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Decision: Affirmed. The board of directors legally controls the basic actions of a company. The
courts rarely interfere with their judgments. Wrigley did not install lights because he was
Managers—The board of directors hires managers to operate the corporation on a day-to-day
basis. The use of hired management is one a significant advantage of the corporate form of
business where management by the owners of the business is impractical.
Terminating the Corporation—The termination is in two phases: the dissolution phase and the
winding up phase. Dissolution may be either voluntary or involuntary and effectively marks the
end of the corporation. Upon dissolution, it is prevented from taking on new business. A
voluntary dissolution involves approval of the shareholders and the board of directors; the board
acts as trustee in winding up the affairs of the corporation. Involuntary dissolution can be
brought about in the following ways:
1. An act of the legislature in the state of incorporation.
2. Court decree in the state of incorporation for any of the following reasons:
(a) Obtaining a corporate charter through fraud or misrepresentation.
(b) Failure to comply with the state incorporation statutes (e.g., failure to pay franchise taxes).
(c) Abandonment of or failure to begin the business before starting up.
(d) Abuse of corporate powers.
3. Bankruptcy.
Close Corporation—Twenty states allow the formation of this type. They usually can have no
more than 30-50 shareholders and the shares may not be openly marketed. Unlike C
corporations, a board need not govern them, so the shareholders usually play a more active role
in control.
S Corporation—An IRS election for firms that may not have more than 100 shareholders.
Primarily chosen for tax purposes, income passes directly to shareholders as in a partnership.
Popular with smaller businesses, most income must be from active operations, not passive
investments.
Professional Corporations—All states have statutes that allow PCs to be formed, so that
physicians and other professionals may join together for purposes of sharing some aspects of
their practice, but each member of the PC has limited liability with respect to the debts and
liabilities of the others. Generally only those involved in the practice may be stockholders. Tax
issues are very complicated.
Benefit Corporation—A form first allowed in Maryland in 2010 and now available in a dozen
states, it allows a firm to make an election that states its purpose is to consider social and
environmental consequences of its actions, and estimates of such impacts will be made. It takes
boards further away from the traditional value maximization presumption.
Add. Info.: Business Organizations in Mexico—
1. U.S.: Corporation; Mexico: Sociedad Anonima (S.A.)
Characteristics: Liability limited to extent of consideration paid for shares of stock; perpetual
life; privately or publicly owned; widely used by foreign investors.
2. U.S.: Corporation with Variable Capital (does not exist); Mexico: Sociedad Anonima de
Capital Variable (or S.A. de C.V.)
Characteristics: Similar to the S.A., except shares issued for variable capital in any amount
(25,000 peso minimum); variable capital may be increased or decreased by board resolution.
3. U.S.: Limited Liability Company; Mexico: Sociedad de Responsabilidad Limitada (or S.R.L.)
Characteristics: Has features of the U.S. corporation and partnership; used largely by small
enterprises with few owners (non-public); owners have limited liability; records show the names
of participants and the amount of their capital contributions. Because this form of business
organization is difficult to use without local subscriptions for participation, rarely used by
foreign investors.
4. U.S.: General Partnership; Mexico: Sociedad en Nombre Colectivo
Characteristics: Similar; in Mexico, articles must be executed before a Notary and inscribed in
the local Public Registry; it is an organization seldom used by foreigners in Mexico.
5. U.S.: Limited Partnership; Mexico: Sociedad en Comandita Simple (S. en C.)
Characteristics: Very similar; but in Mexico the restrictions on the activities of the limited
partners are more rigid with regard to controlling the business; seldom used by foreigners in
either country.
6. U.S.: Limited Partnership with Shares (does not exist); Mexico: Sociedad en Comandita pro
Acciones
Characteristics: Similar to a limited partnership except that a limited partner’s interests are
represented by stock and are readily transferable; rarely used by foreign investors.
7. U.S.: Sole Proprietorship; Mexico: Empresa or Empresa de Persona Fiscal
Characteristics: No separate legal existence of the owner and the business. Owner is personally
liable for all business debts. In Mexico, must give notice to the appropriate authorities and
establish membership in the appropriate Chamber. In the U.S., the sole proprietor may meet
certain formalities with the state government including “doing business as” filings and
obtaining a tax employer identification number. Frequently used for small business operations
and is seldom used by foreign investors in either country.
