C H A P T E R 1 9
Forms of Business Organizations
TRUE-FALSE QUESTIONS
1. Corporations must incorporate in the state where their headquarters are located.
2. A creditor of a sole proprietorship may seek recovery only from business assets of the sole
proprietorship, not from personal assets of the sole proprietor.
3. A partnership may acquire property in its own name.
4. An S corporation cannot have more than one class of stock.
5. If a sole proprietorship operates under a fictitious business name, then that name must be registered
with the state.
6. In a joint venture, the authority of one member to bind the partnership is more limited than in a
general partnership.
7. A partnership requires a minimum amount of capital in order to be formed.
8. Federal law governs the obligations, if any, that members of a limited liability partnership owe to
creditors.
9. A corporation that is technically defective but that is formed in good faith and exercises corporate
power is known as a de jure corporation.
10. C corporations are taxed as a pass-through entity.
11. A shareholder’s right of appraisal only applies to transactions that were initially subject to
shareholder approval.
12. Partners owe each other a duty of care but not a duty of loyalty.
13. States may not impose a higher fiduciary duty upon partners than that set forth in the Revised
Uniform Partnership Act.
14. B corporations have no duty to maximize shareholder value even when there is a change of control.
15. An outside director is a director who lives outside the state of incorporation.
16. Cumulative voting allows a greater control by the management interests of a corporation.
17. Any corporation not meeting the requirements for an S corporation is automatically a C corporation.
18. The term “appraisal rights” when used in regard to a corporate merger refers to the right of
dissenting shareholders to have corporate property independently appraised.
19. An S corporation would likely be used as the corporate form for a business intending to raise money
from venture capitalists.
20. If a business is operated by a partnership, LLC, or S corporation, then operating losses will be passed
through to the individual partners or shareholders.
MULTIPLE-CHOICE QUESTIONS
1. A ________ is created when two or more persons agree to place their money, labor, or skills in a
business and to share the profits and losses.
A. sole proprietorship
B. general partnership
C. S partnership
D. C corporation
2. The _______ is the simplest and most prevalent form of business enterprise in the U.S.
A. S Corporation
B. Partnership
C. Sole proprietorship
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D. Joint Venture
3. When directors on a board serve for a fixed term but are not elected all at once it is known as a
________ board.
A. cumulative
B. staggered
C. proxy
D. inside
4. A member of the board who also serves as an officer is a(n) ________ director.
A. inside
B. interested
C. outside
D. employed
5. _______ refers to a method by which courts hold shareholders individually liable for claims against
a corporation.
A. Reverse liability
B. Piercing the corporate veil
C. Upholding the ethical theory
D. Unveiling
6. Which of the following is true regarding the effect of the death of a partner on a general partnership?
A. The partnership ceases to exist immediately upon the death of any partner.
B. The partnership ceases to exist 10 days after the death of any partner.
C. The remaining partners must by operation of law continue the partnership for at least one year.
D. Within 90 days, the remaining partners may elect to continue the partnership.
7. A ________ is a public offer to all the shareholders of a corporation to buy their shares at a stated
price.
A. leveraged buy out
B. tender offer
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C. target bid
D. merger
8. In a ________ merger, the shares in the disappearing corporation are automatically converted into
shares in the surviving corporation.
A. cash out
B. noncash
C. freeze out
D. liquidation
9. In a[n] ________ a stock purchase is financed by debt.
A. cash out merger
B. freeze out acquisition
C. leveraged buyout
D. illegal purchase
10. What did the court rule on appeal in Estate of Countryman v. Farmers Cooperative Association, the
case in the text in which the plaintiffs attempted to hold a 95% owner of an LLC personally liable in
tort as a manager when propane gas delivered by the LLC exploded?
A. That only the LLC could be held liable.
B. That the manager was subject to liability along with the LLC regardless of whether it could be
established that the manager participated in tortuous conduct in performing his duties.
