Corp Outline - Haas PDF

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HAAS CORPORATIONS OUTLINE

***FINAL—3 hours, 10 short answer worth 6 points each, 20 MC questions worth 2 points each; need simple calculator. I.

CHOICE OF ENTITY: A. FACTORS TO CONSIDER-when deciding what business form, must consider these factors: i. Liability: when business can’t pay the bills, who is on the hook? ii. Control: who will control/manage entity iii. Transferability: how easily can ownership interests be sold/transferred to 3rd party? iv. Continuity of Existence: how long can a particular entity live? v. Taxation: how is entity taxed? You want to minimize the burden. 1. ENTITY LEVEL TAXATION-entity itself pays taxes; 2. FLOW THROUGH TRETMENT-means profits are allocated to owners and they pay taxes. Entity doesn’t pay income tax. vi. Capitalization: how easily can this entity raise additional $? B. SOLE PROPRIETORSHIP (SP)-most common form; only need (1) individual and (2) business. Can’t have SP with 2 people, though SP can have employees. Don’t usually have to file docs with state (little formality required), but sometimes have to register name (“dba”). Ex-person sells photos. i. Liability: owner is responsible for all debts—has unlimited personal liability (“UPL”) for all business obligations. No other responsible legal entity. 1. PERSONAL CREDITORS-owners personal creditor can go after assets of SP; business and personal assets are one and same. 2. LIMIT LIABILITY-could (1) get insurance, and/or (2) limit exposure by K. ii. Control: management is centralized; owner controls. iii. Transferability: owner is free to transfer interest in SP at will. If you want to sell, transfer or assign, can do so. iv. Continuity of Existence: can last for life of owner; can’t continue beyond owner’s life. Can be closed before death too (sold, bankrupt). v. Taxation: profit/loss flows from company onto owner’s personal income tax (no separate entity). Delineate how it did on Schedule C. 1. EFFECT-if business made $, will be taxed. If lost $, will lower owner’s taxes. 2. ABOVE/BELOW THE LINE-every $ above the line has $ for $ impact on taxes; everything below the line is watered down if you make too much $ (ex-if you have $40K below the line, may only get credit for $20-25K). vi. Capitalization: best way to raise $ is taking out loan (if bring in other people, not SP; if you sell ownership interest, not SP). 1

