Law 245 Week 7 Notes
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This 12 page Class Notes was uploaded by Frankie Fucci on Sunday March 6, 2016. The Class Notes belongs to LA 245 at Boston University taught by David Randall in Spring 2016. Since its upload, it has received 18 views. For similar materials see Introduction to Law in Law at Boston University.
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Date Created: 03/06/16
Starting a Business: LLCs and Other Options Sole Proprietorship: an unincorporated business owned by one person Most common forms of business Not required to hire a lawyer/register with the government Business is flow-through tax entity - doesn't need a separate tax return, sole proprietor pays personal income tax on the profits, but the business itself does not States generally require sole proprietors to register their business name if it is different from their own o Very few states and some cities/towns, require sole proprietors to obtain a business license Disadvantages: o Unlimited liability - owner is responsible for all business's debts, personally liable o Limited options for financing his business Debt is usually only source of working capital because there are no stocks/memberships to sell If someone else brings in money and helps with management, then it's now a partnership o Because of this, sole proprietorships work best for small businesses without large capital needs Corporations - dominant form of organization Corporations in General o Limited Liability - corporation protects managers and investors from personal liability for the debts of the corporation and actions of others, but not against liability for their own negligence (or other torts and crimes) o Transferability of Interests - provide flexibility for enterprises small (with one owner) and large(thousands of shareholders) Partnership interests - not transferable without permission of other partners Corporate stock - can be bought and sold easily o Duration - corporations have perpetual existence, they can continue without their founders o Logistics - require substantial expense and effort to create and operate Cost of establishing - legal/filing fees, annual filing fees required by states Must hold meetings for both shareholders and directors Minutes must be kept indefinitely in the company minute book o Taxes - corporations of taxable entities --> must pay taxes and file returns Sole proprietor pays taxes on all business's profits Partnership not a taxable entity --> doesn't pay taxes itself Income/losses passed through to partners/reported on their personal income tax returns Corporations are taxable entities --> pay income tax on their profits Shareholders must then pay tax on dividends --> a dollar is taxed twice before deposited into shareholder's bank account Corporations created/regulated by state law but must pay federal and state taxes Federal law gives favorable tax treatment to smaller corporations (S Corps) Many states also treat small corporations differently (called Close Corps) Federal tax law and state corporations statutes are completely independent --> possibly can be any combo of Regular/Close and S/C corps Image S Corporations - created to encourage entrepreneurship by offering tax breaks o Shareholders of S corps have both the limited liability of a corporation and the tax status of a partnerships Not a taxable entity - all profits/losses pass through the shareholders, who pay tax at individual rate Avoids double taxation of regular corporations (C corps) o Major restrictions: Can be only class of stock (although voting rights can vary within the class) Can be no more than 100 shareholders Shareholders must be individuals, estates, charities, pension funds or trusts, not partnerships/corps Shareholders must be citizens or residents of US, not nonresident aliens All shareholders must agree that the company should be an S corp o Most states follow the federal lead on S corps, small number require these companies to pay state corp tax Close Corporation (Closely Held Corporation): company whose stock is not publicly traded, privately held company o Most are small, some are huge o Although provisions of close corp statues vary from state to state, tend to have certain common themes: Protection of minority stakeholders 0 does this because a minority stakeholder being mistreated by majority cannot just sell his stocks and get out Ex: require unanimous vote to choose officers, salaries, dividends, etc. Grant veto power to each stakeholder over important decisions Transfer restrictions - often need to work closely together --> typically permit corporation to require that a shareholder first offer shared to the other owners before selling them to another outsider That way, remaining owners have some control over who their new co-owners will be Flexibility - can typically operate without BOD, formal set of bylaws or annual shareholder meetings Dispute resolution - shareholders allow to agree in advance that any one of them can dissolve corporation if some particular event occurs, if they