Law 322 Chapters 12 and 13
Law 322 Chapters 12 and 13 LAW 3220
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Date Created: 03/31/16
Law 322 Chapter 12 Notes 1. Three stages of creating a business a. Creation/set-‐up stage: How hard or easy it is to create this entity, b. Operating stage: up and running, does the entity meet the needs c. Exit stage: if the business makes a lot of money and you want to retire, how hard/easy is it for you to get out of the business 2. Sole Proprietorship a. Someone deciding to start up their business, quickest and easiest to start a business, typically don’t have to register usually or have a license i. You start conducting business, almost anyone can do it ii. Disadvantages: if you need operating capital, the cash to run your business, you have a limited ability to raise capital 1. To ways to raise capital: a. Debt financing-‐borrowing money b. Equity financing-‐you sell shares and other people own a piece of your business iii. Personally liable for the business iv. If your business makes/loses money, it goes on your tax return 3. Partnership a. Associating of two or more people/businesses that come together as co-‐owners to run a business for profit b. Uniform Partnership Act (federal)-‐tells you how to make a partnership i. Name, purpose of partnership ii. Who the partners are iii. What capital they have contributed to the partnership iv. Partners are assumed to share profits/loss equally and have equal voting rights c. Partners put their share on their tax returns d. Partners are personally liable for the debts of the business-‐unlimited liability, personal assets are at risk e. The more partners you have, the more potential you have to raise capital and borrow money 4. Limited Partnership a. Uniform Limited Partnership Act-‐federal act i. Limited partnership agreement ii. Must have at least one general partner and one limited partner 1. General-‐personally liable for the debts of the partnership, unlimited liability, not good a. Has the right to run the day to day business 2. Limited-‐limited liability, all they can lose is the partnership capital they put in a. Not personally liable for the debts b. They do not participate in the day to day management of the business 3. If the general partner dies, withdrawals or goes bankrupt, the partnership terminates 4. If there is one general partner and 5 limited partners, partnership can continue if one limited partner dies, as long as there are still two partners 5. Corporation a. Most Fortune 500 companies b. Created under State law c. File articles of incorporation with the secretary of state i. Name of business ii. What the business is iii. Who the owners/shareholders are iv. What kinds of stock you plant to issue v. Secretary of state will look at these and make sure nobody is using the same business name and issue the certificate of incorporation d. Treated as a separate legal entity, which means if it borrows money, creditors can only sue the corporation not the shareholders (shareholders have limited liability) e. Disadvantage: pays a separate level corporate income tax, federal level, state level and local level (double taxation) f. Three groups of individuals i. Owners (shareholders) 1. People who buy the stock and put equity into the business 2. They hope the company is going to pay them dividends 3. No legal obligation to repay the shareholders ii. Board of directors 1. Set management goals and targets of the business iii. Managers 1. Run the business, hiring/firing g. Business Judgment rule i. Directors and managers can’t be sued for damages/losses when they make honest mistakes in judgment ii. If the loss is due to gross negligence or fraud, then you can sue h. Corporation is the only type of entity that can have a perpetual existence, it can last forever i. Can be terminated by: i. Voluntary dissolution 1. 50% of shareholders vote to dissolve the business ii. Involuntary dissolution 1. When the creditors put the company into a chapter 7 bank filing, business terminates and no longer has a life 6. Professional Corporation a. Corporation=separate legal entity, owners have limited liability i. One except: piercing the corporate vale 1. If someone sets it up as a corporation and doesn’t respect it as a corporation 2. Holding the shareholders personally liable for the shareholders, not treating it as a separate legal entity b. Developed because you could put more retirement benefits into corporations to maximize profits c. Subject to double taxation i. Not as big of a deal because they are the doctors and lawyers ii. Easier than with a larger corporation d. All 50 states allow for professional