Corps & P-Ships Outline PDF

Corps & P-Ships Outline: I. Business Forms Overview: - 6 most common business forms: sole proprietorship, partnership/ general partnership, Limited Liability Partnership (LLP), Limited Partnership (LP), Corporation, and Limited Liability Company (LLC) - Key purpose of starting a busin...

Corps & P-Ships Outline: I. Business Forms Overview: - 6 most common business forms: sole proprietorship, partnership/ general partnership, Limited Liability Partnership (LLP), Limited Partnership (LP), Corporation, and Limited Liability Company (LLC) - Key purpose of starting a business is to avoid personal liability. - Sole Proprietorship/ proprietorship: is a business owned by a single person (a sole proprietor)/ single-owner business who has NOT filed the paperwork to operate the business in some other legal form. But the owner can opt into some other form by filing paperwork, typically with the secretary of state. \(c) Management: \(d) Liability Exposure: \(e) Taxation: \(f) Legal Name: ii\. General Partnership/ Partnership: \(a) Definition: - the owners of a partnership are referred to as "partners." - Usually, partners will agree up front which states' partnership laws they are forming the partnership. - However, sometimes people do NOT realize they are forming a partnership and therefore obviously do NOT know to agree on a state of formation. In this situation: - Each state has its own partnership statute based on either UPA or RUPA, EXCEPT for LA - UPA and RUPA are drafted by the Uniform Law Commission (ULC). \(c) Partnership Agreement: - Most partnerships have a written partnership agreement, signed by each partner. - A partnership agreement typically addresses management structure, allocation of profits and losses among the partners, partner taxation, admission and withdrawal of partners, and dissolution. - Partnership statutes are composed largely of default rules that a partnership can alter or opt out of through appropriate language in the partnership agreement. - A partnership agreement allows the partners to tailor the rules to their specific needs and preferences. - i.e., default rule under UPA and RUPA is that partners share profits equally. However, a partnership agreement may provide for some other rule if all the partners contributed a different amount. - The starting point for providing advice to a partnership on partnership law issues is usually a review of the partnership agreement, NOT the applicable statute. - However, the statute is relevant because it contains rules -- mandatory rules -- that the partners cannot K around. - An oral partnership agreement is NOT advisable - A written partnership agreement will lessen the likelihood of future disputes between the partners as to what was agreed. - The management structure of a general partnership is typically specified in the partnership agreement. - Common management structures are: - The partners select a managing partner, who is generally vested with the authority to make ALL decisions. - The partners select a management committee composed of partners, which is generally vested with the authority to make ALL decisions. - The partners ALL get a say in managing the business, with each partner having an equal vote. - The partners ALL have a say in managing the business, with each partner having voting power in accord with that partner's capital contribution to the partnership. - If the partnership goes with the managing partner or committee structure, the partnership agreement will typically require a partnership vote on matters outside the ordinary course of business. - i.e., admitting new partners, expelling partners, selling the business. - the partnership agreement will specify the required vote for approval. - i.e., majority, supermajority, or unanimous. - The partner's personal assets are at risk of being reached to satisfy the obligations of the business. - A general partnership is normally taxed under Subchapter K ("Sub-K") of the IRC. - Sub-K compromises provisions specifically designed for the taxation of a business organized as a partnership. Under Sub-K, a general partnership is NOT required to pay federal income tax. Instead, it allocates the partnership's profits and losses to its partners pursuant to the partnership agreement or the applicable partnership statute if there is NO agreement or provision allocating profits or loses. - "Pass-through" taxation: the business's/ partnership's profits or losses are passed through to the owners' tax returns. Each individual partner then reports their share of the profits or losses on their personal federal income tax return (usually by attaching Schedule E to Form 1040) and pay ANY resulting tax liability. - The IRS requires a partnership to file an annual information return (Form 1065) specifying the partnership's income and deductions and each partner's allocation of profits or losses. - It is possible for a general partnership to opt out of Sub-K taxation and into Sub-C or Sub-S taxation. - Key feature and distinction from a general partnership: LLP partners are NOT personally liable for the obligations of the partnership; LLP partner's liability on obligations is limited. - States created the LLP by adding LLP provisions to their general partnership statutes. - An LLP is a general partnership that has elected LLP status. - States do NOT have discrete LLP statutes. - Most LLPs have a written partnership agreement signed by each partner. - Partnership agreement of a general partnership applies equally to the partnership agreement of an LLP. - The management structure of a general partnership applies equally to LLPs because LLPs are a type of general partnership. - The management structure of an LLP is typically specified in the partnership agreement. - Distinguishing feature of an LLP from a general partnership. - LA and SC do NOT provide a full liability shield. - The IRC treats an LLP the same as a general partnership for federal income tax purposes - An LLP is normally taxed under Sub-K taxation, which provides for pass-through taxation. - it is possible for an LLP to opt out of Sub-K taxation and into Sub-C or Sub-S taxation. \(b) Governing Law: - Based on UPA - Most LPs have a written LP agreement signed by each partner. - The same matters covered in general partnership's partnership agreements plus additional provisions addressing the rights and obligations of the limited partners. - An LP agreement tailors the statutory rules to the specific needs and preferences of the partners. \(d) Management: \(e) Liability Exposure: - When limited partners exercise control then they may be personally liable. - The IRC treats an LP the same as a general partnership for federal income tax purposes for the most part. - Generally taxed under Sub-K. - Key features: limited liability for ALL of its owners (called "shareholders" or "stockholders"), and management authority is vested in a board of directors elected by the shareholders. - Shareholders elect the board of directors. - Organizing a corporation is referred to as "incorporation." - Each state has its own corporate law statute. - DE has a very sophisticated corporate law. - DE judges are highly sophisticated in corporate law. - most states have adopted either the full or part of the MBCA. - When a corporate law issue comes up with respect to a corporation incorporated in an MBCA state, you should consult the applicable state's corporate law statute, NOT the MBCA. - DE is the most important non-MBCA state because it attracts the most incorporations by out-of-state businesses and is the state of incorporation for over 50% of US publicly traded companies. I. Internal Affairs Doctrine: - It is a choice of law rule. - The internal affairs doctrine ONLY governs the business's internal affairs, and it does NOT govern the business's external affairs. - What falls under internal affairs? - Whenever a lawsuit concerns the business's board, the shareholders =\> then the law of the state of incorporation applies. - What falls under external affairs? - Lawsuit involving a 3^rd^ party =\> then the law of the state of incorporation will NOT likely apply. - A consequence of this is that a business entity can choose which state's statute it wants to be governed by because a business can organize as an entity in the state it chooses, even if it does NOT do business in that state. - Each state has its own statute that regulates each of its business entities. - A business can incorporate in ANY state it chooses. - A business does NOT have to incorporate in the state in which it sits. - Most common for a business to incorporate in the state in which it sits or in DE. - Internal affairs doctrine provides certainty and predictability, while also protecting the justified expectations of the parties with interests in the corporation. II\. Default Rules vs. Mandatory Rules: - Default rule: is one that can be altered by the agreement between the parties (owners); it applies ONLY if the parties have NOT otherwise agreed to a different rule or if the agreement is silent about a rule. - Mandatory rule: is one that applies [regardless] of a contrary agreement by the parties (owners); the parties [cannot] K around a mandatory rule; an agreement that Ks around a mandatory rule has NO effect. - A mandatory rule reflects a public policy reason why it cannot be drafted around. - Mandatory rules differ across forms. - ALWAYS look at the rule's language to decide whether the rule is a default rule or a mandatory rule. - Business entity statutes are composed largely of default rules (i.e., RUPA). - Corporate law statutes do NOT have blanket-type default rules (i.e., MBCA). - UNLESS a corporate law statutory provision specifies that a rule can be altered, the rule is a mandatory rule. - When it comes to corporate law default rules, you MUST pay attention as to how the rule can be overridden. - Is it in the charter, bylaws, or by resolution of the board of directors? - Default rules that can be altered ONLY in a corporation's charter are more "sticky" than those that can be altered in a corporation's bylaws or by some other means. III\. Majority Owner vs. Minority Owner Perspective: - Whether a particular change to a default rule is in your client's best interest usually depends on whether your client is a majority owner or minority owner of the entity. - Majority owners/ shareholder typically do NOT want to modify default rules because they favor majority owners/ shareholders. - A majority owner/ shareholder may be willing to change a default rule to give more power/ control to a minority owner/ shareholder because it could encourage investments, which would make more revenue for the majority owner/ shareholder. - Minority owners/ shareholders typically want to change or modify default rules in order to have more power/ control because default rules typically favor majority owners/ shareholders. - A minority owner/ shareholder has little control UNLESS the default rules are modified/ changed which gives the minority owner/ shareholder more control. IV\. Public Companies vs. Private Companies: - Public company: is one whose shares (or other ownership