BE – A General-Basic Video Lecture Intro to
Corporation Law(s)- Business Forms- Selection Factors
• Intended as video lecture for last Class of BEPart II or as a general lecture for Perspectives
of Am. Bus. L.
• Video link is:__________________
• Intro- Review of “Continuity and Choice of
Business Forms” Chart
• Intro- Review of Ethical Considerations in Coownership, entity situations.
• Review of some basic terminology
BE-Class- Intro to Corp
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Intro. Cont’d
• Intro- Historical Development(CB Ch 1 and
Arner article on Twen), including recent/modern
trends of corporation law
• State Corporate Statutes - Basics
• Internal Affairs Rule- Conflicts of Law-Case law
• Basic Corporate Governing Structure
• Rights & Protection of Owners
• Statutory Gaps
• Foreign Corporations
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Intro cont’d
• The Processes- Pre-Formation,
Formation, Post-Formation
• Interplay of Statutes-Contracts-Case law
• Importance of Structure/Planning:
Allocation and Maintenance of Ownership
and Managerial Control; Dispute
Resolution; Exit Mechanisms
• Corporate Taxation & Sec. Reg. Basics
• Business Form Selection Factors
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Continuity and Choice of
Business Forms
entity v. non-entity
legal rights & duties
flows of liability
statutory compliance
taxation (federal & state)
advantages and disadvantages of choice
A. STATE LAW
Unincorporated
No State Action
LTKs_____SP ____
Franchise
Supply
GP __
LP**
Incorporated
State Action
State Action
LLC ** _
Corp____________
JV LLP* -------LLLP*
Bus
Non-Profit
Gen CHC
Special
Prof. Banks Ins. Corp.
Agency Law
* State filing ** state action
___________________________________________________________________
B. FEDERAL LAW:
_____
Special – TVA (e.g.)
SEC. Reg. (BE) - PHCE (34 Sec. Act)
Tax - GP (Reporting, not taxable entity) Corp. – C Corp. (general) & Subch S (GP like)
BE-Class- Intro to Corp
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Basic Ethical Issues
• Entity Representation/Client Identification (Sec
1.13of ABA Code)
• Conflicts of Interest(ABA, Sec 1.7-1.8)
• Scope of Representation/Engagement Letter
(ABA 1.2)
• Competency (ABA 1.1)
• Confidentiality(ABA 1.6)
• Fee Arrangements(ABA 1.5)
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BE- Clarification of certain
terminology
• In the past, for course and exam purposes, some
confusion appears to arise for certain students as certain
terminology being used . Hopefully, the following will
help you avoid such confusion:
• Business enterprise: generic term covering any form of
sole ownership, co-ownership or long-term, cooperative
business arrangement contemplating an ongoing
business objective(s). Effectively would descriptively
cover all the business forms covered in this course.
Though “business enterprise” may have a specific
meaning for economists, it has no specific legal content
and is merely an umbrella, descriptive term.
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Terminology cont’d
• Corporation- in this course, unless otherwise expressly indicated, a
business entity formed under and subject to (for corporate law
purposes) a state general corporation statute. Most states have
separate special corporate-type statutes for Non-profit Corporations,
Professional Corporations, Banking Corporations, and Insurance
Companies. In addition as mentioned below, most states now has
special statutory provisions under their corporation laws for electing
to be a Statutory Close Corporation.
• CHE (closely-held enterprise)- descriptively covers all forms of
business enterprise formed under relevant state law that are coowned by a few owners , most (if not all) of whom are involved in the
active management of the enterprise.
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Terminology cont’d
• CHC (closely-held corporation)- descriptively covers
all corporations formed under a general state business
corporation statute that are co-owned by a few owners
(shareholders/stockholders), most (if not all) of whom are
involved in the active management of the corporation.
• Close Corporation (statutory) - A corporation formed
under a special state “Close Corporation statute” (e.g.
Texas, Delaware etc.).
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Terminology cont’d
• PHE (publicly-held enterprise) – Federal securities law
status- any business enterprise formed under relevant
state (e.g., corp., LP, business trust, LLC etc) whose
ownership interests would come under the federal
securities law definition of a “security” and which has a
equity class of such securities registered under the
ongoing registration/disclosure/and liability requirements
of the 1934 Securities Exchange Act and subject to
Securities Exchange Commission (SEC) scrutiny and
enforcement. Normally, an enterprise with 500 or more
owners and $10 million of more in assets. Still subject to
the relevant state law(s) under which it was formed.
