Business Organizations Outline PDF

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BUSINESS ORGANIZATIONS OUTLINE The Nature of the Corporation I. Introduction – Economic Foundations – The Decision to Create a Business Entity a. Sole Proprietorship: Simplest form of business organization to create i. No formalities required; state law governs ii. Formation: All you have to do is say, “Here I am; I am a sole proprietor!” 1. All you need is intention and an act evincing your intention iii. Ownership: 1 person iv. Relation to Co-Owners: Not applicable, no co-owners v. Duration: Limited to one human life – it dissolves when the life ends; heirs get the assets, but not the sole proprietorship 1. You can end it whenever you want, though vi. Transferability: No 1. The sole proprietorship is attached to the person, thus it is personal to the individual. 2. Ex: If you were to give them all your capital and equipment, and they were to continue on that business, it would merely be a new sole proprietorship created in a new person a. However, if dad has debt in his sole proprietorship and “transfers” to son, the son is still obligated to pay the debts. Otherwise, it would not be fair vii. Conduct of Business Affairs: Market transactions, contractual relationship 1. You just go to the store and buy stuff viii. Liability: Unlimited personal liability 1. Risk: The liability is unlimited, and it extends to the full extent of your personal stuff. ix. Taxation: The assets, profits, and losses are taxes as the income of the sole proprietor personally 1. profits and losses are attributable to the owner personally b. Partnership: An association of 2 or more persons organized to carry on a business for profit i. Formation 1. Common Law: You only need to say that you are partners. 2. Generally, no formalities are required a. Partnership agreement (contract) is recommended 3. State law governs (Revised Uniform Partnership Act) 4. Test: Intent of parties; did these individuals intend to create a partnership? Courts look at how you behaved ii. Ownership 1. Co-owners  You have an undivided right to the ownership of whatever the property is. Each partner has an equal share which generates an equal right to participate (at common law) a. With an agreement, you can split up the partnership any way you like. 2. Share equally in profits, losses, and management a. One partner’s decisions bind the others iii. Relation to Co-Owners 1. Agency: Each partner is the agent of the other partners and the partnership a. Middle Ages Risk: If one partner screws up, you get sold to pay off your partner’s debt (if he runs off & they can’t find you) iv. Duration 1. Common Law: The death or the expression of one partner’s lack of interest in remaining in the partnership ends the partnership a. Until there was no longer an intent to be in the partnership, one partner lacked capacity, one partner died, etc… 2. Today: The partnership survives the death of one partner a. It lasts until it is dissolved voluntarily or involuntarily, e.g. death or imprisonment (by operation of law) v. Transferability 1. Not transferable – Partnerships consist of the people who expressed intent to be in the partnership (at common law – because the act of desiring to transfer was equivalent to a an expression of no longer having an intent to be a partnership) vi. Conduct of Business Affairs 1. By any partner, pursuant to the law of agency vii. Liability 1. Unlimited to the partnership 2. Joint & several liability for the individual partners a. The creditor can take everything from just one partner. b. It can extend to the full assets of all the partners