interests) are traded on a public secondary market like the stock market; its shares are publicly traded (like the NYSE). - Public companies are generally larger than private companies in terms of assets, revenues generated, and number of employees. - Public company shares are highly liquid. - Private company: is one whose shares are NOT publicly traded. - Private companies are sometimes called "closely held" because they often have a small number of owners. - Private company shares are considered illiquid. - The same corporate law statute applies to a corporation [regardless] if it is public or private. - A company starts out as private and then may later choose to go public. - A company generally goes public by hiring an investment banking firm to market and sell its common stock to the public in an initial public offering (IPO) V. Agency Law: - Agency law dictates when a business will be bound by a K with a 3^rd^ party that someone entered into on the business's behalf. - Agency law answers the question as to when a company is bound. - Principal gives consent - Consists largely of state common law. - Restatement (Third) of Agency law is commonly applied. - The most common way an agency relationship is created is when a business hires a person as an employee. - If the relationship meets the 3 elements, then the person hired by the business will be an agent regardless if the person is hired as an employee, independent contractor, or nonemployee agent. - NOT all individuals hired by a business are employees. - BUT there MUST be an agency relationship for this to apply. - It is common for a K between 2 businesses to include a clause explicitly stating that there is no agency relationship. However, how the parties characterize a relationship is relevant, but it is NOT controlling: ii\. When a Principal is Bound to a K: - You ONLY need 1, either actual authority or apparent authority - Most times there is either actual authority or apparent authority - BOTH actual authority and apparent authority can be implied. - Often apparent authority and actual authority coincide. 1. Actual Authority: - Agent needs to have a reasonable belief. - Actual authority can be expressed or implied. - Actual authority is expressed when the principal expressly communicates to the agent. - The focus is on the communication by the principal to the agent, and the agent's reasonable interpretation of that communication. - Implied actual authority includes authority to do acts necessary or incidental to achieve the principal's express objective. It can also arise from manifestations by the principal that reasonably lead the agent to believe they have authority to take a particular action. - Whether an agent is bound on the K depends on whether the 3^rd^ party has actual or constructive knowledge that the agent is acting for a principal and the 3^rd^ party has identified the principal. - If the 3^rd^ party knows, then the agent is NOT bound by the K. - But - If the 3^rd^ party does NOT know that the agent is acting for a principal, or even if the 3^rd^ party knows that agent is but does NOT know the principal's identity, then the agent is bound by the K. 2. Apparent Authority: - Based on what the principal tells a 3^rd^ party. - The focus here is on communication by the principal and the reasonable interpretation of this communication by the 3^rd^ party. - Direct and unambiguous communication is NOT required for finding apparent authority. - Apparent authority can be implied. - When does an agent have apparent authority to bound a principal? - Reliance element is NOT required in some states. - Information that has been channeled through other sources can be used to support apparent authority so long as that information can be traced back to the principal. - The information received by the 3^rd^ party may come directly from the principal by letter or word of mouth, from authorized statements of the agent, from documents or other indicia of authority given by the principal to the agent, or from 3^rd^ persons who have heard of the agent's authority through authorized or permitted channels of communication. - It does NOT need to be expressly stated to the 3^rd^ party. - When the principal gives an agent a specific title, the agent has the apparent authority to act in a way that someone with that specific title would act. - The appointment of an agent by a principal to a particular position or office constitutes a manifestation by the principal. - If a 3^rd^ party knows an agent is in a particular position and this knowledge is traceable to the principal, then the agent has apparent authority to do what a person in the agent's position would customarily have authority to do. - A person who is NOT even an agent of a principal, and has NO actual authority, can still possess apparent authority and bind the principal. - Imputed knowledge: organizations are treated as possessing the collective knowledge of their employees and other agents. - For purposes of determining a principal's legal relations with the 3^rd^ party, notice of a fact that an agent knows or has reason to know is imputed to the principal if knowledge of the fact is material to the agent's duties to the principal. 3. Estoppel: - A business may be bound to a K entered into on its behalf by an agent or other person lacking BOTH actual and apparent authority under the doctrine of estoppel. 1. the person intentionally or carelessly, caused such 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. - Principal can be bound by the action of an agent who does NOT have actual or apparent authority. - When can estoppel occur? 1. 3^rd^ party believes they are dealing with an agent of the principal; 2. 3^rd^ party detrimentally relies on the agent; and 3. either: a. principal intentionally or carelessly caused the 3^rd^ party to believe that; or b. the principal knew the 3^rd^ party did NOT know the agent lacked authority, but did NOT take reasonable steps to notify the 3^rd^ party of this. - To prevent this, the principal MUST notify the 3^rd^ party that the agent lacks authority. As soon as the 3^rd^ party has knowledge of this, then there is NO agency relationship by estoppel. - As soon as 1 party of the 3^rd^ party has notice, then this is sufficient to prevent estoppel. - Estoppel does NOT require a manifestation traceable to the principal re the purported agent's authority. - Estoppel does require detrimental reliance by the 3^rd^ party. - a business may be bound to a K entered into on its behalf even in the absence of actual authority, apparent authority, or estoppel under the doctrine of inherent agency power. - When fairness dictates that a principal should be bound by a K, but there is NO actual authority, apparent authority, or estoppel. - It would be unfair for the principal to retain the benefit provided by the agent. So, courts hold the principal liable in fairness. - Courts invoke inherent agency power when fairness dictates holding a principal liable on a K even though the purported agent lacked authority and one or more estoppel elements is missing. - The imposition of liability upon the principal because of unauthorized or negligent acts of their servants and/ agents or other agents. These powers or liabilities are created by the courts primarily for the protection of 3^rd^ persons, either those who are harmed by the agent or those who deal with the agent. - A business may be bound to a K entered into on its behalf even in the absence of actual authority, apparent authority, or estoppel under the doctrine of ratification. 1. manifesting assent to be bound by the act; or 2. through conduct that justifies a reasonable assumption that the person/ principal so consents. - Principal could either expressly acknowledge and appreciate the agent's prior action or will retain the benefit. VI\. Entity-Specific Rules: 1. Partnerships: - ONLY for K's inside the ordinary course of the partnership's business: 1. each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course of the partnership business or business of the kind carried on by the partnership binds the partnership, UNLESS the partner had NO authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority. - Gives partners actual authority and apparent authority - Partners have actual authority and apparent authority to act for the partnership within the scope of the partnership's ordinary business UNLESS a partnership agreement is to the contrary. - \*Note: when it comes to apparent authority, there is NO requirements that a manifestation traceable to the partnership has reached the 3^rd^ party. - This section essentially serves as a manifestation to ALL 3^rd^ parties that every partner has the authority to bind the partnership when it comes to partnership business in the ordinary course. - If the 3^rd^ party's belief that a partner has authority is NOT reasonable because the 3^rd^ party knew or had received a notification that the partner lacked authority, then the partnership is NOT bound. 2. an act of a partner which is NOT apparently for carrying on in the ordinary course of the partnerships' business or business of the kind carried on by the partnership binds the partnership ONLY if the act was authorized by the other partners. 1. comes to the person's attention; or 2. is duly delivered at the person's place of business or at ANY other place held out by the person as a place for receiving communications. - \*Note: the common law of agency applies to partnerships and partners notwithstanding RUPA §301. - i.e., a partnership manifests to a 3^rd^ party that a partner has authority to bind the partnership to something outside the ordinary course. The partner and 3^rd^ party then enter into a K on behalf of the partnership consistent with such manifestations. The partnership is bound by the K under common law apparent authority even though it is NOT bound under RUPA §301 because the K is outside the ordinary course. - Ratification of an agent's unauthorized acts may be made by overt actions or inferred from silence and inaction. - Ratification does NOT concern actions or events that may occur in the future. - Ultimate decision-making authority resides in a corporation's board of directors, which includes the power to authorize people to act on behalf of the corporation. - An individual director [cannot] confer actual or apparent authority. - Directors can ONLY act collectively as a board. - An individual director is NOT an agent of the corporation. The position confers NO actual or apparent authority to bind the corporation. - However, the corporation may confer actual or apparent authority to a director. - Shareholders do NOT have the authority to bind the corporation. - Shareholders are NOT agents of the corporation. - Board of directors are NOT agents. - A corporation acting through its board of directors, an officer, or other employee could confer actual or apparent authority on a shareholder or anyone else by telling the shareholder or other person that they have authority. - Officers are agents of the corporation. - Board of directors are responsible to appoint executive officers, i.e., the president, CEO, CFO, etc. - Authority