corporations 7. Limited Liability Corporation (Company) a. Formed under Limited Liability Act i. It is a company, you get limited liability ii. If you set it up and operate correctly, it’s income only gets taxed to its owners, doesn’t pay a separate corporate level income tax iii. Typically small to medium size businesses (not Fortune 500) iv. Not allowed to have a perpetual existence v. If a member/owner dies, goes bankrupt or withdrawals, the LLC seizes to exist unless all of the remaining members vote to keep it going 1. When it terminates unexpectedly, it is very costly vi. Can be used for a limited life, you can specify that the business will terminate after a specific event 8. Sub Chapter S. Corporation a. Limited liability for its owners b. Does not pay a separate corporate level income tax c. Goes on shareholders taxes d. Family-‐run businesses usually i. They can control who their shareholders are e. Cannot have more than 100 shareholders i. Everyone must be a U.S individual, resident, or citizen ii. Business terminates if over 100 or not U.S individual 9. Joint Venture a. Not a separate legal entity, where two or more people come together to accomplish one specific project, typically there is a joint agreement (contract) to accomplish project, when the project is done, the joint venture is terminated i. Examples: research projects 10.Cooperative a. Designed to pool purchasing power, sells membership interest b. Cooperative goes to manufacturers and try’s to buy large sums of products to go back and sell c. Food and produce d. Contractual arrangement, entitles you to certain purchasing e. Goes on and on until it says it terminates 11.Syndicate a. Designed to finance a specific project, not a separate legal entity, typically an agreement b. Way to conduct a type of business, used in businesses a lot c. Example: Office building d. When the financing is raised, the project is done, the syndicate is terminated 12.Franchising-‐typically state laws deal with franchising a. Franchisor=parent company i. Burger King, Wendys, etc. ii. Want to own businesses in large populated cities b. Franchisee=person running the company c. Perspective-‐ to help make decision, controlled by state law i. Has to provide certain information ii. Names, address’ and numbers of all other franchisees iii. Financial information (don’t want them to be in financial difficulty) iv. Background and experience of key executives working there v. Number of franchisees they have and how many went out of business vi. Responsibilities that they have to you as a franchisee and what responsibilities you have to them d. They must give you a copy of their legal franchising agreement (franchisor to franchisee) i. Fees you have to pay will be in there (typically upfront fee) ii. Monthly royalty that goes to franchisor iii. Marketing fee iv. Territorial rights, no one else can open that same company in that zone v. What kind of assistance you will get from franchisor 1. Financing assistance 2. Mass purchasing power 3. Training vi. What can terminate the agreement 1. Non-‐payment of fees=immediate cancellation 2. Entering into a franchising agreement with competitor 3. Drop in your quality or service depending on what type of franchise you are 4. If you don’t follow their guidelines and rules 13.Characteristics of types of businesses: a. Liability i. Do the owners have limited liability or unlimited? 1. If you want limited, you want to be a shareholder or a limited partner in a limited partnership 2. General partner or sole partner then you have unlimited liability b. Transferability of ownership i. The easiest ownership to sell or transfer are shares in a publicly traded organization 1. Easy because: a. You know what the fair market value is of your shares at any point b. If you want to sell it all you do it pick up the phone and call your broker (ready purchasers) ii. The hardest is a sole proprietorship, difficult and time consuming 1. You have sit down and negotiate a price and you don’t know what is it worth iii. Must read partnership agreements before trying to sell because it is common to not be able to sell partnerships without consent from other partners c. Management i. If this is your business, how important is it to you that you can run the day to day business 1. If it is important than you want to be a sole proprietor or you want to be a general partner because then you can run the day to day business d. Continuity i. Continuity of life ii. When you set it up what do you foresee for it? iii. Only a corporation has perpetual existence iv. All other entities have a limited life e. Tax i. Corporation is the