BUSINESS ORGANIZATIONS
Chapter 12
Meiners, Ringleb & Edwards
The Legal Environment of Business, 12th Edition
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CHAPTER ISSUES
o
Major forms of business organizations
o
How businesses are created
o
Factors that may influence a business’s choice of its
type of organization
o
Alternative business forms to apply to various
circumstances
o
See Exhibit 12.1
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SOLE PROPRIETORSHIPS
o
o
o
o
o
o
o
o
o
A person doing business for him/herself (sole proprietor)
Usually the proprietor owns all of the business property
Responsible for control of the business
Responsible for management
Responsible for liabilities/debts
May hire agents – liable for them as well
Capital must come from the owner’s own resources or is
borrowed
Profits from the business are taxed personally to the
proprietor
Record keeping formalities are at the owner’s discretion
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PARTNERSHIPS
Definition: An association of two or more persons to
carry on business as co-owners for a profit
 Partners or General partners control the operations &
profits
 Equal control unless agreed differently
 Under most state laws, a partnership may be sued as
an entity.
 Most states have adopted the Uniform Partnership Act
(UPA) and Revised Uniform Partnership Act (RUPA).

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PARTNERSHIPS
o
No required to enter into a formal agreement for a
partnership to exist at law
o
However, agreements are preferable, especially regarding
finances, management and dissolution issues
o
If the Partnership Agreement is silent, the UPA governs
(“default rules”).

Each of the partners has a fiduciary duty to other partner(s)


Latta v. Kilbourn: One partner may not use partnership
assets for own benefit
If the agreement does not state otherwise, the profits of the
partnership are divided equally.
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CASE
ZHOU V. BICKLEY

Bickley worked at a Yamaha shop. Frequently ate lunch at a Chinese restaurant
where Zhou and Zhang (Chinese immigrants) worked. Bickley told Zhou and
Zhang that the Yamaha shop was going out of business. Suggested they help
him open a new motorcycle repair shop.

Three of them signed two-year lease on building for the shop. Zhou and Zhang
paid security deposit & 1st month’s rent. They helped pay for inventory; helped
get the shop ready. Gave Bickley more money when he asked for it.

Soon after Zhou and Zhang asked for keys to building; Bickley refused. Asked to
see receipts and invoices; he refused. Asked to work at the shop; he refused.
Demanded a written agreement; he refused. Attorney sent a demand letter on
behalf of Zhou and Zhang; he ignored it.

Suit was filed. Demanded return of funds expended.

Bickley counterclaimed for breach of contract by his partners.

Trial court held: No partnership, only “a vague agreement to open a motorcycle
repair shop.”

Bickley operated as a sole proprietor who borrowed money that he owed to
Zhou and Zhang. Bickley appealed.
(Continued)
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CASE
ZHOU V. BICKLEY





Mere fact parties called themselves partners and refer to business as
a partnership, doesn’t make them partners or a partnership.
Zhou, Zhang and Bickley contributing money for expenses and
signed a lease, is no binding contract, much less a partnership. A
reasonable person could conclude that Zhou and Zhang simply
intended to enter into a partnership agreement in the future.
Bickley denied Zhou and Zhang access to building; denied them
access to financial records; refused to let them participate in the
operations of business. Such actions not consistent with a
partnership.
Affirmed: Parties did not intend to do things that would constitute a
partnership.
Intent to do things which constitute a partnership determines if
parties are partners.
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TERMINATION OF THE PARTNERSHIP

Dissolution occurs when an event takes place to dissolve the
partnership.

Change of the composition of the partners

Withdrawal of a partner

Bankruptcy of a partner concerning the business

Death of a partner

Winding up of the partnership involves completing any unfinished
business.

If terminated, partnership must be reformed.

Common: Partnership purchases life insurance on partners

Proceeds used to buy back the interest of deceased partner from her
estate
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LIMITED PARTNERSHIP

Definition: 2 or more persons (partners) who have entered into an
agreement to carry on a business venture for profit

MUST have a written agreement that is filed with the state. Called
Certificate of Limited Partnership. Puts 3rd parties on notice that limited
partners assets not available to satisfy claims against the LP

General partners (at least one)


Manage the business; Are personally liable to creditors; Have the
duty to account to the limited partners
Limited partners (at least one) are investors only

Do not manage the business; Are not liable for debts beyond their
contributions

Limited partners BECOME general partners at law IF they participate in
or manage the business (lose their limited liability).