C. That only the manager, not the LLC, could be held liable.
D. That the manager was not protected from liability if he participated in tortuous conduct in
performing his duties.
11. The _______ theory applies to the situation in which owners of a corporation have so mingled their
own affairs with those of the corporation that the corporation does not exist as a distinct entity.
A. undercapitalization
B. alter ego
C. per se
D. absolute
12. In most jurisdictions, there is no quorum unless the holders of at least _______ of the outstanding
shares are present in person or by proxy.
A. 25%
B. 33%
C. 50%
D. 75%
13. Which of the following is true regarding taxation of losses of a C corporation?
A. The operating loss is passed on to shareholders, but the corporation itself does not realize any
benefit.
B. The operating loss is recognized at the corporate level, and shareholders also receive a tax
benefit.
C. The operating loss will be recognized at the corporate level, shareholders receive no tax benefit,
and the corporation receives no benefit until it has operating income against which its prior losses
can be deducted.
D. The operating loss is not recognized at the corporate level; and although shareholders may
receive a deduction, they must wait until they receive some amount of profit from the corporation at
which point they can deduct up to 10% of the losses per year.
14. What does the term “reverse piercing” reference in regard to a corporation and its shareholders?
A. Holding a corporation liable for debts of a shareholder
B. Holding a shareholder liable for debts of a corporation
C. Holding a corporation liable for debts of a shareholder and holding a shareholder liable for debts
of a corporation
D. Holding a corporation liable for debts of a shareholder, holding a shareholder liable for debts of a
corporation, and holding officers liable for debts of a corporation.
15. Which of the following statements is not true regarding the advantages and disadvantages of a sole
proprietorship?
A. A sole proprietorship can be created without formal agreements or state filings.
B. The proprietor reports income from the business on a personal tax return.
C. The proprietor alone bears liability for the losses.
D. It is usually easy for sole proprietorships to raise capital.
16. Which of the following is false regarding limited partnerships?
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A. General partners of a limited partnership remain jointly and severally liable for partnership
obligations.
B. Limited partners assume no liability for partnership debts beyond the amount of capital they
contributed.
C. Limited partners are responsible for the management of the partnership.
D. Limited partnerships are often used to raise capital.
17. Which of the following requirements is not required by a corporation to qualify for S corporation
status?
A. The corporation must have only one class of stock.
B. The corporation must file a timely election signed by all the shareholders to be treated as an S
corporation.
C. The corporation must have no more than twenty-five shareholders.
D. The corporation must be a domestic corporation.
18. In _______ voting, a shareholder can cast one vote for each share the shareholder owns for each
nominee whereas in _______ voting, a shareholder may cast all of his or her votes for one nominee
or allocate them among the nominees as the shareholder sees fit.
A. cumulative, straight
B. absolute, cumulative
C. straight, cumulative
D. straight, absolute
19. A shareholder who cannot be present at a meeting can vote by _______, that is, by a written
authorization for another person to vote on his or her behalf.
A. proxy
B. allowance
C. record
D. nomination
20. Which of the following is generally true regarding the liability of members of a limited liability
partnership for malpractice?
A. Members split evenly among themselves 50% of any assessed liability for malpractice against
any member with the limited liability company retaining liability for the remaining 50%.
290 MANAGERS AND THE LEGAL ENVIRONMENT
B. Members are not liable for their own malpractice or for the malpractice of other members
because recovery for malpractice may only be obtained from assets of the limited liability
partnership itself.
C. Members are liable for their own malpractice but not for the malpractice of other members.
D. Members are liable for their own malpractice and also for the malpractice of other members.
21. Which of the following involves settling accounts and liquidating assets of a partnership for the
purpose of making distributions and ending the partnership?
A. Debt resolution
B. Bypassing formalities
C. Termination
D. Winding-up
22. Which of the following refers to a merger in which some shareholders are required to surrender their
shares in the disappearing corporation for cash?