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viii. Taxation 1. Partnership is not a taxable entity – it is a pass through; profits & losses are attributed to each partner pro rata 2. Each individual is taxed c. Limited Liability Entity i. IRS Standards – If you have at least 3 of the below factors, it is a corporation 1. Limited Liability – Preferred 2. Centralized Management – Preferred 3. Continuous Existence – Not preferred 4. Free Transferability – Not preferred ii. Characteristics 1. Flow-through tax treatment – not double taxed a. The profits go directly to the shareholders, rather than to the corporation. The result is single taxation 2. Fewer managerial formalities 3. Members receive limited liability d. Corporation i. Formation 1. Creature of the state. It does not exist w/o state’s authority 2. Formalities required – Two Organic Documents (documents that create something) Required a. Articles of Incorporation/Charter  General terms about how the corporation is organized; capital structure, officers, etc. b. Bylaws  Govern day-to-day operations of the corporation (what the president does, where meetings are held, housekeeping info, etc.) i. May contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with law or the articles of incorporation c. Procedures: i. Organizational meeting ii. Issuing shares d. Without these formalities, the court will say you have a partnership, and you will be subject to unlimited personal liability 3. Two Ways to Construct an Organization: a. “Off the Shelf”  Get a “how to create a corporation” book; take the forms in the book to the Secretary of State, who stamps them & files them after you pay fees i. Risks  Those documents may not meet your exact expectations; you can end up with a partnership & have unlimited liability b. “Tailor Made” or Custom Corporation  Go to a lawyer and tell him your concerns: these are the relationships; this is the capital structure, etc. 4. Compliance w/State Statute (not federal law) Model Business Corporations Act & Corporate Formalities a. Most states follow MBCA, except Delaware ii. Ownership 1. Owned by shareholders pro rata a. Shares are owned that establish indicia of ownership in relation to the proportion of share that you own b. The corporation issues equity interests that are readily transferable iii. Relation to Co-Owners 1. Governed by: State Corporation Statute; Federal Securities Law; Organic Documents; Contracts b/w Shareholder a. Federal law generally governs the issuance of securities (1933 Act & 1934 Act – establish how corporations are to operate) and shares of a corporation are securities. There are a lot of requirements concerning the way shares are issued and the consequences iv. Duration 1. Perpetual (it can last for as long as it can) 2. Advantages: It doesn’t have to be reorganized when investors die. It can acquire resources and powers beyond that acquired by an individual. 3. Corporation can do anything that any long-living entity could, like the establishment of a dynasty v. Transferability 1. Generally, readily transferable, unless the charter or bylaws prevent this a. You might want to make it not easily transferable to keep it a closely-held corporation (no more than 30 shareholders), as opposed to a publicly held corporation.

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b. When the stock “goes public” it is placed on an exchange so that anyone can buy. The court may interpret it as public if it has more than 30 shareholders. However, for certain situations, this will not constitute a “public corporation” vi. Conduct of Business Affairs 1. Agency  The corporation authorizes an agent (usually an officer and/or director of the corporation) to transact business on behalf of the corporation a. A director is someone elected by shareholders to manage the corporation, who thereby hires an officer to manage the day-to-day operations vii. Liability 1. Limited to the amount of the shareholder’s investment a. If you are given shares b/c you are director’s cousin, you can be assessed for the actual value of the shares (that you did not pay). But if you paid in real money, you won’t be assessed for more than you paid. viii. Taxation 1. Double Taxation: Corporation is a taxable entity and profits are taxable to shareholders upon distribution a. Exception: S corporation – it will be taxed only once. This is only useful in smaller businesses. e. Choice of Entity: The decision to invest your time, energy, and money with the expectation that such an investment will produce benefits in excess of the amount of your initial investment. i. Major considerations: Control & Risk 1. Control a. Exclusive Control – no agency problems b. Shared Control – agency costs i. Agency Costs 1. Financial costs – may make you hire others, such as accountants or auditors 2. will decrease the amount of investment return ii. Costs & Benefits: 1. Traditionally, why do most businesses organize as partnerships or corporations? a. to achieve joint ownership 2. Cost or a Benefit? a. Benefits i. Multiply resources – not dependent solely on your own resources (sole proprietor) b. Cost i. Divide responsibilities (can sometimes be a benefit) Agency Principles a. Rst 3d of Agency § 1.01 – Agency Defined i. Agency is the fiduciary relationship that arises when one person (a “principal”) manifests assent to another person (an “agent”) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to the act 1. starts with the principal who gives authority to the agent, who in turn gives the principal loyalty – the agent now can engage in actions with third parties and the result of the agent engaging in actions with third parties is that the agent can construct a contract that binds the principal. b. Rst 3d of Agency § 1.04 – Terminology i. Co-agents. Co-agents have agency relationships with the same principal. A co-agent may be appointed by the principal or by another agent actually or apparently authorized by the principal to do so. ii. Disclosed, undisclosed, and unidentified principals. 1. Disclosed principal. A principal is disclosed if, when an agent and a third party interact, the third party has notice that the agent is acting for a principal and has notice of the principal's identity. 2. Undisclosed principal. A principal is undisclosed if, when an agent and a third party interact, the third party has no notice that the agent is acting for a principal. 3. Unidentified principal. A principal is unidentified if, when an agent and a third party interact, the third party has notice that the agent is acting for a principal but does not have notice of the principal's identity. iii. Dual agent; joint principals. A dual agent acts on behalf of more than one principal with regard to the same transaction. Such principals are joint principals. iv. Gratuitous agent. A gratuitous agent acts without a right to compensation. v. Notice. A person has notice of a fact if the person knows the fact, has reason to know the fact, has received an effective notification of the fact, or should know the fact to fulfill a duty owed to another person. Notice of a fact that an agent knows or has reason to know is imputed to the principal as stated in §§ 5.03 and 5.04. A notification given to an agent is effective as notice to the principal as stated in § 5.02(1). vi. Person. A person is (a) an individual; (b) an organization or association that has legal capacity to possess rights and incur obligations; (c) a government, political subdivision, or instrumentality or entity created by government; or (d) any other entity that has legal capacity to possess rights and incur obligations.

