BE-Class- Intro to Corp1 BE – A General-Basic Video Lecture Intro to Corporation Law(s)- Business...

BE-Class- Intro to Corp 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

Intro. Cont’d

• 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


Intro cont’d

• 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



Continuity and Choice of Business Forms

entity v. non-entitylegal rights & duties

flows of liabilitystatutory compliance

taxation (federal & state)advantages and disadvantages of choice

A. STATE LAW

Unincorporated Incorporated 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)


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)

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.


Terminology cont’d• 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.


Terminology cont’d

• 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/stockholders), 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.).


Terminology cont’d

• 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.


Terminology cont’d• 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.


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


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)


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-Berle; but today, can have large, influential institutional shldrs


Development-Trends cont’d

• 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


Development-Trends Cont’d

• 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



What is a Corporation . . . .?

Starting Point: State Statutes

MBCA §§ 1.40 (4),2.02 & 2.03

DGCL §§ 102 & 106


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


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


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)


Business Corporate Stat. Models

MBCA

RMBCA

Dela. Gen. Corp. L.

Hybrids (e.g., Texas)

Special Close Corp. – Statutes (e.g, Texas and Delaware)


Special Close Corp. Statutes

Governance/Management

OPTIONS} Traditional

Partnership-like

Hybrid


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


New Texas Business Organization Code (TBOC)

http://tlo2.tlc.state.tx.us/statutes/bo.toc.htm • Spoke and Wheel Codified Consolidation Table of ContentsTITLE 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

http://tlo2.tlc.state.tx.us/statutes/bo.toc.htm


TBOC- T of C cont’d

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


TBOC- T of C cont’dTITLE 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 • CHAPTER 401. GENERAL PROVISIONS• CHAPTER 402. MISCELLANEOUS AND TRANSITION PROVISIONS


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”


Corporate Management – Decision-Making Levels

Shldr - Fundamental Matters

Director - Policy(Fiduciaries)

Officers - Day-to-Day(Agents & Fiduciaries)


Corp. – Management Structure

Traditional

Shareholders – Directors – Officers

Non-Traditional

CHC can approximate “partnership” no directors – “statutory close corp.”

PHC – power in management


Statutory Governance Model

Shareholder----> Directors ----> Officers

Legal Flow of Authority/Power ---->

? Reality = -----> Or <-----

? CHCs ? PHCs


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 P+C under Fed Sec. Law

• Derivative Litigation• Case-law – particularly fiduciary duties and judicial gloss

on freeze-out


General Shareholder Voting

• Requirement of State Law– Annual Meeting – Election of Directors– Meetings – Fundamental Changes

• Management Initiate > Shareholder Contact

• Practical Realities = Use of Proxies


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


Foreign Corporations

• Internal Affairs Rules

• Pseudo Foreign Corporation Laws

• Qualification Statutes


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

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)



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

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 codeBut taxed similar to (but not exactly) as a partnership – modified

conduct treatmentFormal 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 aliensOne 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



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


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.


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.



Duration Sole Proprietor determines.

Dissolved by Partners 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.

Characteristics of Alternative Forms of Business Organizations- Hamilton


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


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

Yes=Applies to firms governed by most or all status.

No=Does not apply to firms governed by some statues.

?=Application of feature is unsettled or varies from state to state.


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.

BE-Class- Intro to Corp1 BE – A General-Basic Video Lecture Intro to Corporation Law(s)- Business...

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