only entity that has double level of tax (federal, state and local) f. Capital i. When you look at your business, how much money do you need to get it started? ii. Two ways to raise: 1. Sell shares of stock if you are a corporation 2. Equity financing iii. Publicly traded company can raise the largest amount of capital iv. Hardest to raise capital=sole proprietorship v. Partnerships=more owners, the more capital you can raise Law 322 Chapter 13 Notes 1. Negotiable instruments a. Negotiable-‐something that can be transferred of value i. Example: A check b. Functions i. Substitute for cash ii. Method for merchants to expand their business c. “Negotiability” d. Requirements i. Article three under Uniform of Commercial Code says it must meet these conditions to qualify as a negotiable instrument: 1. Must be a written instrument 2. Must be an unconditional order or promise to pay somebody 3. Has to be signed by the maker or the drawer a. Cash can’t be cashed without signature 4. Must be paid on demand or at a specified time a. Payable on demand-‐ takes check to bank and must be given the cash right away 5. Must be made to the “order of” or the “bearer” a. To the bearer,-‐that means whoever has possession of that instrument can get the value of it i. Very risky, someone finds it on the street can pick it up and cash it 6. Has to state a fixed amount of money to be paid 7. If all these requirements are met, it qualifies as a negotiable instrument 8. Types of holders under article three a. Ordinary holder i. If there are any defenses against that check to be paid, then you might not be able to cash it and get the money b. Holder in due course i. Guaranteed they are going to get paid ii. Rather be this than an ordinary holder iii. Must give value to the instrument iv. Have to take the instrument not knowing its fraud or bad v. Must take instrument in good faith, innocent e. Types-‐ i. Orders to Pay (three party instruments) a. Drawer-‐person who creates the instrument (person who writes the check) b. Drawee-‐ entity that is going to make the payment (check to bank, the bank is the drawee_ c. Payee-‐ person who is going to benefit, you are paying (“Pay to the order of”) 2. Checks a. Limited type of draft, has two limits that general drafts don’t have b. Can only be paid currently, can’t be paid in the future c. Drawee can only be a bank or financial institution d. A check IS a draft, but has restrictions on it e. Some merchants prefer a credit card over a check so that they are guaranteed payment 3. Drafts a. Legally binding order to pay an amount of money, involves three parties, drawee can be about any entity that has the ability to pay b. Three parties, draft can be paid now or in the future c. Specific types in business: Site draft i. Requires immediate payment, preferred in business sometimes because you know you can get paid right away ii. Cashier Check-‐way to ensure you are going to get paid, the bank is the drawer and the drawee iii. International business-‐Bill of exchange, draft that guarantees payment for goods in international trade ii. Promises to pay (two party instruments) 1. A promissory note-‐promise from one person o pay back another person a. Person who lends the money-‐creditors b. Debtor-‐owes money c. Promise to pay you back at a certain time with a certain amount on interest d. Collateral note-‐debtor’s assets that might be put up as security for their promise to pay e. **Note you get from the bank when you buy your house (what is this called?) f. Installment note-‐when you buy a car, make fixed payments periodically until price is paid off g. Balloon note-‐ a large portion of the principal isn’t paid until the maturity of the note 2. Certificates of Deposit a. Typically issued by a bank b. Banks promise to repay your principal plus your specified interest in a specific amount of time c. Most large certificates are very liquid, can cash them in at any time if you need money 2. Credit a. Creditor-‐lends the money b. Debtor-‐owes the money c. Two ways to finance a business: i. Can go to the bank and borrow money (debt financing) ii. Issue shares of stock in your company (equity financing) 1. People buy stock because they hope the value goes up and they hope you pay them dividends during it d. Terms i. If merchants want to use credit: 1. Merchants must figure out their credit policy, who are we going to let buy from credit 2. Merchants look at credit history, can do a credit search 3. They will look at your ability to pay, do you have other assets, do you have a car 4. Merchants may ask you to pledge assets as a security 5. Secretary of state keeps all financing agreements