CHOICE OF ENTITY
· Two documents to be filed by a corporation when it goes public
o Certificate of incorporation (aka “articles” or “charter”)
o By-laws
§ Operating agreement of the corporation
· Corporate law is driven by statutes and case law
o In order to properly structure a document from a model, you must understand the nuances of corporate law to write the provisions to your liking
· Other than the SC, DE is the most important court in terms of corporate law
o DE court system is well-versed in corporate law
§ Cynics…DE is keen on protecting its corporate interest
§ So long as you are chartered in a specific state, that is the law that applies, not where the corporation is headquartered
· “business” … a broad term describing all kinds of profit-making conduct
· businesses are divided in those that are closely held and those that are publicly held
o CH firm…a business with relatively few owners whose ownership interests are not publicly traded on an establish market (e.g., a law partnership or a local air condition corporation)
§ Generally 5 or fewer shareholders
o PH firm…a business that typically has a large number of owners with ownership interests that are routinely bought and sold on a public market (e.g. Wal-Mart)
· Unlike subjects such as property and torts, the subject of business associations is largely governed by statutes
CHOOSING ENTITIES
Issues…Type of entity you want to create will depend on how you want to manage these issues
· Ownership/Profits
o General partnership
§ Each general partner owns an equal share of the ownership and profits
o Limited partnership
§ Each general partner owns an equal share of the ownership and profits
o Corporation
§ Ownership and profits are determined by how many shares you own
o Equal split is a default rule for all types, you can always contract around this to create different percentages
§ Discussion is of default rules within this entire context, you can always contract around them though
· Liability
o GP
§ All general partners are completely liable for the business’s debts
o LP
§ LPs shielded from liability
o Corporation
§ Shareholder…shielded from liability
§ Director/officer…shielded unless engaging personal affairs
o Corporation is the best shield for liability
§ GP is the worst
· Management/Control
o GP
§ Every partner gets to participate in the management of the business
o LP
§ Only general partners manage
o C
§ Separation of management and ownership
§ Owners (shareholders) could potentially have no involvement in management
· Shareholders could become directors or officers
o If you have someone you think may go from in and out of management, the LP is the worst choice
§ Limited partners are shielded from liability, and if they engage in management they lose this protection
· Taxation
o Taxes drive almost everything
§ Business forms, business transactions
§ People will jump through hoops to avoid taxes
o GP
§ Flow through tax treatment
· Tax flows through the entity and only the individual partners get taxed
§ Partnerships prepares an income statement and the amounts that would be divvyed up
· Even if the case is that all money is being funneled back into business, and is not being distributed to the partners
o Partnership is still seen as the best route for avoiding taxes
§ Tradeoff for nice tax treatment is poor liability structure
o LP
§ Flow through tax treatment
· Tax flows through the entity and only the individual partners get taxed
§ Partnerships prepares an income statement and the amounts that would be divvyed up
· Even if the case is that all money is being funneled back into business, and is not being distributed to the partners
o Partnership is still seen as the best route for avoiding taxes
§ Tradeoff for nice tax treatment is poor liability structure
o C
§ Double tax
· Tax on the entity level, and shareholders get taxed when the corporation distributes money
o However, the second tax only comes about when money is distributed
§ Not to way to go if looking to avoid taxes
· Tradeoff for poor tax treatment is nice liability structure
· Transfer/Liquidate
o GP
§ Will last as long as partners want it to
§ Very difficult to transfer/very easy to liquidate
o LP
§ Easy to transfer…no managerial right
§ Relatively easy to liquidate unless you have a situation where you don’t have enough limited partners (all you need is one)
o C
§ Meant to last in perpetuity
§ Shares…easy to transfer
§ Very hard to liquidate
PARTNERSHIPS
ESTABLISHING A PARTNERSHIP
Partnership formation
· Agreement…two people who go into business together with the intention of making a profit
o Does not need to be written, nor do the people involved even need to intend to create a partnership
§ Written agreement is not needed, but highly recommended
· Protect against malpractice
· Avoid disputes and trouble spots
· Statute of frauds issue
o Oral agreement would be trumped by written partnership rules
· Many firms do not write down agreement, often because the issues are so complex
o No public filing
o Default form of business
o Enterprise of choice for most professional organizations
o Family businesses are generally partnerships
§ Often times they do not write down the agreement
SHARING PROFITS AND LOSSES
· Joint venture…partnership based around a single enterprise
· for legal rule purposes, joint ventures and partnerships are not different
o courts use the terms interchangeably
· How many people do you need to create a partnership?
o 2 or more people
o 1…sole proprietorship
· How is a partnership dissolved?