A. Illegal merger
B. Termination merger
C. Surrender consolidation
D. Freeze-out merger
23. Which of the following is false regarding decision making in a partnership?
A. Each partner’s assets are vulnerable to the poor business decisions of the fellow partners.
B. A partnership is prohibited from placing managerial control of the business in one partner.
C. Unless the partners expressly agree otherwise, partnership law requires unanimous agreement
of all partners on all but the most ordinary matters.
D. If the partners in an informal partnership cannot agree on a decision, they may disband the
partnership, distribute its assets, and terminate it.
24. Which of the following is true regarding incorporation?
A. A corporation must be incorporated in the state in which it has its principal place of business.
B. Laws regarding incorporation and the rights and duties of corporations are uniform from state
to state.
C. Since the mid-1930’s, Delaware has been considered the preeminent state for incorporation.
D. Incorporation may be done pursuant to common law as well as statute.
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25. Which of the following statements is not true regarding the characteristics of a corporation?
A. A corporation is a legal entity distinct from its owners.
B. A corporation is owned by shareholders.
C. The corporation itself is responsible for its liabilities.
D. The board of directors implements the decisions of the officers.
26. ________ of a general partnership occurs when all the affairs are wound up and the partners’
authority to act for the partnership is completely extinguished.
A. Dissolution
B. Termination
C. Winding up
D. Staged end
27. A _______ is a for-profit corporation that uses the power of business to solve social and
environmental problems.
A. C corporation
B. S corporation
C. B corporation
D. Benevolent Recognized Group
28. The ________ set forth the steps that must be taken to establish a corporation in a state.
A. Uniform Federal Rules
B. corporate statutes of each state
C. corporate bylaws
D. corporate charter requirements
29. If incorporators cannot show substantial compliance with statutes regarding incorporation but can
show that they were unaware of any defect and acted in good faith, a court may treat the entity as
a(n) ________.
A. de jure corporation
B. real corporation
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C. de facto corporation
D. equitable corporation
30. A corporation can conduct business as a ________ in states other than its state of incorporation.
A. domestic corporation
B. foreign corporation
C. pass through entity
D. alien
31. Sarah Smith works as a laser technician for a local dermatology center consisting of physicians
operating under a partnership agreement. Sarah purchased supplies through the mail from a medical
supply facility totaling $5,000. She signed the contract agreeing to pay for the supplies in her name,
Sarah Smith. A few weeks later the dermatologists became embroiled in a bitter dispute regarding
profits and terminated the partnership. Unfortunately, the partners were not aware of the debt owed
to the medical supply facility; and the bill remained unpaid. Sarah received a bill from the supply
company for $5,000. Is she liable to the medical supply company, and why or why not?
A. No, because she was only employed as a technician.
B. No, because the medical supply facility should have asked for proper identification.
C. Yes, because she signed in her own name.
D. Yes, but only because the partnership terminated.
Fact Pattern 19-1 (Questions 32-33 apply)
Joan decides to enter into a franchise agreement with XYZ Burgers to sell their burgers in her town.
The franchise agreement did not prohibit XYZ Burgers from granting other franchises in the area,
but that did not concern Joan because she thought XYZ Burgers would treat her fairly. She did not
bother to read the franchise papers, contracts, and disclosures she was provided. Joan’s business
went very well for the six months. Then, however, another XYZ Burgers franchise opened just
down the street from Joan’s restaurant. She was very upset and called XYZ Burgers to complain.
The CEO brushed off her concerns and told her that there was enough business for everyone. Joan,
however, is interested in suing XYZ Burgers.
32. Refer to fact pattern 19-1. Which of the following is the term used when a franchisor sells a
franchisee an outlet in a certain location, and then a few months later, sells another outlet a few
blocks away to someone else?
A. Encroachment
B. Fair trace
C. False competition
D. Crowding
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33. Refer to fact pattern 19-1. What is the position of the Federal Trade Commission regarding a
franchisor selling a franchise very near to an existing franchise?
