BE

1
BE A General-Basic Video Lecture Intro to
Corporation Law(s)- Business Forms- Selection
Factors

• Intended as video lecture for last Class of
  BE-Part II or as a general lecture for
  Perspectives of Am. Bus. L.
• Video link is__________________
• Intro- Review of Continuity and Choice of
  Business Forms Chart
• Intro- Review of Ethical Considerations in
  Co-ownership, entity situations.
• Review of some basic terminology

2
Intro. Contd

• Intro- Historical Development(CB Ch 1 and Arner
  article on Twen), including recent/modern trends
  of corporation law
• State Corporate Statutes - Basics
• Internal Affairs Rule- Conflicts of Law-Case law
• Basic Corporate Governing Structure
• Rights Protection of Owners
• Statutory Gaps
• Foreign Corporations

3
Intro contd

• The Processes- Pre-Formation, Formation,
  Post-Formation
• Interplay of Statutes-Contracts-Case law
• Importance of Structure/Planning Allocation and
  Maintenance of Ownership and Managerial Control
  Dispute Resolution Exit Mechanisms
• Corporate Taxation Sec. Reg. Basics
• Business Form Selection Factors

4
Continuity and Choice of Business
Formsentity v. non-entitylegal rights
dutiesflows of liabilitystatutory
compliancetaxation (federal state)advantages
and disadvantages of choice

• STATE LAW
• Unincorporated Incorpor
  ated
• No State Action State
  Action State Action
• LTKs_____SP ____ GP __ LP
  LLC _
  Corp____________
• Franchise
• Supply
• JV LLP -------LLLP
• Bus Non-Profit Special
• Gen CHC
  Prof. Banks Ins. Corp.
• Agency
  Law
• State filing state action
• __________________________________________________
  _________________
  _____
• Special TVA (e.g.)
• B. FEDERAL LAW SEC. Reg. (BE) - PHCE (34 Sec.
  Act) Tax - GP (Reporting, not taxable
  entity) Corp. C Corp. (general) Subch S (GP
  like)

5
Basic Ethical Issues

• Entity Representation/Client Identification (Sec
  1.13of ABA Code)
• Conflicts of Interest(ABA, Sec 1.7-1.8)
• Scope of Representation/Engagement Letter (ABA
  1.2)
• Competency (ABA 1.1)
• Confidentiality(ABA 1.6)
• Fee Arrangements(ABA 1.5)

6
BE- Clarification of certain terminology

• In the past, for course and exam purposes, some
  confusion appears to arise for certain students
  as certain terminology being used . Hopefully,
  the following will help you avoid such confusion
• Business enterprise generic term covering any
  form of sole ownership, co-ownership or
  long-term, cooperative business arrangement
  contemplating an ongoing business objective(s).
  Effectively would descriptively cover all the
  business forms covered in this course. Though
  business enterprise may have a specific meaning
  for economists, it has no specific legal content
  and is merely an umbrella, descriptive term.

7
Terminology contd

• Corporation- in this course, unless otherwise
  expressly indicated, a business entity formed
  under and subject to (for corporate law purposes)
  a state general corporation statute. Most states
  have separate special corporate-type statutes for
  Non-profit Corporations, Professional
  Corporations, Banking Corporations, and Insurance
  Companies. In addition as mentioned below, most
  states now has special statutory provisions under
  their corporation laws for electing to be a
  Statutory Close Corporation.
• CHE (closely-held enterprise)- descriptively
  covers all forms of business enterprise formed
  under relevant state law that are co-owned by a
  few owners , most (if not all) of whom are
  involved in the active management of the
  enterprise.

8
Terminology contd

• CHC (closely-held corporation)- descriptively
  covers all corporations formed under a general
  state business corporation statute that are
  co-owned by a few owners (shareholders/stockholder
  s), most (if not all) of whom are involved in the
  active management of the corporation.
• Close Corporation (statutory) - A corporation
  formed under a special state Close Corporation
  statute (e.g. Texas, Delaware etc.).