is provided by the bylaws, delegated from the board, and can be delegated to them by another officer who has the authority to delegate. - Included within an officer's authority is typically the authority to confer authority to bind the corporation on a subordinate, which conferral may authorize that subordinate to confer authority to a person below them in the hierarchy. Hence, authority is conferred down the line all the way to the office clerk who has the authority to buy office supplies on behalf of the corporation. - Officer has actual authority and apparent authority. - \*Note: for the final, when you read a section of bylaws of a K provision, you ONLY need to know the rules that inform the bylaws or the K. - MUST check the applicable LLC statute and the LLC's operating agreement to determine the LLC's authority rules. - Some states follow RUPA and limit member authority of a member-managed LLC and manager authority of a manager-managed LLC to acts apparently carrying on the business of the LLC. - You cannot have apparent authority if the 3^rd^ party has knowledge that the agent lacks authority. - i.e., acting on behalf of yourself when you know you lack authority. - Minority member knew he had NO authority to act and because the minority member's knowledge of their own wrongdoing was imputed to the LLC that the minority member secretly formed and was the sole owner, it took the property with knowledge that the minority member had NO authority to sign the deed. VII\. Ensuring Authority: - For more significant transactions, such as the acquisition of a business, the parties will conclude that it makes sense to take some steps to ensure authority. - Whenever you deal with an agent, there is ALWAYS a chance that a principal will say that the agent is NOT their agent. - So, how do you draft a K, to protect the principal from that? How do you verify authority and verify agency? - Includes the delivery of 2 documents at closing that addresses authority: - 1\. Secretary's certificate - 2\. Opinion letter - If a partnership or LLC is involved, a party may also require the filing of a certificate of authority. a. Secretary's Certificate: - A secretary's certificate is a document signed by an entity's secretary certifying that certain actions were approved by the governing body of the entity (board of directors, managing partner, board of managers, etc.). - In this context, a secretary is the officer of the business entity responsible for maintaining the books and records of the entity. - It gives actual authority to the named parties in the secretary certificate - May authorize more than one officer. - Verifies that the person(s) signing the K has authority - Most LLCs will provide for a secretary in their operating agreement. - Most corporate statutes require a corporation to appoint a secretary. - Secretary affirms that they are the secretary of the corporation - Secretary authorizes that they are certified to provide a certificate - Shows the board's resolution. - May include an "incumbency provision," which confirms the positions of the listed individuals and gives rise to implied actual authority or apparent authority. - An "incumbency certificate" is a separate document. b. Opinion Letters: - An opinion letter/ legal opinion is a letter from the attorney of one law firm of one party to a transaction to the other party/ law firm to the transaction that addresses various legal issues with respect to the transaction. - Designed to address authority - The drafting attorney will draft resolutions that the board wants. - Gives actual authority to the officers who will close the transaction. - It will verify that the process to reach the resolution complied with the bylaws. - If the transaction is small, then there may not be an opinion letter. However, the larger the transaction, the more of opinion letters there will be. - Goes together with the Secretary's Certificate. c. Statement of Authority: - Optional NOT required. - Specifies the actual authority of the partners. - Outlines the decisions that individual partners can make on their own, and the decisions that require all of the partners to decide on. - Used for large transactions. - Effect of this is that it gives actual authority to the partner/ CEO/ named partner in the statement of authority. - For LLCs the process is similar. - Partnerships: - LLC: - Corporations: - if the corporation alleges that the agent did not have authority for the particular transaction, then the corporation could not repudiate but could go after the agent who purchased it. d. Signature Blocks: - The typical means by which an agent indicates they are signing a K on behalf of a principal. - Typically placed at the end of the K. - Begins with "In witness whereof" - Name of the company - Name of the person signing - Language preceding the signature block is the "concluding clause." - Any reference to the "preamble" in the concluding clause is to the 1^st^ paragraph of a K, which specifies the parties and the date of the K. - Signature block format: name of the entity followed by a signature line with the word "By" preceding it and the person's position with the entity specified below the signature line. This makes it clear that the person signed on behalf of the entity. - In some situations where an agent/ person has to sign themselves, the person signing who is an agent will sign "\[their name\] for ABC corp." VIII\. Liability of a Principal for Agent Torts: 1. Direct Liability: - i.e., principal fails to do background check on employee and employee assaults customer. If the principal would have done a background check, then it would have revealed that the employee had a previous record of assaulting people. - Justification: the principal's own fault contributed to the agent's commission of the tort. 2. Vicariously liable: - Key issues: respondeat superior/ vicarious liability turns on whether the agent was an employee, and then on whether they were acting within the scope of employment. - Respondeat superior means "let the master answer." - MUST be an employment relationship. - ONLY applies to employees and does NOT apply to independent contractors. - 1\. Was the agent an employee? - If YES =\> go to 2 - 2\. Was the employee acting in the scope of employment? - If YES =\> then the principal is liable for the agent's actions. - Distinction between an employee and a non-employee: a. the extent of control that the agent and the principal have agreed the principal may exercise over details of the work; b. whether the agent is engaged in a distinct occupation or business; c. whether the type of work done by the agent is customarily done under a principal's direction or without supervision; d. the skill required in the agent's occupation; e. whether the agent or the principal supplies the tools and other instrumentalities required for the work and the place of in which to perform it; f. the length of time during which the agent is engaged by a principal; g. whether the agent is paid by the job or by the time worked; h. whether the agent's work is part of the principal's regular business; i. whether the principal and the agent believe that they are creating an employment relationship; and j. whether the principal is or is not in business. - also relevant is the extent of control that the principal has exercised in practice over the details of the agent's work. - As to whether an employee was acting within the scope of employment: - Is a principal liable for a "nonemployee agent's" tortious conduct? - Justifications for respondeat superior/ vicarious liability: - Creates an incentive for principals to choose employees and structure work within the organization so as to reduce the incidence of tortious conduct. - Reflects the likelihood that an employer will be more likely to satisfy a judgment and the employer will likely have insurance against liability. - If an employee commits a tort within the scope of employment, the V could sue the employee and the employer - Rarely happens because most businesses have liability insurance and/ or the employee may be valued by the principal, thus, the principal does NOT want to damage the relationship. IV\. The Principal-Agent Problem and Fiduciary Duties: 1. The Principal-Agent Problem: - The "principal-agent" problem is that the interests of a principal and those of an agent will invariably diverge; that is, an agent will NOT always act in the best interests of the principal. - A principal can take steps to minimize this problem through "agency costs." - "agency costs" are defined as monitoring costs, bonding costs, and residual loss. - Monitoring costs: are expenditures incurred by a principal to minimize divergent behavior by an agent - Bonding costs: are expenditures incurred by an agent to bond itself to the principal so that the agent will limit its divergent behavior. - Residual loss: is loss resulting from the divergence notwithstanding monitoring and bonding. Residual loss reflects the fact that no matter what a principal does, it probably will NOT be able to totally eliminate divergent behavior by an agent. 2. Agent's Duties to Principal: - Principals will usually fire agents who breach their fiduciary duties. If substantial money is at stake, then principals will bring legal action (breach of fiduciary duty action/ claim) against agents who breach their fiduciary duties. 1. a duty NOT to acquire a material benefit from a 3^rd^ 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; 2. a duty NOT to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship; 3. a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal's competitors; and/ or 4. a duty: a. NOT to use property of the principal for the agent's own purposes or those of a 3^rd^ party; and b. NOT to use or communicate confidential information of the principal for the agent's own purposes or those of a 3^rd^ party. 1. a duty to the principal to act with the care, competence, and diligence normally exercised by agents in similar circumstances; 2. a duty to take action ONLY within the scope of the agent's actual authority; 3. a duty 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; 4. a duty, within the scope of the agency relationship, to act reasonably and to refrain from conduct that is likely to damage the principal's enterprise; and 5. a duty to use reasonable efforts 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. - Even though the agent owes extensive duties to the principal, in the real world, they are NOT a primary factor for keeping agents in line. Most people strive to do what is right, to work hard, and to be honest because of their moral codes or cultural values. These moral codes are reinforced by ambition and reputational concerns. - Thus, agency law fiduciary duties serve more as a backstop. They only come into play when these moral/ cultural values factors have failed and/ or if substantial money is at stake. 1. whether the employee is highly paid; 2. whether the employee shares in the company's profits and losses; and 3. whether the employee has significant discretion in their autonomy and how they work. 1. actively exploit their positions within the corporation for their own personal benefits; or 2. hinder the ability of the corporation to conduct the business for which it was developed. 