Business Law Exam 3 Study Guide
Ch. 18 (Corporations), Ch. 16 & 17 (Non-Corporate Business Organizations), Ch. 28 (Investor Protection)
Ch. 18 Key Terms:
Dividends= a distribution of corporate profits to the corporation’s shareholders in proportion to the number of shares held
Proxy= authorization to represent a corporate shareholder to serve as his/her agent and vote his/her shares in a certain manner
Voting trust= an agreement (trust contract) under which a shareholder assigns the right to vote his/her shares to a trustee, usually for a specified period of time
Retained earnings= the portion of a corporation’s profits that has not been paid out as dividends to shareholders
Stock certificates= certif. issued by a corp. evidencing the ownership of a specified number of shares in the corporation
Stock warrants= rights given by a company to buy stock at a stated price by a specific date
Preemptive rights= the right of a shareholder in a corp. to have the first opportunity to purchase a new issue of that corps. stock in proportion to the amount of stock already owned by the shareholder
Inside director= a person on a corporation’s board of directors who is also an officer of the corporation
Outside director= a person on a corporation’s board of directors who does not hold a management position at the corporation We also discuss several other topics like How is fallacy different from a mistake?
Quorum= the minimum number of members of a body of officials that must be present for business to be validly transacted
Watered stock= shares issued by corporation for less than their fair market value
Holding company= a company whose business activity is holding shares in another company
Domestic corporation= in a given state, a corporation that is organized under the law of that state
Foreign corporation= in a given state, a corporation that does business in that state that it is not incorporated in
Alien corporation= a corporation formed in another country but doing business in the United States
Benefit corporation= a type of for-profit corporation, available by statute in a number of states, that seeks to have a material positive impact on society and the environment
Bylaws= the internal rules of management adopted by a corporation at its first organizational meeting
De jure= rightful and lawful, term often used to describe a corporation that has substantially complied with all conditions precedent to incorporation Don't forget about the age old question of What is the international criminal court?
Securities= stocks, bonds, other items that represent an ownership interest in a corporation or a promise of repayment of debt by a corporation
Stocks= equity securities, an ownership interest in a corporation measured in units of shares
Bonds= debt securities, a security that evidences a corporate (or gov.) debt
Crowdfunding= people network/pool funds and other resources via the internet to assist a cause (such as disaster relief) or invest in a business venture (startup)
A corporation is a legal entity created and recognized by state law as a person (an artificial legal person, as opposed to a natural person). As a “person” it enjoys many of the same rights/privileges under state and federal law as U.S. citizens do.
o Constitutional guarantees of due process, free speech, and freedom from unreasonable searches and seizures all apply to corps. We also discuss several other topics like How does language influence our thinking?
We also discuss several other topics like What are the two dominate environmental factors that affect how people live in micronesia?
o The Catholic Church is incorporated, cities can be incorporated
Board of Directors: hold the responsibility for the overall management of the firm, members are elected by the shareholders.
o Make the policy decisions
o Hire/fire corporate officers and other employees to run the daily business operations
o When an individual purchases a share of stock in a corporation, that person becomes a shareholder/owner of the corporation
o Unlike partners in a partnership, the body of shareholders can change constantly without affecting the continued existence of the corp.
o Shareholder can sue the corporation, and corp. can sue a shareholder
o Under certain circumstances a shareholder can sue on behalf of a corp.
Limited Liability of Shareholders
∙ Typically, corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments Don't forget about the age old question of What are the economic systems around the world?
∙ However, a court can pierce the corporate veil and impose liability on shareholders for the corporation’s obligations
∙ Additionally, creditors often will not extend credit to small companies unless the shareholders assume personal liability, as guarantors, for corporate obligations
Corp. Earnings/Taxation: when a corporation earns profits, it can either pass them on to shareholders in the form of dividends or retain them as profits. These retained earnings will yield higher corporate profits in the future, higher profits cause the price of the company’s stock to rise.
o Failure to pay income taxes can lead to suspension of the organization’s corporate status until taxes are paid and can even dissolve the corp. for failing to pay If you want to learn more check out What is an example of iconography?
