Corporations & Partnerships Outline PDF

Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Agency Law Agency Law: dictates when a business will be bound by a contract with a third party that someone entered into on the business's behalf ex. a sole proprietor of a paint business allocating authority for an employee to buy paint on behalf of the sole proprietor's account An agency relationship is created when an agent-to-be and a principal-to-be consent to their association with each other 1) a principal "manifests assent" to the agent that ○ 2) the agent shall act on the principal's behalf and subject to the principal's control, and ○ 3) the agent manifests assent or otherwise consents to so act "manifests" include written or spoken words or other conduct employee (agent) - employer (principal) relationships are a classic example of agent-principal relationships Johnson v. Priceline.com, Inc., 2d Cir. 2013 Facts: Priceline is an online travel accommodation site that, through one of its offerings called the "Name Your Own Price" service, allows consumers to bid for hotel rooms Priceline did not disclose to consumers how they offer the rooms at somewhat higher rates and retains the difference as profit Issue: Did Priceline owe a fiduciary duty to disclose to their consumers about their pricing strategy for the "Name Your Own Price" service? ○ Was there an agency duty between P and D to disclose Holding: No Rule: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Restatement 2d of Torts - Agency: the fiduciary duty which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act ○ 1) a manifestation by the principal that the agent will act for him ○ 2) acceptance by the agent of the undertaking; and ○ 3) an understanding between the parties that the principal will be in control of the undertaking Reasoning: the plaintiffs retained no authority over how the price would be procured There was a contractual obligation for Priceline to obtain the principal's desired price, which it successfully completed, and once it did, the principal retained no right of interim control over how it procured the desired price ○ the right of control is what distinguishes an agency relationship from a mere contractual one B. When is A Principal Bound to a Contract? if an agent acted with actual or apparent authority 1. Actual Authority (R.3) - the agent reasonably believes, per the principal's manifestations to the agent, that the principal wishes the agent to act focuses on the communication by the principal to the agent, and the agent's reasonable interpretation of that communication actual authority can be express or implied implied ex. - someone gets told by the owner of a biz they are in charge while the owner is away on vacation, it is implied that the actual authority would include any actions necessary in running the biz, like signing contracts for new jobs 2. Apparent Authority (R.3) - 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 based on what the principal tells a third party ○ ex. if an owner calls a paint store (third party) that they have authorized an employee to buy paint on their account H.H Taylor, C.A. v. Ramsay-Gerding Construction Co., Or. 2008 Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Facts: While constructing a hotel, Ps became concerned about the possibility that the new stucco system would rust the contractor organized a meeting with the stucco installer and an agent of the stucco manufacturer ○ the agent made several representations to Ps, including that they had a 5-year warranty, confirmed in writing The stucco system rusted, but the stucco installers never did anything to fix the problem Issue: Was apparent authority given to the stucco agent that legally bound the principal under Oregon law when Rule: Apparent authority can be created by conduct which, when reasonably interpreted, causes a third party to believe that the principal consents to have the apparent agent act for him on that matter ○ when a distant principal places an agent "in charge of a geographically distinct unit or branch, it may lend weight to a finding of apparent authority, depending on circumstances ○ Apparent authority exists when the principal does something that makes a third party reasonably believe the agent has authority Reasoning: ChemRex gave McDonald the authority to help process warranties and communicate with customers ○ P testified that he believed McDonald was the person in charge of supervising the area, and knew he represented ChemRex Ps did not need to learn directly from ChemRex of McDonald's position, but they knew he was the territory manager for Oregon It was reasonable for Ps to infer McDonald had the authority to address their concerns about the warranty 3. Estoppel A business may be bound to a contract entered into on behalf by an agent or other person lacking both actual or apparent authority under the doctrine of estoppel. R. 3d of Agency states: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL a third party believes they are dealing with an agent of the principal, and the third party detrimentally relied on the agent. As such, the principal ○ 1) intentionally or carelessly caused such a belief, or ○ 2) having notice of such belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts ○ ONLY USE THIS AFTER ACTUAL AND APPARENT AUTHORITY FAIL 4. Inherent Agency Power A business may be bound to a contract entered into on behalf by an agent or other person lacking both actual or apparent authority under the doctrine of inherent agency power. R. 2d of Agency states: It is a term that indicates that the power of an agent which is derived not from authority, apparent authority, or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent ○ courts invoke inherent agency power when fairness dictates holding a principal liable on a contract even though the purported agent lacked authority and one or more estoppel elements are missing. 5. Ratification A business may be bound to a contract entered into on behalf by an agent or other person lacking both actual or apparent authority under the doctrine of ratification. R. 3d of Agency states: the affirmance of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority ○ ex: an employee buying an item knowing the owner of the biz is looking for the item bought, and after the employee tells of the purchase to the owner is commended for taking action 6. Entity-Specific Rules a. Partnerships RUPA S. 301 Elting v. Elting, Neb. 2014 Facts: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Glenn Elting and Sons, a farming partnership, was formed among Glenn and his sons Kerwin and Perry Kerwin entered into a series of focal point contracts with Cargill on behalf of the partnership ○ ended up losing $2,144,350 as a result Hoppe met with Kerwin, Perry, Carl, and ReJean to review partnerships financial information In Hoppe's review of Perry and Knud's financial information, he noticed their numbers were different Issue: Did the partners ratify Kerwin's decision to enter into the Focal Point contracts Is constructive knowledge sufficient to ratify Kerwin's decision to enter into the Focal Point contracts Holding: No…Kerwin is liable for damages to other partners Constructive knowledge is not sufficient for ratification ○ actual knowledge is required for ratification Rule: 1998 UPA - each partner is an agent of the partnership for the purpose of its business, and must have authority to act on behalf of the partnership NOTE: RUPA 301 (default rule) gives managing partners actual and apparent authority absent a partnership agreement that may modify this provision, but since the partnership agreement supersedes RUPA, it governed over RUPA 301 ○ "the approval of a majority of the Managing Partners shall be required for the Managing Partners to act on behalf of the Partnership" Reasoning: The partnership agreement has express language regarding the partners' authority to act on behalf of the partnership The other partners were unaware of the focal point contracts and thus did not authorize Kerwin to enter into them, and thus the other managing partners did not ratify his actions NOTE: It is common for corporate lawyers in contracts to write a provision that there is no agency relationship between the parties Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL helps avoid creating unintended agency relationships and thus fiduciary duties b. Corporations decision-making authority resides in its board of directors; they can authorize authority to other people to act on behalf of the corporation officers are considered agents of the corporation, pursuant to a state's corporate law statute ○ a corporation's bylaws usually specify what officers have authority and to what extent that authority runs (actual authority) c. LLCs some state statutes follow RUPA, and some states follow the corporate rule and provide that a member is not an agent of an LLC member-managed LLCs vs manager-managed LLCs ○ the next case discusses LLC member authority under Mississippi law In re Northlake Development LLC, Miss. 2011 (p. 66) Facts: Michael Earwood, a minority member of Kinwood Capital Group, LLC, secretly formed Northlake Development LLC, with himself as sole owner ○ signed a deed to transfer a parcel of Kinwood's property to Northlake, with it a deed of trust on the property ○ Northlake defaulted on a loan and filed bankruptcy, listing the property as an asset Kinwood's majority member, George Kiniyalocts, filed an objection in Northlake's bankruptcy proceeding, and Northlake's deed was void Issue: When a minority member of an LLC executes a deed to land on behalf of the LLC without actual or apparent authority, is the LLC bound by the agent's actions Holding: The deed is void unless it is ratified by the principal, Earwood was without authority Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Rule: Restatement third of agency, ratification in