9
Terminology contd

• PHE (publicly-held enterprise) Federal
  securities law status- any business enterprise
  formed under relevant state (e.g., corp., LP,
  business trust, LLC etc) whose ownership
  interests would come under the federal securities
  law definition of a security and which has a
  equity class of such securities registered under
  the ongoing registration/disclosure/and liability
  requirements of the 1934 Securities Exchange Act
  and subject to Securities Exchange Commission
  (SEC) scrutiny and enforcement. Normally, an
  enterprise with 500 or more owners and 10
  million of more in assets. Still subject to the
  relevant state law(s) under which it was formed.

10
Terminology contd

• PHC (publicly-held corporation)- Federal
  securities law status-.a PHE that is formed as a
  corporation the most common form of PHE. Still
  formed under and subject to relevant state
  corporation law.
• C Corp- Tax Status- the Subchapter of the
  Internal Revenue Code under which most corporate
  entities or other business entities electing to
  be taxed as corporation would be subject. Tax as
  a separate entity/taxpayer. Double taxation
  situation. Still formed under and subject to
  relevant state corporation law.
• S or Subchapter S Corp- Tax status- The
  Subchapter of the IRC under which a corporate
  taxpayer could elect special tax status so as to
  receive partnership-like income tax treatment.
  Still formed under and subject to relevant state
  corporation law.

11
Theories of Corporation

• - Entity- Legal Person- Creature of State
• - Collection of Constituent Relationships
• - Contractarians- Nexus of Ks Party
  Autonomy
• - Default Rules v. Mandatory Rules
• - Team Production Model
• - ? Role of Government Regulation outside
  of state corporate laws

12
Consequences of Incorporation

• Separate Legal Personality
• Possibility of Centralized Management
• Divisibility and Transferability of Ownership
  Interests- Ability to raise capital
• Limited Liability for Owners (LtdL came later in
  18th century was not an original characteristic)

13
Development of State Corporation Laws
(including recent trends)

• The historical beginnings in US -Distrust of
  Corporation and Corporate Power-Specific Charter
  Grants-Limited statutory powers-No holding
  companies) (parent-subs)
• Rise of Enabling Statutes in mid 1800s
• Late 19th century- start of code liberalization-
  The impact of Delaware Corp. Laws- ? Race to the
  Bottom- Liggett v. Lee
• Separation of Ownership and Control-Implications-B
  erle but today, can have large, influential
  institutional shldrs

14
Development-Trends contd

• The impact of Model Bus. Corp. Act (M.B.C.A
  RMBCA) impact of Dela statute as a national
  corporation law
• Spread of other Ltd Liability Forms/Statutes
  (e.g. LLC) and flexibility within Corporate Codes
  ( e.g. RMBCA approach and Texas separate
  Statutory Close Corporation provision of
  Code)-Public Policy favoring small business
  person(s)-flexibility and party autonomy.
• Reduction/elimination of role of statutory capital

15
Development-Trends Contd

• Judicial trend to apply partnership analogies to
  CHC
• ? Federal Corp. Law- Fed Sec. Laws
• Modern Day approaches on Corporate Governance
  for larger corp.- Pre and Post- SOX
• PHC v CHC
• With modern LLC form, is there still a role for
  the business corporation

16
What is a Corporation . . . .?

• Starting Point State Statutes
• MBCA 1.40 (4),2.02 2.03
• DGCL 102 106

17
Incorporation An Event and a Process

• Grant of the State Creature of the State-
  Enabling Statute
• Legal Entity(separate legal personality) Ltd.
  Liability for owners Separate Ownership
  Instruments (transferability-ownership
  dispersion)
• Ownership instruments certain debt instruments
  securities/securities laws
• Statutory management/governance structure
  centralized management v. owner management
• Modern exception statutory close corporations
  and RMBCA possible broad use of Shldr Agreement
  ( Sec 7.32) to structure internal management and
  governance including doing away with Bd. Of Ds .
  Some States (e.g. Texas and Dela.) also have
  special Statutory Close Corporation provisions
• Incorporation- starting point for allocating and
  maintaining control (ownership and management),
  effective dispute resolution, exit

18
Corporate Statutory Status

• Corporation General
• Special e.g., banks, NPCs, PCs
• Hybrid Stat. close corp.
• Subch S Tax
• PHC Sec. Law (not strictly speaking a corporate
  statute- investment securities statutes