1. fail to inform the company that employees are forming a rival company or engaging in other fiduciary breaches; 2. solicit the business of a single customer before leaving the company; 3. use the company's facilities or equipment to assist them in developing their new business; or 4. solicit fellow employees to join a rival business. - independent contractors: - Termination of the agency relationship: - Non-compete Agreements: - Confidentiality provision - Employer protects its business interests from the employee and prevents employees from starting rival companies and taking customers/ clients. - It is a K. - Commonly used - Used especially for upper-level employees. - Contains: - Non-competition covenant: employee agrees to NOT be employed by a competitor while employed or for a reasonable amount of time after (1 year). - Covenant not to solicit customers - Covenant not to solicit employees - Injunctive relief: company can stop the employee from violating this and get paid by suing for monetary relief. \(3) Principal's Duties to Agent: RULE: agency law also imposes duties on a principal, which include: 1. 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; and/ or 2. a duty to indemnify an agent: a. UNLESS otherwise agreed, when the agent makes a payment within the scope of the agent's actual authority; and b. when the agent suffers a loss that fairly should be borne by the principal in light of their relationship. V. Choice of Form Considerations: 1. Liability Exposure: - A primary reason to set up a business is to avoid personal liability. 1. inside liability exposure: the extent to which the owners of a business operated in a particular legal form face potential personal liability on the business's obligations; and 2. outside liability exposure: the extent to which the creditors of the owners of a business operated in a particular legal form can recover against the business's assets. - i\. Inside liability exposure: - sole proprietorship: sole proprietors get NO liability shield. - Partnerships/ general partnerships: partners get NO liability shield. - For many business owners, the fact that NEITHER a general partnership NOR a sole proprietorship provides an owner with any inside liability protection immediately eliminates these forms as a possible choice. - LPs: afford limited partners full liability shields because limited partners are generally investors and have NO control UNLESS they do, then they may be partially liable due to control rules. General partners get NO liability shield regardless of the state of organization. - For LPs, lawyers could get all owners of an LP a liability shield by simply incorporating the general partner. Because the individual controls the corporation, the individual controls the LP to the same extent as if they were the general partner. However, the individual would now be protected against personal liability for the obligations of the LP by the liability shield of the corporation. Not as popular today because of LLCs and LLPs. - LPs are NOT the most favored because the general partner is personally liable to the LPs debts if the general partner is an individual. - LLPs: most LLPs provide their partners with full inside liability shields EXCEPT for LLPs organized in LA and SC which provide ONLY partial shields. - For some business owners, liability exposure concerns even eliminate an LLP from contention because in 3 states, NY is one of them, the LLP is limited to professional practices, i.e., law, medicine, and accounting. - While a non-professional business operating in one of these states is free to organize as an LLP in a state without a professional practice restriction, there is a good change that a professional practice restriction state will treat such LLP as a general partnership, which means NO liability shield for its partners. - Also, the strength of an LLP liability shield is weakened by the existence of the 2 partial-shield states, LA and SC. While a business operating on one of these states is free to organize as an LLP in a full-shield state, some uncertainty remains as to whether a court in a partial-shield state will honor the full-shield state provided by the state of organization. - Corporations and LLCs: provide a full liability shield, best protection, for owners against inside liabilities. The corporate law and LLC statutes of ALL states provide full inside liability shields regardless of their state of incorporation/ organization and NO state limits their use to professional services. - LLCs are more common/ favored than LPs because the LLC receives a full liability shield, and LLCs are taxed the same by pass-through taxation. - LLCs and corporations are the most common - a\. Veil Piercing: - Heavily litigated issue - NO bright line test exists - Applies to ANY entity with a liability shield - Court will disregard the liability shield and will go after the individuals - Piercing the corporate veil (a.k.a. veil piercing) - Piercing the veil is a LAST RESORT. - Common route for veil piercing is that there is a fraud, the injured party sues the business, but the business has no money, then the injured party seeks to pierce the veil. - When is veil piercing allowed? 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; and 2. the facts are such that an adherence/ maintaining the fiction of its separateness would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity. - The test is fact-driven and flexible, and it focuses on whether the LLC has been operated as a separate entity as contemplated by statute, or whether the member has instead misused the entity in an inequitable manner to injure the P. - The test and factors considered MUST be attuned to the facts of a given case. 1. whether there has been fraud; 2. inadequate capitalization; - undercapitalization alone will NOT suffice to pierce the veil. - Relative concept. - Weight to be given to this factor depends upon the particular circumstances of the case. - Did the individual (i.e., LLC member) intentionally screen the money to insulate themselves? - Courts will NOT pierce the veil if the business merely ran out of cash. 3. failure to observe company formalities as required by law; and - i.e., NOT following an operating agreement, failing to comply with the bylaws, etc. 4. the degree to which the business and finances of the limited liability entity and the member are intermingled. 1. funds and assets should be separated and NOT comingled; 2. failure to maintain an arm's-length relationship between the member and the limited liability entity, as by NOT keeping enough separate bank accounts and book keeping records. 3. if the member treats the limited liability entity's property as if it were that person's or company's personal property; and/ or 4. manipulation of assets and liabilities between the member and limited liability entity so as to concentrate the assets in the former and the liabilities in the latter, which can show improper use. - Corporate and personal funds MUST be separate. - NO single category, EXCEPT fraud alone, justifies a decision to pierce the veil of an LLC. Rather, there MUST be some combination of them AND an injustice or unfairness MUST be proven. Piercing the veil is a LAST RESORT. - Alter ego: the entities are one of the same. - b\. Direct Liability: - If a business owner's own negligence injures someone, even if committed while working, the injured party can sue the business owner personally for the business owner's negligence because the business owner is being sued in their individual capacity and NOT in the business owner's capacity as a member of the business entity. The business entity's limited liability shield does NOT protect the business owner in this case. - But, - If an employee of a limited liability business entity negligently injures someone, and the injured party sues the LLC, then the limited liability shield would protect the business owner from personal liability (assuming the P have NO negligent hiring or similar claim on which to sue the business owner directly). If the LLC is sued too and is unable to cover the judgment, then the P will NOT be able to recover against the business owner's personal assets (UNLESS the P can convince the court to pierce the limited liability veil of the business owners limited liability business entity). - ii\. Outside Liability Exposure: - outside liability exposure refers to the extent to which the creditors of the individual owners of a business operated in a particular legal form can recover against the business's assets. - For outside liability exposure, unincorporated entities are generally superior to corporations. - i.e., shareholder injures someone in a car accident, the injured party sues the shareholder, then the shares are liable? - This is the same if the business was instead organized as a general partnership, LLP, or LP. - \* Charging order is an economic interest NOT a management interest. - Judgment creditor cannot force the LLC to make distributions; judgment creditor ONLY gets the normal distributions the LLC would otherwise make. 1. judgment creditor receives a charging order; 2. charging order ONLY constitutes as a lien on the judgment debtor's LLC interest. 3. the charging order is the exclusive remedy for the judgment creditor; and 4. NO judgment creditor of an LLC member has any management/ property rights. - Judicial foreclosure on a charging order: - ONLY really works if the membership interest is liquidated and/ or can be easily sold. - The purchaser at the foreclosure sale does NOT become a member of the LLC, which means they acquire NO management rights. Thus, even if a creditor forecloses on a charging order, the LLC's assets are still protected. - a\. Single-Member LLC's: - Big caveat to the above analysis: - Sole member of an LLC means the sole member is the ONLY owner/ member. - Why? - Charging orders exist to protect other LLC members NOT to protect the debtor. - A charging order protects the autonomy of the other original LLC members, and their ability to manage their own enterprise, and for them to decide who they want to go into business with. In a single-member LLC, there are NO other members to protect. - Majority of states follow this, but it is unclear in others. - The way a judgment debtor who is a single-member LLC can prevent this is by having another member, even 1 member with a 98% interest and the other has a 2% interest, because a charging order would then apply protecting the other member. However, a judgment debtor who is a single-member LLC [cannot] add another member AFTER the judgment creditor obtains a judgment/ charging order against the judgment debtor who is a single-member LLC. - b\. Reverse Veil-Piercing: - Creditors of a business owner may also be able to reach the assets of a business under the doctrine of reverse veil piercing, which applies to ALL limited liability entities (corporation, LLC, LLP, LP, etc.). - Idea that the creditors of an owner may go after the business's assets. - When looking for veil piercing, there MUST be something sketchy. 