HAAS CORPORATIONS OUTLINE

C. GENERAL PARTNERSHIP (GP)- are statutory provisions; most states have adopted UPA or RUPA (“default” or “supplementary” provisions). There are some provisions, however, that cannot be waived (ex-RUPA 103(b)). CAN HAVE A PARTNERSHIP WITHOUT PARTNERSHIP AGREEMENT!!! i. Is it a GP? 1. DEFINITION-UPA 6(1) says you need an “association of two or more persons to carry on as co-owners a business for profit”. Must be consensual, with goal to make $. 2. INTENT-partnership can be express or implied; partners don’t have to subjectively intend a partnership. a. Objective Intent: subjective intent is NOT important; just objective. Even if say no partnership, if facts show otherwise, that is controlling. 3. PARTNERSHIP AGREEMENT-its possible to have GP without partnership agreement (many don’t). a. Doesn’t Have To Be In Writing: partnership agreement can be oral or implied. RUPA 101(7). b. Actions Are Controlling: even if you put in writing it is NOT partnership, actions are controlling. Look at all facts and circumstances. QUESTION OF FACT. 4. SHARING PROFITS-sharing profits isn’t dispositive (UPA 7.1, RUPA 202(c)); there is presumption you are partner when share profits, UNLESS loan involved and just getting profits until loan is repaid. 5. MARTIN V. PEYTON (1927)-Martin was suing partnership because they were Ds that had $; Martin was creditor, and tried to argue Peyton was partner, and thus J&S liable for GP’s debts. Peyton got involved with corp because they loaned them $. Signed document that said “no partnership is being formed”. Court said doc wasn’t conclusive, and neither was sharing profits; must look to all facts. D’s were trustees; collect income/dividends. Measures they took were to protect their loan; facts indicate this was loan, not partnership. ii. Liability: all partners are liable for debts of partners. There is JOINT & SEVERAL LIABILITY for all debts of partnership if partnership cant pay (can use just one person for everything; liable for it with partners and as individuals. Then one person go after partners). 1. PERSONAL CREDITORS-cant go after business assets; separate entity that didn’t incur debt (but can join onto your ownership stake in GP—one of your personal assets). 2. LIMIT LIABILITY-GP can take certain steps to limit liability: a. Insurance: can get malpractice insurance, etc. b. Limit Creditor’s Recourse: can limit creditors’ recourse to certain assets only. c. Limit Partner Authority to Incur Debt: can limit partners’ authority to incur debt/bind partnership to K. i. RUPA 303-can be filed with state. 3. NEWLY ADMITTED PARTNERS-UPA 17 & RUPA 306 state that newly admitted partner is liable for debts prior to partnership, but only to extent of his investment. iii. Control: depends on partnership agreement; will delineate control. 1. CONTROL v. CO-OWNERSHIP-courts says if co-owner, have RIGHT to participate in control (don’t have to exercise, just need right to do so). Does not mean have joint title to all assets. a. Lupien v. Malsbenden -P wanted to buy Bradley Auto; went to Craigan and entered into K for loan. P never got car; Craigan disappeared. Sued D, under theory that was partnership, and thus J&S liable (meaning, can sue Malsbenden for 100%). D said just provided loan, not partner. P frequently dealt with D, involved in day to day business, participated in control of 2

HAAS CORPORATIONS OUTLINE

business, paid salaries, etc. He had right to participate in control of business! Doesn’t matter that D says he isn’t partner; court finds he is partner (went beyond role of banker). Has J&S liability, and is fully responsible to P. 2. DEFAULT RULE; EQUAL CONTROL-if no partnership agreement, or if agreement silent on control, UPA 18h and RUPA 401f says equal control. Decisions made by majority (even if 1 partner has 90%, other 2 have 5%). Summers v Dooley- two partners; one wanted to hire new employee, other didn’t. Hired anyway, sued other partner for a. expenses incurred. No partnership agreement. Idaho statute said decisions must be made by majority; each has veto power, must agree. Said didn’t have to pay. b. Hypo: A invests 90% and B and C each invest 5%; if partnership K that doesn’t talk about control, default says decision is made by majority (B&C could win against A). A should include “MANAGERIAL CONTROL PROVISION” in partnership agreement, that says he gets 90% of say—overrides default rule. 3. LOYALTY-partners generally owe duty of loyalty to each other. a. Meinhard v. Salmon- S entered into another K without notifying partner. Cardozo said “joint adventurers, like co-partners, owe to one another, while enterprise continues, duty of finest loyalty”. RUPA 403, 404 and UPA 20, 21 require to hold benefit received as a result of partnership in a trust. b. Statutes: RUPA 403, 404 and UPA 20, 21 require partner to hold any benefit they receive as a result of partnership in trust for partners. iv. Transferability: partnership is consensual association; usually, agreement will address issue of transferability. If it doesn’t, fall back on default provisions. 1. DEFAULT; CAN TRANSFER FINANCIAL INTEREST-UPA 27(1) & RUPA 503(a)(b) say partner can transfer interest, but only financial attributes are transferred! Transfers share of P&L, and right to receive distributions are considered personal property (RUPA 502); thus, can transfer.