choose, for any reason at all If shareholders are in stalemate, problem can be solved by dissolving corporation Even without such agreement, shareholder can ask a court to dissolve close corp if the other owners behave "oppressively" or "unfairly" Limited Liability Companies (LLCs) Offers the limited liability of a corporation and the tax statutes of a partnership Limited liability - members not personally liable for the debts of the company o They only risk their investment, as if they were shareholders of a corporation o Ridgaway v. Silk Costello and Giordano members of Silk, LLC, which owned a bar and adult entertainment nightclub in Connecticut Sulls went drinking there (heavily) and despite his state, employees continues to serve him Costello and Giordano were working that night, greeting customers, supervised employees and other PR stuff When Sulls left nightclub at 145AM with two friends, he drove off the highway at high speed, killing himself and one of the passengers, Ridgaway Ridgaway's estate sued Costello and Giordano personally, defendants fueled motion for summary judgment seeking dismissal of the complaint Issue: Are Costello and Giordano personally liable to Ridgaway's estate? Argument for Costello and Giordano: Defendant didn't own the club, they were simply members of an LLC that owned it Whole point of LLC is to protect its member against personal liability Assets of Silk, LLC are at risk, but not the two men's' personal assets Argument for Ridgaway's Estate: they are not liable for being member of Silk, they are liable for their own misdeeds as employees of the LLC They were both present at the club greeting customer and supervising employees They did not adequately supervise/train employees to handle overly drunk customers Tax status - as in partnership, income flows through the company to the individual members, avoiding the double taxation of a corporation Formation - to organize an LLC, must have a charter and should have an operating agreement o Short charter - basic info such as name/address, filed with the Secretary of State in the jurisdiction in which it's being formed o Operating agreement sets out the rights and obligations of the owners, called "members" If LLC doesn't adopt its own operating agreement, LLC statutes provide a default option But this option may not be what members would choose if they thought about it Wyoming.Com, LLC v. Lieberman Lieberman was member of LLC Wyoming.com Withdrew and he and other members disagreed about what his membership was worth Wyoming.com filed suit asking court to determine financial rights and obligations of the parties, if any, upon the withdrawal of a member Supreme Court of Wyoming ruled that Lieberman still owned part of the business despite his withdrawal, but neither the LLC statute nor company's operating agreement required the LLC to pay a member the value of his share Therefore, neither party had any further rights/obligations Not quite understanding what this meant, Lieberman filed a motion seeking financial information about the company Original trial court denied the request on theory that since Lieberman had no right to a payout, the company had no obligation to give him financial data Issue: Does Lieberman have a right to any financial data about Wyoming.com? The question was answered in the prior case, because no provisions were in statue or the agreement, neither side can force the other side to do anything Which means nothing more is needed and there's nothing more the court to order Wyoming.com to do Flexibility - LLCs can have members that are corporations, partnerships or nonresident aliens o Can also have different classes of stock o LLCs are not required to hold an annual meetings/maintain a minute book Transferability of Interests - unless operating agreement provides otherwise, members of LLC must obtain unanimous permission of remaining members before transferring their ownership rights o Cannot issue stock options, which is potentially a serious problem because option may be an essential lure in attracting/retaining top talent Duration - used to be that LLCs automatically dissolved upon the withdrawal of a member, currently, trend in state laws is to permit an LLC to continue in operation even after a member withdraws Going public - once LLC goes public, it loses favorable tax status and is taxed as a corporation, not a partnership o Thus, no advantage to using the LLC form of organization for a publicly traded company o Some disadvantages: Unlike corporations, publicly traded LLCs do not enjoy a well- established set of statutory and case law that is relatively consistent across the many states Because of securities laws, it's important for LLCs to have an operating agreement that permits managers the right to convert the LLC into corporation at the time of a public offering without the consent of the members Changing forms - some corporations may want to become LLCs o IRS considers this change to be a sale of the corp assets and would levy a tax on the value of the assets --> so not many have made the change o