of who has security interest, can seize assets if you need to 6. Options: Get a security interest or take a security interest in other assets they own ii. Types of Credit accounts: 1. Open Account a. Kind you see between merchants b. “I’m selling to Walmart, they have 30 days to pay, I’m continuing to sell to Walmart” c. Very common 2. Installment Credit Account a. One time transaction b. Buy a car and agree to pay it back installment payments 3. Revolving Credit Account a. What is behind a credit card b. What most people are carrying around c. Most cards have a limit, you are continuing making payments and buying iii. Collection policy 1. Merchants have to decide how aggressive you have to be a. Usually send out a letter or a phone call reminding they are late b. Next, you might pay them a personal visit c. If this isn’t working, you might want to resort to a collection agency d. They hound you to death until money is collected e. The history and volume of the customer is what the merchants look at i. If you are a small customer, you might be more aggressive ii. Large customers want to keep around f. Most U.S businesses do sell on credit e. Credit Policy f. Credit with security i. When a new business is starting, banks look for collateral, somebody to co-‐sign your note ii. Surety 1. Under article three, someone that co-‐signs a note and is primarily reliable for the note iii. Guarantor 1. Only secondarily liable for the debtors obligations 2. Only if they can’t collect from the debtor then they come after the guarantor 3. Better position than a surety a. Both are creating legal exposure iv. Defenses of sureties 1. If the subject matter of the agreement was illegal, if you can prove that it was fraud 2. Bankruptcy is NOT a defense v. Surety’s rights against principal 1. Exoneration a. Where the surety goes to the court and says the lender is coming to me to insist to pay and I know the borrower has the money to pay back b. Court order to the debtor to repay the debt 2. Subrogation a. If you make the payments (surety), you have the write to sue the debtor to get personal assets vi. Article three says that you can get a security interest in inventory, it’s called a floating lean, get by filing a financial statement vii. If the debtor defaults (not paying as promised), if you are a secured creditor you have priority over unsecured creditor, article three says if you are a secured creditor you have the legal right to repossess that asset on your own if you can do it without breaching the peace, if it does breach the peace you must get the police involved viii. Attachment lean-‐court order that says to the person who has the asset that you can’t sell that asset ix. Writ of execution-‐ court order that gives the police the right to go out and get _______ x. Exempt property-‐ you can’t seize or sell it as part of a secure transaction xi. Homestead Exemption-‐ a modest living accommodation cannot be taken away from someone to pay off debts, you can’t put someone on the streets, also a car, clothes, or tools that are involved with your job can’t be taken away xii. Lien-‐ someone has a legal claim over your property xiii. Mechanics lean-‐if someone does work on your real property and you don’t pay them in time xiv. Possessory lean-‐on personal property, if someone is in possession of your personal property they can keep it until you pay for it, if you drop your car off, or laptop. They can sell it in a certain amount of time if not paid xv. Court leans-‐attachment (freezes assets) judgment lean-‐says you win, defendant owes you a certain amount of money, this is typically followed by a writ of execution, garnishment order-‐ court order that allows you to get up to 25% of a persons net pay until the full amount has been repayed g. Secured Transactions 3. Bankruptcy-‐federal laws a. Changes to bankruptcy law in 2005 i. Before an individual can file for bankruptcy they have to take credit counseling (looks at the past) 1. Do you need to file for bankruptcy? 