o Good thing about partnership…easy in/easy out
o Partnership dissolves upon the death, withdraw, or bankruptcy of a partner
§ Sometimes its hard to tell if a person has withdrawn
§ Any withdraw changes the partnership
· If 1 partner walks away from a 3-person partnership, the partnership is technically dissolved
· Management of the partner
o Every partner gets to participate in the management of the business
· Profits and losses divided
o Unless there is a rule, profits are divided up equally
o Losses follow profits
· Remember: you can always agree around the rules
· Liability
o Each partner is personally liable
o You can go after all of a partner’s personal assets to satisfy debts
· Taxation
o Tax is on the distribution
· The important question is whether the situation can be considered a sharing of profits or not
o One argument to make within the loan context is that the loaner did not expect to receive any part of the profits
§ Some management oversight of the business may be acceptable for a loaner so as to make sure that the loan will be paid back
· This can be done still without making a partnership
o A business may then be thus characterized as a sole proprietorship, and the other individual may be characterized as a creditor rather than a partner
Kessler
· No question as to whether these two people are in a partnership
· Kessler: 498, 917
o Capital contribution
· Sale: 420, 000
· Three different possibilities for divvying up
o Default rule
§ The financial partner gets paid their capital contribution before they get paid their profits
· UPA 18(a)
§ This means Kessler would get paid the whole 420, 000
· Shortfall: 78,917
o Courts deem this as a lost
§ Antinora would pay 50% of 78, 917 under the default rule, unless there is an agreement about losses or profits (which losses then follow)
· 40% + interest = 65, 000
§ If you are in a partnership and you make a capital contribution, and the partnership doesn’t make enough money to pay you back, then the leftover is deemed a loss and that is split amongst the partners.
§ Even though A worked for 3 years, he gets nothing
· As a general rule, you do not get compensated for being a partner
o One thing lawyers write around is compensation
§ Calculation
· Kessler: 498,917
· Sale: 420, 000
· [78, 917]
· 50%
· A = 40%, K= 60%
o 50%, 50%...without agreement
o California Rule (exception to the default rule)
§ Exception…default rule does not apply when one party contributes the money and the other the labor
· not all courts recognize this exception and apply the default rule
§ Split the profits 60% and 40%
§ The DR does not put any value on A’s services, while K gets paid for making a contribution
§ CA says that services are presumed to be valued at the same amount as the contribution
· Profits are split…capital contributions are not given preference as they are in the default rule
§ Would CA rule apply if A had been paid for his services?
· CA rule only applies if the service partner has no arrangement made with regards to how he will get compensated for his labor
· CA rule assumes that with no agreement the arrangement values the service in the same way as the capital contribution
§ Calculation
· 420,000
o 60%, 40%
§ 50%, 50%...without agreement
o Kessler
§ Court says the agreement controls
§ It is clear from the agreement that the amount to be paid back to K is to be out of the sale
· Not exactly clear in the agreement because the agreement does not explicitly addresses losses
o The lower court acknowledged this
§ Nobody will be responsible for the $78, 917
§ Calculation
· 420,000…Kessler
· 78,917 is not considered
· Fairness considerations
o Fairness problem is at the core of the CA Rule
o What is the default rule?
§ Some people draft statutes to encourage people to write around the default provision/rules
· Drafters want you to create a written agreement
o But, many people do not want to think about losses when going into business
§ Rationale for default rule
· Ensures that service partner is managing the money properly
o The financial partner may not have direct oversight of the management of money
· Remember: losses always follow profits
· Quick recap
o If there is a written agreement with regards to losses, that
agreement applies. If there is no written agreement, the default rule
applies and the split is 50/50. If there is a written agreement with
regards to profits, the default rule applies, but losses follow
profits and the split is whatever was designated with regards to the
profit breakdown.
MANAGEMENT & AUTHORITY
CREATION OF THE AGENCY RELATIONSHIP AND ACTUAL AUTHORITY
· Partners have agency and their business decisions bind all partners
· Decisions of an agent bind a principal so long as the agent acts within the scope of her authority
· Two critical types of authority
o Actual authority
§ Type of authority that runs from the principal to the agent
§ The principal, through her words or conduct, leads the agent to reasonably believe she has been authorized
§ P…A
§ Actual authority could be express or implied
§ Actual authority will bind the partnership, so long as the decision made is within the scope of the authority given
o Apparent authority
§ Principal creates the impression of authority in a third party
§ What would be reasonable for a third-party to believe based on the words and actions of the principal?
§ P…TP
§ You can have both actual and apparent authority at the same time
§ Even if the agent isn’t acting with actual authority, he may be acting with apparent authority
· And all you need is one to have the decision to be binding
o Actual authority is no stronger than apparent authority
· Two threshold questions
o What kind of authority is given?
o Does the decision fall within the scope of the authority given them?
o Remember: authority and scope of authority problems are sometimes one and the same
§ You should still address both questions, even if you are just saying that you addressing them together
· Each individual partner is an agent acting on behalf of a principal, in this case the principal is the partnership
Stroud
· Clue…
o Whenever you have a renegade partner doing something, you are dealing with an authority issue.
· Review…
o Default rule…
§ No sweat equity
§ Stroud gets his money back, and the amount they are short is split
o CA
§ So long as Freeman does not get paid, we split the 30k equally
§ If he gets paid, we go back to the default rule
· What kind of authority does Freeman have?
o Actual authority
§ Source of authority
· Written agreement; or,
· Through the nature of the business
o F has actual authority by implication
o Partners have equal shares and thus equal ability to manage the business and bind the business
o When talking about actual authority, it doesn’t matter what Nabisco thinks in terms of agency
· Why doesn’t it matter that S told Nabisco that they don’t want their bread?
o The idea in the partnership is you have one vote, regardless of the split of the profits
o If there were more partners…
§ Three partners
· 2…no bread
· 1…ordered bread
§ Questions
· What type of authority?
o Here, actual authority
§ Focus on what the agent reasonably believes
o Notice to a third party only matters when discussing apparent authority
§ If, two people came to the third party and told them the deal is off, that could destroy apparent authority
· But, it may not destroy actual authority
· Can S restrict F’s authority?
o The only way to change the authority of the partners is by agreement of the majority