Most states use some form of the Uniform Limited Partnership Act
(ULPA) or Revised Uniform Limited Partnership Act (RULPA).
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CASE
EAGLES LANDING DEVELOPMENT, L.L.C. V. EAGLES
LANDING APARTMENTS, L.P.







Eagles landing Development LLC (Eagles) contracted to build
apartments for Eagles Landing Apartments, LP (ELA) for $1.4
million.
ELA’s general partner was Bluff City. Two limited partners,
PNC, (a limited partnership) & Columbia (a corporation).
Eagles completed work but still was owed $931,000.
Agreement stated that Bluff City’s contribution wouldn’t exceed
net cash flow from rental of apartment.
Cash flow was not good; no money there. All cash invested in
ELA by partners was gone.
Eagles sued for contribution by PNC and Columbia.
Trial Court Held: ELA owed the $931,000.
ELA appealed.
(Continued)
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CASE
EAGLES LANDING DEVELOPMENT, L.L.C. V. EAGLES
LANDING APARTMENTS, L.P.







Columbia and PNC argue that if full developer’s fee is due under the
Development Agreement, they were not parties to it. They were only
limited partners
Contend they can’t be charged for any liability of partnership under
Development Agreement. Court agreed.
Unlike general partners, a Limited Partnership (LLP) protects partners
registered as limited liability partnerships. Partner in a registered LLP
is not liable. As partners in an LLP, neither Columbia nor PNC can be
held liable for partnership debts.
Trial court appeared to disregard PNC and Columbia’s status as
LLPs.
HELD: Affirm trial court’s judgment and amount of $ owed.
Reverse assessment of judgment to PNC and Columbia
Remand to trial court for purpose of entering judgment against only
the partnership, ELA.
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TERMINATING A LIMITED PARTNERSHIP
o
Similar to the termination of a general partnership
o
Death, insanity, withdrawal of a limited or general
partner will terminate
o
Bankruptcy of a general partner = termination
o
Bankruptcy of a limited partner does not
o
Organization must wind up the business
o
Creditors are paid and profits are dispersed according
to agreement
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CORPORATIONS
o
Legal “entities”/”persons”
o
Can sue & be sued
o
It has liability
o
It has constitutional rights
•
o
Except the privilege against self-incrimination (only
officers & employees have that right)
MUST meet formal requirements according to state
statutes
•
States issue corporate charter.
o
Liable for agents’ actions and contracts
o
Each state has its own corporation laws; federal
government places very limited role
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CREATING A CORPORATION
o
o
o
o
Articles of Incorporation and an application are sent to the
appropriate state office
• Name & Address of corporation
• Name and Address of registered agent
• Purpose of business
• Class(es) of stock and par value
• Names & Addresses of incorporators
The state issues a Certificate of Incorporation
Incorporators hold a first organization meeting
At the first meeting
• Elect a Board of Directors
• Enact bylaws or rules that govern internal operations (bylaws
cannot contradict the Articles of Incorporation)
• Issue the corporation’s stock
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RELATIONSHIP OF THE PARTIES





Important Separation
•
Of ownership (the shareholders)
•
AND of control (management & board of directors)
Shareholders

Owners of the corporation; no day-to-day control of activities

Shareholder meetings need quorum (usually more than ½ total shares present)

Most shareholders give their proxy to 3rd parties to represent them.