o Corporate profits can be subject to double taxation: company pays tax on its profits, then if profits are passed on to shareholders as dividends, the shareholders must also pay income tax on them
o Corporations don’t usually receive tax deductions for dividends it distributes
o Double taxation is a major disadvantage of the corporate form
Holding company (parent company) is a company whose business activity consists of holding shares in another company. o Typically established in a low-tax/no-tax offshore jurisdiction such as the Cayman Islands, Dubai, Hong Kong, Luxembourg, Monaco, or Panama.
o This way the U.S. corp. can transfer cash, bonds, stocks, and other investments to the holding company and any profits received on these investments are taxed at the rate of the offshore jurisdiction (once profits are brought “onshore” they are then taxed at federal corporate income tax rate, as well as any payments received by the shareholders
Criminal Acts: a corporation may be held liable for the criminal acts of its agents and employees… this is known as respondeat superior.
-Two-part analysis in determining if they are to be held liable:
1. you must decide if the wrongful act occurred during time of employment
2. Did it benefit the company in some way?
Ex: Flower Delivery Co: driver runs red light while delivering some flowers… Was it during the scope of employment? Yes. Was it deriving benefit for the company? Yes. Therefore, you are responsible.
o Corps. cannot be imprisoned, but can face fines amounting to hundreds of millions of dollars (corp. directors and officers may be imprisoned)
A corporation does not have an automatic right to do business in a state other than its state of incorporation, unless it obtained a certificate of authority.
o Once certificate has been issued the corp. can exercise in that state all of the powers conferred on it by its home state
o If a foreign corp. does business in a state without obtaining a certificate, the state may impose substantial fines/sanctions on that corporation
o A foreign corp. does not need a certificate to sell goods/services via the Internet or by mail
A public corporation is one formed by the government to meet some political/governmental purpose.
Ex: cities/towns that incorporate, U.S. Postal Service, TVA, and AMTRAK
A publicly held corporation (public company) is any corporation whose shares are publicly traded in a securities market…the New York Stock Exchange or NASDAQ. o Privately owned, publicly traded
A private corporation is created either wholly or in part for private benefit (profit).
o Most corporations are private
o Owned by private persons rather than by a government o Privately owned, not publicly traded
A nonprofit corporation is formed for purposes other than making money.
Ex: private hospitals, educational institutions, charities, religious organizations, etc.
o Nonprofit corp. and its members may also be immune from liability for a personal injury caused by its negligence
A close corporation is one whose shares are held by relatively few persons, often members of a family (a.k.a. closely held, family, or privately held corporations)
o Only some states allow for them
o operated more like a partnership than a corporation (all SH must agree in writing), corp. can operate without directors and bylaws
o management resembles that of a sole proprietorship or partnership (control is held by a single shareholder or tightly knit group of SHs)
…allowed to be a close corporation if the following criteria are met:
1. no public offering of stock
2. small number of shareholders (usually between 30-35)
***A potential for corporate assets to be used for personal consumption is especially high in a close corporation. The conmingling of corporate and personal funds and the shareholders’ continuous personal use of corporate property (vehicles) invite trouble for close corps.
A close corp. that meets the requirements specified in Subchapter S of the Internal Revenue Code can choose to operate as an S Corporation (defined by tax treatment)
o taxed like a partnership, able to avoid double taxation o must exist in a state that allows for close corporations
…requirements for S Corporation status:
1. the corporation must be a domestic corporation 2. corporation must not be a member of an affiliated group of corporations
3. shareholders must be individuals, estates, or certain trusts and tax- exempt organizations.
Partnerships and non-qualifying trusts cannot be
shareholders. Corporations can be shareholders under certain circumstances.
4. must have no more than 100 shareholders
5. must have only one class of stock
6. no shareholder of the corporation may be a nonresident alien
A professional corporation is typically identified by the letters P.C. (professional corporation), S.C. (service corporation), or P.A. (professional association).
Ex: physicians, lawyers, dentists, and accountants can incorporate
-for liability purposes, courts treat professional corporations like partnerships and hold each professional liable for malpractice by others in the firm.
A benefit corporation is a for-profit corporation that differs from traditional corporations in the following ways:
1. Purpose: to benefit the public as a whole (unlike that of ordinary business corporations which aim to provide long-term shareholder value).