8. U.S.: Joint Venture; Mexico: Asociacion en Participacion (A. en P.)
Characteristics: Similar; used primarily for managing short-term project between two
companies. In Mexico, a joint venture has no separate status as a legal entity and cannot
transact business in its own name and no special tax treatment is provided. The percentage of
Mexican ownership is determined by the division of profits. In the U.S., a joint venture is viewed
as a general partnership. While in U.S. the joint venture is used occasionally by foreign
investors, it is seldom used by foreign investors in Mexico.
Add. Info.: S Corporations—S corporations provide its owners with limited personal liability
and allow company profits to pass through to owners who are then taxed at individual rates.
Corporate taxation is eliminated. However, use of an S corporation is restricted to individuals
(no corporations) and to U.S. citizens (no foreigners). Also, it can have no more than 35 owners
or shareholders.
International Perspective: Offshore Businesses
Offshore business operations are often portrayed as a corrupt or unethical way to hide profits
from legitimate or dubious sources. In fact, in some high-quality locations, such as the Caymans,
there is no interest in having shady firms. The firm creation process is more stringent than in
U.S. states. Any business operation in another country, from any other country’s perspective, is
offshore. A Japanese firm that creates an operation under U.S. law is an offshore operation. Why
do it? Often for tax reasons—the jurisdiction chosen has more favorable tax treatment. The band
U2 moved its business operations (income) from Ireland to the Netherlands due to favorable tax
treatment there. Sophisticated offshore locations, such as the Caymans, offer expert services by
highly-skilled professionals in law, finance, and other areas of operation. Nations compete to
attract capital and business operations. Shady businesses operations have little concern for the
quality of legal services.
LIMITED LIABILITY COMPANIES—Compared to partnerships and proprietorships, the
corporate form of business has a disadvantage—double taxation—and an advantage—limited
personal liability. To encourage ventures by overcoming the difficulties found in the various
corporate forms of organization, states have enacted statutes allowing limited liability companies
(LLC), a hybrid organization treated like a corporation for personal liability purposes but a
partnership for tax purposes. The LLC has been a common in Latin American and Europe (the
GmbH in Germany and Holding Companies in the U.K.). LLCs were first recognized as a legal
entity in the U.S. in 1977 but were not of great interest until the IRS ruled in 1988 that it would
treat LLCs like partnerships for federal tax purposes, as long as the company structure is more
like a partnership than a corporation. The IRS states it basically considers four factors:
1. Limited liability
2. Management centralization
3. Transferability of member interests
4. Continuity of life
If the LLC has more than two of these characteristics, the IRS will consider it a corporation—not
a partnership—for tax purposes. To help ensure federal taxation as a partnership, state LLC
statutes now focus on placing some restrictions on the transferability of member interests and on
the length of the time the company is expected to be in existence.
Method of Creation—As with corporations, state statutes provide a procedure to be followed in
the creation of an LLC. In general, the procedure requires that the organizer file with the
Secretary of State a document referred to as the Articles of Organization, which are similar to a
corporation’s Articles of Incorporation and include:
1. Company name (generally must include “Limited Liability Company” or “LLC”)
2. Address of the company
3. Business purpose of the company
4. List of company members
5. Date (or event) upon which the company will be dissolved
Personal Liability—After reviewing the application, the state will issue a certificate allowing
the company to commence business activities as an LLC. Most state statutes providing for the
creation of an LLC contain a specific provision stating that no member or manager will be
personally liable for the debts of an LLC.
Relationship of the Parties—An LLC is usually formed by two or more members having equal
status (In Texas and Florida, an LLC may have just one member). Members are much like the
shareholders of a corporation and have a membership interest in the company. There are
generally no restrictions on number or type of members. Individuals, corporations, partnerships,
and other LLCs may be members. Members usually enter into an agreement, called an Operating
Agreement. In Texas and Florida, this is referred to as the company “regulations.” Like the
bylaws of a corporation, the Operating Agreement provides more extensive rules regarding the
operation of the company and the relationships of the members. Unless the Agreement says
otherwise, members may not transfer their interests without the consent of the other members. In
contrast to stock in a corporation, membership interests may not be freely sold or given away to
third parties.