1. the limited liability entity sought to be pierced has been controlled or used by the debtor to evade a personal obligation, to perpetuate a fraud or crime, to commit an injustice, or to gain an unfair advantage; 2. the standards are very stringent, and piercing is an extraordinary measure that is permitted ONLY in the most egregious circumstances. The piercing of a veil is justified when the unity of interest and ownership is such that the separate personalities of the limited liability entity and the individual NO longer exist, and adherence to that separateness would create an injustice; 3. a court considering reverse veil piercing MUST weigh the impact of such action upon innocent investors/ innocent members/ owners/ innocent limited partners/ innocent general partners; MUST consider the impact of such an act upon innocent secured or unsecured creditors; and MUST also consider the availability of other remedies the creditor may pursue; and 4. a litigant who seeks reverse veil piercing MUST prove the necessary standards by clear and convincing evidence. - Use the same test for BOTH direct and reverse veil piercing - A charging order in reverse piercing makes the business itself the debtor and the judgment creditor can access control of the business. The business has NO protection. - c\. Prevalence of Sole Proprietorships: - Why would people do this? - They do NOT know - They do NOT want to pay the legal fees - They do NOT have a risky business - They have insurance - One way to think about the costs of forming and maintaining a limited liability entity is in terms of excess insurance. Specifically, these costs are equivalent to premiums for insurance that protects you from personal liability when the business's assets and primary insurance are exhausted. - For many business owners, federal tax treatment is the most important consideration for choosing a form. - 2 issues relevant to business form selection: - 1\. Minimizing federal income tax liability; and - 2\. Minimizing federal employment tax liability. - Federal income tax liability for a business depends largely on how the business is classified for tax purposes. - A business generally gets to pick its classification, but the choices available vary by form. Sub-C Sub-S (if eligible) LP: Choices: Sub-K\* =\> default classification Sub-C Corporation: Choices: Sub-C\* =\> default classification Sub-S (if eligible) Single-Member LLC: Choices: Disregarded\* =\> default classification Sub-C Sub-S (if eligible) 1. it is a domestic entity -- incorporated or organized in one of the 50 states or the District of Columbia; 2. it has 100 or fewer owners; 3. ALL of its owners are individuals, estates, certain types of trusts, or tax-exempt organizations; 4. NONE of its owners are nonresident aliens; and - NOT a US citizen or national - A nonresident alien is an alien who has NOT passed the green card test or the substantial presence test. 5. it has ONLY 1 class of ownership interest outstanding. - A corporation is generally considered to have ONLY 1 class of stock if ALL outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds. - Sub-S taxation is often described as "fragile" because eligibility is easily inadvertently lost. 1. interest; 2. dividends; 3. real property rents; 4. gain from the disposition of real property; 5. gain from mineral or natural resources activities; and 6. gain from the disposition of capital assets. A. Sub-K and Sub-S Taxation: - BOTH Sub-K and Sub-S provide for pass-through taxation. - Pass-through taxation: the entity calculates its income/ loss for the tax year and then allocates it to each owner but the company itself is NOT taxed. - i.e., if you own 40% of the entity, you are allocated 40% of its income or loss/ year. - "marginal rate analysis" is used to figure out the tax impact of the next dollar earned. - Under BOTH Sub-S and Sub-K, owners of a business are taxed on business income allocated to them even if the business did NOT distribute any money to them. - One downside to going with a Sub-S LLC over an S-corporation is that several states do NOT recognize S-elections by LLCs for state tax purposes. - An entity taxed under Sub-C is treated as a separate taxpayer. The entity MUST file an annual income tax return (Form 1120) reporting its income, deductions, and credits for the year and pay any resulting income tax at the corporate income tax rate (21%). - Double taxation: a Sub-C entity's profits are taxed when earned and then taxed again when distributed to owners. So, if a Sub-C entity distributes money to its owners (dividend), then the owners MUST include the distribution/ dividend in their taxable incomes. Dividends paid by C-corporations are generally taxed at the capital gains rate, which was 0%, 15%, or 20% in 2022 depending on the owner's taxable income. More money goes to the IRS. - Currently, Sub-C is the worst because of the tax rates and double taxation. - "disregarded entity" is an entity that is treated as an entity NOT separate from its single owner for income tax purposes. - A single-member/ owner LLC is taxed under a disregarded entity UNLESS it opts for Sub-C or Sub-S taxation (if it meets the Sub-S requirements). - A disregarded entity is taxed essentially the same as a sole proprietorship. The owner reports net income or net loss from the business on their personal federal income tax return. - A single-member LLC cannot elect to be taxed under Sub-K because Sub-K taxation is ONLY available to unincorporated entities with 2 or more owners. - Business owners will choose a business form that allows them to elect the tax treatment that will result in the lowest tax liability. - For multi-owner business the choice is usually between Sub-K vs. Sub-S. - For single-owner business the choice is usually between disregarded entity vs. Sub-S. - 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. - Generally, when allocating losses based on ownership percentage for Sub-S taxation, you want to allocate the losses to the person with the most income and who is in a higher tax bracket. - SEE is very complicated. B. Minimizing Federal Employment Tax Liability (may tip the scale towards Sub-S): - An owner of a business taxed under Sub-K or as a disregarded entity is subject to self-employment tax ("SE tax") on the businesses' income if the owner participates actively in its business affairs. The owner is also subject to SE tax on ANY compensation paid to the owner by the business. - Business owners who work for their employment can diminish their self-employment taxes by going with Sub-S taxation. - Under Sub-K, salaries and distributions receive a self-employment tax at the same rate. - In a Sub-S, business salaries receive a self-employment tax, but distributions do NOT. - So, owners want to lower their salaries as much as possible to receive a lower self-employment tax and receive higher distributions so that you do NOT have to receive higher self-employment taxes. - Salaries MUST be reasonable. - If the IRS thinks that the salary is unreasonably low, then the IRS will disregard the salary and impose penalties and make the business owner redo their taxes. - Business owners are responsible for paying self-employment tax; the business does NOT cover half of it. - Business owners who work for the business can significantly reduce employment taxes by going with Sub-S taxation over Sub-K or disregarded. 1. the amount paid for services rendered MUST be based on FMV, which is subject to FICA tax; and/ or 2. the rest is considered a distribution. C. Summation of Sub-K vs. Sub-S: 3\. Attractiveness to Investors: - A business that needs 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. - Bootstrap business: NO outside owners or debt, you finance the business yourself. - When a business owner signs a loan for a debt, they K around the liability shield, which makes the business owner personally liable. - If the business does NOT want to K around the liability shield, then the bank will likely just hold the business' assets, which will raise the liability shield and protect the owners' personal assets. - Emerging growth companies such as businesses pursuing research and development of new technologies, need to raise a significant amount of capital from outside investors. Thus, for these companies the primary consideration when it comes to choosing an entity is the entity's attractiveness to outside investors -- venture capitalists and angel investors. - Venture Capitalists (VCs) specialize in investing in emerging growth and other development-stage companies with great potential but high risk. VCs raises money from institutional investors (pension funds, endowments, insurance companies, etc.) and wealthy individuals by selling them interests in an investment fund formed and managed by the VC. The fund then makes large investments in a handful of companies (called portfolio companies) that the VC views as promising. The VC makes money by charging the fund a management fee of 1%-3% of assets and a performance fee of 20% of the fund's profits. At the end of a specified timeframe, the VC liquidates the fund and distributes the cash to the fund's investors. VCs want it to occur fast and within a specified time period. - Angel investors are wealthy individuals who directly invest in emerging growth companies, typically prior to a VC investment. - A startup business usually loses money in its first few years while it develops. It will need a significant amount of capital during this timeframe to fund its operations. The business's founder will generally NOT have enough out of pocket funds or bank loans. So, they will need to raise the balance by selling ownership interests to investors (this is called equity financing). 1. VCs insist on preferred stock in exchange for their investments, and ONLY C-corporations can issue preferred stock; 2. 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; and 3. a gain on the sale of stock in a C-corporation may qualify for favorable tax treatment under IRC§1202, a treatment NOT available for the sale of S-corporation stock or ownership interest in an unincorporated entity. - IRC §1202 avoids taxes for certain stocks, but it only applies for Sub-C entities. - Angel investors are typically individuals and can invest in S-corporations and are more open to pass-through taxation since it is not as complicated for them and they likely have passive income against which they could offset passive losses. However, angel investors typically invest expecting that venture capital funds will provide later rounds of financing, which leads most angels to have a strong preference for investing in C-corporations. - Summation: - If a company is seeking funding from a VC, then the company should incorporate as a C-corporation. - If an owner is bootstrapping a business, then the company should incorporate as an LLC. - A company is NOT bound by the entity it first chooses, but if they do change, then it can be very expensive. D. Other Considerations: 1. Formalities: a. The amount of legal formalities involved for formation and maintenance. 