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vii. Power given as security. A power given as security is a power to affect the legal relations of its creator that is created in the form of a manifestation of actual authority and held for the benefit of the holder or a third person. It is given to protect a legal or equitable title or to secure the performance of a duty apart from any duties owed the holder of the power by its creator that are incident to a relationship of agency under § 1.01. viii. Power of attorney. A power of attorney is an instrument that states an agent's authority. ix. Subagent. A subagent is a person appointed by an agent to perform functions that the agent has consented to perform on behalf of the agent's principal x. Superior and subordinate co-agents. A superior co-agent has the right, conferred by the principal, to direct a subordinate co-agent. xi. Trustee and agent-trustee. A trustee is a holder of property who is subject to fiduciary duties to deal with the property for the benefit of charity or for one or more persons, at least one of whom is not the sole trustee. An agenttrustee is a trustee subject to the control of the settlor or of one or more beneficiaries. c.

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Rst 3d of Agency § 2.01 – Actual Authority i. An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act. Rst 3d of Agency § 2.03 – Apparent Authority i. Apparent authority is the power held by an agent or other actor to affect a principal's legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations. Rst 3d of Agency § 2.04 – Respondeat Superior****need to know for FINAL i. An employer is liable for torts committed by employees while acting in the scope of their employment. Rst 3d of Agency § 3.01 – Creation of Actual Authority i. Actual authority, as defined in § 2.01, is created by a principal's manifestation to an agent that, as reasonably understood by the agent, expresses the principal's assent that the agent take action on the principal's behalf. Rst 3d of Agency § 3.03 – Creation of Apparent Authority i. Apparent authority, as defined in § 2.03, is created by a person's manifestation that another has authority to act with legal consequences for the person who makes the manifestation, if a third party reasonably believes the actor to be authorized and the belief is traceable to the manifestation. Rst 3d of Agency § 3.11 – Termination of Apparent Authority i. The termination of actual authority does not by itself end any apparent authority held by the agent. ii. Apparent authority ends when it is no longer reasonable for the third party with whom the agent deals to believe that the agent continues to act with actual authority. Rst 3d of Agency § 4.01 – Ratification Defined i. A person may ratify a prior act done by another without actual or apparent authority. ii. A person ratifies an act by 1. manifesting assent that the act shall affect the person's legal relations, or 2. conduct that is justifiable only on the assumption that the person so consents. iii. Ratification does not occur unless 1. the act is ratifiable as stated in § 4.03, 2. the person ratifying has capacity as stated in § 4.04, 3. the ratification is timely as stated in § 4.05, and 4. the ratification encompasses the act in its entirety as stated in § 4.07 Agency is the fiduciary relation which results from the manifestation of consent by one person [the principal] to another [the agent] that the other [the agent] shall act on the principal’s behalf and subject to the principal’s control, and consent by the other [the agent] so to act