2. MANAGEMENT/CONTROL-part of consensual nature of partnership; cannot be transferred unless all partners agree (UPA 18(g) says can have lower voting threshold; but if you don’t specify, need unanimity). Transferor retains mgmt/control of partnership. 3. LIABILITY-transferor retains J&S liability since he is responsible for making decisions that impact business. a. Limit Liability: to limit, can withdraw from partnership, and cede mgmt/control to other partners. v. Continuity of Existence: 1. SPECIFIED IN PARTNERSHIP AGREEMENT-generally, GP lasts until one of laundry list of events in partnership agreement occurs (ex-death of partner, completion of project, specific date). 2. DEFAULT RULES-if no partnership K, UPA/RUPA specify events that will cause DISSOLUTION of partnership. a. Dissolution: happens automatically upon occurrence of specified event. Doesn’t terminate partnership; designates change in relationship (ex-if one dies, can go on with less partners and reconstitute, or wind up). 3

HAAS CORPORATIONS OUTLINE

vi. Taxation: partnerships as entities don’t pay income tax; they are flow through tax entities (no entity level tax). 1. NO ENTITY LEVEL TAX-partners personally pay income tax based on their allocated share of P&L. 2. FLOW THROUGH-GP will fill out 1065 and sent to IRS; partnership will send K-1 to each partner, which shows P/L for year. Enter that info in Line 17 on the 1040 (“above the line”). 3. PROBLEM-may get no $/distribution from partnership but will get tax bill. GP doesn’t need to distribute $-it is self-financing. a. Ex-GP might make $100K for the year, but not distribute. If your share is $25K, will still get taxed on that. vii. Capitalization: best way is taking out loans OR having more people buy into it (bring in more partners; depends on partnership K). viii. Note—Distribution of Profits: profits are distributed via agreement; don’t necessarily get what you put in (although you can). Ex-person who puts in 20% might contract to get 50% profits. D. JOINT VENTURE (JV)-legally, no real distinction between JV and GP. Only real distinction is the purpose; JV’s usually have narrow purpose (i.e., build a building, discover a drug, etc). Every other factor same as GP. E. LIMITED PARTNERSHIP (LP)-partnership where 1 or more GPs and 1 or more limited partners. Distinguishes itself from GP with respect to LIABILITY and CONTROL/MANAGEMENT. Other factors are same as GP. i. Formation: to form LP, have to file Certificate of Limited Partnership with Secretary of State. Puts world on notice that some partners have limited liability (not J&S). ii. Liability: GP have J&S liability; limited partners have limited liability—they can only lose what they have invested (no more). 1. LIMITED PARTNERS-LPs have limited liability; they can only lose what they have invested. 2. GENERAL PARTNERS-GPs of LP have J&S liability for debts of LP if it cant pay its debts. In return, GPs get to manage and control partnership. a. Mitigating J&S Liability: to mitigate, don’t become GP themselves; interpose corporation (LL entity) or LLC instead. Form corp/LLC and invest minimal assets; corp buys into LP and becomes GP. Still have control, but if LP fails, cant get your personal assets. Assets of corp or LLC are exposed to LP but not personal assets. Corp

LP

LP

LP

GP LIMITED PARTNERSHIP

iii. Management & Control: 1. “CONTROL RULE”-GPs manage/control partnership; because limited partners can only lose what they have invested, they give up any management/control ( “silent partners”). If limited partners participate too much in mgmt/control, might lose their status as such. Most states follow and embrace “control rule”. 2. SOME CONTROL-ULPA 303 has eroded “control rule” by allowing limited partners to exert some control. Reason is to make LP more competitive, trying to reform it. 4

