1045
Chapter 43
Law for Small Business
See Separate Lecture Outline System
INTRODUCTION
This chapter discusses law with a particular emphasis on options and legal requirements faced by entrepreneurs who
wish to start up their own businesses. It explains how general legal principles found throughout the text apply in the
entrepreneurial context. Because of the importance of legal compliance in the success of an entrepreneurial venture, the
chapter also discusses how to obtain legal counsel.
ADDITIONAL RESOURCES—
VIDEO SUPPLEMENTS
1046 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
The following video supplements relate to topics discussed in this chapter—
PowerPoint Slides
To highlight some of this chapter’s key points, you might use the Lecture Review PowerPoint slides compiled for
Chapter 43.
Business Law Digital Video Library
The Business Law Digital Video Library at www.cengage.com/blaw/dvl offers a variety of videos for group or
individual review. Clips on topics covered in this chapter include the following.
• Drama of the Law
Intellectual Property: Trade Name: Rally Round the Trade Name—The name of your business is an important
may occur.
• Legal Conflicts in Business
Choosing a Business Name and a Domain Name: Wizard for Hire dot com—A start-up software company
finds that there are others who have similar business and domain names. What options do they have for resolving the
conflict?
Intellectual Property: Permissions in Cyberspace: Deep Linking Just Good Business?—The software
company has set up a web site that uses deep links to another site. Do they need permission from the linked site to put
them into a frame?
• Ask the Instructor
Intellectual Property: Patents and Trade Secrets: What’s the Difference between a Patent and a Trade
Secret?—Both patents and trade secrets are forms of intellectual property. A patent is a right, granted by the
government, to exclusive use of an invention. As a government granted right, the details of a patent are part of the
public record. Trade secrets, on the other hand, consist of valuable unique processes, formulas, or ideas that are
protected by virtue of the fact that they are kept confidential.
• Real World Legal
rights.
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• LawFlix
The Jerk—Intellectual Property—The Invention.
Midnight Run—Liability: Contract Negotiation, Formation, Statute of Frauds; Hiring a Bounty Hunter.
Mary Tyler Moore—Employment law—first show first season, the Lou Grant (Edward Asner) interview with Mary.
The Family Man—Employment law—Jack sells himself.
1048 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
CHAPTER OUTLINE
I. The Importance of Legal Counsel
Legal counsel is necessary to stay current and comply with the rules and statutes governing business. Activities for
which legal assistance may be necessary include—
* Negotiate a franchise agreement.
* Create standard business forms (purchase orders, etc.).
* Buy or sell property or a business.
* Negotiate an agreement to license intellectual property rights.
* Obtain new outside investors.
A. FIND AN ATTORNEY
Sources for finding an attorney include friends, associates, business networks, the Yellow Pages, and the
Martindale-Hubbell Law Directory.
B. RETAIN AN ATTORNEY
Reasons for retaining an attorney on an ongoing basis are—
C. HIRE AN ACCOUNTANT
Having an accountant adds to a business’s credibility.
II. Selection of the Business Organization
The following factors should be considered when choosing a business form (sole proprietorship, general partnership,
limited partnership, a corporation, an S corporation, a limited liability company, or a limited liability partnership).
ENHANCING YOUR LECTURE—
MOVING YOUR SMALL BUSINESS ONLINE:
SELLER BEWARE
It seems as if every owner of a small business wants to create a Web site, preferably one that contains as much
information as possible and pursues numerous goals. Before you do this, though, you have to consider some of the
global implications of pursuing an all-inclusive online presence.
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JURISDICTION
Small businesspersons creating any type of Web site that allows individuals to purchase goods and/or services may
run into jurisdictional issues. Because the Internet is a worldwide communications device, there is no way you can
effectively prevent your Web site from being viewed by virtually anyone with Internet access throughout the world.
Even within the United States, you cannot put a disclaimer on your Web site stating that you will only sell your goods or
services within the state in which your business has its principle office.