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k. Tripartite Relationship 1. Agent 2. Principal 3. Third Parties ii. The Agent acts on behalf of the Principal in the Principal’s best interest (fiduciary duty). The Agent is subject to the Principal’s control and is required to subordinate her interests to the interests of the Principal (fiduciary duty). 1. Purpose: Because the principal is not normally around, we have to create a mechanism to make sure that someone [agent] acts on behalf of the principal. l. Agency Costs & Fiduciary Duties i. Agency Costs: It is something that the principal incurs in excess of any compensation she provides to the agent; it is the cost you must incur to make sure that the agent is behaving in the way he is supposed to 1. costs associated with making sure that the agent is actually acting in the principal’s interests and not taking advantage of the principal 2. must make sure that the agent does what you want the agent to do a. i.e. – not pay 500K for a 200K house – make sure the agent is functioning in the manner in which you want them to function. 3. The principal is entitled to rely on the fiduciary’s trustworthiness 4. Ex: Hire an auditor to make sure bank records are OK; hire a lawyer to make sure contracts are OK and there are no conflicts of interest 5. The law imposes fiduciary duties on the agent to help align the agent’s self-interest with the best interests of the principal a. Ex: Agent knows he can be sued, so he won’t act out of line; but this is not always enough ii. Fiduciary Duties: 1. Duty of Care  the duty that a reasonably prudent person in the same circumstances would exercise a. The agent must act in good faith, with the care of an ordinarily prudent person in a like position under similar circumstances, and in a manner reasonably believed to be in the best interests of the principal. 2. Duty of Loyalty  the agent has to sacrifice his own interest on behalf of the principal a. The duty of loyalty addresses fiduciaries’ conflicts of interests and requires fiduciaries to put the corporation’s interests ahead of their own—a sort of mandatory altruism. Corporation fiduciaries beach their duty of loyalty when they divert corporation assets, opportunities, or information for personal gain. b. The duty of loyalty requires the agent to place the best interests of her principal above her own personal interests 3. In a partnership, each partner is the agent of the partnership and of each partner 4. If the officers fire you, you still have an obligation to the partners/board/shareholder m. Exam Tip: This course is about two things – duty of care and duty of loyalty. Almost every paragraph on the exam should talk about duty of care or duty of loyalty n. Risk  the probability that the actual and expected returns will differ i. Investment = Utility Expectation + Risk ii. Relationship between the actual return and the anticipated return; iii. Probability that the actual and expected returns will differ; iv. Exists when there is a large range of potential outcomes o. Rules of Professional Conduct – Rule 1.7 – Conflict of Interest: Current Clients i. (a) … a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: 1. the representation of one client will be directly adverse to another client; or 2. there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer ii. (b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: 1. the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; 2. the representation is not prohibited by law; 3. the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and 4. each affected client gives informed consent, confirmed in writing. p. Fenwick v. Unemployment Compensation Commission (Partners compared with employees) i. Plaintiff – Unemployment Compensation Commission 1. the plaintiff, acting on behalf of Cheshire wants Fenwick to pay money (unemployment)

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2. argument – Cheshire is an employee, Defendant argues that Cheshire is a partner ii. Defendant – Fenwick 1. argument – arguing that Cheshire is a partner iii. Issue – what is the effect of the agreement (written)? Is there a partnership? Is Fenwick responsible for paying unemployment compensation? 1. Court looks to the intent of the parties – in any case dealing with whether there is a partnership the standard the Court uses to determine whether there is a partnership is the INTENT OF THE PARTIES. iv. Facts: Fenwick & his receptionist go to a lawyer to draft a compensation agreement which refers to their relationship as a partnership, but she had no management power and did not share in t...