BUT change from partnership to LLC or from LLC to corporation isn't considered a sale and doesn't have the same adverse tax impact Piercing the LLC Veil - if corporate shareholders do not comply with the technicalities of the law, they may be held personally liable for the debts of the corporations, the same can be said for the members of an LLC o BLD Products, LTD. V. Technical Plastics of Oregon, LLC Hardie was sole member of Technical Plastics, LLC, operated business out of his home office Regularly used TPO's accounts to pay such expenses as landscaping and housecleaning, also paid some of his credit card bills, loan payments on his car, the cost of home renovations, college bills and trips At same time, Hardie deposited cash advances from personal credit card into TPO checking account Hardie didn't take a salary from TPO When TPO filed for bankruptcy, it owned BLD about $120,000 for goods it'd purchased In some cases a court will "pierce the veil" of a corporation and hold shareholders personally liable BLD argued the same doctrine should apply to LLCs and court should hold Hardie personally liable BLD filed for summary judgment Issues: Does the corporate doctrine of piercing the corporate veil apply to LLCs? Should Hardie be personally liable for TPOs debts? Piercing the veil doctrine may be applied to LLCs under same circumstances where it applies to corps Defendant controlled the debtor corporation; Defendant engaged in improper conduct; and As a result of that conduct, plaintiff was unable to collect on debt against insolvent corporation Conditions 1 and 2 are met in full, cannot determine as matter of law if inability to pay debt was due to Hadie's improper conduct over the years Therefore, grant partial summary judgment that BLD can pierce the veil, making Hardie personally liable, but that the amount for which he is liable will have to be determined by the jury Legal Uncertainty - LLCs are relatively new form of organization without a consistent and widely developed body of law o Managers' duties to the members of the organization Ex: not clear in many jurisdictions if managers of an LLC have a legal obligation to act in the best interest of members Delaware: LLC's managers do have fiduciary duty to its members unless operating agreement provides otherwise When mangers violate their duty to the organization, shareholders are allowed to bring a derivative lawsuit in the name of the corporation again the managers It's unclear whether members of LLC have same right, especially in states that do not explicitly authorize derivative lawsuits in their statues Tzolis v. Wolff Tzolis owner 25% of Smith Pennington Property Co., LLC, which owned an NYC hotel Wolff managed the hotel Tzolis claimed that Wolff first leased and then sold the hotel to family and friends at a price below market value Tzolis filed a derivative lawsuit against Wolff on grounds that he violated his duties to LLC Trial court ruled that members of an LLC had no right to bring a derivative action because the statute had not explicitly permitted such suits, Tzolis appealed Issue: DO members of an LLC have the right to bring a derivative suit against manager of the company? The derivative suit is part of the general corporate law of [New York] state Not created by statute but by case law Must consider whether to recognize derivative actions on behalf of LLC, as to which no statutory provision for such an action exists When fiduciaries are faithless to their trust, victims mustn't be left w/out remedy To abolish derivative action in the LLC context would be a radical step Courts repeatedly recognize deriv. suits in absence of express statutory authoriz. Hold that LLCs may sue derivatively THIS IS FOR NEW YORK ONLY Choices: LLC v. Corporation o Venture capitalists prefer C corps over LLC because: Arcane tax issues C corps are easier to merge, sell or take public Corporations can issue stock options General legal uncertainty involving LLCs Socially Conscious Organizations - aka flexible-purpose organizations, benefit corporations (B corps), low-profit LLCs (L3Cs) and community interest companies (CICs) Allowed by a dozen states, now To form this type of company, business must pledge to behave in a socially responsible manner as it pursues profit o Focus on triple bottom line - directors are not required to maximize shareholder returns but may instead trade off some profitability in interests of social responsibility To become socially conscious organization, typically 2/3 of investors must first give approval o With B corp, company has to obtain certification from independent third party, such as B Lab o Must also prepare regular reports that assess their societal and environmental impact o Don't receive favorable tax treatment, but advocates are pushing Congress to change this Issues: still a lot of uncertainty o Rules are vague, shareholders will have virtually no right to challenge board decisions General Partnerships Partnership: unincorporated association of two or more co-owners who operate a business for profit o Each co-owner is called