The Continuity-of-Life Factor—To enjoy federal taxation as a partnership, the LLC will not
likely be allowed continuity of life. IRS regulations provide that continuity of life does not exist
if the death, insanity, bankruptcy, retirement, resignation or expulsion of any member causes
dissolution. This way, the regulations provide that dissolution of the limited liability company for
this purpose—eliminating continuity of life—does not mean termination of the company. Rather,
it means just a change in the relationship of the company members as determined under state
law. Thus, while the loss of any member terminates the continued membership of a member, the
company itself can continue if all remaining members give their consent. This way, while the
company continues in existence, the relationship of the members has changed—satisfying the
IRS regulations.
Add. Case: Lieberman v. Wyoming.com (Sup. Ct., Wyo., 2000)--Lieberman and others created
Wyoming.com LLC in 1994. Initial capital was $50,000, of which Lieberman contributed
$20,000 for a 40% interest. The Articles of Organization were amended in 1995 to reflect an
increase in capitalization to $100,000. Additional funds came from new members, but
Lieberman’s share remained 40%. In 1998, Lieberman was fired as vice president of
Wyoming.com. He demanded the return of his share of the current value of the company, which
he estimated to be $400,000 for 40%. His withdrawal was approved but he was only offered his
original $20,000 back. He sued. The court held that he was only due $20,000; he appealed.
Decision: Affirmed in part. The LLC need not be dissolved due to Lieberman’s withdrawal. He is
entitled to the return of his capital contribution of $20,000, which has been offered. His
contention that he should get the fair market value of his interest in the LLC is less clear. The
Termination—An LLC is dissolved and its affairs wound up:
1. Upon expiration of a period fixed for the duration of the company in the Articles of
Organization;
2. By the occurrence of an event specified in the Articles of Organization to bring about the
disillusionment of the company;
3. By the unanimous consent of all the members; or,
4. By the death, retirement, resignation, expulsion, bankruptcy, dissolution of a member or
occurrence of any other event that terminates the continued membership of a member, and the
remaining members vote not to continue the business.
In some states, if there is no event or time specified in the Articles of Organization, the LLC
dissolves by statute after 30 years. Upon dissolution, the LLC winds up its affairs. Then the
assets are liquidated, first to satisfy creditors and then to the members. In some states, the
company must file a Certificate of Cancellation of Articles of Organization with the Secretary of
State.
CASE: 1545 Ocean Avenue, LLC (App. Div., NY, 2010)—1545 was formed in a 50-50 deal by
two companies under an operating agreement to develop a piece of property. One company
appointed Van Houten to run 1545, the other company appointed King to run 1545 with Van
Houten. The two argued. King sued to pull his company out of the LLC and sued to stop
construction. The trial court agreed with that request. Van Houten and his company appealed.
Decision: Reversed. The Operating Agreement does not provide for one party to have the right to
withdraw and, thereby, shut down the operation due to a dispute over operations. Each of the two
Questions: 1. The unhappy member, King (Crown Royal), cannot get out of the LLC this way.
What options exist?
In this instance, not many. What the court said was that you bound yourselves to the agreement,
so live by it. There was no claim of fraud by King against Van Houten, the two just argued about
how to best accomplish the job. Van Houten had authority under the agreement to do what he
2. What should the members have done differently when they set up 1545 LLC?
The agreement was not drafted to consider what to do if parties come to disagree. When there is
equal control in a 50-50 deal, it can be tough. The courts do not like to settle ordinary business
disputes. Since deadlocks were possible, the operating agreement could have made a provision
KEY ORGANIZATIONAL FEATURES—Several key factors influence the choice of business
organization, including liability, the transferability of ownership rights, the ability to continue the
business in the event of the death or withdrawal of one or more owner(s), the capital
requirements of the business, and the tax rate applicable to the business organization selected.
Limited Liability—Limited liability allows investors in a business to put at risk only the amount
invested, not the rest of their wealth..
Entities with Unlimited Liability—Sole proprietors and partners in a general partnership
potentially have unlimited personal liability for the debts of the business, including its torts.
