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CHAPTER 39
CORPORATE FORMATION AND FINANCING
ANSWERS TO CRITICAL THINKING QUESTIONS
IN THE FEATURE
DIGITAL UPDATE—CRITICAL THINKING
Is thinking about committing a crime illegal? In general, the obvious answer is, no. Thinking
about murdering one’s spouse, so long as no positive actions are taken toward that goal, does
not constitute a crime. Thus, using preventive analytics to predict malfeasance on the part of
GLOBAL INSIGHT—CRITICAL THINKING
The law underlying the case against Microsoft is the Electronic Communications Privacy
Act, which was enacted three years before the invention of the World Wide Web. Should
that law still apply today? Why or why not? Of course, Microsoft argues that this law has to
be amended by Congress for the government to obtain, via a search warrant, electronic
communications stored abroad.
Further, Microsoft has argued that U.S. search warrants have not been able to reach
overseas just as U.S. residents would not want foreign courts to be able to search domestic
2 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 39.1—CRITICAL THINKING
LEGAL ENVIRONMENT
Why would the appellate court permit Polyflow to get away with not paying for delivered
and presumably merchantable goods? Drake filed a suit in a Pennsylvania state court to
collect the unpaid amount of its contract with Polyflow. The court entered a judgment in Drake’s
favor. A state intermediate appellate court reversed this judgment, however, permitting Polyflow
to get away with withholding payment for Drake’s delivered and presumably merchantable
CASE 39.2—LEGAL REASONING QUESTIONS
1. How do the purposes of the CIA support each other? The CIA (New jersey’s state
Charitable Immunity Act) serves two primary purposes. First, immunity preserves a charity’s
assets. Second, immunity recognizes that a beneficiary of the services of a charitable
2. Can a person be a direct beneficiary of a nonprofit’s good works even though the
person is on the nonprofit’s premises under the direction of a third party? Explain. Yes,
a plaintiff can be the beneficiary of a nonprofit entity’s good works even though his or her
presence on the premises results from a relationship with another person or entity, and not the
nonprofit itself.
For example, a member of an organization that receives charitable benefits from a local
church could be on the church grounds at the behest of the member’s organization to receive a
3. Suppose that the Museum had not been hosting an educational panel in its auditorium
but instead had rented the facility to an organization for a sales conference. Would the
result have been different? Discuss. The result in the Pantano case might or might not have
been different if the Museum had not been hosting a panel discussion in its auditorium but had
rented the facility to an organization for a sales conference. The outcome would depend on the
purpose of the organization and its conference, and the amount of the fee. If, for example, the
Other cases in which charitable, religious, and educational institutions have been held
immune under the CIA have included the following circumstances.
1. The plaintiff fell while attending a concert at a hall owned by a university and
rented to a non-profit chamber symphony. The university was immune.
3. A member of a Greek Orthodox parish that paid a nominal fee for the use of a
4. A church was immune from liability for the injuries suffered by a non-parishioner
guest at a wedding held on the church’s grounds.
CASE 39.3—CRITICAL THINKING
ETHICAL
The failure of Teal Properties and Jerry Teal to reimburse the tenant, Dog House, for the
repair costs placed the tenant in a dire financial situation. Does this consequence make
the landlord’s conduct unethical? Discuss. A breach of contract is a failure to keep a
promise. This is clearly unethical. In this case, the contract included a promise by the landlord—
Jerry and Teal Properties—to reimburse its tenant—Dog House—for the funds expended to
repair the flood damage to the leased premises. Neither Jerry nor Teal Properties repaid Dog
House.
4 UNIT EIGHT: BUSINESS ORGANIZATIONS
LEGAL ENVIRONMENT
The trial court also concluded, and the appellate court affirmed, that Teal Properties had
breached its contract with Dog House. What was the contract? How was it breached?
The contract included the terms of the lease and Jerry’s promise to reimburse Dog House for
the cost to repair the flood damage to the leased property. Under the lease, the landlord
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Theory
2A. Articles
Sharp is likely to be personally liable based on piercing the corporate veil due to ignoring the
corporate form. Technical details in the articles of incorporation alone would not be likely to
3A. Credit
4A. Classification
The corporation was formed and operated in Georgia, so it is a domestic corporation. It is
owned by one person, so it is private; its stock is not traded, so it is also a close corporation.
