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This is the simplest form of business organization. The owner is the business. These are usually small enterprises.
Advantages of Sole Proprietorships
Single ownership and the owner receives all the profits. Usually easier to form, less costly and more flexibility. A sole proprietor pays only personal income taxes on the business's profit. Also allowed to establish certain tax exempt retirement accounts.
Disadvantages of Sole Proprietorships
The owner alone bears the burden of an loses, unlimited liability. A lawsuit against the business or employees can lead to unlimited personal liability for the owner. Owner's personal assets are at risk. Lack of continuity if the owner dies. Difficulty in raising capital, proprietor is limited to personal funds.
definition is any arrangement in which the owner of a trademark, tradename, or a copyright licenses others to use these intellectual properties to sell goods or services. The franchisee purchaser is usually legally independent from the franchisor seller. The franchisor wants this because of liability problems, such as the franchisee being an agent for the franchisor.
3 Types of franchises: Distributorship
manufacturing concer (franchisor) liecenses a dealer to sell its products, often with an exclusive territory such as a Ford Dealership.
3 Types of Franchises: Chain-Business Operation
franchise operates under a franchisor's trade name and it identified as a certain materials can only be purchased from the franchisor in order to assure a quality product.
3 Types of Franchises: Processing Plant Arrangement
Franchisor transmits to the franchisee the ingrediants or formula to make a particular product, the franchisee then markets the particualr product. An example is Coca-Cola.
Law Governing Franchises
is contract law. The states and federal government have also enacted laws to protect franchises from fraud and bad faith dealing. The Federal Trade Commission (FTC) requires franchisors to disclose material facts concerning the puchase of a frnachise. The states have done likewise. Major issues are addressed in the contract. The franchisee pays a fee or lump sum for the franchise license, the franchisee must purchase certain products from the franchisor, and the franchisor in most instances will receive a % of the annual sales.
Arises from an agreement, express or implied, between 2 or more persons to carry on a business for profit. Traditional partnerships are governed by common law concepts and statutory law (UPA and Revised UPA). Each partner is deemed to be an agent for the other partners and the partnership. The partner has an ownership interest whereas the agent does not. The Unifor PArtnership Act (UPA) governs the operation of the partnership in the absence of an express agreement.
The UPA looks at 3 elements to determine whether a partnership exists:
- 1. Sharing or profits and losses
- 2. Joint ownership of the business and
- 3. Right to be involved in the management of the business.
- Today the UPA treats a partnership as an entity for most purposes; examples, a partnership can sue and be sued, collect judgements and have accounting procedures in the name of the partnership. As an entity a partnership may hold title to real or personal property in its own name. (So, there are some entity characteristics as well.) Also, for taxation putposes, the partnership is an aggregate of individuals and has no tax liability, income is passed through to the owners-partners of the entity.
Can be oral, written or implied. A written partnership agreement if known as articles of partnership.
- Basic Structure
- -Name of the partnership
- -Names of the partners
- -Location of the busines and the state law under which the partnership is organized
- -Purpose of the partnership
- -Duration of the partnership
- Capital Contributions
- -Amount of capital that each partner is contributing
- -The agreed-on value of any real or personal property that is contributed instead of cash
- -How gains and losses on contributed capital will be allocated and whether contributions will earn interest
- Sharing of Profits and Losses
- -Percentage of the profits and losses of the business that each partner will receice.
- -When distributions of profit will be made and how net profit will be calculated
- Management Control
- -How management responsibilities will be divided among the partners
- -Name(s) of the managing partner or partners and whther other partners have voting rights
- Accounting and Partnership Records
- -Name of the bank in which the partnership will maintain its business and checking accounts
- -Statement that an accounting of partnership records will be maintained and that any partner, or her or his agent, can review these records at any time
- -The dates of the partnership's fiscal year (if used) and when the annual audit of the books will take place
- Dissociation and Dissolution
- -Events that will cause the dissociation of a partner or dissolve the partnership such as the retirement, death, or incapaity of any partner
- -How partnership property will be valued and apportioned on dissociatino and dissolution
- -Whether an arbitrator will determine the value of the partnership property on dissociaiton and dissolution and whether that determination will be binding
- -Whether arbitration is required for any dispute relating to the partnership agreement
Rights of partners are governed by partnership
- In a traditional partnership, all partners have equal management rights and have one vote. In a large partnership, this responsibility can be delegated management committe. Majority rule controls decisions in ordinary matters unless otherwise specified in the agreement. Major decisions outside the ordinary course of the partnership business require unanimous consent of the partners.
