governance And Business Organizations.

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Chapter McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Corporate Governance And Business Organizations.

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Presentation on theme: "Chapter McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Corporate Governance And Business Organizations."— Presentation transcript:

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