2. Expense: b. The more formalities associated with a business form, the more expensive it is to form and maintain. i. i.e., filling fees, legal fees, and franchise taxes 3. Continuity of Existence: c. A corporation can exist perpetually/ forever, regardless if all of its founders die or sell their shares. d. An LLC can exist perpetually/ forever depending on the state. e. A sole proprietorship terminates upon the death of the sole proprietor f. The withdrawal of a partner may terminate the existence of a general partnership, LLP, or LP depending on the state of formation and/ or partnership agreement. 4. Fiduciary Duty Waivers: g. Business entity law generally imposes fiduciary duties on owners and managers of a business. These duties are owed by an owner to their co-owners and to the business entity. Managers also owe fiduciary duties to the owners and to the business entity. h. Most states LLC statute allows an LLC to waive these duties in its operating agreement. i. Most states partnership and limited partnership statute gives wide latitude to narrow these duties. j. Corporation law does NOT allow fiduciary duties to be waived for corporations. 5. Form Eligibility: k. Some types of businesses are prohibited by licensing requirements or ethical rules to operate in particular forms. l. A single-owner business cannot operate as a general partnership, LLP, or LP because state statutes require these entities to have at least 2 owners. 6. Management Default Rules: m. Many LLC and partnership default rules assume that ALL owners will participate in management. n. Corporate law default rules provide for centralized management by a board of directors (BOD) and complete control by a shareholder owning a majority of the corporation's outstanding stock. 7. Buyout Rights: o. Partnership and many LLC statutes include a default rule requiring the entity to buy out a departing partner. p. Corporate law statutes do NOT have a default rule requiring the entity to buy out a departing owner. 8. Newness: q. LLCs and LLPs are relatively new and do NOT have as much case law, customs, or form documents, but there is still less comfort with them. E. Conversion: - A business is NOT locked into the form it initially chooses. It can always change forms later if wanted. - Many states amend their business entity statutes to add provisions that allow one type of entity to change to another type of entity simply by adopting a plan of conversion and then making a filing with the secretary of state. - A business is NOT locked into the tax status it initially chooses. - The big issue with changing an entity's tax status is whether changing tax status will trigger significant adverse tax consequences. - Generally, converting from a Sub-K or Sub-S to Sub-C or from Sub-C to Sub-S triggers minimal tax consequences. - However, converting from Sub-C to Sub-K triggers significant adverse tax consequences and is viewed as prohibitively expensive. - Conversion also involves legal fees, filing fees, and other transaction costs. - All these factors MUST be weighed by the business against the anticipated benefits of converting. VI\. Partnerships: 1\. Governing Law: - Usually, partners will agree upfront under which states' partnership laws they are forming the partnership, and this state's statute will be specified in the partnership agreement. This is what is meant by the state of organization -- that is, the state of the partnership statute specified in the partnership agreement as governing the partnership. - Sometimes people do NOT realize they are forming a partnership and therefore obviously do NOT know to agree on a state of formation. In this situation: - LA does NOT follow UPA or RUPA. - You should NOT assume that a state has adopted UPA or RUPA. - When a partnership issue comes up you should consult the applicable state partnership statute. - NO formalities are required to form a partnership. 1. 2 or more people associate to carry on as co-owners a business for profit; and 2. they do NOT file the paperwork (i.e., articles of incorporation/ organization) to operate the business in some other form. - People who intend to form a partnership usually express their intentions in a written partnership agreement. - Partnership formation issues arise when 2 or more people have some sort of business relationship, but it is unclear whether they intended to create a partnership. In this situation: - If 2 partners make a verbal agreement to start a business but they do NOT discuss sharing profits does a partnership exist? Yes. - Profit = generally cash but can be something of value. - When determining whether a partnership exists, the receipt by a person of a share of the profits of a business is prima facie evidence that they are a partner. However, profit/ loss sharing is ONLY evidence of a partnership; profit/ loss sharing, by itself, is NOT conclusive of a partnership. - Look for 2 or more people coming together and agreeing on a business idea and then their subsequent actions after. - Partnerships do NOT have board of directors and NO board meetings. - Common fact pattern for partnership formation: - One of the people in a business relationship argues that the relationship constituted a partnership so that they can claim a violation of the partnership statute, such as breach of fiduciary duty. By establishing a partnership, so that the P benefits from the statute. The D argues that there is NO partnership, so that the P does NOT benefit from the partnership. - A creditor of a sole proprietorship argues that the business was actually an inadvertent partnership in an effort to reach additional pockets. - This generally translates into partners voting on a proposed course of action, with each partner getting 1 vote. But NOT always. - It I very common for a partnership to vary RUPA's default management rules, which may look like: - Allocating votes based on the amount of capital each partner has contributed - Delegating decision-making authority with respect to a "managing partner" or "managing committee." - Requiring supermajority votes for specified decisions. - Changing approval requirements for matters outside the partnership's ordinary course of business to less than unanimous. - Most partnerships have a written partnership agreement signed by each partner. - These agreements typically address management structure, allocation of profits, and losses among the partners, partner taxation, admission and withdrawal of partners, and dissolution. - Partners can alter or opt out of default rules in the partnership agreement. - The goal of a partnership agreement is to modify the default rules. However, it will also contain the default rules because it informs the other partners of what the rules are. - If a partnership loses their partnership agreement, then the default rules essentially becomes the partnership agreement. 1. except as otherwise provided in subsection (2), the partnership agreement governs the partnership. The default rules governs the partnership agreement UNLESS they are modified or eliminated in the partnership agreement; or 2. mandatory rules that cannot be altered or opt out of (10): the partnership agreement may NOT: a. eliminate the duty of loyalty, but; - a very broad provision in a partnership agreement in effect negating ANY duty of loyalty, such as a provision giving a managing partner complete discretion to manage the business with NO liability except for acts or omissions that constitute willful misconduct, will NOT likely be enforced. i. the partnership agreement may identify specific types or categories of activities that do NOT violate the duty of loyalty, if NOT manifestly unreasonable; or - it is clear that the remaining partners can "consent" to a particular conflicting interest transaction or other breach of a duty, after the fact, provided there is full disclosure. - It is NOT necessary that the agreement be restricted to a particular transaction. - The agreement may be drafted in terms of types or categories of activities or transactions, but it should be reasonably specific. ii. all or a percentage of the partners specified in the partnership agreement may authorize or ratify, AFTER full disclosure of ALL material facts, a specific act or transaction that otherwise would violate the duty of loyalty. - This is intended to clarify the rights of partners, recognized under general law, to consent to a known past or anticipated violation of duty and to waive their legal remedies for redress of the violation. This is intended to cover situations where the conduct in question is NOT specifically authorized by the partnership agreement. It can also be used to validate conduct that might otherwise NOT satisfy the "manifestly unreasonable" standard. 3. unreasonably reduce the duty of care; - the partners' duty of care may NOT be unreasonably reduced below the statutory standard. - Provisions releasing and/ or indemnifying partners for action taken in good faith and honest belief are fine. - But, - Provisions absolving partners of intentional misconduct is probably unreasonable. - As with contractual standards of loyalty, determining the outer limit in reducing the standard of care is left to the courts. - The partnership agreement may increase the standard of care. 4. eliminate the obligation of good faith and fair dealing, BUT the partnership agreement may prescribe standards by which the performance of the obligation is to be measured, if the standards are NOT manifestly unreasonable; 5. eliminate the court-ordered dissolution rules because they are mandatory rules; 6. restrict access to the partnership records; 7. stop a partner from dissociating. 5\. Fiduciary Duties: - Partners owe each other and the partnership fiduciary duties. i. partners are trustees of partnership property (trustees for the partnership); ii. self-dealing is prohibited (doing things for self-benefit); and iii. partners are NOT allowed to compete against the partnership. - As long as the partnership exists, partners owe other partners fiduciary duties. - A trustee is held to something stricter than the morals of the market place. - \*Note: the managing partner could have waited for the partnership to end by letting the lease expire and then enter into the new lease or he could have informed the other partner about the new business opportunity. - Relationships that are called "joint ventures" are partnerships if they otherwise fit the definition of a partnership. - Obligation of good faith and fair dealing is NOT a fiduciary duty NOR a separate and independent obligation. - Obligation of good faith and fair dealing is a contractual obligation based on the bargaining position the partner was in at the time of the transaction. What would the partners have agreed to. Once a partner enters into a K, the partner MUST act fairly and in good faith based on the obligation of the parties at the time the K or transaction was entered into. - The obligation of 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 or RUPA. - Good faith clearly suggests a subjective element of how an individual partner thinks they are acting. - Fair dealing implies an objective component in relation to the partnership. 