-directors must consider the impact of their decisions on society
2. Accountability: shareholders determine whether the company has achieved a material positive impact, - if not, they may sue the corporation if it fails to pursue or create public benefit
3. Transparency: must issue an annual benefit report on its overall social and environmental performance that uses a recognized third-party standard to assess performance.
-report must be delivered to all SHs and posted on a public website
Forming your corporation… after deciding the nature of your business:
o pick a state to incorporate in
o secure your corporate name
o prepare your articles of incorporation (these include) o business name
o # of shares authorized to issue
o name & address of registered agent
o name & address of each incorporator
o (possibly) name of board members
o hold first organizational meeting
o adopt corp. bylaws (rules of internal management) o elect board of directors (if not named in articles of incorp.)
The courts will treat a corporation as a legal corporation despite a defect in its formation if the following three requirements are met: 1. a state statute exists under which the corporation can be validly incorporated
2. the parties have made a good faith attempt to comply with the statute
3. the parties have already undertaken to do business as a corporation
Express Powers of a corp. are found in its articles of incorporation, in the law of the state of incorporation, and in the state and federal constitutions. Corporate bylaws and the resolutions of the corporation’s board of directors also establish express powers.
The following order of priority is used if a conflict arises among the various documents involving a corporation:
1. The U.S. Constitution
2. state constitutions
3. state statutes
4. the articles of incorporation
6. resolutions of the board of directors
Implied Powers: a corporation has the implied power to borrow/lend funds within certain limits and to extend credit to parties with whom it has contracts.
o The corp. has the implied power to perform all acts reasonably necessary to accomplish its corp. purpose o The president or chief executive officer of the corp. signs the necessary documents on behalf of the corp. and have the implied power to bind the corp. in matters directly connected with the ordinary business affairs of the enterprise
o A corporate officer does not have authority to bind the corp. to an action that will greatly affect the corp. purpose or undertaking (sale of substantial corp. assets)
In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts.
o Typically involve nonprofit corps. or municipal (public) corporations
o Corporation or its shareholders can seek damages from the officers/directors who were responsible for ultra vires acts
Piercing the Corporate Veil…occasionally owners will use a corporate entity to perpetrate a fraud or accomplish an illegitimate objective. In these situations, courts will ignore the corporate structure by piercing the corporate veil and exposing the shareholders to personal liability.
o Only happens if plaintiff in a lawsuit asks a court to order PCV, but courts are generally reluctant to PCV
o Court will PCV if…
o Corporate entity is used to perpetrate fraud/get around the law
o Corp. entity is abused for personal gain of shareholders o Corp. form treated carelessly
Some factors the court considers when deciding whether to PCV… Did the corporation comply with requisite formalities?
Did the corporation conceal or misrepresent assets or shareholders?
Did the corporation not pay dividends when appropriate?
Did the corporation intermingle shareholders and corp. assets?
Was there a proper separation of the corp. and shareholders or was the corp. operated as alter ego of shareholders?
Whether or not the corporation was undercapitalized (insufficient capital at the time of formation causing inability to meet debts/potential liabilities)
Was a party tricked into dealing with the corporation rather than the individual?
The Alter Ego Theory: applied when a corporation is so dominated and controlled by an individual (or group) that the separate identities of the person (or group) and the corporation are no longer distinct.
Board Members (directors):
- The board of directors is the ultimate authority in every corporation
- Hires/fires officers and high-level employees, determines capital structure of the corporation, and declares
- Few qualifications required for directors (few states impose min. age)
- Directors are elected by shareholders, and may also be a shareholder themselves
- Holds regular meetings with recorded minutes, each board member gets one vote
- Has fiduciary duty of care and loyalty/good faith to corp. & shareholders
- Directors can be removed for cause (not performing req. duties)
- Do not have protection from liability
Boards of large, publicly held corporations typically create committees of directors and delegate certain tasks to these committees.
*Executive committee: handles interim management decisions between board meetings, does not have the power to declare dividends, amend the bylaws, or authorize the issuance of stock.