- If the agreement is silent as the apportion of profits, profits will be shared equally. (Same for losses.)
- A partner generally receives no salary, a partner's income from the partnership takes the form of a distribution of profits according to the partners share. Partnership books and records must be accessible to all partners. An accounting of partnership assets or profits is required, can be performed voluntarily or compelled by court order. Property acquired by the partnership is the property of the partnership and not the individual partners. A partner may use partnership property only on behalf of the partnership, a partner is not a co-owner of th eproperty and has not right to sell or mortgage it. A creditor of an individual partner may not use partnership property to satisfy a partners debt. A creditor can seek a charging order to attach an individual partner's interest in the partnership.
Duties and Liabilities of partners are governed by partnership
These are basically derived from agency law. A partner owes fiduciary duties to the partners and the partnership, duty of care and the duty of loyalty. A partner must disclose an interest that may conflict with partnership duties to other partners.
Authority of Partnership
UPA affirms general agency law that pertains to a partners authority to bind the partnership to a contract. A partner can subject the partnership to tort liability if the partner is carrying out partnership business. Both the partner and the partnership share liability. Implied authority generally is broader for partners. The character and scope of partnership business determines the implied powers of the partners. PArtners can exercise all implied powers reasonably necessary and customary to catty out that particular business. If the partner acts within the scope of authoriy the partnership is legally bound.
Disadvantage of a partnership
is that the partners are personally liable for the debts of the partnership. Joint liability- third party must sue all of the partners as a group but each partner can be liable for the full amount. Joint and several- partners are both jointly and several liable for all partnership obligations; including contracts and torts. New partners/'s liability for existing debts before becoming a partner is limited to capital contribution to the firm.
Dissociation of Partnership
- partner ceases to be associated in the carrying on the partnership business, withdraws. This normally entitles the partner to have his or her interest purchased by the partnership.
- Events that cause dissociation, p. 396. IF the dissocaition breaches the partnership agreement, it is wrongful. See example, p.396. Case in point, p. 397. To avoid liability, a partnership should notify its creditors, cutosmers and clients of a partner's dissociaiton.
The same events that cause dissociation may result in the termination of the partnership. Generally, the partnership continue if the remaining partners consent. Termination is referred to as dissolution. Winding up after the act of dissolution is th eactual process of closing the partnership down. See case point, p. 397. Winding up includes collecting and preserving partnership assets, dischargin liabilities, paying debts and accounting to each partner's interest in the partnership. Partners continue to have fiduciary duties to one another and to the firm during this process. A partner is entitled to compensation for services in the winding up phase.
Limited Liability Companies and Limited Partnerships
The LLC is a hybrid form that combines the limited liability aspects of the corporation and the tax advantages of a partnership. Another advantage is that foreign investors are allowed to become LLC memebers (compare to S corporation- no shareholder may be a non-resident alien). LLCs are creatures of the state, formed and operate in compliance with state law. Owners of an LLC are called members. LLCs are legal entities: can sue and be sued, enter into contracts and hold title to property.
Articles of Organization must be filed with a central state agency (usually secretary of state's office). Articles are required to include- name of the business, its principaladdress, registered agent, names of the owners and information on the management of th eLLC. The business name must include LLC. A majority of the states permit one-memebr LLCs, some at least 2 members.
LLC Jurisdictional Requirements
Remember under federal jurisdiction, a corporation is deemed to be a citizen of the state where it is incorporated and has its prinicpal place of business. The statute does not mention the state citizenship of LLCs, courts have tended to regard LLCs as citizens of every state in which their memebrs reside. (This can be a problem in federal diversity cases.)