Mississippi can occur when the principal has notice of the action and after the fact manifests his assent to the act Reasoning: His actions were never ratified after the fact by Kinwood LLC, and there was no previous legal authority for him to take such action He transferred authority to himself, and provided the deed to himself, an agent cannot have apparent authority when the agent knows he lacks actual authority 7. Ensuring/Verifying Authority For significant transactions, such as an acquisition of a biz, the parties will conclude that it makes sense to take some steps to ensure authority steps could include requiring the delivery of two documents at closing that address authority: a secretary's certificate and an opinion letter; and, if a partnership or LLC is involved, a party may also require the filing of a certificate of authority a. Secretary's Certificate a document signed by an entity's secretary certifying that certain actions were approved by the governing body of the entity the secretary - the officer of the biz responsible for maintaining the book and records of the entity b. Opinion Letters a letter from the attorney or law firm of one party to a transaction to the other party to the transaction that addresses various legal issues concerning the transaction ○ the opinion is designed to address authority, among other things ○ the law firm will draft resolutions conferring actual authority on one or more individuals to close the transaction c. Statement of Authority RUPA S. 303 authorizes a partnership to file an optional statement of partnership authority with the secretary of state specifying the actual authority of its partners ○ In light of this provision, it is common for a third party engaging in a significant transaction with a partnership to require the partnership to file a statement of authority with respect to the transaction Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL RULLCA provides a similar filing for an LLC there are no equivalents for corporations 8. Signature Blocks the typical means by which an agent indicates he or she is signing a contract on behalf of a principal is via the signature block of a contract ○ begins with the statement "in witness whereof" C. Liability of a Principal For Agent Torts a principal can be liable for the torts committed by its agents ○ if the principal was negligent in selecting or supervising the agent (ex. someone hires a mover who assaults a customer, and the principal failed to do a background check which would have revealed the mover has a history of assaulting people) ○ if the agent commits a tort within the scope of employment (AKA the doctrine of respondeat superior) or aka vicarious liability NOTE: An employee's act is not within the scope of employment when it occurs within an independent course of conduct not intended by the employee to serve any purpose of the employer The agent owes a principal a duty of good conduct D. The Principal-Agent Problem and Fiduciary Duties 1. The Principle-Agent Problem the agent of a principal may not always act in the best interest of the principal The law addresses the principal-agent problem by imposing a fiduciary duty of loyalty on agents 2. Agent's Duties to Principal Restatement Third of Agency provides: An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship, including: ○ not to acquire a material benefit from a third party in connection with transactions conducted or other actions taken on behalf of the principal or otherwise through the agent's use of the agent's position ○ not to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship ○ to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal's competitors Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ not to use property of the principal for the agent's own purposes or those of a third party, and not to use or communicate confidential information of the principal for the agent's own purposes or those of a third party It also imposes duties of performance of an agent, including: ○ to act with the care, competence, and diligence normally exercised by agents in similar circumstances ○ to take action only within the scope of the agent's actual authority ○ to comply with all lawful instructions received from the principal and persons designated by the principal concerning the agent's actions on behalf of the principal ○ to act reasonably and to refrain from conduct that is likely to damage the principal's enterprise ○ to use reasonable effort to provide the principal with facts that the agent knows or has reason to know that the principal would wish to have the facts or the facts are material to the agent's duties to the principal Foodcomm International v. Barry, 7th. Cir. 2003 (p. 81) Facts: Foodcomm: importer of chilled Australian beef Barry and Leacy, senior sales reps a Foodcomm, used Foodcomm's computers to propose a business plan to Empire (they never informed Foodcomm of their plans and Leacy maintained he was still trying to smooth things over with Empire) Outback (their new biz venture) was incorporated in July 2002, but they did not resign from Foodcomm until late August 2002 Upon learning about Outback and its ownership by Empire and operation by Leacy and Barry, Foodcomm filed a complaint in district court Issue: Did Barry and Leacy's actions constitute a breach of fiduciary duty to Foodcomm when they created a new biz venture with a former biz partner of Foodcomm while still being employed Holding: Yes Rule: Agency Law: agents owe a fiduciary duty of loyalty to their principals not to Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ 1) actively exploit their positions within the corporation for their own personal benefits ○ 2) hinder the ability of the corp. to conduct business for which it was developed Reasoning: Instead of smoothing things over, Leacy conspired with Barry to present Empire with a biz plan to create an Empire-owned entity that would provide the same services as were already being provided by Foodcomm, and directly competed with Foodcomm ○ Efforts to actively exploited their positions within Foodcomm for their own personal benefit ○ They also failed to inform Foodcomm of each other's plans to join Empire and form Outback, kept their negotiations hidden from Foodcomm, and used Foodcomm's resources to draft and communicate a biz plan to Empire 3. Principal's Duties to Agent "a duty to deal with the agent fairly and in good faith, including a duty to provide the agent with information about risks of physical harm or pecuniary loss that the principal knows, has reason to know, or should know are present in the agent's work but unknown to the agent" "a duty to indemnify an agent” ○ 1) "unless otherwise agreed... when the agent makes a payment within the scope of the agent's actual authority" and ○ 2) "when the agent suffers a loss that fairly should be borne by the principal in light of their relationship" Chapter 3: Choice of Form Considerations A. Liability Exposure There are two aspects of liability exposure relevant to form selection: 1) the extent to which the owners of a biz operated in a particular legal form face potential personal liability on the biz's obligations (aka "inside liability exposure") and 2) the extent to which the creditors of the owners of a biz operated in a particular legal form can recover against a biz's assets (aka "outside liability exposure") 1. Inside Liability Exposure Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Corps and LLCs provide full liability shields to all owners regardless of the state of incorporation/organization Most LLPs provide their partners with full inside liability shields (besides LLPs in Louisiana or SC, which provide only partial shields) Limited Partnerships afford limited partners full liability shields, but in many states, this shield can be partially lost under the control rule General Partners of a limited partnership get no liability shield regardless of the state of organization, and neither do sole proprietors or partners of a general partnership Corporations and LLCs provide the best protection for owners against inside liabilities b. Veil Piercing all shields are subject to veil piercing: a judicially created exception to limited liability. ○ a court under this exception holds an entity's owners personally liable for the entity's obligations ○ no bright line test exists for when a court will pierce...there is no leading case on piercing GreenHunter Energy, Inc. v. Western Ecosystems Technology, Inc., Wyo. 2014 Facts: 3 parties: GHE Inc. (sole member of the LLC), GHE LLC (“the LLC”), WET 2009: WET and the LLC entered into a contract where WET undertook to provide the LLC consulting services related to the potential development of a wind turbine farm ○ While under K, the LLC did not pay WET for WET's services, so they went to court. WET won a judgment of $43,646, but it could not be paid by the LLC since they had no assets, so they attempted to pierce the corporate veil and hold GHE Inc. liable for the contractual obligations and thus having to pay the judgment Issue: when is it appropriate to pierce a corporate veil? Holding: Yes Rule: 2010 Wyo. Act: Two factors of piercing the veil of an LLC: ○ 1) the LLC is not only owned, influenced, and governed by its members, but the required separateness has ceased to exist due to misuse of the LLC Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ 2) the facts are such that adherence to the fiction of its separate existence would, under particular circumstances, lead to injustice, fundamental unfairness, or inequity Considered Factors: ○ whether there has been fraud (actual or constructive) ○ inadequate capitalization ○ failure to observe company formalities ○ the degree to which the biz and finances of the company and the member are intermingled Must be some combination of these factors, and that unfairness or injustice is proven to exist Note: Courts tend to apply the veil-piercing common law of the state in which the entity is incorporated or organized as opposed to the state in which it operates or is headquartered C. Direct Liability a liability shield does not protect a biz owner from liability arising from his own actions or inactions 2. Outside Liability Exposure a. Overview Outside Liability Exposure: refers to the extent to which the creditors of the individual owners of a biz operated in a particular legal form can recover against the biz's assets ○ unincorporated entities are generally superior to corporations Corp: a suing creditor would be able to seize ownership of a corp. (and thus the biz assets (stock, real prop, etc.) LLC: a suing creditor would only be entitled to a Charging Order (entitles the suing entity to any distributions made by the LLC until the judgment is paid off), and thus none of the LLC’s biz assets or ownership ECONOMIC RIGHTS, NOT MANAGEMENT RIGHTS ○ ^^This is the case with DLLCA, with similar provisions found in the ULLCA, UPA, RUPA, and RULPA Many states permit a creditor to pursue judicial foreclosure of a charging order, in other words, a court order directing the judicial sale of the ownership interest to which the charging order relates b. Single-Member LLCs Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL In re Albright, Bankr. D. Colo 2003 Facts: Ashley Albright, "Debtor", is the sole member and manager of a Colorado LLC named Western Blue Sky, LLC. It owns certain real estate located in CO, the LLC is not a debtor in bankruptcy The Chapter 7 Trustee contends that because the Debtor was the sole member and manager of the LLC at the time she filed bankruptcy, he now controls the LLC and he may cause the LLC to sell the Real Property and distribute the net sales proceeds to his bankruptcy estate ○ The Debtor maintains that, at best, the Trustee is entitled to a changing order and cannot assume management of the LLC or cause the LLC to sell the Real Property Issue: Do charging orders apply to single-member LLCs Holding: Pursuant to Colorado LLC statute, the entire membership interest passed to the bankruptcy estate, and the Trustee has become a "substituted member" ○ In other words, The Trustee became a sole member of Western Blue Sky LLC once Debtor filed for bankruptcy Charging orders do not apply to single-member LLCs, they are only meant to protect the other members of the LLC from the creditor, not the debtor Reasoning: The charging order limitation serves no purpose in a single-member LLC because there are no parties' interests affected C. Reverse Veil Piercing This applies to all limited liability entities The next case discusses reverse veil piercing in the context of a limited partnership Not every state recognizes reverse veil piercing C.F. Trust, Inc. v. First Flight Limited Partnership, Va. 2003 Facts: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Plaintiffs, two corporations, filed an action against defendant First Flight Limited Partnership, seeking a declaration that the Partnership was the alter ego of a judgment debtor, Mr. Peterson. The debtor had endorsed and guaranteed certain promissory notes, and the plaintiffs were judgment creditors seeking to satisfy their judgments with assets held by the partnership (which they claimed were essentially Mr. Peterson’s assets) Issue: Does VA recognize reverse veil piercing - not every state recognizes it If yes, what standards must be met before an entity will be reverse veil pierced Holding: (fact-specific determination) P must show that D used ○ "the corporation to evade a personal obligation, to perpetrate fraud or crime, to commit an injustice, or to gain an unfair advantage" ○ a unity of interest and ownership between an owner and a biz that created an alter ego ○ A court must weigh the impact of such action upon innocent investors, and the impact on secured and unsecured creditors Same analysis as traditional veil piercing, with the addition of weighing the above Rule: Nothing in the Revised Unifrom Limited Partnership Act (RULPA) prevents reverse veil piercing Note: Judgment Creditor - the party getting paid Judgment Debtor - the party having to pay Overall: Traditional veil piercing concerns attaching liability to a parent company for acts of its subsidiary, or to an individual shareholder or director for a company’s debts. ○ Reverse veil piercing, the inversion, is a mechanism to reach assets a debtor hides or transfers to a business entity Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL 3. Prevalence of Sole Proprietorships Most common form of business in the US ○ due to a large majority of businesses are only owned by a single individual, and a sole proprietorship is the default biz form for single-owner biz ○ they do not have a lawyer, they do not want to pay for one, and they do not know any better liability insurance is usually the first line of biz protection, concerning tort liability ○ a biz owner would have to pay for only the costs that exceed the insurance premium if sued pp. 109-132 B. Tax Treatment For many business owners, federal tax treatment is the most important consideration for choosing a form Two important considerations: minimizing federal tax liability minimizing federal employment tax liability 1. Minimizing federal income tax liability overview Possible classifications are Subchapter-C, Sub-K, Sub-S, or disregarded entity Multi-owner unincorporated entity other than a limited partnership (general partnership, LLP, LLC) : ○ Sub-K*, Sub-C, Sub-S (if eligible) Limited Partnership: ○ Sub-K*, Sub-C Corporation: ○ Sub-C*, Sub-S (if eligible) Single-member LLC: ○ disregarded*, Sub-C, Sub-S (if eligible) The "*" represents the default classification for the applicable business entity unless the entity opts into some other classification the "if eligible" for Sub-S applies if: ○ it is a domestic entity Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ it has 100 or fewer owners ○ all of its owners are individuals, estates, certain types of trusts, or tax-exempt organizations ○ owners are not nonresident aliens, and ○ it has only one class of ownership interests outstanding An entity must continually meet the above criteria to qualify for Sub-S taxation Under IRC S. 7704, a publicly traded unincorporated entity is taxed under Sub-C unless at least 90% of its gross income consists of "qualifying income", in which it can be taxed under Sub-K "qualifying income" includes interest, dividends, real property rents, gain from the disposition of real property gain from mineral or natural resources activities, and gain from the disposition of capital assets a. Sub-K and Sub-S Taxation Sub-K and Sub-S provide for pass-through taxation, meaning that the entity calculates its income/loss for the tax year and then allocates it to each owner in other words, the company itself is not taxed, but the owners are ○ for Sub-S, allocations have to be based on percentage ownership ○ for Sub-K, allocations can be based on something other than percentage ownership Ex. Someone earns 100,000, they pay 10% tax for any income earned between 0-10,000 dollars, 12% for any income earned between, 10,000-41,000, 22% on any earned income between 41,000-89,000, and 24% on any earned income between 89,000-170,000, etc... ^Some types of income (gifts, most scholarships, life insurance proceeds) are not included in gross income and thus are not subject to income tax Under both Sub-S and Sub-K, owners of a biz are taxed on biz income allocated to them even if the biz did not distribute any money to them b. Sub-C Taxation an entity taxed under Sub-C is treated as a separate taxpayer thus, they must file an annual income tax return reporting its income, deductions, and credits for the year and pay a resulting income tax at the corporate income tax rate If a Sub-C entity distributes money to its owners (aka dividend payments), the owners must include the distribution in their taxable incomes ○ ^generally, these dividends are taxed at the capital gains rate (as opposed to ordinary income rates) Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL thus, a Sub-C entity's profits are taxed when earned and then taxed again (generally at a lower rate) when distributed to owners c. Disregarded Entity Taxation a single-owner LLC is taxed as a disregarded entity - an entity that is treated as an entity not separate from its single owner for income tax purposes unless it opts for Sub-C or Sub-S taxation taxed essentially the same as a sole proprietorship A single-member LLC cannot elect to be taxed under Sub-K because Sub-K taxation is only available to unincorporated entities with two or more owners d. Summation biz owners highly consider tax liability when choosing a biz form generally, Sub-C is the worst because of its double taxation Sub-S and Sub-K have pass-through taxation, but there are numerous differences between the regimes ○ Allocating losses sometimes tips the balance in favor of Sub-K ○ Minimizing federal employment tax liability sometimes tips the balance in favor of Sub-S 2. Choosing Between Sub-K and Sub-S Taxation a. Allocating losses Passed-through losses reduce a person's tax burden only to the extent that the person has income against which the losses can be subtracted Say someone rich invested 500,000 into your startup biz, and you agree that you own a 60% ownership stake and the other person now has a 40% stake, and in its first year amounts 300,000 in losses, it would make sense to allocate the entire 300,000 in losses to the rich person since they are making more money elsewhere and can use the allocated loss as a deduction on their taxable income, thereby reducing the amount of tax she owes ○ You could even ask this person to reduce their ownership stake to compensate you for agreeing to allocate all losses to her ^^^ Allocating losses on a basis other than percentage ownership is possible under