2. What type of bankruptcy? ii. Debtor education course 1. Designed to help the individual budget for the future iii. If you go through a type of bankruptcy where the debts are legally discharged, you can only do this type of bankruptcy every 8 years b. If you do need to file for bankruptcy, the first choice you have is chapter 13 bankruptcy i. Only available for individuals not businesses ii. File a plan with bankruptcy court iii. An individual can have up to a 5 year extension to pay back their debt and get current iv. Creditor status if frozen as soon as you file for any type of bankruptcy plan v. No debts are discharged under chapter 13 vi. If this is filed and you find out during the process that it is not working, you can convert to chapter 7 bankruptcy c. Chapter 7 (liquidation) i. If you say more time isn’t going to help, you would file to chapter 7 proceeding, it is available to both individuals and businesses ii. Business is done, out of business, all assets sold off iii. Individuals start life fresh but you don’t have a lot of assets iv. Debtors assets except exempt assets (definition above) are taken and sold by trustee v. Trustee generates as much cash as they can vi. Can be two types 1. Voluntary Filing a. Individual/ business files with bankruptcy court b. Must give a full honest disclosure of financial position, all assets, all liabilities, all operating income c. They can deny you if they don’t think you are telling the truth 2. Involuntary Filing a. Creditors are fed up and they go to the courts and initiate the proceeding d. Chapter 13 (reorganization of debts)-‐above i. Need more time as an individual ii. If you start at chapter 11 or 13 and it isn’t working, you can convert to chapter 7 at any point whether individual or business e. Chapter 11 (business reorganization) i. Counterpart to Chapter 13 ii. Businesses file for this when it is thinks it is not hopelessly in debt, just needs time to get current iii. Business will file plan and a proposal showing about how much time they need, there is no cap on time iv. Reasonable extension defined by bankruptcy judge v. Protected, creditor status is frozen, can’t sue vi. Purpose is that the business continues to operate vii. At the end, the hope is that the business is still in business and it is profitable and continues on its way viii. Business can’t make any big expenditures without approval ix. Can be problematic 1. As soon as you file for bankruptcy, the trustee’s job is to maximize amount going to creditor 2. Can be expensive 3. Legal fees, more operating expenses f. Priority classes of creditors i. Trustee liquidates assets and passes down the chain ii. No money goes to the below creditor until the above creditor is fully satisfied iii. Creditors can’t really say much against the trustee and bankruptcy court iv. Secured creditors must be taken care of first v. 1-‐Secured creditors 1. Security interest 2. Preferred class to get cash in a chapter 7 liquidation vi. Person who owed money died vii. Unpaid wages 1. If you had employees viii. Claims of farmers and fisherman ix. Refund of security deposits x. Alimony and child support payments xi. Taxes xii. 7-‐General unsecured creditors (very seldom get much of anything) 1. You said “I’ll pay you back, don’t worry” 2. You don’t want to be an unsecured creditor g. Discharge in bankruptcy i. Comes at the end of a chapter 7 ii. That debt disappears iii. Bankruptcy person starts fresh with a couple exceptions: 1. There are certain debts that are not legally discharged by the bankruptcy court a. Alimony and child support b. Taxes c. Most student loans unless it would create an undue hardship if they are not discharged, tough burden of proof d. If you borrow money shortly before you file for bankruptcy e. If you owed these before, you owe them after 2. Transfer of assets within 90 days of filing will be taken back and reclaimed a. Can’t transfer out of your name to someone else to protect them, they are void and considered fraudulent h. Non Bankruptcy alternatives i. All voluntary, which means creditors must agree for them to work ii. Less costly, no trustee fees, quicker, less damaging to reputation iii. Bankruptcy filing is public information, part of credit history 1. More difficult to borrow money in the future 2. Can damage your image no matter what chapter iv. These are not public v. Types 1. Debt extension a. Debtor gets creditors together and typically asks for either an extended period of time to pay back creditors or asks them to take what he has now (you know exactly what you’re getting) i. Creditors must evaluate alternatives and risks ii. In a bankruptcy you aren’t exactly sure what you are going to get paid 2. Bank workout a. Voluntary b. If most of money is owed to banks or creditors c. Asks for either more time to pay back debt or for the bank to owe you more money i. Banks hate to write off loans ii. They typically like to give you more time to pay it off 3. Assignment a. Voluntary chapter 7 b. Debtor says to creditors if you agree, ill transfer all my assets to a fiduciary and will sell them all and distribute cash to creditors c. Debts discharged, start life fresh d. If you can’t get all creditors to agree, then only option is bankruptcy
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