Advantages of LLC
MEmebrs risk of loss is limited to the amount of their investment. Flexibility in regard to both taxation and management. Is an enduring business entity, can exist beyond the death and illness of its members. LLC can include foreign in investors.
Disadvantages of LLC
Main one is that the state statutes are not uniform. Also, since this is rather new form of business entitiy, case law may be thin.
LLC Operating Agreement
MEmebrs get to decide who will participate in the management and operation of the business. Memebrs do this by forming an operation agreement. Operating agreements typically contain the following: management provision; how profits will be divided, transfer of memebrship interests, impact of death or depature of a memebr and other provisions. A written operating agreement is not required in some states. It does protect the interests of the memebrs and is recommended.
Management of the LLC
In a memebr managed LLC, all the members participate and majority vote controls. In a member- managed LLC, the memebrs designate a group of persons to manage the firm. Can consist of members and non-members, or a combination. Managers in the manager-managed LLC owe fiduciary duties to the LLC and its members (just like corporate officers and directors to shareholders).
Dissociation and Dissolution of an LLC
A member has the power to dissociate from the LLC, but he may not have the right dissociate. Events that trigger dissociation- voluntary withdrawal expulsion by other members or court order, bankruptcy, incompetence or death. The other members of the LLC can choose to continue the LLC.
Effect of Dissociation of an LLC
losses right to participate in the management and act as an agent. Generally, has the right to have his interest in th eLLC bought out by th eother members at fair value. If the dissociation is wrongful (violates the LLC's operating agreement), dissociated members can be held liable for damages. Normally, the dissociated member has no right to force the LLC to dissolve. (This can be addressed in the operating agreement.) When an LLC is dissolved, any member who did not wrongfully dissociate can participare in the winding up process. In th ewhinding up phase, members must collect, liquidate and distribute the LLC;s assets. Proceeds are distributed to pay off debts to creditors first, members capital contributions are returned new and any remaining amounts are then distributed to members in equal amounts or according to the operating agreement.
ia a creature of statute and its existence depends on state law. All states have enacted laws creating corporations, Model Business Corporation Act (MBCA). There is a revised version. A corporation can engage in any act and enter into any contract available to a natural person.
A Corporation Consist of
one or more natural persons. Shareholders are protected by the corporate veil, creditors can reach teh assets of the corporation but not th epersonal assets of shareholders unless the corporation was established to commit fraud.
The Board of Directors in a Corporation
has the responsibility for the overall management of th ecorporation, they set goals. The BOD hires officers to carry out the goals and objectives of the board. Members of the board are elected by the shareholders. By purchasing stock, shareholders. By purchasing stock, shareholders become owners in the corporation. The body of the shareholders can change without affecting the exitence of the corporation. (A major positive for this business form.)
can be taxed twice, earning and dividends. PRofits that are not distributed are retained by the corporation, there are called retained earnings.
Classification of Corporations
Domestic, foreign and alien. Public and Private. Nonprofits are usually private. Close corporation- Shares are held by members of a family or just a few persons. Management of a close corporation resemebles that of a sole proprietoryship. Sale of the stock can be restricted or require a right of first refusal.
qualifies with the IRS. This avoids imposition of income taxes oat the corporate level while retaining limited liability. Major benefit, when the corporation has losses, shareholders are allowed to use the losses to offset other income. Limited liability companies age faining popularity here.
Before a corporation comes into existence,
people must invest their money as subscribers. The subscribers are investing in an idea that will hopefully make money. Promoters must go out and sell the idea or investment undertaking to potential subscribers in the potential corporation. The promoter must issue a prospectus. As a general rule, a promoter has personal liability on preincorporation contracts. (The corporation has not yet come into existence so no agency.) Promoter can get the subscriber to agree to hold the promoter harmless, and look to the newly formed corporation . Subscribers generally become shareholders as soon as the corporation is formed. Uner the RMBCA, a stock subscription agreement is irrevocable for 6 months. This protects the other subscribers.
must file in a state, domestic corporation in that state. Pcik a state with the least restrictive laws, Delaware. The primary document to begin the corporation is the articles of incorporation. The articles include basic information about hte corporation and its authority. The persons who sign the articles are called incorporators. The corporate name, nature and purpose, duration, capital structure, internal organization and registered office and agent are included in the articles. Incorporators must sign the articles, be listed by name an address, number can be 3 or even 1. The articles are then sent to the appropriate state offical along with a filing fee. The certificate of incorporation or corporate charter is then issued by the state. The incorporators then hold the initial organizational meeting.