Entities with Limited Liability—The liability of a limited partner in a limited partnership is
restricted to partner’s investment in the partnership. Members of LLCs risk only their capital
contribution. Shareholders risk only their capital investment if the corporation fails. They are not
personally liable for the business debts or torts of the corporation, unless they contract to make
themselves personally liable. However, if a limited partner, member, or a shareholder disregard
the rules that protect them from liability, the courts will hold them personally liable.
CASE: K.C. Roofing Center v. On Top Roofing (Ct. App., Mo., 1991)—The Nugents owned a
series of roofing companies, changing the names, but always running the company out of their
home. They did not pay KC $45,000 for roofing supplies, despite paying themselves $100,000
each and paying themselves $99,290 for renting space in their home to run the business. Their
company had no money, so KC asked the court to hold the Nugents personally liable for the debt.
The court ruled for KC. The Nugents appealed, contending only their corporation could be liable.
Decision: Affirmed. Courts pierce the veil when the business is shown not to be a real
independent operation but rather controlled by defendants for commit fraud or wrong—to avoid
Questions: 1. When a court pierced the corporate veil, doesn’t that defeat the purpose of limited
liability?
No, it strengthens it. Limited liability is understood by all dealing with a corporation. Deal with a
company on shaky grounds, and you might not get paid. But here, the cash flow, evidenced by
2. Could K.C. Roofing have protected itself by filing a lien against On Top?
Not given the speed with which Nugent switched companies and moved funds around. The result
Add. CASE: Miner v. Fashion Enterprises (Ct. App., Ill., 2003)—Miner gave a ten year lease
for a store to Karen Lynn, a corporation. Lynn defaulted. Miner sued and won a judgment that
Lynn could not pay. Miner sued Lynn’s parent company, requesting that it be held liable for
Lynn’s debt. Trial court dismissed the suit. Miner appealed.
Decision: Reversed. The corporate veil may be pierced when there is really a unity of interest
Add. Case: Dana v. 313 Freemason (Sup. Ct., Va., 2003)--Dana and Hall bought an old
building at 313 Freemason St. and converted it into condos. They formed a corporation as only
shareholder. The building was the only asset. After they sold the condos, they were sued by the
new owners for fraud for serious construction problems. They contended that only the corporate
entity, 313 Freemason, could be sued. It was worth nothing. The court held them personally
liable. They appealed.
Decision: Affirmed. The corporate veil is pierced on a case-by-case basis. The evidence was
clear that Dana and Hall were concerned about liability problems related to construction when
Add. Case: Tigrett v. Pointer (Ct. App., Tex., 1978)--In April 1974 Tigrett sued Heritage
Building Co., resulting in a judgment against Heritage in 1976 for $49 per week for 401 weeks.
Heritage was insolvent according to the testimony of its president and sole stockholder, Pointer.
In May 1974, Pointer transferred all of Heritage’s assets to himself to repay a loan he had made
to the company. The same day, Pointer transferred those assets to Heritage Corp. (a new
corporation) as a loan. Tigrett sued for a writ of garnishment against Pointer, Heritage Corp.,
and other corporations owned and controlled by Pointer. She alleged there was a fraudulent
transfer of assets and that all corporations were the alter egos of Pointer and should all be
liable for the previous judgment. The court found for Pointer. Tigrett appealed.
Decision: Reversed. Pointer is personally liable for the debts of Heritage Building. When a
corporation transfers its assets to its controlling stockholder to repay cash advances, without
providing for other creditors, the court may consider whether the manipulation of the corporate
form to serve personal interests justifies imposition of personal liability: “Personal liability may
be imposed on the sole stockholder only in extraordinary circumstances. ... Pointer organized
Transferability of Ownership Interests— The ease of ability of owners to transfer ownership
interests differs significantly among the various forms of business organizations.
Nontraded Entities—Since the proprietor in a sole proprietorship is, in essence, the business, a
decision to sell or otherwise transfer the business terminates of the existing proprietorship and
creates a new one. Such businesses are difficult to value, as are most partnerships and LLCs. The
market for such businesses is “thin” because they do not commonly sell part or all of the
businesses, and often cannot without high transaction costs. Closed corporations are not
publicly-traded and generally have only a few shareholders, so the sale of a closed corporation is
very similar to the sale of a sole proprietorship.