19
Basic Sources of Corporation Laws

• State Enabling Statutes
• Contract(s)
• Case Law Judicial Gloss- Gap-filling,
  Interpretation, Equity
• ? Fed. and State Sec. Laws
• Fed State Tax Laws
• ? Accounting Principles/Standards (including RAP
  for PHCs)

20
Business Corporate Stat. Models

• MBCA
• RMBCA
• Dela. Gen. Corp. L.
• Hybrids (e.g., Texas)
• Special Close Corp. Statutes (e.g, Texas and
  Delaware)

21
Special Close Corp. Statutes

• Governance/Management
• OPTIONS Traditional
• Partnership-like
• Hybrid

22
Special Close Corp. Statutes

1. Share Restrictions
2. Compulsory Purchaser
3. Shareholder Agreements
4. Board Elimination
5. Elim. Bylaws
6. Special Dissolution and Dispute Resolution

23
New Texas Business Organization Code (TBOC)
http//tlo2.tlc.state.tx.us/statutes/bo.toc.htm

• Spoke and Wheel Codified Consolidation
• Table of Contents
• TITLE 1. GENERAL PROVISIONS
• CHAPTER 1. DEFINITIONS AND OTHER GENERAL
  PROVISIONS CHAPTER 2. PURPOSES AND POWER OF
  DOMESTIC ENTITY
• CHAPTER 3. FORMATION AND GOVERNANCE
• CHAPTER 4. FILINGS
• CHAPTER 5. NAMES OF ENTITIES REGISTERED AGENTS
  AND REGISTERED OFFICES
• CHAPTER 6. MEETINGS AND VOTING FOR DOMESTIC
  ENTITIES
• CHAPTER 7. LIABILITY
• CHAPTER 8. INDEMNIFICATION AND INSURANCE
• CHAPTER 9. FOREIGN ENTITIES
• CHAPTER 10. MERGERS, INTEREST EXCHANGES,
  CONVERSIONS, AND SALES OF ASSETS
• CHAPTER 11. WINDING UP AND TERMINATION OF
  DOMESTIC ENTITY CHAPTER 12. ADMINISTRATIVE POWERS

24
TBOC- T of C contd

• TITLE 2. CORPORATIONS
• CHAPTER 20. GENERAL PROVISIONS CHAPTER 21.
  FOR-PROFIT CORPORATIONS
• CHAPTER 22. NONPROFIT CORPORATIONS CHAPTER 23.
  SPECIAL-PURPOSE CORPORATIONS
• TITLE 3. LIMITED LIABILITY COMPANIES
• CHAPTER 101. LIMITED LIABILITY COMPANIES

25
TBOC- T of C contd

• TITLE 4. PARTNERSHIPS
• CHAPTER 151. GENERAL PROVISIONS
• CHAPTER 152. GENERAL PARTNERSHIPS
• CHAPTER 153. LIMITED PARTNERSHIPS CHAPTER
• 154. PROVISIONS APPLICABLE TO BOTH GENERAL AND
  LIMITED PARTNERSHIPS
• TITLE 5. REAL ESTATE INVESTMENT TRUSTS
• CHAPTER 200. REAL ESTATE INVESTMENT TRUSTS
• TITLE 6. ASSOCIATIONS
• CHAPTER 251. COOPERATIVE ASSOCIATIONS
• CHAPTER 252. UNINCORPORATED NONPROFIT
  ASSOCIATIONS
• TITLE 7. PROFESSIONAL ENTITIES
• CHAPTER 301. PROVISIONS RELATING TO PROFESSIONAL
  ENTITIES
• CHAPTER 302. PROVISIONS RELATING TO PROFESSIONAL
  ASSOCIATIONS
• CHAPTER 303. PROVISIONS RELATING TO PROFESSIONAL
  CORPORATIONS CHAPTER 304. PROVISIONS RELATING TO
  PROFESSIONAL LIMITED LIABILITY COMPANIES
• TITLE 8. MISCELLANEOUS AND TRANSITION PROVISIONS

26
Corporate Governance Structure

• Statutory Model v. Real Model
• Position of Shareholders
• Ownership interest (including liquidation and any
  dividend rights)
• Voting rights
• Liquidation rights
• Inspection rights
• ? Dividend rights
• Litigation rights
• Derivative Litigation rights
• Appraisal rights-fundamental changes
• Position of Directors
• Position of Officers
• Indemnification of Management
• Special Close Corp. Provisions
  Partnership-like