The same is true for foreign countries. Assume you are an online book seller. You can legally ship copies of Adolf
Hitler’s book, Mein Kampf, to anyone in the United States. But if you ship it to residents of Germany, you will have
violated German law. The same might be true for certain of Charles Dickens novels. Some of those novels are viewed
by many as anti-Semitic. Germany has strong anti-discrimination laws, so you might be in violation of those laws if you
shipped those offending novels to customers residing in Germany. Let’s say you started an online auction site. If some
of the items for sale on that site include Nazi memorabilia, then if you allow this Web site to be viewed by French
citizens, you are violating French law.a
TRADEMARK ISSUES
Before the advent of the Internet, small businesses would only have to check with the state in which they were
doing business to determine whether their business name did not infringe on someone else’s established business
name. With the Internet, business names often become part of a business’ Web site address. Consequently, small
businesses have to make sure that the company or major product names that they choose will allow them to purchase
a similar Web site name that does not infringe on some other company’s trademark, even if that company is in Europe
or Asia.
FOR CRITICAL ANALYSIS
Researchers are attempting to create technology that would allow Web site operators to screen out users
from certain geographic areas. What global issues discussed in this feature might be less of a problem if
such technology becomes cheap and effective?
a. Yahoo! Inc. v. La Ligue Contre le Racisme et l’Antisemitisme, 379 F.3d 1120 (9th Cir. 2004); cert denied, 126 S.Ct. 2332, 164 L.Ed.2d 841
(2006).
.b This is the general term used for all of Hitler’s actions to exterminate Jews during World War II).
A. LIMITATIONS ON LIABILITY
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Limiting personal liability for business debts and obligations is discussed as a key consideration in starting up a
business. Corporations, limited partnerships, limited liability companies (LLCs), and limited liability partnerships
(LLPs) offer this advantage. Insurance is still needed for business liability.
B. TAX CONSIDERATIONS
Taxes are a critical factor. Federal taxation differs among sole proprietorships, partnerships, and corporations. S
corporations and limited liability companies are taxed like partnerships (no “double” tax).
ADDITIONAL BACKGROUND—
Limited Partnership Associations (LPAs)
In the last decades of the nineteenth century, a partnership entity known as the limited partnership association
(LPA) was created. The first LPA statute was enacted in Pennsylvania in 1873, and before the end of the century,
Michigan, New Jersey, Ohio, and Virginia had also passed similar statutes. Unlike a general partnership, all of the
members of an LPA had limited liability, without regard to their participation in management. Interests in an LPA could
not be freely transferred to nonmembers. Like corporations, LPAs were allowed continuity of life and other corporate
characteristics, such as officers, bylaws, capital stock, and dividends.
So why aren’t businesses rushing to form LPAs instead of LLCs or LLPs? At the time of the LPA, courts
refused to recognize, in a state other than the state in which the LPA was formed, the limited liability of the LPA’s
members unless the foreign state also had an LPA statute. Because so few states had passed the statutes, this became
court case.
C. CONTINUITY OF LIFE
Regarding continuity of life (survival of an enterprise when an owner dies, resigns, is expelled, or becomes
incapacitated), corporations and partnerships may go on, but a sole proprietorship terminates with the death of
the owner.
D. LEGAL FORMALITY AND EXPENSE
To avoid heavy start-up costs, some entrepreneurs initially undertake business operations as sole proprietorships
or partnerships.
1. Requirements for All Businesses
Any business must meet requirements relating to—
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2. Formalizing the Business
Advantages of more expensive arrangements include their formality—the effects, should the owners have a
falling out, can be specified beforehand.
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III. The Limited Liability Company
The limited liability company (LLC) has become the preferred choice of business organization. Benefits include the
limited liability of the corporation without its double taxation.
A. THE BASIC STRUCTURE
An operating agreement serves as the firm’s charter. The owners are called members (and may be persons or
entities such as corporations). Its operators are known as managers.
1. Flexibility in Determining Members’ Rights
States allow LLCs much flexibility—for example, formal annual meetings are not required—but each states
provides rules that apply unless an operating agreement provides otherwise.
CASE SYNOPSIS—
Case 43.1: Mixon v. Iberia Surgical, L.L.C.