A. That the practice is illegal.
B. That the practice is illegal unless the first franchisee provides specific permission for the sale to
the second franchisee.
C. That the practice is legal and that no disclosures are required.
D. That the practice is legal but that certain disclosures must be made to the first franchisee when
that agreement is made.
Fact pattern 19-2 (Questions 34-36 apply)
Maxine and Vince verbally agree to form a dog grooming partnership called “XYZ Grooming.”
They file nothing with the state. Maxine puts up 80% of the capital needed for the partnership, and
Vince supplies 20%. Maxine assumed that Vince would do extra work to account for the small
amount of capital contributed by him, but that did not occur. Maxine found herself grooming more
than 90% of the animals on her own. Maxine told Vince that he was only entitled to 10% of the
profits because he was only doing 10% of the work. Vince disagreed, and a heated argument
occurred. Not surprisingly, Maxine and Vince decided to end the partnership. While winding up
affairs, Maxine discovered that Vince paid an excessive amount for some dog shampoo. She
thought he bought it from a certain supplier just so he could flirt with the receptionist there. She told
him that paying for the shampoo was entirely his responsibility because she had not agreed to the
purchase. Maxine and Vince also became aware of a lawsuit filed by the owner of a Welsh
Pembroke Corgi complaining that the dog developed a skin rash following bathing by Vince in the
expensive shampoo he had purchased, and that the owner lost money because the dog could not be
entered into shows. Maxine told Vince that the litigation was entirely his responsibility and that she
disavowed any liability to the plaintiff.
34. Refer to fact pattern 19-2. Which of the following is true regarding Vince’s entitlement, if any, to
share in profits of the business?
A. Because he was not doing his share of the work, he was not entitled to any profits.
B. He was entitled to 10% of the profits.
C. He was entitled to 20% of the profits.
D. He was entitled to 50% of the profits.
35. Refer to fact pattern 19-2. Is Maxine, XYZ Grooming, or Vince responsible for payment of the
shampoo purchased by Vince?
A. The partnership is liable and Vince is liable in the event there are insufficient partnership assets,
but Maxine is not liable on the debt.
294 MANAGERS AND THE LEGAL ENVIRONMENT
B. The partnership is liable, and so are both Vince and Maxine if insufficient partnership funds exist
to pay the debt.
C. Vince is liable on the debt, but neither Maxine nor XYZ Grooming is liable.
D. Since the winding-up process has begun, neither Maxine, Vince, nor XYZ Grooming is liable.
36. Refer to fact pattern 19-2. Which of the following is true regarding liability on the lawsuit brought
by the Corgi owner?
A. The partnership is liable and Vince is liable in the event there are insufficient partnership assets
to pay any judgment, but Maxine would not be liable on any judgment.
B. The partnership is liable, and so are both Vince and Maxine if insufficient partnership funds exist
to pay any judgment.
C. Vince is liable on any judgment, but neither Maxine nor XYZ Grooming would be liable.
D. Since the winding-up process has begun, neither Maxine, Vince, nor XYZ Grooming would be
liable on any judgment obtained.
ESSAY QUESTIONS
1. Define a joint venture and list the elements necessary for a finding of a joint venture.
2. Explain requirements for formation of an S corporation.
ANSWER: To qualify for S corporation status, a corporation must satisfy the following
requirements:
1. The corporation must have no more than 100 shareholders, all of whom must be individuals who
3. Mike owns a small but successful coffee house. He decides to incorporate. Considering only tax
benefits, should Mike form a C corporation or a subchapter S corporation and why? Discuss
taxation under both forms.
4. Define class voting. Why would a group of investors be interested in a guarantee of class voting?
5. Set forth four of the shareholder proposals that must be included in proxy materials according to the
Securities and Exchange Commission.
6. In what five categories does the Franchise Rule require a franchisor to make material disclosures to
prospective franchisees?