HAAS CORPORATIONS OUTLINE

3. GATEWAY POTATOE SALES V. GB INVESTMENT CO- Sun Packing was getting seed potatoes from Gateway; didn’t pay. Sun Corp didn’t have any $, but GBIC had deep pockets. Gateway argued GBIC crossed line with respect to mgmt/control, and became de facto GP (subject to J&S liability). a. ARIZONA STATUTE-said limited partner not liable UNLESS also GP or takes part in control of business. Thus, can be GP and LP at same time; but if cross line, lose LL and have J&S. BUT… only liable to those creditors who thought overstepped boundary based on their conduct with you/business. INDIRECT KNOWLEDGE/CLANDESTINE PROBLEM. b. OLD ULPA 302-says even if overstep line, only liable to those who thought were GP because they dealt with you in conducting business. Some sort of privity. Problem-could be LP with GP control if do it secretly; cant learn LP activity from 3rd party-must witness it yourself. c. OLD ULPA 303(B)-limited partner may have certain rights and powers she can exercise without losing LL. For example, can request meeting of partners. But if stop over line, lose LL and J&S liability. F. LIMITED LIABILITY PARTNERSHIP (LLP)-essentially GPs that have limited J&S liability to some degree. Almost exclusively used by professionals; groups that could incur malpractice (doctors, lawyers). i. Formation: to form LLP, have to file with state to put people on notice that partners are not vicariously liable (RUPA 1001). 1. NAME-entity name must end in “LLP” (RUPA 1002). ii. Liability: under most LLP statutes, partners of LLP are J&S liable for all obligations of LLP (no different than GP). 1. MALPRACTICE-where it is different comes to malpractice; each partner is liable ONLY for their own malpractice. Fellow partners not responsible for your malpractice. a. Most statutes require minimum amount of malpractice. G. LIMITED LIABILITY COMPANY (LLC)-Wyoming formed first LLC statute; form has very quickly become one of most popular forms. Creatures of statute. i. Generally: designed to take advantage of best of corp and best of partnership form; hybrid between corp & partnership. Owners are called “members”. ii. Formation: have to file; in NY, have to file Articles of Organization with Secretary of State. 1. OPERATING AGREEMENT-governs LLC relationship; similar to partnership K covers governance, transferability, etc). iii. Liability: provides owner with limited liability, where limited to investment (like corps). EVERYONE has LL, even those who manage and control (can lose only investment). 1. PERSONAL ASSETS-LLC creditors can NOT take personal assets. iv. Management & Control: anyone who controls is benefited by limited liability. Type of control: 1. MEMBER MANAGED-default rule is that LLC managed by all members; if nothing in agreement, all members manage. 2. MANAGER MANAGED-OA often puts managerial control in hands of 1 or few members (“managers”). Cedes management to select authority (really runs other members into limited partners). 5

HAAS CORPORATIONS OUTLINE

v. Transferability: can be transferred, but only financial interest is transferred (mgmt/control attributes not transferred unless approved by members, although OA can provide otherwise). vi. Continuity of Existence: like partnership; OA can specify “Events of Disassociation”. Will continue until event specified in OA occurs, or default to RUPA.

vii. Taxation: generally like partnership; flow through tax treatment. 1. PERSONAL INCOME TAX-members are taxed based on their rates. 2. FLOW THROUGH-members receive schedule K-1 allocating pro rata share of P/L. Goes into 1040 “above the line”. viii. Capitalization: to extent OA/statute provides, can bring in new members. Can also have different classes (ex-Class A with voting rights, class B without voting rights, subordinated rights, etc). Tremendous flexibility!! ix. Note—Distribution of Profits: profits are distributed via agreement; don’t necessarily get what you put in (although you can). Ex-person who puts in 20% might contract to get 50% profits. H. CORPORATION i. Basic Features: 1. SEPARATE ENTITY-separate & distinct legal entities!!! “Artificial people”; separate/distinct from owners/manager. 2. FORMATION-existence begins after filing Articles of Incorporation (“charter”). 3. OWNERS-shareholders/stockholders are owners of a corporation (“residual claimants”). 4. MANAGEMENT-officers (CEO, CFO) manage day to day operations. BOD oversee management; SH vote to elect BOD. Note: can be on BOD and be senior officer. 5. POWERS-corp has power to K, sue and be sued, commit a crime, to be subject to income and other taxes, entitled to due process and equal protection, power to attorney/client privilege, enjoy 4th Amend. Rights, sue for defamation, 1st Amendment rights to Free Speech. No right to privacy. 6. DISTINCTIONS BETWEEN PUBLIC & PRIVATE CORPORATIONS-

ii. Factors: 1. LIABILITY-SH have limited liability; not liable for debt of corp if it cant pay (unless pierce corporate veil). Separate legal entity! Reason why most companies incorporate. 6