*Audit committee: responsible for the selection,
compensation, and oversight of the independent public accountants that audit the firm’s financial records. **The Sarbanes-Oxley Act requires all publicly held corps. have an audit committee
- Responsible for day to day operations
- Hired/fired by board members
- Have duty of care & loyalty
- Do not have protection from liability
- Business judgement rule: officers are not liable for honest mistakes or bad business decisions
- At minimum, most corps. have a president, VPs, secretary, & treasurer
- Have right to sell shares
- Have right to vote on directors nominated by other board members
- Have right to propose shareholder resolutions
- Have right to receive dividends
- Have right to purchase a number of shares when issued - Must hold annual meetings where board is elected - Have right to receive notice of annual meeting in writing - No right to make policy decisions
- Right to bring shareholders derivative suit
- Majority shareholders owe a fiduciary duty to minority shareholders
Liabilities… shareholders are not personally liable for the debts of the corporation. If corp. fails, shareholders can lose their investments but that’s it (unless court decides to PCV which would hold shareholders individually liable).
- Can be personally liable if a majority shareholder attempts to exclude minority shareholder from receiving certain benefits.
- Shareholders who receive watered stock may be liable to creditors of corporation for unpaid corporate debts - If majority shareholder breaches fiduciary duty to a minority shareholder, minority can sue for damages
Ch. 17: Limited Liability Business Forms
Member= person who has an ownership interest in a limited liability company
Operating agreement= members of a LLC set forth the details of how the business will be managed and operated
Certificate of limited partnership= the document that must be filed with a designated state official to form a limited partnership
Limited partner= a partner who contributes capital to the partnership but has no right to participate in its management and has no liability for partnership debts beyond the amount of his/her investment
General partner= in a LP, a partner who assumes responsibility for the management of the partnership and has full liability for all partnership debts
-must file a lot of paperwork and pay fees
- a hybrid between partnership and corporation
-the owners are called members
- members of LLC have the same protection from liability that corporate shareholders have- limited liability
-foreign investors are allowed to become LLC members -statutes are not uniform, businesses that operate in more than one state may not receive consistent treatment in these states
Formation: articles of organization must be filed with a central state agency (usually the secretary of state’s office). Articles must include: the name of the business, its principal address, the name and address of a registered agent, the members’ names, and how the LLC will be managed.
Preincorporation contracts: persons who are forming a corporation may enter into contracts during the process of incorporation but before the corporation becomes a legal entity.
- The individual promoters who sign the contracts are bound to their terms
- Once the corp. is formed and adopts the preincorporation contracts by means of novation (which substitutes a new contract for the old) it can then enforce the contract terms
Tax Liability: if your LLC has two or more members you can choose to be taxed as corporations or as a partnership (most often prefer taxation as a partnership to avoid “double taxation”)
- Unless an LLC indicates that it wishes to be taxed as a corp. the IRS automatically taxes it as a partnership… meaning the LLC, as an entity, pays no taxes, profits are passed through the LLC to the members who then personally pay taxes on the profits
- An LLC with only one member cannot be taxed as a partnership
- for federal income tax purposes, one-member LLCs are automatically taxed as sole proprietorships unless they indicate they wish to be taxed as corporations
How to operate an LLC:
Operating agreement: agreement in which the members of a limited liability company set forth the details of how the business will be managed and operated
- not required for an LLC to exist, need not be in writing
*members of LLC have the power to dissociate at any time but may not have the right to dissociate
- voluntary withdrawal, expulsion by other members, court order, incompetence, bankruptcy, and death
- a dissociated member may have their interest bought out by the other members through the provisions establishing a buyout price, or at fair value
- if member’s dissociation violates the LLC’s operating agreement, it is considered legally wrongful, and the dissociated member can be held liable for damaged caused by the dissociation
LLP: hybrid form of business designed mostly for professionals who normally do business as partners in a partnership. -you are not responsible for another partners malpractice -only responsible for your own bad acts, such as negligence
-if you and a partner screw up your other partners are not responsible for it unless your partner is your supervisor
Major advantage: allows a partnership to continue as a pass through entity for tax purposes but limits personal liability for partners, attractive for big service firms and family businesses
All of the “Big Four” accounting firms are organized as LLPs (including Ernst & Young, LLP, and PricewaterhouseCoopers, LLP)
Formation: must be formed/operated in compliance with state statutes which include provisions of the Uniform Partnership Act (UPA). Form must be filed with a central state agency, usually the secretary of state’s office, and the business’s name must include either “Limited Liability Partnership” or “LLP”. Must file an annual report with the state to remain qualified as an LLP in that state.
Family limited liability partnership (FLLP): partners are related to each other.