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Terminology cont’d
• PHC (publicly-held corporation)- Federal securities law status-.a
PHE that is formed as a corporation: the most common form of PHE.
Still formed under and subject to relevant state corporation law.
• “C Corp”- Tax Status- the Subchapter of the Internal Revenue
Code under which most corporate entities or other business entities
electing to be taxed as corporation would be subject. Tax as a
separate entity/taxpayer. Double taxation situation. Still formed
under and subject to relevant state corporation law.
• “S or Subchapter S Corp”- Tax status- The Subchapter of the IRC
under which a corporate taxpayer could elect special tax status so
as to receive “partnership-like” income tax treatment. Still formed
under and subject to relevant state corporation law.
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Theories of Corporation
- Entity- Legal Person- Creature of State
- Collection of Constituent Relationships
- Contractarians- Nexus of Ks – Party
Autonomy
- Default Rules v. Mandatory Rules
- Team Production Model
- ? Role of Government Regulation
outside of state corporate laws
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Consequences of Incorporation
• Separate Legal Personality
• Possibility of Centralized Management
• Divisibility and Transferability of
Ownership Interests- Ability to raise capital
• Limited Liability for Owners (LtdL came
later in 18th century: was not an original
characteristic)
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Development of State Corporation Laws
(including recent trends)
• The historical beginnings in US -Distrust of
Corporation and Corporate Power-Specific Charter
Grants-Limited statutory powers-No holding
companies) (parent-subs)
• Rise of Enabling Statutes in mid 1800s
• Late 19th century- start of code liberalization- The
impact of Delaware Corp. Laws- ? “Race to the
Bottom”- “Liggett v. Lee”
• Separation of Ownership and Control-ImplicationsBerle; but today, can have large, influential
institutional shldrs
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Development-Trends cont’d
• The impact of Model Bus. Corp. Act (M.B.C.A &
RMBCA); impact of Dela statute as a “national
corporation law
• Spread of other Ltd Liability Forms/Statutes (e.g. LLC)
and flexibility within Corporate Codes ( e.g. RMBCA
approach and Texas separate Statutory Close
Corporation provision of Code)-Public Policy favoring
small business person(s)-flexibility and party
autonomy.
• Reduction/elimination of role of statutory capital
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Development-Trends Cont’d
• Judicial trend to apply partnership analogies
to CHC
• ? “Federal Corp. Law”- Fed Sec. Laws
• Modern Day approaches on “Corporate
Governance” for larger corp.- Pre and PostSOX
• PHC v CHC
• With modern LLC form, is there still a role for
the business corporation
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What is a Corporation . . . .?
Starting Point: State Statutes
MBCA §§ 1.40 (4),2.02 & 2.03
DGCL §§ 102 & 106
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Incorporation: An Event and a Process
• Grant of the State: Creature of the State- Enabling Statute
• Legal Entity(separate legal personality); Ltd. Liability for owners;
Separate Ownership Instruments (transferability-ownership
dispersion)
• Ownership instruments & certain debt instruments –
securities/securities laws
• Statutory management/governance structure: centralized
management v. owner management
• Modern exception – statutory “close” corporations and RMBCA
possible broad use of Shldr Agreement ( Sec 7.32) to structure
internal management and governance including doing away with
Bd. Of Ds . Some States (e.g. Texas and Dela.) also have special
Statutory Close Corporation provisions
• Incorporation- starting point for “allocating and maintaining control”
(ownership and management), effective dispute resolution, exit
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Corporate Statutory Status
•
•
•
•
•
Corporation – General
Special – e.g., banks, NPCs, PCs
Hybrid – Stat. close corp.
Subch S – Tax
PHC – Sec. Law (not strictly speaking a
corporate statute- investment securities
statutes
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Basic Sources of Corporation “Laws”
• State Enabling Statutes
• Contract(s)
• Case Law & Judicial Gloss- Gap-filling,
Interpretation, Equity
• ? Fed. and State Sec. Laws
• Fed & State Tax Laws
• ? Accounting Principles/Standards
(including RAP for PHCs)
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Business Corporate Stat. Models
MBCA
RMBCA
Dela. Gen. Corp. L.