27
Corporate Management Decision-Making Levels

• Shldr - Fundamental Matters
• Director - Policy
• (Fiduciaries)
• Officers - Day-to-Day
• (Agents Fiduciaries)

28
Corp. Management Structure

• Traditional
• Shareholders Directors Officers
• Non-Traditional
• CHC can approximate partnership no directors
  statutory close corp.
• PHC power in management

29
Statutory Governance Model

• Shareholder----gt Directors ----gt Officers
• Legal Flow of Authority/Power ----gt
• ? Reality -----gt Or lt-----
• ? CHCs ? PHCs

30
Rights/Protection of Shareholders-Owners

• Equity Owners
• Voting directors and major changes
• Preemptive rights maintaining proportionate
  ownership interests
• Cumulative voting - minority representation
• Liquidation rights
• Dividends (not mandatory)
• Information limited under state law
• broad if a PC under Fed Sec. Law
• Derivative Litigation
• Case-law particularly fiduciary duties and
  judicial gloss on freeze-out

31
General Shareholder Voting

• Requirement of State Law
• Annual Meeting Election of Directors
• Meetings Fundamental Changes
• Management Initiate gt Shareholder Contact
• Practical Realities Use of Proxies

32
Statutory Gaps

• In General
• Conflicts of laws / fiduciary duties?
• Disclosure
• Special treatment of larger corporations
• Special treatment for CHCs
• Significance of legal status
• Selected problem areas
• Promoter problems
• Disregard of corporate entity and limited
  liability shield
• Relationship of controlling to minority
  shareholders

33
Foreign Corporations

• Internal Affairs Rules
• Pseudo Foreign Corporation Laws
• Qualification Statutes

34
Importance of Structuring/Planning (see Building
Block No. 6- Twen)

• Basic allocation and maintenance of control
  issues (e.g., ownership interests other
  financial interests managerial control exits,
  dispute resolutions)
• Use of Articles, Bylaws, Share Instruments,
  Shareholder Ks etc
• Tax Issues

35
Redux- Legislative and Judicial Trends

• Legislative- greater flexibility options greater
  party autonomy greater protection of limited
  liability shield.
• Statutory objectification of fiduciary
  standards
• Judicial- looking at CHC more as a partnership
  greater protection in shareholder oppression
  situations judicially crafted remedies exercise
  of its equity powers. Can vary among
  jurisdictions (e.g., compare Mass. V. Delaware)

36
Corporation - Taxation

• Separate taxpayer separate tax schedule/rates
• Subch C IRC - standard
• No Pass thru (except with subch S) but often
  can Zero-out
• Double Taxation (indiv. Shareholders)
• 351 tax free incorporation
• Cannot use check-the-box rules

37
Tax Status-C Corp. v. S Corp

• C corp.- usual taxable entity- double
  taxation
• S Corp.- special tax status-partnership-like
• A Corporation under state law code
• But taxed similar to (but not exactly) as a
  partnership modified conduct treatment
• Formal election can be lost (serious adverse
  practical consequences-re-characterization for
  tax purposes as a C corp.)
• Max. of 100 individual shareholders (limited
  exception for estates of decedents and certain
  trusts). Most, though, are sole owner entities.
• No non-resident aliens
• One class stock (except can have common with
  different voting rights- no pfd stock).
• Can now have subsidiaries No maximum asset
  size.
• All shareholders must consent in writing to
  election

38
The Selection Process General Considerations

• The Players (owner, other financing sources
  including future investors and external sources,
  key employees)
• Purposes and Objectives Business Non-Business
• Financing Requirements
• The Risks Business Legal
• Basic Liability Issues
• Basic Tax Securities Concerns
• Employee benefits
• Advisers Lawyers, Accountants, Fin. Planners
• Basic Ethical Concerns
• Time Frame
• Costs

39
Some Key Selection Factors- See Egan Article
(Twen)

• Legal Restrictions Burdens
• Limited Liability
• Tax Status- federal and state (e.g. Texas
  Margin/Franchise tax)
• Securities Status
• Informality v. Formality
• Simplicity v. Complexity
• Costs
• Flexibility Double Edged
• Continuity of Life
• Centralization or Diffusion of Management
• Exit Options other than ownership interest
• Transferability of Ownership Interest
• Concentration Non-Transf.