Issue Spotter: Keeping Things in Order
Keep company records. Small companies often fail to follow formalities–after all, it is mostly the
person running the place. But remember that the business is a separate legal entity, and must be
seen as such. You must follow state law regarding such things as the need for an annual meeting
of the board of directors–keep minutes of that meeting with signatures by directors. File needed
papers and/or payments as required by the Secretary of State, to keep your corporate status in
place in the state capital. Keep your accounting records straight as advised by your accountant
for proper tax filing. Do not mix company funds and your personal funds–a common problem.
And keep company records that show good faith to follow the Uniform Preservation of Private
Business Records Act (adopted by eight states). In general, all business related records should be
kept three years. Formality counts. And make sure all documents, checks, etc. include the formal
designation of the company–Inc. or LLC.
Publicly Traded Corporations—The stock of large public corporations is traded on a stock
exchange such as the New York Stock Exchange. A stock can be sold/transferred without the
permission of the other owners, with the only fee being a sales commission imposed by the stock
broker. The sale of ownership shares is very easy and has low costs.
Duration—A business’s duration refers to its ability to continue to operate in the event of the
death, retirement, or other incapacity of an owner of the business.
Limited Life—A proprietorship terminates with the death or incapacity of the proprietor. A
partnership is dissolved by the death, retirement, or other incapacity of a partner, but is not
necessarily terminated. It may be terminated with the liquidation of the partnership’s assets, but
partners usually agree in advance that the partnership will continue by entering into a
continuation agreement. The same is true of LLCs.
Perpetual Existence—Unless its articles of incorporation provide for a specified period of
duration, a corporation has perpetual existence. With perpetual existence, the death, retirement,
or other incapacity of a shareholder will not bring about the termination of the corporation. In
fact, in most large corporations the death of a shareholder has no impact on the operations of the
business.
Add. Info.: Other Forms of Business Organization: Besides the most common forms of
business organization, other forms are available, including joint ventures, syndicates, and
cooperatives:
Joint Ventures—Defined by the Supreme Court as a general partnership for a limited time and
purpose. It usually involves two or more individuals or companies who agree to combine their
mutual interests in a specific project and to share in the subsequent losses or profits. Joint
ventures vary in size and are most popular as an international business organization.
Cooperatives—A business (that may or may not be incorporated) to provide an economic service
to its members. Cooperatives are usually formed for members to pool their purchasing power to
gain some advantage in the marketplace, usually to get lower prices for members through large
quantity purchases. Cooperatives that are not incorporated are usually treated as partnerships;
the members are jointly liable for its acts. If formed as a corporation, it must meet the
appropriate state laws governing nonprofit corporations. In contrast to corporate dividends,
cooperative dividends are on the basis of a member’s (shareholder’s) transactions with the
cooperative rather than on the basis of capital contributed.
Syndicates—Name given to a group of persons who join to finance a specific project. A common
example of a syndicate is the large real estate development, such as a shopping center or
professional office building. They may exist as general partnerships, limited partnerships, or
corporations.
FRANCHISES—About one-third of domestic retail sales–more than $1 trillion--take place in
franchised outlets. Nationwide, there are about 3,000 franchises and more than 500,000 franchise
outlets. A franchise is considered to exist whenever a franchisee, in return for the payment of a
“franchise fee,” is granted the right to sell goods or services by a franchisor according to a
marketing plan. The marketing plan must be substantially associated with the franchisor’s
trademark, copyright or other commercial symbol. As a rule, the franchisee operates as an
independent businessperson subject to the established standards and practices of the franchisor.
Types of Franchises—Product and trade name franchising is the largest, accounting for more
than 70% of franchise sales. These include distributorships (auto dealers and gas stations) and
manufacturing franchises (soft drink bottlers). These franchises are licensed to distribute the
product as it comes from the franchisor’s plant, or to take essential ingredients (Coca-Cola
syrup), manufacture the finished product, and distribute it. In business format franchising, the
franchisor provides the franchisee with things needed to begin the business, demanding that the
franchisee operate the business according to fixed standards. Included in this category are
franchised restaurants, non-food retailers, business services, rental services, and hotels and
motels.
The Law of Franchising—Franchise law is relatively new and still developing. Most of the
statutory law is intended to protect investors from fly-by-night, unethical, and criminal operators.
The statutes require franchisors to register the franchise and to disclose relevant information for
franchisees to make informed investment decisions.