CHAPTER 39: CORPORATE FORMATION AND FINANCING 5
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
The sole shareholder of an S corporation should never be able to avoid liability for
the torts of her or his employees. Perhaps it makes sense to allow individuals to use business
organization forms that allow them to pass through profits to their personal tax returns, but it
ANSWERS TO ISSUE SPOTTERS
AT THE END OF THE CHAPTER
1A. Northwest Brands, Inc., is a small business incorporated in Minnesota. Its one
class of stock is owned by twelve members of a single family. Ordinarily, corporate
income is taxed at the corporate and shareholder levels. Is there a way for Northwest
Brands to avoid this double taxation? Explain your answer. Yes. Small businesses that
meet certain requirements can qualify as S corporations, created specifically to permit small
businesses to avoid double taxation. The six requirements of an S corporation are (1) the firm
2A. The incorporators of Consumer Investments, Inc., want their new corporation to
have the authority to transact nearly all conceivable types of business. Can they grant
this authority to their firm? If so, how? If not, why not? Broad authority to conduct business
6 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO BUSINESS SCENARIOS
AT THE END OF THE CHAPTER
39-1A. Preincorporation
(a) As a general rule, a promoter is personally liable for all pre-incorporation contracts
made by the promoter. The basic theory behind such liability is that the promoter cannot be an
agent for a nonexistent principal (a corporation not yet formed). It is immaterial whether the
(b) Incorporation in and of itself does not make the newly formed corporation liable for
pre-incorporation contracts. Until the newly formed corporation assumes Peterson’s contracts
39-2A. Ultra vires doctrine
It could be argued that Oya exceeded her authority when she cosigned the note on behalf of the
corporation. The board of directors of a corporation delegates the authority to transact all
ANSWERS TO BUSINESS CASE PROBLEMS
AT THE END OF THE CHAPTER
39-3A. SPOTLIGHT ON SMART INVENTIONS—Piercing the corporate veil
A corporation can be liable under the doctrine of respondeat superior for the torts of its agents
or employees committed while they are acting within the scope of their employment. In this
case, Nokes was acting on behalf of Smart Inventions, which would thus be liable for Nokes’s
39–4A. Piercing the corporate veil
The appellate reversed the trial court’s opinion as it relates to the piercing of the corporate veil.
The appellate court pointed out that genuine issues of material fact existed as to whether
Smith’s corporation abused the corporate form by disregarding it and using it to undermine
39-5A. Close corporations
Yes, Pourgol’s acts may likely have constituted misconduct. In this problem, Burnett charged
Pourgol with the submission of incorrect plans to obtain the building permit, misrepresentation of
the extent of the renovations, and a failure to fix the house. The submission of incorrect plans
might arguably have been a mistake and the misrepresentation a misstatement in good faith.
39–6A. Piercing the corporate veil
The court may hold Greenblatt, Jahelka, and Nichols personally liable by piercing the corporate
veil. Loop was essentially a sham that existed only for the benefit of its owners. Given that its
three shareholders invested only $1,000, Loop was comically undercapitalized. Moreover, after
39–7A . BUSINESS CASE PROBLEM WITH SAMPLE ANSWER—Piercing the corporate veil
Yes, there are sufficient grounds in the facts of this problem to support piercing the corporate
veil and holding Kappeler personally liable to Snapp. First, in a case in which a plaintiff seeks to
pierce a corporate veil, there must be a fraud or other injustice to be remedied. In that situation,
the factors that a court will consider in determining whether to pierce the corporate veil include
39–8A. Torts
Yes, R&K can be held liable for the torts of its employees. A corporation is liable for the torts
committed by its agents or officers within the course and scope of their employment. The
doctrine of respondeat superior applies to corporations in the same way as it does to other
agency relationships.
39–9A. A QUESTION OF ETHICS—Piercing the corporate veil
(a) Yes, assuming that 2406–12’s allegations are true, there are sufficient grounds to
pierce Alianza LLC’s corporate veil. When the owners of a corporation, or as in this case, an
LLC, use the entity to perpetrate a fraud, circumvent the law, or in some other way accomplish
(b) If the parties to this dispute in this case were small, close corporations, the court
might more readily pierce the business entity’s veil to hold its owner personally liable for the
sought-after rent.
The potential for the assets of a business entity to be used for personal benefit is especially
great in a close corporation. In such a corporation, the separate status of the corporate entity
and the shareholders (often family-members) must be carefully preserved.
In a close corporation or a similarly sized limited liability company, the business entity is
owned by only a few persons. Certain practices can create a risk for the owners by intertwining
their interests with the interests of the entity. For example, the commingling of business and
10 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO LEGAL REASONING GROUP ACTIVITY QUESTIONS
AT THE END OF THE CHAPTER
39–10A. Corporate versus LLC form of business
(a) Forms of business entities such as corporations have long histories, the law is
generally predictable and well known, and the agreements and other forms required are fairly
standard. This is not true with limited liability companies (LLCs) and other more recent types of
(b) An LLC of five members could be member-managed or manager-managed. The
most important factor is what the state requires with respect to the management of the firm.
Other factors that should be taken into consideration include whether the members want all of