8\. Transfer of Partnership Interests: - These rules reflect the "pick your partner" principle; that is, partners get to choose with whom they share management rights for the business. - The "pick your partner" principle can be modified or eliminated by a partnership agreement. - It is common for the partnership agreement to provide for a different allocation rule (i.e., pro rata based on the amount of capital contributed to the partnership by each partner). - Distinction between allocation of profits and the distribution of profits: - An allocation of profits refers to the amount of partnership profits a partner MUST include as income on their individual tax return. - A distribution of profits refers to the amount of partnership profits that are actually paid out to a partner. - It is common for a partnership agreement to include a provision requiring the partnership to distribute to each partner sufficient funds to cover the partners' tax liabilities resulting from the allocation of the partnership's profits to the partners (Tax Burden Distributions). 10\. Dissociation: RULE: RUPA §601: "dissociation" is when a partner departs from a partnership. 1. the default rule for dissociation is that a partner can dissociate at ANY time by notifying the partnership of their express will to withdraw; or 2. automatic dissociation (involuntary) upon a partner's: a. expulsion from the partnership pursuant to the partnership agreement; b. bankruptcy; or c. death. 3. other partners may cause a partner's dissociation through a unanimous vote if, subject to limited exceptions, there has been a transfer of all or substantially all of that partner's transferable interest in the partnership. 11\. Dissolution: - The partnership continues for the limited purpose of winding up the business. This means the scope of the partnership business contracts to completing work in process and taking such other actions as may be necessary to wind up the business, including finishing up projects. Winding up the partnership business entails selling its assets, paying its debts, and distributing the net balance, if any, to the partners in cash according to their interests. The partnership entity continues, and the partners associated in the winding up of the business UNTIL winding up is completed. When the winding up period is completed, the partnership entity terminates. 1. a partnership for a definite term; 2. a partnership at will; and 3. a partnership for a particular undertaking. 1. the economic purpose of the partnership is likely to be unreasonably frustrated; 2. 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; or 3. it is NOT otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement. - i.e., something in the partnership agreement that cannot be carried out. - If the default rule is modified re dissolution providing that the dissociation of a partner does NOT cause the partnership to dissolve, then the other partner may petition the court to dissolve the partnership. - If the partnership is for a partnership for a particular term or a partnership for a particular undertaking, then the dissociation of a partner does NOT trigger dissolution. 1. after the expiration of the term or completion of the undertaking, if the partnership was for a definite term or particular undertaking at the time of the transfer or entry of the charging order that gave rise to the transfer; or 2. at ANY time, if the partnership was a partnership at will at the time of the transfer or entry of the charging order that gave rise to the transfer. 1. contributions made to the partnership by the partner and the partner's share of the partnership profits; minus 2. amounts distributed by the partnership to the partner and the partner's share of partnership losses. - The partnership then pays each partner an amount equal to the partner's capital account balance, and the remaining surplus, if any, is divided among the partners based on their profit-sharing percentages. VII\. Limited Liability Partnerships (LLPs): 1\. Formation: 1. the name of the partnership; 2. the street address of the partnership's chief executive office; and 3. a statement that the partnership elects to be an LLP. - the name provisions are intended to alert persons dealing with an LLP of the presence of the liability shield. - This vote is typically done in connection with approving revisions to the partnership agreement. Partners are NOT required to revise their agreement when the partnership becomes an LLP. However, revising the agreement is advisable because partner contribution and indemnification provisions will likely need to be revised. - A new business that chooses to operate as an LLP will simply include a provision in the initial partnership agreement stating that "the partnership shall be an LLP," with the necessary consent of each partner indicated by them signing the partnership agreement. - The atty handling the LLP's formation typically drafts the partnership agreement. - The reason for unanimous approval by the partners in a partnership agreement is because partners would NOT want to become a partner if there was NOT a unanimous vote for certain topics/ issues. VIII\. Limited Partnerships (LPs): - LPs are decreasing importance today because of the rise of LLPs and LLCs. - Private investment funds (venture capital funds, hedge funds, and private equity funds) are still typically organized as LPs. - Estate planners use "family" LPs (Flip). - Publicly traded LPs -- known as master LPs (MLPs) -- are structured to fall within the narrow IRC exception, which allows them to be taxed under Sub-K instead of Sub-C. - It is common for courts, especially DE, to look to LP law when deciding issues of first impression under the less developed LLC law. 1. the name of the LP; 2. its office address; and 3. the name(s) and address(es) of its general partners. 2\. Governing Law: - Conversely, - RULPA uses a provision-by-provision approach. Each provision will specify whether it can be altered in a partnership agreement. - The language "except as provided in the partnership agreement" indicates that the RULPA rule is a default rule. - If there are multiple general partners, then the general partners have equal management rights. - Typically, the general partner is a business entity to negate the effect of the general partner being personally liable. UNLESS the corporate veil is pierced or there is a single-member LLC. 4\. Liability Exposure: 1. working for the LP or its general partner; 2. guaranteeing LP obligations; 3. attending partner meetings; and 4. voting on dissolving or selling the partnership, changing the nature of its business, admitting or removing a general or limited partner, or an amendment to the partnership agreement. - It is left for the courts to decide whether limited partner activities that are NOT on the exclusion list constitute "participating in the control of the business." i\. General Partners: ii\. Limited Partners: - Why the different treatment of limited partners re fiduciary duties? - Limited partners have very limited power and NO power imposing fiduciary duties upon the LP or other partners. - BUT - It is possible for the partnership agreement to allocate significant managerial authority and power to a limited partner, but in this case that power exists as a matter of K and NOT as a matter of status or role, which is required to attach a fiduciary duty. The proper limit on K based power is the obligation of good faith and fair dealing, NOT fiduciary duty, UNLESS the partnership agreement expressly imposes a fiduciary duty or creates a role for a limited partner which, as a matter of law, gives rise to a fiduciary duty. - i.e., if the partnership agreement makes a limited partner an agent for the LP as to particular matters, the law of agency will impose fiduciary duties on the limited partner with respect to the limited partner's role as an agent. - Fairly common for an LP 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. - ULPA-2001 does NOT contain a default rule for the allocation of profits and losses. - However, ULPA-2001 does have a default rule for distributions. 8\. No Default Buyout Right: IV\. LLLPs: 1\. Formation: - The fact that 18 states do NOT provide for LLLPs is a major disadvantage of operating a business in the LLLP form because it gives rise to the risk of interstate non-recognition of the liability shield. - New LLLP: - Existing LP to LLLP: - Name: 2\. Liability Exposure: - Typical fee schedule for a venture capital re payment of the general partner: 2 & 20 pay schedule: general partner gets 2% of assets under management (AUM) and 20% of any profits. V. LLCs: A. Formation: - The state's LLC statute will specify the list of information that MUST be included in the certificate. B. Governing Law: - 18 states have adopted some version of RULLCA original 2006 version. - DE attracts 8-% of LLCs formed outside of their home states but has NOT adopted RULLCA. - DLLCA and RULLCA are relevant for this class. - Default rules for ALL business entity's favor majority shareholders - So, minority members want to modify the default rules to provide more favorable terms to them. However, majority members do not want to modify the default rules as much. - Operating agreement does NOT need to be filed with the state, but it can be filed. - Most LLCs have a written operating 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's operating agreement is analogous to a partnership agreement if the LLC is to be member managed. - An LLC's operating agreement is analogous to a combination of a corporate charter and bylaws if the LLC is to be manager managed. - An LLC's operating agreement typically addresses management structure, allocation of profits and losses among them members, member taxation, transfer of membership interests, and dissolution. - An operating agreement can be oral or implied, but it is inadvisable to go with an oral operating agreement. - A written operating agreement lessens the likelihood of future disputes. - LLC owners are referred to as members. - Member management is similar to partnership or decentralized management -- the statute vests the members with the authority to manage the LLC. - Manager management is similar to corporate or centralized management -- the statute vests management authority in a board of managers elected by the LLC members. - A manager does NOT need to be a member. - Typically, manager or managers are chosen by member voting based on percentage ownership in the LLC. - LLCs that opt for manager management often choose to duplicate the corporate governance structure of having ultimate authority vested in a board of managers elected annually by the LLC's members. E. Fiduciary Duties: 1. the duty of loyalty (essentially do NOT compete with the LLC) includes the duty 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 LLC and the duty to refrain from competing with the company in the conduct of the company's activities before the dissolution of the LLC; and 2. the duty of care (1. Act in the best interest of the company; and 2. Act how a reasonable person in the same circumstances would act;), subject to the business judgment rule. - In DE, they are common law duties. - Duty of disclosure falls under the fiduciary duty of loyalty. - When a party with a fiduciary duty is on both sides of a transaction, how do they demonstrate entire fairness of the transaction? 