Sub-K but not Sub-S (aka special allocations) Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ Special allocation is valid for federal income tax purposes only if it has a "substantial economic effect", in which it has to at least appear that the partners agreed to it for economic reasons rather than to merely minimize the partners' tax obligations ○ This is a gross oversimplification since special allocations is a very lengthy and complex topic better suited for a tax class b. Minimizing Federal Employment Tax Liability An owner of a biz taxed under Sub-K or a disregarded entity is subject to a self-employment tax (aka SE tax) on the biz's income if he participates actively in its biz affairs Owners are responsible for paying SE tax, which is set at a 15.3% rate of the first $147,000 of an individual's self-employment income and a 2.9% rate thereafter say there are two owners who have 50/50 ownership: ○ each of these individuals of an entity taxed under Sub-K would have to pay SE tax on 150,000 ○ each of these individuals of an entity taxed under Sub-S, on the other hand, only the salaries from the company would be subject to the SE tax, in which the company pays for half and they individually pay for the other In the Sub-S scenario, the owners could further save on SE tax by decreasing the amount they take in salary and correspondingly increasing the amount they take in dividends ○ the IRS is aware of this and requires that the salaries paid to employee-owners of Sub-S biz’s be reasonable ○ If the IRS finds a salary is unreasonably low, they would tax part of the distribution they deem should be part of the salary and issue penalties Watson v. Commissioner, 8th Cir. 2012 Facts: Watson was an accountant, who incorporated a biz entity called DEWPC, transferred his 25% interest to this biz entity, and this entity replaced him as a partner at LWBJ ○ he served as DEWPC's sole officer, shareholder, director, employee DEWPC employed Watson, but exclusively provided his accounting services to LWBJ, DEWPC elected to be taxed as an S-Corp DEWPC distributed 24,000 to Watson as employment compensation The IRS investigated DEWPC and determined that it underpaid certain employment taxes Issue: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL When analyzing the payments made by the biz to its owner, how does a court determine what amount should be treated as wages and what amount should be treated as a distribution ○ Whether the DC properly characterized 91,000 as wages for the purposes of assessing FICA tax in 2002 and 2003 Rule: Precedent scrutinized the form of a transaction to evaluate whether it was unreasonably low, fact-based inquiry Reasoning: looking at the substance of a transaction instead of its form is a hallmark principle in resolving tax disputes Watson was an extremely qualified accountant with an advanced degree and 20 years of experience ○ 24,000 was unreasonably low compensation compared to the roughly 200,000 distributed to DEWPC in 2002 and 2003 The fair market value of Watson's services was 91,000 c. Summation of Sub-K vs. Sub-S If a biz owner wants to allocate losses for tax purposes on some basis other than percentage ownership, they will have to organize a biz as an unincorporated entity so that the biz can be taxed under Sub-K ○ ^They would need provisions in the biz's operating or partnership agreement providing for "special allocations" ○ These allocations, however, must have "substantial economic effect" or they will be disregarded by the IRS Alternatively, if biz owners who participate actively in the biz want to potentially reduce their employment taxes, they should go with an entity that qualifies to be taxed under Sub-S or, like Watson, provide services to the biz through a Sub-S entity C. Attractiveness to Investors Venture Capitalists - invest in growth or development-stage companies with great potential but high-risk invest through a fund into a few companies and hope to get a winner Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL VCs only invest in businesses organized as corporations and taxed under Sub-C for the following reasons: VCs insist on preferred stock in exchange for their investments, and only a C-Corp can issue preferred stock VCs want to avoid the extra accounting and tax complications associated with passing through portfolio company profits or losses to fund investors if a portfolio company is taxed under Sub-S or Sub-K A gain on the sale of stock in a C-Corp may qualify for favorable tax treatment under IRC S.1202, a treatment not available for the sale of S-Corp stock or an ownership interest in an unincorporated entity Angel investors are typically individuals and therefore can invest in S-Corps The bottom line is that a biz needing to raise money from angel investors and VCs should probably organize as a corporation and stick with Sub-C taxation because this is the form most attractive to these investors D. Other Considerations 1. Formalities less formalities for a sole proprietorship, most with corporations, unincorporated entities fall between the two 2. Expense The more formalities with a biz form, the more expensive it is to form and maintain 3. Continuity of Existence A corp can exist perpetually, regardless if all of its founders die or sell their shares An LLC can likewise exist perpetually, although a few states impose a maximum duration Conversely, a sole proprietorship terminates upon the death of the sole proprietor Additionally, the withdrawal of a partner may terminate the existence of a general partnership, LLP, or limited partnership depending on the state of formation and/or partnership agreement 4. Fiduciary Duty Waivers Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL The LLC statute of several states allows an LLC to waive these fiduciary duties in its operating agreements Corporations generally cannot waive their fiduciary duties 5. Form Eligibility Some types of businesses are prohibited by licensing requirements or rules from operating in particular forms ex: many states prohibit law firms from operating as LLCs or Corps, sole proprietorships cannot operate as general partnerships, LLPs, or limited partnerships 6. Management Default Rule Many LLCs and partnership default rules assume that all owners will participate in management Most LLCs and partnership rules can be varied by agreement of the owners, as can most corporate law rules either through a shareholders' agreement or provisions in the corporation's charter or bylaws 7. Buyout Rights Partnership and many LLC statutes include a default rule requiring the entity to buy out a departing owner Corporate law statutes do not provide an analogous right, but at least in closely held corporations, it is common for shareholders to address buyouts and similar rights in a shareholders' agreement or the corporate bylaws 8. Newness The recency of biz entity forms affects the amount of case law available, the development of customs and form documents, name recognition, etc. E. Conversion A biz is not locked in the form it initially chooses historically, a biz changes forms through a merger A biz is not locked into the tax status it initially chooses this can be changed by filing out a form and filing it with the IRS and perhaps a vote by the biz owners This process involves legal fees, filing fees, and other transaction costs Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Notes: Sub-S classification is fragile (very easy to lose if you do lose one of the eligibility) Founders try to consider what biz entity to form based on minimizing liability exposure, tax treatment, and maximizing attractiveness to investors ○ this triad of considerations comes into conflict occasionally and trade-offs are common pp.137-165 Chapter 4. Partnerships and Limited Liability Partnerships 1. Governing Law A partnership is governed under either the state statute in which it is organized or the state statute specified in the partnership agreement If not specified in the partnership agreement, the common law rule is that the partnership law of the jurisdiction where the partnership agreement was made governs RUPA, however, includes a governing law provision that states that "the law of the jurisdiction in which a partnership has its CE(chief executive) office governs relations among the patterns and between the partners and the partnership ○ 39 states use RUPA, while the remaining use UPA ○ However, always check the applicable state partnership statute, as states are free to make changes or not to adopt uniform act amendments 2. Formation No formalities are required to form a partnership. It is formed when: 1) two or more people associate to carry on as co-owners a business for profit, and 2) they do not file the paperwork to operate the business in some other form ○ this occurs even if the partners are unaware, which is called an "inadvertent partnership" ^^^ This formation issue is frequently resolved by courts if they did not intend to form a partnership Holmes v. Lerner, Cal. App. 4th Div, 1999 Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Facts: An oral partnership agreement to start a cosmetics company dispute ○ Holmes and Lerner have a verbal agreement to start a company, Holmes worked for free (contributed sweat equity), asked what her role was, and worked regardless, Soward and Lerner had secret meetings Issue: Was there a partnership agreement as a matter of law between Lerner and Holmes If two partners have a verbal agreement to start a biz but they do not discuss sharing profits, do they have a partnership Rule: UPA 1949 "an association of two or more persons with an intent to carry on as co-owners a business for profit" ○ ^^language becomes a question of fact (fact-based inquiry) Reasoning: An express agreement to divide profits is not a prerequisite to proving the existence of a partnership ○ profit sharing is evidence of a partnership, but