A state intermediate appellate court affirmed. “Dr. Mixon has provided no evidence to suggest the termination
was done to cause him harm or for any other reason than a legitimate business reason.” As for the buy-out amount,
“[u]nder the terms of the Operating Agreement, the parties agreed to use the ‘book value’ in determining the value of
a member’s interest, not fair market value. The book value of a business has a well-defined meaning, is unambiguous,
and is susceptible of only one construction. It is the value as shown by the books of the business, and no other value.
Book value is calculated by measuring the assets of the business against its liabilities.” This was what Mixon was paid.
………………………………………………………………………………………………………………………………..
Notes and Questions
Did Iberia Surgical’s release of Mixon from its membership constitute a “unfair or deceptive practice,” as
Mixon argued? No, at least not in the court’s view. A state statute prohibited “[u]nfair methods of competition and
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ANSWERS TO QUESTIONS AT THE END OF CASE 43.1
1. What might Mixon and the other members of Iberia Surgical have done to avoid the litigation and its
ultimate result in this case? Initially, Mixon could have attempted to negotiate different terms in Iberia Surgical’s
similar concessions. They could have acquiesced to at least some of Mixon’s criticisms of their practices or have made
2. Does the outcome in this case illustrate the advantages or the disadvantages of the LLC form of business
organization? Explain. The outcome in this case illustrates the advantages that the limited liability form of business
organization has over some other forms, including the sole proprietorship and partnership. Had Iberia Surgical been a
sole proprietorship, withdrawal from the firm by its owner would end its business and terminate it as an organization.
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent cases involving the termination of a member of a limited liability company (LLC) under the LLC’s
operating agreement include the following.
• Risk Management Services, LLC v. Moss, 40 So.3d 176 (La.App. 5 Cir. 2010) (The expulsion of a member of an
LLC was valid and binding under the terms of the operating agreement, even though the agreement did not contain a
detailed procedure for expulsion and required unanimous consent of all members to dissolve the LLC on the expulsion
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2. Extent of Fiduciary Duties
States impose requirements of fair and honest dealing among members an managers.
B. CONVERTING AN LLC INTO A CORPORATION
IV. How to Form a Business Entity
There are no special requirements for creating a sole proprietorship or a general partnership (except an agreement
between the partners). Forming a limited partnership is more complicated, but the process of incorporation is the
most complex (and without compliance, the chief advantage of limited liability can be lost). The corporation’s legal
formalities include the following.
A. CORPORATE NAME
It must be filed with the appropriate state office, and it must be different from that used by existing businesses.
Filing a name with the appropriate state official will protect the name as a trade name only within the state.
B. ARTICLES OF INCORPORATION, BYLAWS, AND INITIAL MEETINGS
1. Articles of Incorporation
2. Corporate Bylaws
3. The Initial Board of Directors’ Meeting
At their first meeting, they can adopt the bylaws, appoint corporate officers and define their authority, issue
stock, create a bank account, and take other necessary actions.
C. CORPORATE RECORDS BOOK
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V. Intellectual Property
There are aspects of intellectual property law that entrepreneurs should consider at the outset of any business
venture.
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A. TRADEMARKS
A business (trade) name used as a trademark must follow the principles of trademark law.
1. Trademark Selection
• A trademark cannot be too similar to another’s distinctive or famous mark or lead a customer to think
2. Trademark Registration
3. Trademark Protection
To protect a mark, an owner should use it and diligently complain to others who later use similar marks.
B. TRADE SECRETS
1. Nondisclosure and Noncompete Agreements
• To protect trade secrets, companies may require employees with access to secrets to agree in their
2. Misappropriation
At common law, a company can sue a firm or an individual that misappropriates trade secrets.
VI. Financial Capital
Raising capital is critical to business growth.
A. LOANS
A business can raise capital through a bank loan, a loan from the Small Business Administration, or credit cards.
Capital can also accrue for business expansion through tax breaks and tax cuts.
B. VENTURE CAPITAL
Most new businesses raise capital through exchanging certain ownership rights (equity) in the firm for capital.
1. The Pros and Cons of Venture Capital Financing