- A person acting in a fiduciary capacity for persons so related can also be a partner, all of the partners must be natural persons or be acting in a fiduciary capacity for the benefit of natural persons
- Most often seen in agriculture by family-owned farms
LP: consists of at least one general partner and one or more limited partners
-the general partnership is responsible for firm management and has full responsibility for the partnership and for all its debts
- they make managerial decisions
- the limited partners are not involved with management… they contribute cash or other property and own an interest in the firm
Formation: public and formal proceeding, partners must strictly follow statutory requirements.
Must sign a certificate of limited partnership which includes the name, mailing address, and the capital contribution of each general and limited partner.
- Certificate must be filed with the designated state official under the RULPA, the secretary of state…usually open to public inspection
Liabilities- general partners are personally liable to the partnership’s creditors
- If a corporation is the general partner, no one in the limited partnership has personal liability
- The liability of a limited partner is limited to the capital that he/she contributes or agrees to contribute to the partnership
- A limited partner who participates in management will be just as liable as a general partner to any creditor who transacts business with the limited partnership
Rights & Duties: limited partners have essentially the same rights as general partners (except for the right to participate in management), this includes the right of access to the partnership’s books and to information regarding partnership business
- On dissolution of the partnership, limited partners are entitled to a return of their contributions in accordance with the partnership certificate
- They can also assign their interests subject to the certificate
- They can sue an outside party on behalf of the firm if general partners with authority to do so have refused to file suit
- Limited partner can withdraw by giving 6 mo. notice
*bankruptcy of a limited partner does not dissolve the partnership unless it causes the bankruptcy of the firm *death or an assignment of the interest of a limited partner does not dissolve a limited partnership
*LP can be dissolved by court decree
On dissolution, creditors’ claims, including those of partners who are creditors take first priority.
A limited liability limited partnership (LLLP): in this, the general partner has the same liability as a limited partner in a limited partnership.
- Liability of all partners is limited to amount invested in the firm
Ch. 16 Key Terms:
Entrepreneur= one who initiates/assumes the financial risk of a new business enterprise and undertakes to provide or control its management
Articles of partnership= a written agreement that sets forth each partner’s rights and obligations with respect to the partnership
Goodwill= the valuable reputation of a business viewed as an intangible asset
Franchise= any arrangement in which the owner of a trademark, trade name, or copyright licenses another to use that trademark, trade name, or copyright in the selling of goods or services
Franchisee= one receiving a license to use another’s (the franchisor’s) trademark, trade name, or copyright in the sale of goods and services
Franchisor= one licensing another (the franchisee) to use the owner’s trademark, trade name, or copyright in the selling of goods or services
Partnership by estoppel= a partnership imposed by a court when nonpartners have held themselves out to be partners, or have allowed themselves to be held out as partners, and others have detrimentally relied on their misrepresentations
Pass-through entity= a business entity that has no tax liability. The entity’s income is passed through to the owners, and they pay taxes on the income
Winding up= the second of two stages in the termination of a partnership or corporation, in which the firm’s assets are collected, liquidated, and distributed, and liabilities are discharged
Buyout price= the amount payable to a partner on his or her dissociation from a partnership, based on the amount distributable to that partner if the firm were wound up on that date, and offset by any damages for wrongful dissociation
In selecting which organizational form to take, entrepreneurs must consider:
1. ease of creation
2. liability of the owners
3. tax considerations
4. ability to raise capital
Requirements for All Business forms:
1. business name registration
2. occupational licensing
3. state tax registration
4. health and environmental permits
5. zoning and building codes
6. import/export regulations
Trademarks should be registered with the U.S. Patent and Trademark Office (PTO)
Loans with desirable terms may be available from the U.S. Small Business Administration (SBA).
Sole Proprietorship- simplest form of business, the owner is the business
- More than 2/3 of all U.S. businesses
- No protection, high risk=high reward
- Pass through entity
- No longevity, unless stated in a will (when owner dies so does business)
- Only pays personal income taxes on business’s profits - More flexibility than a partnership or corporation - Unlimited liability, creditors can pursue owner’s personal assets to satisfy any business debts
Partnership (general)- an association of two or more persons to carry on as co-owners of a business for profit
…arises from an agreement, express or implied, between two or more persons to carry on a business for profit
- Co-owners of business with joint control over its operation and the right to share in its profits
- Fiduciary duty to one another
- UPA (uniform partnership act) governs the operation of partnerships in the absence of express agreement - A corporation can be a partner in a partnership
- Pass-through entity- a business entity that has no tax liability
- A sharing of profits and losses
- A joint ownership of the business
- An equal right to be involved in the management of the business
If a partner leaves a partnership it is called “dissociation”, it could dissolve and become a sole proprietorship or it could get more partners.