it is not dispositive of a partnership "we will do...everything", "it's going to be our baby", and "We will hire people to work with us" all show evidence of an intent of a partnership between the parties 3. Management Default rule under RUPA: "Each partner has equal rights in the management and conduct of the partnership business" this generally translates into partners voting on a proposed course of action, with each partner getting one vote A matter is usually put to a vote if: ○ there is disagreement among the partners regarding how to proceed ○ the matter is outside the ordinary course of the biz ○ a third party is requiring formal partner approval as a condition of entering into a transaction with the partnership default rule: each partner gets one vote, regardless of capital or time put into the partnership Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL default rule: a majority vote is needed for the approval of anything inside the ordinary course of biz ○ default rule: unanimous partner approval of anything outside the ordinary course of biz It is fairly common for a partnership to vary RUPA's default management rules. These could include the following: ○ allocating votes proportionally based on the amount of capital that each partner has contributed to the partnership ○ delegating decision-making authority to one partner (typically called the managing partner) ○ requiring supermajority votes for specified decisions ○ changing the approval requirement for matters outside the partnership's ordinary course of business to something less than unanimous partner approval 4. Partnership Agreement most partnerships have a written partnership agreement signed by each partner, typically addressing, among other things, management structure, allocation of profits and losses among the partners, partner taxation, admission and withdrawal of partners, and dissolution If a partnership agreement is silent on a particular issue addressed by a default statutory rule, the default statutory rule applies 5. Fiduciary Duties Partners owe each other and the partnership a fiduciary duty codified in RUPA S. 404 (once common law) A duty of loyalty and care ○ loyalty: a duty to account to the partnership and hold as a trustee for it any property, profit, or benefit...derived from a use by the partner of partnership property ○ prohibitions against self-dealing and competing against the partnership ○ care: a duty to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law in connection with partnership business Meinhard v. Salmon, NY 1928 Facts: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL A joint venture existed in which two partners pooled their money to lease a building for shops and offices. Salmon entered into an agreement with another businessperson to purchase surrounding property as a leasehold estate. The specifics of this transaction were not disclosed to Meinhard, and he subsequently sued for breach of the joint venture agreement when he discovered the transaction. Issue: does a partner have a fiduciary duty to inform another partner of a biz opportunity related to their biz? Rule: Yes! duty to disclose from the duty of loyalty Reasoning: As long as the partnership still exists, they owe each other fiduciary duties Salmon had a fiduciary duty to disclose and loyalty to Meinhard, especially as the managing partner 6. Obligation of Good Faith and Fair Dealing Good faith and fair dealing is an ancillary obligation that applies whenever a partner discharges a duty or exercises a right under the partnership agreement of the Act The partners must act subjectively in good faith and objectively in fair dealing based on what is agreed upon in the contract, circumstances As with the duties of care and loyalty, a partnership agreement cannot eliminate the obligation of good faith and fair dealing it can carveout, however, certain activities that will not breach the duty of loyalty 7. Liability Exposure Each partner is personally liable for the obligations of the partnership liability is joint and several a judgment creditor generally must first seek to recover against the partnership itself, known as the "exhaustion rule" Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL A partner who has to pay a creditor out of his own pocket will have the right to recover some of this money from the other partners (indemnification) pursuant to RUPA S. 401(c) based on the sharing losses principle 8. Transfer of Partnership Interests The default rule is that an ownership interest in a partnership is not freely transferable in its entirety ○ a partner can transfer his or her economic, but not management rights under RUPA S. 503 ^^same rationale for charging orders, since you cannot force partners to work with other people they did not consent to 9. Allocation of Profits and Losses RUPA S. 401(b): default rule for the allocation of partnership profits and losses: each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partner's share of the profits ○ partnership agreements often provide for a different allocation rule based on the capital contributed to the partnership by each partner Allocation of Profits: the amount of partnership profits a partner has to include as income in his or her individual tax return (the partnership's overall profits/income) Distribution of Profits: the amount of partnership profits that are paid out to a partner (the amount actually paid to each partner) 10. Dissociation The term RUPA uses for when a partner departs a partnership default rule: a partner can dissociate at any time by notifying the partnership of his or her express will to withdraw Automatic dissociation in the event of a partner's ○ expulsion from the partnership pursuant to the partnership agreement ○ bankruptcy ○ death ○ unanimous vote In this event, the previous partner now has no management rights The partnership is required to buyout the partner of his partnership interest for cash 11. Dissolution Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL refers to the point at which the partnership begins the winding-up phase of its existence Default Rule: triggered by "the expiration of a term or completion of the undertaking" or "express will of all the partners to wind up the business" before the expiration or completion ○ this can be changed by either a provision in the partnership agreement that overrides the default rule or by the partnership was created and stated to end at a particular date Dissolution may also arise by a court on the application of a partner if the court determines that: the economic purpose of the partnership is likely to be unreasonably frustrated another partner has engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with that partner it is otherwise not reasonably practicable to carry on the partnership business in conformity with the partnership agreement Involves settlements of accounts among partners: RUPA S. 807 provides the default rule that any amount remaining after the partnership liquidates its assets and pays its creditors is divided among the partners based on each partner's capital balance and, if any money remains, each partner's profit-sharing percentage A partner's capital account consists of ○ contributions made to the partnership by the partner and the partner's share of partnership profits minus ○ amounts distributed by the partnership to the partner and the partner's share of partnership losses A capital account's purpose is to note how much the partnership owes them if it were to dissolve pp. 165-171, 175-199 B. Limited Liability Partnerships 1. Formation LLP: a partnership that has elected LLP status under the applicable provisions of its partnership statute Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Under RUPA, they must file "a statement of qualification" with the applicable secretary of state to become an LLP ○ this includes the name of the partnership, the street address of the partnership's chief executive office, and a statement that the partnership elects to be an LLP There must be a vote of the partners approving the formation of the LLP the attorney handling the LLP's formation typically drafts the partnership agreement 2. Liability Exposure partners of an LLP are not personally liable for the obligations of the LLP Chapter 5. LPs and LLLPs A. LPs (used often by VC, hedge, and private equity funds due to very developed case law) used to reduce a client's federal gift tax burden can be taxed under Sub-K 1. Formation Formed by filing a "certificate of limited partnership" with the secretary of state of the state in which the client wants the limited partnership organized ○ The state's LP statute will specify what should be included in the certificate Must have one or more general partners and one or more limited partners 2. Governing Law An LP is governed by the LP statute of the state in which it filed its certificate of LP, based on some version of the Uniform Limited Partnership Act, except Louisiana 21 states have adopted the ULPA 2001 version LP statutes are composed mostly of default rules that the partners can alter or opt out of through a partnership agreement (unless it’s a mandatory rule) 3. Management Under the default rule, an LP is managed by its general partners, and limited partners have no rights to participate in the control of the business Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ the default rule requires the consent of the limited partners to amend a partnership agreement or to sell, lease, or otherwise dispose of all of the LP's property, other than in the normal course of business 4. Liability Exposure RULPA/ULPA: General partners of an LP are personally liable for the debts and obligations of the LP, while limited partners are not ○ RULPA, however, recognizes an exception to the limited liability of a limited partner known as the "control rule": a limited partner that participates in the