1. CHAPTER 32 FORMATION OF A BUSINESS DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)

2. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 2 HISTORICAL OVERVIEW OF PARTNERSHIPS Foundation of business organizations throughout history. Foundation of business organizations throughout history. U.S. followed English common law for partnerships. U.S. followed English common law for partnerships. Today, partnerships governed by the Unified Partnership Act (UPA). Today, partnerships governed by the Unified Partnership Act (UPA). Revised Uniform Partnership Act (RUPA) for general partnerships. Revised Uniform Partnership Act (RUPA) for general partnerships.

3. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 3 HISTORICAL OVERVIEW OF PARTNERSHIPS RUPA 1997 amendments are: RUPA 1997 amendments are: – Limited liability for partners registered in limited liability partnerships. – Views partnership as separate entity. – Dissolution no longer required every time a partner leaves. – Permits, but not required, filing of statements when partnership formed, dissolved, merged, or limitations on partnership authority.

4. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 4 HISTORICAL OVERVIEW OF PARTNERSHIPS Partnerships generally easy to form and have wider potential financial bases than proprietorships. Partnerships generally easy to form and have wider potential financial bases than proprietorships. Partnerships are not perpetual. Partnerships are not perpetual. Partners face unlimited liability for business-related conduct. Partners face unlimited liability for business-related conduct. No one formation of business organization is perfect. No one formation of business organization is perfect.

5. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 5 PARTNERSHIPS DEFINED Uniform Partnership Act defines partnership with five characteristics: Uniform Partnership Act defines partnership with five characteristics: – An Association: mutual and unanimous assent to be partners jointly and severally at time of agreement. – Of Two or More Persons: identifiable entities that elect to associate. – To Carry on a Business: continuity of trade, occupation, or profession. – As Co-Owners: sharing of ownership of business. – For Profit: operate for profit (money).

6. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 6 PARTNERSHIPS DEFINED Limited Partnership. Limited Partnership. – Must have two or more persons with at least one limited partner. – Limited partners have limited liability. – Limited partner is not personally liable for partnership obligations. – Limited partner cannot control the business of the partnership.

7. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 7 PARTNERSHIPS DEFINED Limited Partnership (cont’d). Limited Partnership (cont’d). – Limited partner is precluded from management of the business. – Revised Uniform Limited Partnership Act (RULPA) requires profits and losses to be shared based on: capital contributions capital contributions unless an agreement specifies otherwise unless an agreement specifies otherwise

8. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 8 PARTNERSHIPS DEFINED Limited Partnership. Limited Partnership. – Distribution of assets upon termination of the entity and liquidation of its assets is treated differently under revised act than under ULPA – Interesting aspect of RULPA is that it specifies if case not provided for under RULPA, are to be governed by provisions of ULPA.

9. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 9 PARTNERSHIP PROPERTY The UPA defines partnership property as: The UPA defines partnership property as: – Property contributed as capital contributions. – Property acquired on account of partnership. – Property acquired with partnership funds. – Any interest in real property acquired in the partnership’s name. – Any conveyance to the partnership in its name.

10. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 10 THE PARTNERSHIP AGREEMENT Partnership created by agreement, either expressed (oral or written) or implied. Partnership created by agreement, either expressed (oral or written) or implied. Imposed Rules. Imposed Rules. – Partners each entitled to an equal voice. – Partners entitled to equal share of profits. – Partners share losses in same proportion as they share profits. – Books must be kept at central office of business.

11. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 11 THE PARTNERSHIP AGREEMENT Regardless of what partnership agreement says, any attempt to modify rules will be deemed void. Regardless of what partnership agreement says, any attempt to modify rules will be deemed void. Imposed Rules: Imposed Rules: – Partners are agents of partnership. – Partners have unlimited personal liability for torts/contracts which partnership has insufficient assets to cover debt. – Partner is expected to devote service only to the partnership.

12. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 12 THE PARTNERSHIP AGREEMENT Express Terms. Express Terms. – Agreement should designate the name of the business. – Partnership agreement should cover purpose and duration of partnership. – How profits and losses are shared. – Withdrawal procedures.

13. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 13 LIMITED LIABILITY PARTNERSHIPS A growing number of states recognize the limited liability partnership (LLP). A growing number of states recognize the limited liability partnership (LLP). Partner’s personal assets are protected from liability claims against partnership. Partner’s personal assets are protected from liability claims against partnership. Partner in an LLP is not personally liable for malpractice, negligence, or other tort committed by a co-partner or agent. Partner in an LLP is not personally liable for malpractice, negligence, or other tort committed by a co-partner or agent.

14. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 14 LIMITED LIABILITY PARTNERSHIPS Partners remain personally liable for their own negligence and for contractual obligations of partnership. Partners remain personally liable for their own negligence and for contractual obligations of partnership. RUPA amendments require election to become a LLP. RUPA amendments require election to become a LLP. 1997 RUPA amendments, treats LLP’s as partnerships in all respects. 1997 RUPA amendments, treats LLP’s as partnerships in all respects.

15. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 15 TAXATION OF PARTNERSHIPS For taxation purposes, partnership form of business neither an advantage or disadvantage. For taxation purposes, partnership form of business neither an advantage or disadvantage. Partnership is not taxed on its profits and losses. Partnership is not taxed on its profits and losses. Partners are personally taxed on their share of the partnership’s profits and losses. Partners are personally taxed on their share of the partnership’s profits and losses.

16. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 16 HISTORICAL OVERVIEW OF CORPORATIONS Concept of corporate personality may have been recognized as early as the time of Hammurabi. Concept of corporate personality may have been recognized as early as the time of Hammurabi. Canon law distinguished between corporation sole and aggregate. Canon law distinguished between corporation sole and aggregate. The fiction theory probably developed by the papacy. The fiction theory probably developed by the papacy.

17. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 17 HISTORICAL OVERVIEW OF CORPORATIONS English monarchs tightened control over corporations, deemed to exist by virtue of concessionary grants of power from state. English monarchs tightened control over corporations, deemed to exist by virtue of concessionary grants of power from state. Careful regulation of corporations remains an essential characteristic of law of corporations. Careful regulation of corporations remains an essential characteristic of law of corporations.

18. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 18 CORPORATE NATURE Corporations are artificial persons created under statute of state or nation. Corporations are artificial persons created under statute of state or nation. Organized for the purpose set out in application for corporate existence. Organized for the purpose set out in application for corporate existence. Corporation is an invisible, intangible, artificial person. Corporation is an invisible, intangible, artificial person. Corporations enjoy most rights natural persons possess. Corporations enjoy most rights natural persons possess.

19. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 19 CORPORATE NATURE Advantages of Corporate Form: Advantages of Corporate Form: – Insulation from liability. – Centralization of management functions. – Continuity of existence. – Free transferability of shares.

20. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 20 FORMATION OF A CORPORATION Process of forming corporation involves complex issues that demand the attention of well-versed professionals. Process of forming corporation involves complex issues that demand the attention of well-versed professionals. Types of Corporations: Types of Corporations: – Public-issue private corporation. – Close corporation. – Professional corporation. – Municipal (also called public or quasi-public) corporation.

21. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 21 FORMATION OF A CORPORATION Promoters. Promoters. – Help form the corporation by procuring subscribers for stock. – Take other affirmative steps toward incorporating.

22. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 22 FORMATION OF A CORPORATION Articles of Incorporation is a document that signals official existence of corporation and contains: Articles of Incorporation is a document that signals official existence of corporation and contains: – Name of corporation; – Its purpose; – Its duration; – Location of its principal office or registered agent; – Its powers, its capital structure; – Its directors and names; and – Signatures of the incorporators.

23. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 23 FORMATION OF A CORPORATION Corporate Charter/Certificate of Incorporation officially begins a corporation’s existence. Corporate Charter/Certificate of Incorporation officially begins a corporation’s existence. Organizational Meeting where the bylaws are adopted, pre-incorporation agreements approved, and officers elected. Organizational Meeting where the bylaws are adopted, pre-incorporation agreements approved, and officers elected. Bylaws regulate the internal affairs of a corporation. Bylaws regulate the internal affairs of a corporation.

24. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 24 DE JURE vs. DE FACTO CORPORATIONS A de jure corporation is valid by law if slight defect in formation. A de jure corporation is valid by law if slight defect in formation. Corporation has serious defect may be considered de facto corporation unless: Corporation has serious defect may be considered de facto corporation unless: – Law under which the corporation could have been incorporated exists. – There was a good faith effort to comply with statute. – There was some use or exercise of corporate powers.

25. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 25 CORPORATE POWERS Articles of Incorporation set forth powers of the corporation. Articles of Incorporation set forth powers of the corporation. Provisions redundant as states express what entity can do: Provisions redundant as states express what entity can do: – Ability to conduct business. – To exist perpetually. – To sue and be sued. – To use corporate name and seal. – To make bylaws.

26. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 26 CORPORATE POWERS Corporations have implied power to do anything reasonably necessary to conduct business. Corporations have implied power to do anything reasonably necessary to conduct business. Typically implied powers consists of: Typically implied powers consists of: – Holding or transferring property. – Acquiring stock from other corporations. – Borrowing money or effecting loans. Statutes may enumerate these and other implied powers. Statutes may enumerate these and other implied powers.

27. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 27 ULTRA VIRES ACTS Ultra vires is beyond the scope or legal power of a corporation. Ultra vires is beyond the scope or legal power of a corporation. When sued corporations could use ultra vires as defense to enforce contract. When sued corporations could use ultra vires as defense to enforce contract. State statutes abolished ultra vires defense allowing suits in three situations: State statutes abolished ultra vires defense allowing suits in three situations: – Shareholder injunctive action. – Shareholder suit to recover damages. – State proceedings to dissolve corporation.

28. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 28 TAXATION OF CORPORATIONS Tax treatment of corporation stems from law’s recognition of corporation as separate entity for federal income tax purposes. Tax treatment of corporation stems from law’s recognition of corporation as separate entity for federal income tax purposes. Profits and losses of a C corporation are taxed to the corporation. Profits and losses of a C corporation are taxed to the corporation. Profits and losses of an S corporation (Subchapter S corporation) are taxed to the shareholders. Profits and losses of an S corporation (Subchapter S corporation) are taxed to the shareholders.

29. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 29 DISREGARDING THE CORPORATE ENTITY In order to serve justice it will be necessary to “pierce the corporate veil.” In order to serve justice it will be necessary to “pierce the corporate veil.” Law may impose personal liability on shareholders if: Law may impose personal liability on shareholders if: – The shareholder is sole shareholder in an association so thinly capitalized that it cannot meet its obligations. – If shareholder is draining off corporate assets.

30. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 30 LIMITED LIABILITY COMPANIES State statute that allows LLPs is often the same that authorizes LLCs. State statute that allows LLPs is often the same that authorizes LLCs. Concerns about federal and state tax structures. Concerns about federal and state tax structures. State statutes vary. State statutes vary.

31. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 31 LIMITED LIABILITY COMPANIES History of Limited Liability Companies. History of Limited Liability Companies. – Purpose to provide limited liability to investors. – Member’s liability limited to capital investment. – State statutes generally dictate: Two or more members. Two or more members. Stated term of duration less than 30 years. Stated term of duration less than 30 years. All members must have limited liability. All members must have limited liability. Shares not freely transferable. Shares not freely transferable. Central management elected by members. Central management elected by members. Indication in its name that it is an LLC. Indication in its name that it is an LLC.

32. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 32 LIMITED LIABILITY COMPANIES Taxation of Limited Liability Companies: Taxation of Limited Liability Companies: – IRS examines whether enterprise has characteristics of a corporation or not. – LLC is an association. – LLCs article of organization and state statutes determine characteristic of an LLC. – IRS and courts decide if partnership taxation is appropriate if LLC lacks: continuity of life, centralized management and transferability of shares.

33. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 33 LIMITED LIABILITY COMPANIES Flexibility and Variance. Flexibility and Variance. – LLC statutes vary from state to state. – LLC statutes vary is whether professional service associations can form LLC. – Many states will not permit an LLC to continue perpetuity as a corporation can. – Most LLC statutes greatly restrict transferability of shares.

34. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 34 OTHER TYPES OF BUSINESS ORGANIZATIONS Partnership by Estoppel. To use estoppel, three facts must be shown: Partnership by Estoppel. To use estoppel, three facts must be shown: Someone who is not a partner was held out to be a partner by the firm. Someone who is not a partner was held out to be a partner by the firm. Third person justifiably relied on the holding out. Third person justifiably relied on the holding out. Person will be harmed if no liability is imposed. Person will be harmed if no liability is imposed. Joint Ventures: set up to carry out a limited number of transactions, or a single deal. Joint Ventures: set up to carry out a limited number of transactions, or a single deal.

35. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 35 OTHER TYPES OF BUSINESS ORGANIZATIONS Mining Partnerships. Mining Partnerships. – Selling of an interest or bequeathing of an interest by will is permitted.