Dissolution= when a partnership comes to an end and ceases to do business.
Winding up= process of finishing business & collecting, liquidating and distributing partnership assets.
Order of dissolution operations: finish business, pay debts, distribute remaining capital among remaining partners
Indemnification- with joint and several liabilities, a partner who commits a tort can be required to indemnify (reimburse) the partnership for any damages it pays
An arrangement in which the owner of intellectual property- such as a trademark, a trade name, or a copyright- licenses others to use it in the selling of goods/serv.
Franchisee- a purchaser of a franchise, generally legally independent of the:
Franchisor- the seller of the franchise
*Distributorship, a manufacturer (the franchisor) licenses the dealer (the franchisee) to sell its product (ex: auto dealers, beer distributors)
*Chain-Style Business Operation, a franchise operates under a franchisor’s trade name and is identified as a member
*Manufacturing Arrangement, or processing plant arrangement, the franchisor transmits to the franchisee the essential ingredients or formula to make a particular product (ex: Pepsi-Cola/other soft drink bottling co.)
∙ Businesses unregulated started making more money. The federal reserve lowered interest rates almost to zero.
o Soldiers come home from Europe
Have wages they can spend on everything else
∙ Securities act of 1933 and 1934
Offers Definition of a security
Requires registration of that security if you want to sell it
Creates Securities Exchange Commission o Securities Exchange Commission
Administrative agency of federal government
An arm of the government to add protection to certain areas
Enforce securities laws and protect the
Give investors opportunity to educate
themselves before they invest
Headed by 5 sitting commissioners
No more than 3 can be part of the
Oversees all disclosures made by public
Focus of the 33 act
Receives 3,000 Filings per day
Investment Management division
Registering A security
Must File a Prospectus AND a registration statement
Registration statement has 2 part:
Part One is basically repeat of
Part 2 contain additional information
sough by SEC, including:
Management aims & goals
# of shares company is selling
Issuer’s plans for proceeds
Company’s tax status
Are there any pending lawsuits?
Contingent plan for potential legal
Income & Expenses
Inherent risks of enterprise
***Financial Statement certified by
If you are a well known seasoned issuer you still have to prepare everything, but if you
are a well known seasoned issuer you don’t have
to wait for SEC approval to start selling
Seasoned issuer is someone who
has issued 3 billion dollars
If you have 700 million dollars in
Types of securities that are exempt from registration: Government backed, Non-profits
General rule is you have to register
1. Regulation A exemption
2. Regulation D exemption - concerns itself with exemptions for smaller
The rules 504 Applies to
Non- Investment Companies
Up to $1,000,000 in 12-month period
Buyers receive restricted securities
The rules 505 Private, Non-Investment company
Up to $5,000,000 in 12-month period
May sell to unlimited # of accredited investors Only up to 35 unaccredited investors
Buyers receive restricted securities
The rules 506 Private, Non-investment company
Unlimited Dollar amount
May sell to unlimited # of accredited investors
Only up to 35 unaccredited investors
Must check that unaccredited investors are able to evaluate risks/merits of investment
Must give non-accredited investors a prospectus-like document
Buyers receive restricted securities
2 things to file:
Regulation statement (has 2 parts)
Register, then sell (and
If you register it once you don’t have to re
Most securities are resold without further
- Must be adequate current public information about the issuer
- Holding period (6 months for 505 & 506; ONE YEAR FOR 504)
- SEC is notified of resale
- Securities may only be sold to qualified institutional buyer 34 act is designed to prevent FRAUD
In connection with purchase of sales
- The difference is that section 10B is a statute written by congress
- Written by securities exchange commission to better enable them to enforce laws and securities
If one is violated chances are the other is also violated
1. Material misrepresentation in connection with the purchase or sale of securities
2. Intent (Scienter)