control of the LP's business will be personally liable for the obligations of the LP while reasonably believing, based on the limited partner's conduct, that such limited partner is a general partner The LP statute will list what activities constitute "participating in the control of the business" Some items typically listed on this list include: ○ 1) working for the LP or its general partner ○ 2) guaranteeing the LP obligations ○ 3) attending partner meetings ○ 4) voting on dissolving or selling the partnership, changing the nature of the biz, admitting or removing a general or limited partner, or an amendment to the partnership agreement ○ Ultimately up to the courts to decide what activities that are not on the state's LP statute list constitute "participating in the control of the biz" drafters of the ULPA-2001 decided to drop the control rule 5. Fiduciary Duties and the Obligations of Good Faith and Fair Dealing General Partners of LPs owe the LP and its limited partners the duties of loyalty and care ○ Under ULPA-2001, a partnership agreement cannot eliminate the duty of loyalty, but it can identify specific types of categories of activities that do not violate it...if not unreasonable ○ Likewise, an LP agreement may not "unreasonably reduce the duty of care" General Partners owe the LP and its limited partners an obligation of good faith and fair dealing ○ Under ULPA-2001, a partnership agreement may not eliminate this obligation but "may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not unreasonable" Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL The default rule is that a limited partner does not owe fiduciary duties to the LP or any other partner solely because of being a limited partner ○ Under ULPA-2001, limited partners owe the LP and partners obligations of good faith and fair dealing, and this obligation cannot be eliminated by the partnership agreement 6. Transfer of Partnership Interests The default rule is that a partnership interest of an LP is not freely transferable in its entirety (economic, not managerial) ○ ^^^ULPA-2001 defines "partnership interest" as "a partner's right to receive distributions" It is fairly common, however, for a partnership agreement to override this default rule, given that limited partners generally have no say in management, so there is less concern by the other partners as to who becomes a limited partner 7. Allocation of Profits and Losses ULPA-2001 has no default rule for the allocation of profits and losses, but it does provide one for distributions ○ For distributions, it provides that a distribution by an LP "must be shared among the partners based on value, as stated in the required records when the LP decides to make the distribution, of the contributions the LP has received from each partner" 8. No Default Buyout Right Recall under the default RUPA rule, a partner's dissociation, with certain exceptions, triggers the right to be bought out of his or her partnership interest for cash ○ This is not the case for ULPA-2001, which states that the LP interest of a partner who dissociates before the termination of the LP is essentially converted to a transferable interest owned by the dissociated partner B. Limited Liability Limited Partnerships 1. Formation Under ULPA-2001, an LP can elect to be an LLLP by including a line in its certificate of LP along the lines of "this limited partnership is a limited liability limited partnership" (an existing LP can amend its certificate of LP to so state) Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL In other states, an LP becomes an LLLP by registering the LP as an LLP under the state's partnership statute ○ 18 states do not provide for LLLPs, making it a risk to form under this biz entity as it could give rise to the risk of interstate non-recognition of the liability shield 2. Liability Exposure ULPA: LLLPs provide a full liability shield for all partners, even general partners Note: for a partnership to be either for a definite term or for a particular undertaking, it must explicitly state so in the partnership agreement, otherwise it is an at-will partnership pp. 201-224 Chapter 6. LLCs A. Formation An LLC is formed by filing a "certificate of formation" with the secretary of state of the state in which the client wants the LLC organized The state's LLC statute will specify what info must be included in the certificate B. Governing Law An LLC is governed by the LLC statute of the state in which it filed its certificate of organization ○ Each state has its own LLC statute ○ Most states have adopted RULLCA, and 80% of LLCs formed outside of their home states form in Delaware and have adopted DLLCA C. Operating Agreement Most LLCs have a written agreement that tailors the applicable LLC statute's default rules to the specific needs and preferences of the LLC's members and managers An LLC/operating agreement is analogous to a partnership agreement if the LLC is to be member-managed, or a combination of a corporate charter and bylaws if the LLC is to be manager-managed An LLC/operating agreement typically addresses, among other things, management structure, allocation of profits and losses among the members, member taxation, transfer of membership interests, and dissolution An LLC/operating agreement can be oral or even implied but this is inadvisable Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL D. Management Can be either member-managed or manager-managed ○ member-managed: members manage the LLC ○ manager-managed: A board of managers elected by the LLC members manages the LLC DLLCA default rule: LLCs are member-managed ○ This provision of the DLLCA also provides for voting based on percentage ownership in the LLC A Delaware LLC can opt for manager management by providing so in its LLC agreement RULLCA default rule: LLCs are member-managed with each member having equal management rights ○ can opt for manager management by providing so in its LLC agreement E. Fiduciary Duties RULLCA imposes fiduciary duties of care and loyalty on members in member-managed LLCs and on managers in manager-managed LLCs to the LLC and its members (whoever is managing the LLC, they have these fiduciary duties) duty of loyalty: ○ "to refrain from dealing with the company in the conduct...of the company's activities as or on behalf of a party having an interest adverse to the company" and "to refrain from competing with the company in the conduct of the company's activities before the dissolution of the LLC duty of care: ○ "to act with the care that a person in a like position would reasonably exercise under similar circumstances and in a manner the member reasonably believes to be in the best interest of the company" DLLCA does not expressly contain provisions specifying the fiduciary duties owed by managers and members of a Delaware LLC, but this next case fixes this silence issue William Penn Partnership v. Saliba, Del. 2011 Facts: Del Bay was formed to construct a motel on land owned by Ksebe's now-deceased husband ○ became an LLC Lingos declined offers of 2 and 4 mil without communicating to Saliba or Ksebe Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ Lingos eventually decided to end their biz relationship with Saliba and Ksebe, offered to sell the Motel to JGT without informing S or K, but informed Hoyt who prepared a sales contract S and K found out and said to Griffin they did not want to sell the property, gave the partnership agreement instead of the LLC agreement Griffin misrepresented the date of settlement, Hoyt did not inform Griffin ab the new LLC agreement which supersedes the previous partnership agreement Saliba Ksebe and Hoyt own half of Del Bay Lingos wanted to sell Del Bay, needed Hoyt's vote, told Hoyt there was an artificial deadline for tax purposes, which wasn't true, and kept S and K in the dark about the whole transaction, Lingos signed the document and said it was approved unanimously, Lingos acted in their own self-interest and contrary to the other interests in Del Bay Issue: When a party with a fiduciary duty is on both sides of a transaction, how do they demonstrate the entire fairness of the transaction Rule: In Delaware, members of an LLC owe a duty of loyalty and care If a party of a transaction is on both sides, they must demonstrate entire fairness, which includes: ○ fair dealing, AND ○ fair price Reasoning: the Del Bay operating agreement did not modify or eliminate fiduciary duties and it named the Lingos as the managers of the LLC the Lingos manipulated the sales process through misrepresentations and repeated material omissions such as ○ imposing an artificial deadline justified as "tax purposes" ○ failing to inform S and K that they were matching their offer by assuming the existing mortgage ○ failing to inform S and K that they had already committed to selling property to JGT, an entity that Lingos controls ○ failing to inform S and K that Hoyt signed the contract that the JGT board approved the purchase of the Beacon Motel ○ failing to hold a vote on the transaction as required by the LLC agreement The Lingos, being on both sides of a transaction, went against the duty of loyalty. They violate this duty unless they show entire fairness Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL DLLCA provides that duties of care and loyalty can be modified and even eliminated in an LLC's LLC agreement RULLCA provides that the LLC agreement can modify, but not eliminate these duties DLLCA: members of a member-managed LLC owe fiduciary duties to the LLC and its members managers of a manager-managed LLC owe fiduciary duties to the LLC and its members Open Question: Do members of a manager-managed LLC owe fiduciary duties to the LLC and its members??? Feeley v. NHAOCG, LLC, Del. Ch. 2012 Facts: Feeley and Akel ventured to seek funding for a real estate venture, and used Akel's dad and friends to join forces to pursue a venture called