a general partner Universal Partnership Act (UPA) - created by National Conference of Commissioners to regulate partnerships better as there was lack of consistency among state laws with growth of interstate commerce o Latest revisions came in 1997, more than 2/3 of states have passed the latest revision: Taxes - not a taxable entity --> profits flow through to the owners Liability - each partner is personally liable for the debts of the enterprise, whether or not he caused them Partner is liable for any injury that another partner/employee causes while on partnership business as well as for any contract signed on behalf of the partnership Can be risky is group of owners is large and don't know each other Management Management Rights - unless partnership agrees otherwise, partners share both profits and losses equally, and each partner has an equal right to manage the business Managing partners / members of the executive committee - large partnerships are almost always run by one or a few partners Even with this, still less autocratic than corporation Management Duties - partners have a fiduciary duty to the partnership, this means that: Partners are liable to the partnership for gross negligence or intentional misconduct Partners cannot compete with the partnership - each partner must turn over to the partnership all earning from any activity that is related to the partnership's business A partner may not take an opportunity away from the partnership unless the other partners consent If a partner engages in a conflict of interest, he must turn over to the partnership any profits he earned from that activity Marsh v. Gentry Gentry and Marsh were partners in business that bought/sold racehorses They paid $155,000 for a horse and that horse had a foul They decided to sell the horse at an auction Gentry decided to bid on the horse personally, without telling Marsh Paid $135,000 Later, he told Marsh someone was interested in buying the foul, Marsh agreed to the sale Gentry refused to tell him the name of the purchaser 11 months later, the foul won a race, and Marsh learned Gentry bought her Issue: Did Gentry violate his fiduciary duty when he bought partnership property without telling his partner? Partners have ever right to know if a purchaser is one of the partners Marsh explained he would have never allowed either sale if he knew Gentry failed to disclose what he knew about both purchases Requirement of full disclosure within partners cannot be escaped Transfer of Ownership - financing may be hard because the firm cannot sell shares like a corporation Capital needs must be provided by contributions from partners or by borrowing Partner only has the right to transfer the value of her partnership interest, not the interest itself Ex: if partner dies, their estate cannot become a partner, but collects the value ($) of the partnership Formation - partnerships not only help spread the load of responsibility, but they are easy to form If two or more people do business together, sharing management, profits and losses, they have a partnership, whether they know it or not, and are subject to all the rules of partnership law While they should have a written agreement, it's legal without one Nothing is required in the way of forms, filings or agreements Partnership by Estoppel - non-partners are treated as if they were actually partners and are forced to share liability, this exists if: Participants tell other people they are partners (even though they are not), or they allow other people to say, without contradiction, that they are partners A third party relies on this assentation; and The third party suffers harm Termination Dissociation: when a partner quits a partnership Partnership can either buy out the departing partner(s) and continue in business or wind up the business and terminate the partnership Most large firms provide in their partnership agreement that, upon dissociation, the business continues Limited Liability Partnerships (LLPs) - type of general partnership that most states now permit Important distinction between LLPs and general partnership: in an LLP, partners are not liable for the debts of the partnership o Still liable for their own misdeeds To form LLP, partners must file a statement of qualification with state officials Must file annual reports, other attributes of partnerships remain the same LLP is not a taxable entity, and it has the right to choose its duration (it can, but doesn't have to survive the dissociation of a member) Crucial to comply with all technicalities of LLP statute o If not, partnership loses protection against personal liability Limited Partnerships and Limited Liability Limited Partnerships Relatively rare, mostly used for estate planning purposes (usually, to reduce estate taxes) and for highly sophisticated investment vehicles Structure - must have at least one limited partner and one general partner Liability - limited partners are not personally liable, but general partners are o Limited partner only risk their "capital contribution" o BUT revised version of