Chapter 14 – Business Organizations
14-1
Chapter 14
Business Organizations
Learning Objectives
This chapter presents the factors to consider when faced with deciding which organizational form
is best suited for a particular business activity. Upon completing this chapter, the students should
realize that there is no easy answer to the question, which form is the best for all business
activities. The students should become familiar with the various business organizations that may
be created. Specifically, the three basic organizational forms are presented along with four
additional forms which are essentially hybrids of the basic forms.
References
Carter, C.B. and J.W. Lorsch, Back to the Drawing Board: Designing Corporate Boards for
a Complex World. Harvard Business School Press (2004).
Cook, R.A., How to Start Your Own S Corporation. Wiley & Sons (2001).
Cortenraad, W.H.F.M., The Corporate Paradox: Economic Realities of the Corporate Form
Lowry, M.E., Corporate Governance for Public Company Directors. Aspen (2003).
Marcus, A., Big Winners and Big Losers: The 4 Secrets of Long-Term Business Success
Morse, G., Partnership Law. Oxford University Press (2006).
ACTS: Revised Model Business Corporation Act
Teaching Outline
Chapter 14 – Business Organizations
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Introduction
A. Forms of Business Organizations (LO 14-1)
Emphasize:
The meanings of the terms closely held and publicly held organizations.
That there are three basic forms of business organizations:
o Sole proprietorship
o Partnership
o Corporation
That this chapter also discusses four hybrid forms that businesses may use:
o Limited partnership
o S corporation
following material.
I. Factors to Consider When Selecting a Business’s Organizational Form
A. Creation
Emphasize:
That the word creation means the legal steps necessary to form a particular business
The most significant creation-related issues are how long it will take to create a
particular organization and how much paperwork is involved.
Additional Matters for Discussion:
The relevant costs in one’s area involved in the legal work related to creating various
organizations.
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B. Continuity
The impact (or lack of impact) of the dissolution of a business organization on the
business activity being conducted by that organization.
C. Managerial Control
Emphasize:
That the factor of control concerns who is managing the business organization.
Why the liability factor is very important and deserves significant consideration.
E. Taxation
Emphasize:
That there are specific advantages to creating the organizational forms that are “single
taxed.”
That advantages also exist when an organization is subject to the supposed “double tax.”
II. Selecting the Best Organizational Form (LO 14-2)
A. Sole Proprietorships
Emphasize:
That the proprietor obtains whatever business licenses are necessary and begins
operations.
That a proprietorship’s continuity is tied directly to the will of the proprietor.
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That the sole proprietor is in total control of his or her business’s goals and operations.
That a sole proprietor is personally obligated for the debt of the proprietorship.
That a sole proprietorship is not taxed as an organization. All the proprietorship’s
income subject to taxation is attributed to the proprietor.
Additional Matter for Discussion:
Ask students to provide examples, out of their own backgrounds, of businesses
conducted as sole proprietorships.
B. Partnerships
Creation
Emphasize:
That the key to a partnership’s existence is satisfying the elements of its definition:
of partnerships between entities that are not individuals.
Sidebar 14.2—“Formation and Naming of a Partnership”
Continuity
Emphasize:
That a general partnership is dissolved any time there is a change in the partners.
That in a general partnership, unless the agreement provides to the contrary, each
partner has an equal voice in the firm’s affairs.
Liability
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1. Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 (Mont. 1984)
A father and son each owned land and raised seed potatoes. They each used their own
equipment. Each raised about the same amount of potatoes, and they were stored
together and advertised for sale by Wilbur Kimm and Son. A loss arose.
Issue: Are the father and son partners such that they must share this loss?
contained proceeds from their sale of seed potatoes was prima facie evidence that a
partnership existed between father and son.
2. Volkman v. DP Associates, 268 S.E.2d 265 (N.C. 1980)
Volkman contacted David McNamee about obtaining advice on a residential
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David McNamee’s and Phillip Carroll’s names. In fact, there had been no actual
agreement between McNamee and Carroll to go into business together. A dispute arose,
and Volkman sued DP Associates as a partnership. Carroll sought to be dismissed from
this lawsuit since he was not in business with McNamee.
Issue: Should Carroll be estopped from denying his liability as a partner?
by another is estopped or prevented from denying such an association; that person is
liable as a partner to those who relied on such representations.
3. Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988)
Orel Koelling was a partner in a partnership that employed Martin Martinez. Mr.
Martinez died as the result of an accident which occurred in the course of the
partnership’s business. Mrs. Martinez filed suit against Koelling to recover for her
husband’s death. Koelling moved for summary judgment on the grounds that the
partnership was the employer and liable, if anyone was.
Issue: Should Koelling be dismissed from this litigation?
4. Martin v. Barbour, 558 S.W.2d 200 (Mo. 1977)
A jury returned a $125,000 verdict for the plaintiff against Drs. Barbour and Egle. The
case was based on negligence by Barbour in performing an operation. The defendant
Egle did not assist or participate in the surgery and did not treat the plaintiff. However,
Egle was a partner in the practice of medicine with Barbour at the time of the surgery.
Issue: Can one partner (Egle) be liable for another partner’s (Barbour’s) negligence?
C. Corporations
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Emphasize:
Creation
Emphasize:
That a corporation is created by a state issuing a charter upon the application of
individuals known as incorporators.
That in comparison with partnerships, corporations are more costly to form.
The costs of incorporation and the annual costs in continuing a corporation’s
operation.
Sidebar 14.4—“Steps in Creation of a Corporation”
Continuity
Emphasize:
That in contrast to a partnership, a corporation usually is formed to have perpetual
existence.
Additional Matters for Discussion:
That a corporation’s perpetual existence does not assure the success of that
organization’s business activity over time.
Managerial Control
Emphasize:
That the shareholders elect the members of the board of directors.
That these directors set the objectives or goals of the corporation, and they appoint
officers.
That these officers, such as the president, vice president, secretary, treasurer, are
charged with managing the daily operations of the corporation in an attempt to
achieve the stated organizational objectives or goals.
Publicly Held Corporations
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Emphasize:
That in very large corporations, control by management (a combination of the
directors and officers) is maintained with a very small percentage of stock
ownership through the use of corporate records and funds to solicit proxies.
Closely Held Corporations
Emphasize:
That those who own a majority of a closely held corporation can rule with near-
absolute authority.
The rights of the minority interest.
Additional Matters for Discussion:
The importance of a properly drafted buy and sell agreement in closely held
Emphasize:
That when courts find that the corporate organization is being misused, the corporate
entity can be disregarded. This has been called piercing the corporate veil.
What happens when the veil of protection has been pierced.
Case 14.1: Alli v. U.S., 83 Fed. Cl. 250 (2008)
Emphasize:
The techniques used to avoid “double taxation” of corporate income. These
techniques include:
o Payment of reasonable salary
o Use of reasonable expense accounts