1. fair dealing; and - fair dealing involves analyzing how the transaction was structured, the timing, disclosures, and approvals. 2. fair price. - fair price relates to the economic and financial considerations of the transaction (essentially was the price fair?). - a party does NOT meet the entire fairness standard simply by showing that the price fell within a reasonable range that would be considered fair. - The transaction is examined as a whole and BOTH elements of the test MUST be satisfied. - DE common law fiduciary duties: 1. RULE: it is [unsettled] whether default fiduciary duties exist for [members] of a [manager-managed] LLC. To resolve this uncertainty, it is advisable for the LLC agreement of a DE LLC to address this issue (unclear because the members are just investors and do NOT manage the LLC). 2. RULE: in DE, [members] of a [member-managed] DE LLC owe fiduciary duties to other members of the LLC and to the LLC itself. 3. RULE: in DE, [managers] of a [member-managed] DE LLC owe fiduciary duties to the other members of the LLC and to the LLC itself. 4. UNLESS the fiduciary duties of the duty of loyalty and the duty of care are eliminated in the operating agreement. F. Obligation of Good Faith and Fair Dealing: - An implied covenant looks to the past. It is NOT a free-floating duty unattached to the underlying legal documents. It does NOT ask what duty the law should impose on the parties given their relationship at the time of the wrong, but rather what the parties would have agree to themselves had they considered the issue in their original bargaining positions at the time of contracting. - Fair dealing is a commitment to deal fairly in the sense of consistency with the terms of the parties' agreement and its purpose. Likewise, good faith does NOT envision loyalty to the contractual counterparty, but rather faithfulness to the scope, purpose, and terms of the parties' K. Both necessarily turn on the K itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally. - i.e., for meetings, if a member or manager or partner conducts a meeting, but conceals a material topic that MUST be discussed, then that member/ manager/ partner may have breached the obligation of good faith and fair dealing. - Quorum: a quorum is the minimum number of people you need for a decision to be binding. G. Liability Shield: RULE: an LLC affords its members a full liability shield. - Whether a member and/ or manager of an LLC can be liable for torts based on managerial conduct if the conduct was within the scope of the manager's duty? Yes. - Does NOT apply for the LLC's debts. The manager or member is still protected. - Consider this when forming an LLC. - A cooperative/ co-op is essentially a corporation. 1. the LLC statute expressly provides for the member or manager's liability; 2. the articles of organization/ operating agreement provide for the member or manager's liability; 3. the member or manager has agreed in writing to be personally liable; 4. \*the member or manager participates in tortious conduct; or a. members and/ or managers in an LLC will be personally liable if they participate in tortious conduct. i. NO tort liability on a manager for merely performing a general administrative duty. There MUST be some participation. ii. An entity can participate in torts through the conduct of those individuals acting on behalf of the entity. 5. a shareholder of a corporation would be personally liable in the same situation, EXCEPT that the failure to hold meetings and related formalities shall NOT be considered. H. Transfer of LLC Interests: 1. an assignment of an LLC interest does NOT entitle the assignee to become or to exercise ANY rights or powers of a member; and 2. an assignment of an LLC interest entitles the assignee to the transferring LLC member's economic interest -- to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled, to the extent assigned. - \*Note: this outcome would have been different if the assignee was NOT an already existing member because the LLC's operating agreement required the written consent of the other LLC's members for the admission of a new member. - The law wants to protect existing members from having to be a member with an assignee who was NOT already an existing member. - so, the transferee just receives an economic interest? - Based on how much each member contributed to an LLC. - Typically, an LLC agreement will tie ownership percentage interests in an LLC to contributions. So, if an LLC member contributes cash to an LLC equal to 60% of total contributions received by the LLC, the member will get a 60% ownership interest. J. Withdrawal: - It is common for a DE LLC operating agreement to modify this default rule. - The obligation of good faith and fair dealing requires a member/ party to act in good faith with respect ONLY to the original K. If the K does NOT contain a non-compete provision, then there is NO obligation to not compete with the company. - The fact that the LLC members did NOT include a non-compete agreement showed that the LLC members intended NOT to include a non-compete provision. - Once a member leaves the LLC, the withdrawing member does NOT owe fiduciary duties to the LLC UNLESS there is a non-compete provision in the LLC operating agreement. - \*Note: this would have been different if the LLC operating agreement contained a non-compete. Also, this would have been different if the leaving member would have opened the competing business the next day after leaving, then this would have suggested that the withdrawing member planned to open a competing business while still a member of the LLC, which would have been a breach of the member's fiduciary duties owed to the LLC and the other member. K. Dissolution: - The purpose of this is for providing relief when an LLC cannot continue to function in accordance with its LLC operating agreement. - When 2 equal members of an LLC are at a stalemate, but the dissenting member has an exit mechanism in the LLC operating agreement, does the dissenting member have to use the exit mechanism, or can the dissenting member file for judicial dissolution? 1. the LLC MUST have 2 members with 50% ownership interests; 2. those members MUST be engaged in a joint venture; and a. a joint venture is established when 2 parties agree for their mutual benefit (i.e., profit) to combine their skills, property, and knowledge, and are actively managing the business. i. a joint venture may NOT be established if one member agrees to be a passive investor in the LLC who would be subject to the other member's unilateral dominion. 3. those members MUST be unable to agree upon whether to discontinue the business or how to dispose of its assets. - Although an LLC may be technically functioning, the operation could be residual, with inertial status quo that just happens to exclusively benefit 1 of the 50% members. - i.e., if it punishes the dissenting member because that member has an obligation as a personal guarantor since they signed for a loan for the LLC. - 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 certain notice and bookkeeping requirements are satisfied, the assets "associated with" a particular series are insulated from claims against a different series. - Each series provides an internal or horizontal liability shield against obligations of the other series. - The LLC itself is shielded. - P's will ONLY be able to recover against the assets of the series they are suing, and, if those are exhausted, then the P [cannot] sue other series. - Owners of an SLLC are protected by the traditional, or vertical, limited liability shield from personal liability. - Taxis are the classic example of an SLLC. VI\. Corporations: 1\. The Incorporation Process: A. Pre-Incorporation Activities: - A business starts with an idea. - A corporation comes into play ONLY AFTER the founders have developed the idea into a business plan and decided that the best legal form for their startup business is a corporation. - However, when founders come to you as a corporate L 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 Ks. - 2 legal issues related to promoter Ks: 1\. Promoter Liability on Ks: - If things go as planned, the business will get up and running and will honor the pre-incorporation Ks signed by the promoter. - However, if the business NEVER gets off the ground or is NOT interested in honoring the K, then: - However, the analysis varies depending on how the promoter signed the K. - Courts will look to the facts and circumstances surrounding the making of the K at issue to determine whether there was such an agreement between the promoter and the other party. - Signing a K as "a corporation to be formed" is evidence that the promoter and the other party agreed that the other party would look solely to the corporation on the K. - Adoption: 1. a corporation receives the benefits of the K or accepts goods or services under the K with knowledge of the K; or 2. "adoption through acquiescence" -- if the corporation makes payments under the K or attempts to modify or enforce the K. - Ratification: - Distinction between adoption and ratification: - Novation: - A well-informed promoter will include novation language -- a provision stating that the corporation is automatically substituted for the promoter upon incorporation -- in the pre-incorporation K. - Once a business settles on the corporate form, it then needs to decide in which jurisdiction to incorporate. - A business is generally free to choose any of the 50 state or even a non-US jurisdiction. - A business planning to operate in a single state will incorporate in that state UNLESS the business will need VC funding or plans to go public. - A business that plans to operate in multiple states will need either VC funding or is planning on going public will typically choose between the state in which the business will be headquartered or DE. - The business MUST have a registered office and registered agent in DE. - For business seeking VC funding or are planning on going public, may be better to incorporate in DE because VCs and investment banking firms are bias towards investing in DE corporations because of DE's corporate law. - The business MUST "qualify to do business" in its home state, which requires paying filing and other fees that are typically higher than the fees for incorporating in the state it is operating in. - Incorporating in a different state, like DE, exposes the business to being sued in that different state, which is likely more expensive and less convenient than litigating in the business' home state. - "reincorporate" means to change the state of incorporation. A corporation can reincorporate through a merger. 1\. Name Selection: 1. corporation designation; 2. spaces between words; 3. specific punctuation; 4. the case of the letters contained in the name; 5. the use of ampersand (&) vs.