Oculus as a Delaware LLC two members of Oculus include AK-Feel LLC (two members are Feeley and Akel) and NHAOCG (three members are Akel's father and two friends) ○ 50/50 management, AK-Feel managing member, Feeley managing member at AK-Feel, Feeley President and CEO of Oculus NHA alleges Feeley failed miserably in his managerial roles at Oculus and that his "book of business" was illusory ○ only found a few projects and the one they pursued, the "Gatherings project", in FL ended in disaster due to Feeley's gross negligence ○ Feeley negotiated student housing deals for his own account instead of presenting them to NHA for consideration by Oculus ^^^breach of default fiduciary duty claim Issue: did Feeley owe Oculus a fiduciary duty as the managing member of the LLC If the operating agreement of a Delaware LLC is silent, do the managers owe default fiduciary duties Holding: Yes, managers of an LLC owe default fiduciary duties unless those duties are eliminated, restricted, or otherwise displaced by express language in the operating agreement Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ However, monetary relief cannot be awarded due to a provision in the operating agreement that eliminates monetary liability unless there is a finding of gross negligence or willful misconduct or fraud, which gross negligence is found Rule: It must be unambiguous in the LLC agreement to eliminate fiduciary duties F. Obligation of Good Faith and Fair Dealing DLLCA does not allow an LLC to eliminate the implied contractual covenant of good faith and fair dealing RULLCA imposes an express contractual obligation of good faith and fair dealing ○ Fair dealing component asks did this party acted fairly with the terms of the original agreement between the parties ○ Good Faith component is that you have to be faithful to the scope, purpose, and terms of the parties' contract essentially, both deal with what would the parties have likely agreed to at the time they were negotiating G. Liability Shield RULLCA/DLLCA: members of an LLC have full liability shields ○ the next case examines the scope of this shield Estate of Courtyman v. Farmers Co-op. Ass'n, Iowa 2004 Facts: A house exploded, killing 1 and injuring 6 due to a stray propane gas Double Circle delivered propane tanks to the house prior to the explosion Keota provides managerial services to Double Circle including human resource and safety management Keota moved for SJ, claiming the limited liability structure of Double Circle protected it from liability for any tortious acts of Double Circle based on its ownership interest and membership in Double Circle, or its management Ps asserted that Keota, through Hopscheidt, was negligent in failing to provide proper warnings to propane users, wanted to pierce the corporate veil Issue: Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Can a member and manager of an LLC be liable for torts based on managerial conduct if the conduct was within the scope of the manager's duties Rule: Iowa statute ILLCA imposes liability on members and managers of LLCs in tortious conduct Reasoning: You are liable for your own misconduct/torts even if it is done within the scope of the LLC pp. 224-248 H. Transfer of LLC Interests DLLCA default rule: an LLC interest is freely transferable, but the assignee may not participate in the management of the biz except as provided in an LLC agreement or upon affirmative (unanimous) vote or written consent of all the members of the LLC RULLCA default rule: a transfer is permissible but generally does not entitle the transferee to participate in the management or conduct of the biz Achaian, Inc. v. Leemon Family LLC, Del. Ch. 2011 Facts: Parent sold Omniglow, a company that manufactures glowsticks, to 3 biz entities: ○ Leemon Family LLC (50% interest controlled by Ira Leemon) ○ Holland Trust (30% interest) ○ Achaian Inc (20% interest) Holland and Leemon managed the biz, Achaian took the role as a passive investor contention over whether Leemon had full control since the LLC agreement vests managerial authority in the members in proportion to their interest % ○ fed up with this, Holland purported to transfer its entire 30% interest to Achaian Issue: May one member of a Delaware LLC assign its entire membership interest, including that interest's voting rights, to another existing member, even if the LLC agreement requires the affirmative consent of all of the members upon the admission of a new member, or Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL must the existing member assignee be readmitted for each additional interest it acquires after its initial admission as a member? Holding: The LLC agreement allows the full transfer of ownership interest, including managerial and voting, and thus Achaian has a 50% managerial interest Rule: The LLC agreement that changes the DLLCA's default rule governs the issue of law Reasoning: The LLC agreement allowed for full transference of ownership interest, unless it was to someone who was not previously a member of the LLC. ○ since Achaian was already a member, it was entitled to the full interest given to it by Holland I. Allocation of Profits and Losses; Distributions DLLCA default rule (the allocation of profits and losses): based on the agreed value of the contributions made by each member to the extent they have been received by the LLC and have not been returned DLLCA default rule (distributions): based on the agreed value of the contributions made by each member to the extent they have been received by the LLC and have not been returned ○ DLLCA definition of contribution: any cash, property, services rendered or a promissory note or other obligation to contribute cash or property or to perform services, which a person contributes to an LLC in the person's capacity as a member Typically, an LLC agreement ties ownership interests to contributions RULLCA does not provide for a default rule for the allocation of profits and losses, as it assumes it will be addressed in the LLC agreement RULLCA default rule for distribution: equal distributions to all members J. Withdrawal DLCCA default rule: a member cannot withdraw or resign from an LLC prior to the dissolution or winding up of the company ○ It is common for the LLC agreement to provide a different rule, as did in the next case Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL Touch of Italy Salumeria & Pasticceria, LLC v. Bascio, Del. Ch. 2014 Facts: several individuals formed Touch of Itally LLC, an Italian grocery store, each contributing to it in different forms Louis provided notice of his withdrawal, as required by the LLC agreement, and left the LLC, saying he would not compete with them, yet formed Bascio LLC which competed with them and is located on the same block Louis had purportedly mentioned several times that he planned to establish a new biz in Penn., but the Ps do not recall this Issue: Is not disclosing a member's true intentions for leaving an LLC as a former member grounds for breaching the above duties Holding: Ds did not breach the contract, as they complied with the withdrawal requirements of the LLC agreement Ds did not breach the implied covenant of gf and fd, there was no noncompete agreement in the K, so it was foreseeable and they were entitled to open up another biz There is no evidence in the record that supports Ps contention that D was breaching his fiduciary duties to the LLC. Note: The obligation of gf and fd applies to what was actually stated in the original agreement amongst the parties, so a court will not impose these duties if not originally stated at the time of agreement amongst the parties you can’t breach an operating agreement once you are not a member of the LLC unless there is a noncompete or other provisions that live on after you leave K. Dissolution DLCCA provides for both voluntary and judicial dissolution of an LLC DLCCA default rule: an LLC is dissolved and must be wound up ○ at the time specified in the LLC agreement (if a time is so specified), ○ upon the happening of an event (if any) specified in the LLC agreement as triggering dissolution, or ○ upon an affirmative vote of members holding more than two-thirds of the LLC ownership interest Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL RULLCA has similar rules under Chapter 7 Haley v. Talcott, Del. Ch. 2004 Facts: P and D have a 50% interest in Matt & Greg Real Estate, LLC Haley was manager of Redfin Grill, Talcott owned it ○ both parties personally guaranteed the mortgage to secure the loan for the new LLC Haley believed he would eventually gain ownership in Redfin after the work she put in, but he did not, creating a rift in their relationship After Haley and Talcott had a falling out, Haley filed a lawsuit in Delaware chancery court against Talcott and the LLC seeking to have the LLC dissolved because it was not reasonably practicable for it to continue the business of the company in conformity with the LLC agreement. Talcott responded that Haley was limited to a contractually provided exit mechanism in the LLC agreement, by which he could buy out Haley. Issue: Can the court lawfully dissolve the LLC due to the stalemate between Haley and Talcott, even if there is an exit mechanism that a dissenting member can use to dissolve the LLC Holding: They can when it is not reasonably practicable continue the LLC in conformity with the LLC agreement Rule: S. 273: grounds for judicial dissolution of a CORP ○ the corp must have two 50% stockholders ○ those stockholders must be engaged in a joint venture ○ they must be unable to agree upon whether to discontinue the business or how to dispose of its assets: Reasoning: the exit mechanism was not a reasonable alternative, as it was not sufficient to provide an adequate remedy to Haley under the circumstances, as he would then be personally liable for the LLC's debt. Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL L. Series LLCs A series LLC (SLLC) is an LLC that segregates its lines of business, assets, and liabilities into separate "series" the advantage of this structure is that, assuming that certain notice and bookkeeping requirements are satisfied, the assets "associated with" a particular series are insulated from claims against a different series ○ essentially an internal/horizontal liability shield against obligations of the other series Ex. a cab driver gets in an accident due to his own negligence, a party sues and is successful, they are only entitled to that series' assets, There is still a vertical liability shield for members of an SLLC since it is still legally an LLC Note: LLC taxation: passthrough taxation Noncompetes extend the fiduciary duties of a previous member of an LLC, the highest restrictive covenant that can be legally imposed but is currently being litigated solicitation agreements are the second highest restrictive covenant, they state you will not recruit anyone from the previous biz pp. 248-264, 267-278 Part III: Corporations The Incorporation Process A. Pre-Incorporation Activities A biz starts with an idea, a corporation comes into the picture only after the founders have developed the idea into a business plan and decided that there is enough potential to warrant moving forward and the best legal form for their startup business is a corporation However, when founders come to you to get a corporation incorporated, often one or more of them will have already lined up office space, hired a receptionist, ordered supplies, and otherwise entered into contracts ○ Someone who engages in these activities is known as a "promoter" In this section, we discuss two legal issues related to promoter contracts: ○ whether the promoter is personally liable on a pre-incorporated contract, and Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL ○ whether the corporation is liable on the contract following incorporation 1. Promoter Liability on Contracts If things go as planned, the biz will get up and running and honor the pre-incorporation contracts signed by a promoter ○ If, however, the biz never gets off the ground or is not interested in the contract and therefore, for example, does not make rental payments, the landlord is likely to look to the promoter to pay out of his or her own pocket ○ This analysis varies depending on how the promoter signed the contract ○ can be liable under contract or agency law, depending on if it signed under their own name or on behalf of the yet-to-be corporation 2. Corporation Liability on Promoter Contracts The general rule is that a corporation is not liable on a pre-incorporation contract unless the corporation adopts it ○ it adopts the contract by manifesting assent to be bound by it this can only occur after the corporation is formed and the corporation has knowledge of all material facts concerning the contract ○ adoption can either be express or implied through conduct implied adoption may occur when a corp receives the benefits of the contract or accepts goods or services under the contract with knowledge of the contract it can also occur if the corporation makes payments under the contract or attempts to modify or enforce the contract This is sometimes called "adoption through acquiescence" Ratification can also make a corporation bound the the pre-incorporation contract, although there is serious debate over whether a corporation can ratify a contract that was executed before the corporation existed because, under agency law, a purported principal cannot ratify a contract executed before the principal existed Adoption does not relieve a promoter from liability on a contract unless the other party agrees to substitute the corporation for the promoter on the contract ○ ^This is called Novation absent novation, both the corporation and the promoter would likely be liable on an adopted contract, although the promoter would likely be entitled to indemnification by the corp if he has to pay out on the contract B. Jurisdiction of Incorporation Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL A biz can choose what jurisdiction in which to incorporate for a biz operating in a single state, it usually makes the most sense to incorporate in that state unless the biz will need VC funding or plans to go public For a biz that plans to operate in multiple states, that will need VC funding, or that plans to go public, the choice is typically between the state in which the biz is HQ'd and Delaware Bizs choose to incorporate in Delaware for multiple reasons, including: ○ it has the most flexible and advanced corporate statutes in the nation ○ highly respected corporations court, the Court of Chancery ○ populace in the state is generally pro-business due to taxes that come from these corporations are an important part of the state budget A corp would choose not to incorporate there if it operates only in a single state, and would thus save money by incorporating in that state VCs have a bias for investing in Delaware corps C. Incorporation Mechanics You incorporate by filing "articles of incorporation" or a similarly named document with the secretary of state of the state in which the client wants the corporation incorporated The state's corporate law statute will specify what must be included in the articles/certificate of incorporation (often called a charter) 1. Name Selection States typically require the name to be distinguishable from all existing names on record with the secretary of state to prevent confusion within the secretary of state's office, state tax authority, and litigants desiring to name and serve a corporation If the secretary of state clerk determines that the name you listed is not distinguishable, he or she will reject your filing ○ most states allow you to check name availability online and reserve an available name in advance of filing to ensure that it will still be available when you file your document ○ This process says nothing about whether the name has been registered as a trademark with the U.S. Patent and Trademark Office (PTO) ○ You should check to see if your name is not already trademarked for use on goods/services similar to what your business provides, and if it is not you may want to register the name as a trademark with the PTO so you can send out some of your own cease and desist letters Most states require that a corporation's name contain a designation altering those doing business with the company they are dealing with a corporation Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL 2. Authorized Shares, Par Value, and Purpose The first issue of substance that you would discuss with the client in filling out the form is what numbers to put in the blanks in section 4 of the form You use the first blank to indicate the number of shares of stock that the corporation will be authorized to issue ○ the number is known as the corporation's "authorized shares" and represents the maximum number of shares that a corporation has the authority to issue ○ This number is not of great significance, but what is is the number of shares outstanding (the number of shares held by a corporation's shareholders) ○ The number of shares outstanding is important because only outstanding shares are entitled to vote and to distributions upon liquidation of the corporation You use the second blank to set the par value of the corporation's shares ○ par value is the minimum amount of consideration the corporation must receive when issuing a share, it is not the price at which the corporation has to sell shares typically the consideration is money, but a corp. may issue shares in exchange for property or services ○ Delaware allows a corp to have shares without par value by saying so in its certificate ○ the MBCA does not require shares to have a par value, or par value to be mentioned in a corporation's articles You can authorize shares at any number, but in some states, including Delaware, the amount a corp has to pay to file its charter and in annual fees is based on the number of authorized shares it has ○ as a result, in a state like Delaware, if feasible, you want to set authorized shares at the highest possible number that still allows the corp to pay the minimum filing fee and annual fee ○ Many states simply charge a corporation a flat fee and annual fee regardless of how many authorized shares a corp has Most corporations go with a purpose provision that is as broad as possible in the form ○ they are free to specify a narrower purpose, but doing so raises the issue of ultra vires, and is therefore typically avoided unless required by applicable regulations ○ "ultra vires" means "beyond powers", and prohibits a corporation from acting beyond its purpose ○ the MBCA allows, but does not require, articles of incorporation to include a purpose, so most corporations incorporated in MBCA states do not include one Typically, corps want to include in a certificate optional provisions that go beyond form, like, for example, if a corp. wants to issue both common and preferred stock ○ thus, its certificate will need to set forth the number of shares of both that the corp is authorized to issue as well as the rights and preferences of the preferred stock Corporations & Partnerships ~ Prof. Mamaysky ~ Fall 2024 CaseStatute/lawConcept/Definition ImportantTopicRUPAUPAULPARULPARULLCADLLCAMBCADGCL As a general rule, you only include in the charter any required provisions and desired optional provisions that the statute requires to be set forth in the charter ○ you put everything else in the bylaws All states require the charter to list the name and usually the address of the incorporator and to be signed by the incorporator ○ an incorporator is the person listed in the charter as such and can be anyone it is common for the attorney who drafted the charter to list himself or

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