Uniform Limited Partnership Act permits a limited partnership, in its certification of formation and partnership agreement, simply to declare itself a limited liability limited partnership In a limited liability limited partnership, general partners are not personally liable This removes major disadvantage of limited partnership But right now, fewer than half the states have actually passed this revised version of ULPA Taxes - not taxable entities --> income is taxed only once before landing in partner's pocket Formation - general partners must file a certificate of limited partnership with their Secretary of State o Should have partnership agreement, but not required Management - general partners have the right to manage a limited partnership o Limited partners are passive investors with few management rights beyond the right to be informed about the business, but agreements can expand the rights of limited partners Transfer of Ownership - Limited partners have the right to transfer the value of their partnership interest, but they can sell or give away the interest itself only if the partnership agreement permits Duration - unless partnership agreement provides otherwise, limited partnerships enjoy perpetual existence Professional Corporations (PCs) - professionals are allowed to incorporate their practices, but in a special way PCs provide more liability protection than a general partnership o If member if PC commits malpractice, corporation's assets are at risk, but not the personal assets of innocent members Generally, shareholders of a PC are not personally liable for the contract debts of the organization Limitations: o All shareholders of the corporation must be members of the same profession (ex: all licensed physicians) Other valued employees cannot own stock o Required legal technicalities for forming and maintaining a PC are expensive and tie-consuming o Tax issues can be complicated PC is a separate taxable entity --> must pay tax on its profits, then shareholders pay tax on dividends Salaries are deductible from firm profits --> PC can avoid paying taxes on profits but paying out all profits as salary But any profit remaining in firm coffers at the end of the year are taxable To avoid tax, PCs must be careful to calculate their profits accurately and pay then out before year's end Can be time consuming and any error may cause unnecessary tax liability CONTINUATION OF CLASS 10 AND CHAPTER 18 Employment Discrimination Title VII of Civil Rights Act 1964 prohibits discrimination in employment based on these protected classes: Race Color Religion National origin, or Sex It encompasses Workplace discrimination Sexual harassment, and Discrimination based on pregnancy Disparate Treatment: intentionally discriminating against a person because of his protected class status Employer's Defense: had legitimate nondiscriminatory reasons To win: plaintiff must prove employer's stated reasons are a pretext o "Pretext": a cover up/excuse, reason you give that covers up your real reason Disparate impact: using job requirements or other selection criteria that systematically exclude particular groups from certain types of jobs Employer's Defense: challenged practice is a job-related necessity To win: plaintiff must prove either employer's support for the challenged practice is a pretext, or employer could achieve its desired result by less discriminatory means Jespersen v. Harrah's Did Harrah's requirement that women wear make-up violate Title VII? What questions should you consider when starting a business? Funding Type of business (partnership, corporation, sole proprietorship, LLC, etc.) o How much liability o Limited vs. general partners How splitting up the responsibilities Percentage ownership - based on value of contributions/investment People who enter over time (for growth) - based on capital o Operation agreement Buy out - everyone has option to buy out first, and all must agree on new person coming in if not How much does he get? New partner? - 2/3 majority Terminations - voting Handle disputes - mediator, voting Terms of dissolution Allocation of economic interests Compensation How long want partnerships to last o Corporation --> S/C corp Private/public o Socially conscious? B corp? Non profit? Industry profitable? Target market Location (physical, online) IT # employees Long-term goals Suppliers Organizational structure Partnership is a conduit - all the benefits/losses flow through the entity to the owners Business is an "empty shell", everything passes through the owners Corporations are taxable entities, so subject to double taxation Scope of Limited Liability SM323 Miracle – In Class Activity Your family - 75% working capital Want: priority return 3 partners - 25% all together Want: expect returns on their capital contributions 5 other members - expect to share in the value they helped to create 3 professors - want ownership interests rather than compensation Angel/venture capital investors Want - significant control/significant ownership interests
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