HAAS CORPORATIONS OUTLINE

2. MANAGEMENT/CONTROL-mgmt rests with BOD and officers; removed from hands of SH’s in large, public companies. a. DGCL 141(a) & NYBCL 701: must be separation of ownership and control. For small, closely held companies, however, don’t need separation of ownership/control. 3. TRANSFERABILITY-shares of stock can be transferred from one owner to next; federal and state security laws have a lot to say about transferability. a. Closely Held Corps: SH agreement might govern relationships in closely held corps, and tell you to whom can transfer/what process must be followed. 4. CONTINUITY OF EXISTENCE-can specify termination date in agreement; but default rule is perpetual existence. No events of disassociation/dissolution—doesn’t matter if shares change hands. Not consensual association. 5. TAXATION-corps are subject to “double taxation”, because considered separate legal entities. a. C Corporation: subject to double taxation; taxed at entity level, then SH pay taxes again (typical). b. S Corporation: if corp has certain characteristics, might qualify as S Corp, which allows it to get beneficial tax treatment (turns into “flow through” tax entity). Main requirements: i. # AND IDENTITY OF SHAREHOLDERS-SH must be individual (U.S. citizens or resident alien), qualified estate or trust, or another S corp. Can only have 100 SH or less (small businesses). 1. If C corp or foreigner buys shares, S Corp loses treatment; taxed like C corp. ii. CAPITAL STRUCTURE-S Corp can only issue one class of stock; plain vanilla common stock. iii. SUBSIDIARIES-it can buy stock in other C or S corps, but C corp cant buy into S corp; would ruin status. c. Example: 10 owners, pre-tax profit of $1M. Corp dividend tax rate is 15%, Individual tax rate is 39.6%, and C Corp tax rate is 35%.

6. CAPITALIZATION-C corps have amazing flexibility (not S corps, because can only issue plain vanilla common). Typically, raise $ by issuing these types of securities: a. Debt Securities: IOU’s issued by corp to people who lend money. Can be bonds, debentures, notes. i. K CLAIMANTS-rights of debt holders are determined by K, so referred to as “K claimants”. ii. UPSIDE-upside capped at interest rate and eventually principal. Ex-if corp makes 25%, rate is 7%, holders only get 7%. Common stock holders get extra $. iii. SENIORITY-debt securities can be issued with different types of seniority (senior debt, sub debt, etc). Hierarchy is K based. 7

HAAS CORPORATIONS OUTLINE

Preferred Stock: hybrid with debt/common stock features; rights are put into Certificate of Designation filed with SOS. Also referred to as “K claimants”. Holders have two preferences over common SH. i. DIVIDEND PREFERENCE-must get K div payment before common stock dividends (i.e., 7% interest). ii. LIQUIDATION PREFERENCE-preferred holders get liquidation preference before common holders get anything. c. Common Stock: ownership/equity interest in company. i. RESIDUAL CLAIMANTS-common gets what is left after debt, creditors and preferred. Last in line on repayment food chain. Thus, most risky. 7. NOTE: DISTRIBUTION OF PROFITS-$ is paid out in form of dividends, based on ownership. If own 10%, get 10% dividends. b.

iii. State of Incorporation: each state has incorporation statute. We focus on Delaware and NY. Corp governance governed by statutory law of state of incorporation (no matter where operating)! 1. DELAWARE-very common place to incorporate (makes large % of its $ from franchise tax). Why? a. Management Friendly: DE has minimal...