Shareholders elect Board of Directors

No legal relationship to creditors
Board of Directors

Have management power over large decisions

Can be removed from office by shareholders for cause (breach of
duty/misconduct)

Have fiduciary duty of loyalty to the shareholders
Managers

Appointed/hired by directors to manage day-to-day decisions

Have broad duties of care & loyalty to directors
Employees: Workers
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BUSINESS JUDGMENT RULE

Makes directors & managers immune from liability

WHEN problems result from honest mistakes in
judgment

IF there is a reasonable basis for their decisions

IF they act in good faith
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CASE
STORETRAX.COM, INC. V. GURLAND








Gurland founded Storetrax.com – internet-based commercial real
estate listing service in Maryland in 1998. Incorporated as a
Delaware corporation in 1999.
He agreed for a group of investors to buy majority share. Became
president and member of the Board of Directors.
Employment contract said that he had a year’s worth of pay in case
he was fired.
Two years later, he was removed as president, but stayed on the
Board for another year.
Requested severance pay, but was denied it. He sued.
Board claimed he was not due severance pay because his job
duties, title and salary changed.
Also, as Board member, they claimed he breached a fiduciary duty
by suing the company.
Lower Court Held: For Gurland. Storetrax appealed.
(Continued)
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CASE
STORETRAX.COM, INC. V. GURLAND
o
HELD: Affirmed.
o
There is a fiduciary duty of directors to the corporation.
o
However, situations arise where a corporate director may proceed with an
individual interest that may conflict with those of the corporation on whose
Board he sits.
o
When conflicts of interest arise, courts look closely if director’s dealings are
in “good faith and fair dealing”. If conflict arises, director can find a “safe
harbor” by disclosing to the corporation the conflict and important facts to
the remaining shareholders or directors.
o
Gurland had a conflict as an aggrieved former employer and his duty as
director of the corporation.
o
Gurland’s seeking $150,000 severance pay was not in corporation’s best
interest, HOWEVER
o
Gurland notified Storetrax sufficiently of imminence of lawsuit.
o
Gurland’s notification gives him the protections of “safe harbor”.
o
HELD: Gurland receives severance pay.
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TERMINATING THE CORPORATION



Voluntary

Approval of the shareholders and the Board of
Directors

Articles of Dissolution are filed with the state
Involuntary

The state dissolves it

Bankruptcy
“Wind up” business to pay creditors and disburse
profits to shareholders
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CLOSE CORPORATION VS.
S CORPORATION
S Corporation
Close Corporation

20 states allow

Distinguished from a “closely held
corporation” (See Ch. 18)

Limited # of shareholders – 30-50

Shares not sold openly

Shareholders must have
agreement that governs affairs

Not subject to formal rules
regarding shareholder and
director meetings (unlike regular
corporations)

Regular C corporation can elect
with IRS to be classified as S
Corporation

Have only one class of stock

No more than 100 shareholders

Only natural persons (U.S. citizens
or legal residents) can be
shareholders – not another
corporation or partnership

Primarily for tax considerations

Profits/losses allocated to
shareholders who pay income taxes

Very popular in smaller businesses
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PROFESSIONAL CORPORATIONS
o
Created by state laws
o
Owners of PC can only be professionals involved in the
firm itself (i.e. MD’s whose practices are tied together
o
Created to have limited liability for its members
o
Example: Doctors join to reduce liability risk for
malpractice of a member-doctor
o
Stock usually not sold to outside investors
o
Has special tax treatment with IRS
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BENEFIT CORPORATION

New Class of Corporation

Voluntarily meets high standards of purpose, accountability and
transparency.

Characteristics


(1) Corporate purpose to create a material positive impact on
society and environment

(2) Required to consider impacts of their decisions on
shareholders, workers, community & environment

(3) Required to make available to public annual benefit report
assessing their overall social and environmental performance
against a 3rd party standard
This entity gives its leadership greater leeway in making decisions
that may not comport with traditional standard of maximizing
financial interest of the firm.
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LIMITED LIABILITY COMPANIES


LLC is treated like a corporation for
liability purposes but like a partnership
for federal tax purposes.
State laws have procedures to create
LLC’s



Filing a document: Articles of
Organization
State issues a Certificate to
operate as an LLC
Usually is formed by two or more
members

Members have a membership interest

Limited liability of owners – the same
as a corporation

Members enter into an Operating
Agreement


An LLC does NOT have
perpetual life

Death, resignation retirement,
expulsion of member terminates
LLC

If remaining members give
consent, LLC can continue
(should be set out in Articles of
Organization)

Termination: There is a period of
winding up, followed by payment
of creditors and distribution of
profits.
Similar to bylaws of a corporation
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CASE
IN RE 1545 OCEAN AVENUE, LLC
1545 Ocean Avenue LLC formed for real estate project
 Owned 50-50 by two companies (Ocean Suffolk & Crown
Royal)
 Each company had membership certificate in 1545.
Operating agreement had no dissolution provisions
 Two managers appointed to operate 1545: Crown Royal
appointed King; Ocean Suffolk appointed Van Houten
 King and Van Houten argued; King announced Crown Royal
would pull out
 King sued for work to stop and the LLC too be dissolved
 Trial court granted King’s requests
 Ocean Suffolk and Van Houten appealed.