Piercing the Corporate Veil
- At times, owners or officers
- or directors of a corporation will use a corporate entity to commit fraud or
- other illegality. In such a case, a plaintiff may be able to “pierce the
- corporate veil” –i.e., disregard the
- corporate entity and its attendant limitations on personal liability – and
- sue the wrongdoers individually for
- actions they took as owners,
- officers, or directors of the corporation.
- The following factors may
- persuade a court to pierce the corporate veil:
- (1) the plaintiff was tricked or misled into
- dealing with the corporation rather than the individual;
- (2) the corporation was created never to make a
- profit or had insufficient capital at the time of its formation to meet its
- prospective debts or potential liabilities;
- (3) the corporation was formed to evade an
- existing legal obligation;
- (4) the corporation does not observe
- statutorily-required corporate formalities; and
- (5) personal and corporate interests are
- commingled to the extent that the corporation ceases to have a separate
- identity from its owners.
- The alter-ego theory of PCV states is applied
- when the corporation is so dominated by an owner that the identities between
- the corporation and the owner…
Every Corporation is governed
by a board of directors. No individual director can be an agent of the corporation . Directors are not trustees but they do hold a position of trust, fiduciary duty. The initial board of directors is normally appointed by the incorporators. A director can be removed for cause, failing to perform a required duty. Shareholders or the board can fill vacancies. The board conducts business by conducting formal meetings in which minutes are kept. Usually, a quorum is a majority and voting is normally done in person.
Directors Management Responsibilities
- 1. Authorization of majorcorporate policy decisions.
- 2. Appointment, supervision and removal of corporate officers and other managerial employees, set their compensation.
- 3. Financial decisions, example, payment of dividends. The rights of corporate officers and other high level managers are defined by employment contracts. These individuals generally serve at the pleasure of the BOD, and can be discharged without cause. Corporation could be liable to breach of contract, but courts will not require the corporaiton to rehire them.
Officers and directors
have the same fiduciary duties, their relationahip to the corporation is one of trust and confidence.
Liability of officers and directors
may be held liable for crimes and torts committed by themselves or by corporate employees acting under their superfision. Shareholders can sue the directors, shareholders' derivative suit, on behalf of the corporation if they think that the directors are not acting in the best interests of the corporation.
Directors and officers are required to use their best
judgment in directing th eaffairs of the corporatin. Under the business judgment rule, officers and directors, may be able to avoid liability for business judgment for poor judgment. Officers and directors are not insurers of business success and honest mistake occur. Must comply with fiduciary duties and act within the power of the corporation. Directors and officers must act in good faith and with the care of an ordinary prudent person in a similar situation.
they own the corporation but have not title to specific corporate property. Sharehlders have no management responsibilities, that belongs to the board and officers.
must approve fundamental changes, election and removal of the Board of Directors. Shareholders meetings must occur at least annually in addition to any special meetings, must be notified.
Rights of Shareholders
to receive stock certificates, this evidences ownership of so many shares. In many states, the board can decide no actual physical stock certificate be issued. Preemptive right, common law concept, existing shareholders have right to purchase new issues of stock. Shareholders have no right to dividents. Shareholders can go to court to compel directors to issues dividend, corporation has to be flush with cash though. Shareholders have common law and statutory inspection rights. There must be a proper purpose to inspect. If the corporation is dissolved and its oustanding debts and claims are satisfied, remaining assets are distributed to the shareholders. Shareholders can at times file a derivative action. This occurs when the board fails to take action or solve a problem. The wrong could be one caused by the board. Any damages recovered usually go to the corporation's treasury.
Duties of Shareholders
In some cases a majority shareholder has a fiduciary dury to the corporation and to minority shareholders. Such a breach in a close corporation is termed oppressive conduct.