40

Characteristics of Alternative Forms of Business
Organizations- Hamilton
Sole Proprietorship General Partnership Limited Partnership Limited Liability Company S-Corporation Corporation
Formation No filing required. No filing required agreement of parties involved. No permission required. Usually filing required to protect limited partners. Filing with state official required. Filing with state official required. Filing with state official required.
Duration Sole Proprietor determines. Dissolved by Partner?s death or bankruptcy. Same as general partnership. Sometimes limited by state law. Perpetual. Perpetual.
Liability Sole Proprietor has unlimited liability. Partners have unlimited liability. General partners have unlimited liability Limited partners limited to amount of investment. Members not typically liable for debts of the LLC. Shareholders are typically not personally liable for the debts of the corporation. Shareholders are typically not personally liable for the debts of the corporation.
Simplicity of Operation Yes. Yes. Yes, but some formality related to limited partners. More formal than sole proprietorship, less formal than corporation. Formality of board of directors, officers, annual meetings, and annual reports. Formality of board of directors, officers, annual meetings, and annual reports.
Management Sole Proprietor has full control of management and operations. Typically each partner has an equal voice unless otherwise arranged. General partners have control. Members have Operating Agreement that outlines management. The corporation is managed by or under the direction of the board of directors who are elected by the shareholders. The corporation is managed by or under the direction of the board of directors who are elected by the shareholders.
Taxation Not a taxable entity. Sole proprietor pays all taxes. Not a taxable entity. Income or loss is passed through to partners. Not a taxable entity. Income or loss is passed through to partners. Members may choose whether to have LLC be a taxable entity or to have income or loss passed through to members. Not a taxable entity. Income or loss is passed through to the shareholders. Corporation is a taxable entity.
Double Taxation No. No. No. No. No. Yes.
Cost of Formation None. None. May be filing fee. State filing fee. State filing fee. State filing fee.
Raising Equity Capital Not unless individual puts in money. Contributions from partners or an addition of more partners. Same as a General Partnership. Possible to sell interest. Subject to operating agreement. Sell shares of stock to raise capital. Sell shares of stock to raise capital.
Transferability of Interest No. No. Some for limited partners. Possibly. Yes, subject to consent. Shares of stock are easily transferable.
41
Bromberg Comparison of Business Forms
Characteristics LLP LLC Corp. LP
Must be subject to federal corporate tax No No Yes No
May be used by professional Yes Yes Yes1 No
May be used by nonprofit firms No Some Yes2 No
May be used by one-member firms No Yes3 Yes No
Owners have limited liability for all debts of firm Some Yes Yes No4
Insurance requirement Some No Some5 No
Distribution restrictions Some Yes Yes Yes
Decisions-making formalities No No Yes No
Centralization of decision-making power No Yes Yes Yes
Firm necessarily dissolves on member dissociation Some6 No No No
Default buyout right Yes Some No Some
Federal Securities law apply ? ? Yes Yes
State securities laws apply ? Some Yes Yes
Convert or register from other business form Yes7 Some Some Some8
Formation state law governs Yes Yes Yes Yes
42
Notes to Bromberg Chart

• Refers to characteristic determined wholly or
  mostly by governing business association
  statutes.
• Some of these features, notably including
  partners liability, default buyout rights, and
  conversion, may be changed by Re-RU.L.P.A.
• Remember State Margin/Franchise Tax Applicatility
• YesApplies to firms governed by most or all
  status.
• NoDoes not apply to firms governed by some
  statues.
• ?Application of feature is unsettled or varies
  from state to state.

43
Further Notes to Bromberg Chart

1. Applies under professional corporate statutes.
2. Applies under nonprofit corporate statutes.
3. All but Massachusetts.
4. Does not apply to limited partners or to LLLPs.
5. Applies to professional corporations.
6. Applies under U.P.A.-based but not R.U.P.A-based
   statutes.
7. Registration by existing general or limited
   partnerships.
8. R.U.P.A. permits conversion from general
   partnership.