(Continued)
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CASE
IN RE 1545 OCEAN AVENUE, LLC

LLCL 702 (New York LLC Law) states that court must
examine the LLC’s operating agreement

Unilateral action of a single manager was permitted in
Article 4.1 of 1545 LLC Operating Agreement

Lets each manager to act autonomously to bind LLC in
furtherance of business of the LLC

Operating agreement was silent re: manger conflicts

1545 can only dissolved if cannot further purpose of LLC

HELD: Lower Court ruling reversed; proceeding
dismissed.

Dissolution is not granted.
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KEY ORGANIZATIONAL FEATURES
o
Limited liability
o
Control
o
Capital considerations
o
Taxation
o
Transferability of ownership interests
o
Method of creation
o
Entity as a distinct status separate from its owner
o
Each owner must make his/her own choice
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LIMITED LIABILITY

Allows a person to invest in a business without placing
their personal wealth at risk.

Allows investors to be passive toward internal
management.

Sole proprietors and general partners have unlimited
personal liability for debts of business, including torts.

Liability of limited partner is limited to capital
contributed to limited partnership.

Shareholders of corporation and members of limited
liability companies risk only their capital investment if
corporation fails – generally not personally liable for the
business debts or torts.
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LIMITED LIABILITY

Piercing the corporate veil

Affects limited liability organizations

Prove corporation is a sham

Owners actually intend to operate the business as a
proprietorship or partnership

Can involve fraud, undercapitalization or failure to
follow corporate formalities

Result: Owners are personally liable for all corporate
liability – torts, contracts, debts

See KC Roofing Center v. On Top Roofing, Inc.
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CASE
K.C. ROOFING CENTER V. ON TOP ROOFING, INC.
Nugents owned a series of roofing companies. Russell and
wife only shareholders, directors & officers
 1977: Russell Nugent Roofing Inc. was incorporated; 1985:
Corporation name changed to On Top Roofing; 1987: On Top
Roofing ceased doing business; 1987: Nugents did business
through new corporation RNR, Inc. 1988: Replaced by RLN
Construction, Inc. 1989: RLN Construction was replaced by
Russell Nugent, Inc.
 Business was run out of Nugent’s home
 In 1986 Nugents paid themselves salaries over $100,000
each
 Charged corporation $99,290 in rent for space in their home
 K.C. Roofing was owed $45,000 for roofing supplies sold to
On Top Roofing, which no longer existed.

(Continued)
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CASE
K.C. ROOFING CENTER V. ON TOP ROOFING, INC.








K.C. asked court to pierce the corporate veil and hold Nugents personally
liable.
District held for K.C. Nugents Appealed.
HELD: Affirmed. Nugents must pay K.C.
When corporation is used for an “improper purpose . . . to
perpetuate injustice” and “avoid its legal obligations”, corporate
veil is pieced.
Here: 1. Nugents had control of all aspects of business; 2. Control
was used to commit fraud or wrong or other positive legal duty,
including an “unjust act”; 3. Breach of duty caused unjust loss or
injury to plaintiff
Nugents were avoiding debts to plaintiffs.
Refused On Top’s obligations to creditors.
This is unfair, unjust and inequitable to allow Nugent to hide behind
corporate shield and avoid legal obligations to plaintiffs.
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TRANSFERABILITY OF OWNERSHIP INTERESTS

Refers to ability of an owner in a business to sell or
pass interest to others

Nontraded Entities

In sole proprietorship, selling the business ends the existing
proprietorship. Price is FMV to be determined.

If a partner sells or assigns interest in the partnership, the
partnership continues, but the new person doesn’t
automatically become a partner.


New person is just entitled to receive the share of profits the
partner would have received,
But can’t participate in management of partnership or right to
P-ship information without permission of other partners
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DURATION

Duration: Refers to ability to continue to operate in event
of death, retirement or incapacity of owner of business

Sole proprietorship terminates with death or incapacity of
proprietor.

At common law partnerships and LLC’s are dissolved by
death, retirement or incapacity of a partner, but are not
necessarily terminated. (Can reform)

Unless, articles of incorporation provide for period of
duration, corporation has perpetual existence.
•
Death or retirement of shareholder(s) does not bring
termination of the corporation.
•
(In fact, usually does not have any impact on
operations of the business.)
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FRANCHISES

Three types:
1. Product distributorships (i.e. Ford Dealership)
2. Trademark/trade-name licensing (i.e. Coca-Cola)
3. Business format franchising (i.e. McDonald’s)

Franchisor grants a right to sell goods or services to a
franchisee in return for payment of a franchise fee

Uniform product or services and the use of a trademark
help the franchisee establish quickly in the market

See Exhibit 12.4
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FRANCHISES

Laws are still developing

Federal & state laws protect
investors

FTC Franchise Rule: Franchisor is
required to give an offering circular
(disclosure statement) to potential
franchisees
Some states have laws to regulate
franchises as well – for example,
California.
o
Many states have business
opportunity disclosure filing
requirements.
o
Most states use the Uniform
Franchise Offering Circular (UROC)
as basis of reporting.
FTC v. Wealth Systems ,Inc.: FTC
alleged that 3 entities violated
Section 5 in selling home-based
o State agencies have authority to
Internet business opportunity by
investigate franchise fraud and
misrepresenting purchases will earn
other bad business practices.
substantial income.
o Some franchisees given extra
When violations occur, the result is
protection by state laws:
usually that promoted activity is closed
o Example: auto dealers and gas
down.
stations – often have extra rights
over other franchises


o
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FRANCHISES

The franchise agreement sets forth rights and
obligations of the parties, i.e. territorial rights, fees and
royalties, termination, etc.

Termination
•
Through explicit events that bring about franchise’s
termination
•
Fixed expiration time
•
Franchisor’s right to termination re: occurrence of
events –

Inspection problems or violations of franchisee

Bankruptcy of franchisor
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CASE
DUNKIN’ DONUTS FRANCHISED RESTAURANTS V. SANLIP
o
o
o
o
o
o
o
o
Three individuals owned Sanlip, Inc, which was Dunkin’ Donuts
franchisee.
Operated two donut shops in Norcross Georgia
Dunkin’ said defendants breached franchise agreements: Failed to
remodel their shops; Failed to participate in mandatory system-wide
programs; Failed to attend required training; Failed to prepare
immigration forms for new employees
Dunkin’ also said defendants transferred significant part of franchise
w/o Dunkin’s knowledge in violation of franchise agreement.
Sanlip did not dispute claims.
Protested that Dunkin’ was not allowing owners reasonable chance to
sell franchise.
Dunkin’ entered into settlement agreement.
Allowed Sanlip time to try to find buyer.
(Continued)
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CASE
DUNKIN’ DONUTS FRANCHISED RESTAURANTS V. SANLIP








Sanlip submitted proposed sale agreement. Dunkin’ refused to accept
the buyer. Asked court to order Sanlip to return shops to Dunkin’.
Sanlip counterclaimed: Dunkin’ had rejected a reasonable proposal
from buyer to take over shop.
HELD: Summary Judgment in favor of Dunkin’ Donuts. Defendants
must pay attorneys’ fees & costs.
Dunkin’ may not “unreasonably” reject proposed sale agreement.
Dunkin’ analysis: If store will lose money. If so, Dunkin’ rejects
proposed sale agreement. Also looks at financial condition of the
buyer if it decides store may break even.
This is firmly-established policy by Dunkin’ and reasonable.
Dunkin’ has right to terminate the agreement.
Lease agreements provide Dunkin’ may terminate lease if franchise
agreement for shop is terminated for any reason.
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