Hybrids (e.g., Texas)
Special Close Corp. – Statutes (e.g,
Texas and Delaware)
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Special Close Corp. Statutes
Governance/Management
OPTIONS}
Traditional
Partnership-like
Hybrid
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Special Close Corp. Statutes
1. Share Restrictions
2. Compulsory Purchaser
3. Shareholder Agreements
4. Board Elimination
5. Elim. Bylaws
6. Special Dissolution and Dispute
Resolution
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New Texas Business Organization Code (TBOC)
http://tlo2.tlc.state.tx.us/statutes/bo.toc.htm
•
Spoke and Wheel Codified Consolidation
Table of Contents
TITLE 1. GENERAL PROVISIONS
• CHAPTER 1. DEFINITIONS AND OTHER GENERAL PROVISIONS
CHAPTER 2. PURPOSES AND POWER OF DOMESTIC ENTITY
• CHAPTER 3. FORMATION AND GOVERNANCE
• CHAPTER 4. FILINGS
• CHAPTER 5. NAMES OF ENTITIES; REGISTERED AGENTS AND
REGISTERED OFFICES
• CHAPTER 6. MEETINGS AND VOTING FOR DOMESTIC ENTITIES
• CHAPTER 7. LIABILITY
• CHAPTER 8. INDEMNIFICATION AND INSURANCE
• CHAPTER 9. FOREIGN ENTITIES
• CHAPTER 10. MERGERS, INTEREST EXCHANGES, CONVERSIONS,
AND SALES OF ASSETS
• CHAPTER 11. WINDING UP AND TERMINATION OF DOMESTIC ENTITY
CHAPTER 12. ADMINISTRATIVE POWERS
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TBOC- T of C cont’d
TITLE 2. CORPORATIONS
• CHAPTER 20. GENERAL PROVISIONS
CHAPTER 21. FOR-PROFIT CORPORATIONS
• CHAPTER 22. NONPROFIT CORPORATIONS
CHAPTER 23. SPECIAL-PURPOSE
CORPORATIONS
TITLE 3. LIMITED LIABILITY COMPANIES
• CHAPTER 101. LIMITED LIABILITY
COMPANIES
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TBOC- T of C cont’d
TITLE 4. PARTNERSHIPS
•
CHAPTER 151. GENERAL PROVISIONS
•
CHAPTER 152. GENERAL PARTNERSHIPS
•
CHAPTER 153. LIMITED PARTNERSHIPS CHAPTER
•
154. PROVISIONS APPLICABLE TO BOTH GENERAL AND LIMITED PARTNERSHIPS
TITLE 5. REAL ESTATE INVESTMENT TRUSTS
•
CHAPTER 200. REAL ESTATE INVESTMENT TRUSTS
TITLE 6. ASSOCIATIONS
•
CHAPTER 251. COOPERATIVE ASSOCIATIONS
•
CHAPTER 252. UNINCORPORATED NONPROFIT ASSOCIATIONS
TITLE 7. PROFESSIONAL ENTITIES
•
CHAPTER 301. PROVISIONS RELATING TO PROFESSIONAL ENTITIES
•
CHAPTER 302. PROVISIONS RELATING TO PROFESSIONAL ASSOCIATIONS
•
CHAPTER 303. PROVISIONS RELATING TO PROFESSIONAL CORPORATIONS CHAPTER
304. PROVISIONS RELATING TO PROFESSIONAL LIMITED LIABILITY COMPANIES
TITLE 8. MISCELLANEOUS AND TRANSITION PROVISIONS
•
CHAPTER 401. GENERAL PROVISIONS
•
CHAPTER 402. MISCELLANEOUS AND TRANSITION PROVISIONS
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Corporate Governance Structure
•
Statutory Model v. Real Model
•
Position of Shareholders
–
–
–
–
–
–
–
–
Ownership interest (including liquidation and any dividend rights)
Voting rights
Liquidation rights
Inspection rights
? Dividend rights
Litigation rights
Derivative Litigation rights
Appraisal rights-fundamental changes
•
Position of Directors
•
Position of Officers
•
Indemnification of Management
•
Special Close Corp. Provisions – “Partnership-like”
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Corporate Management
– Decision-Making Levels
Shldr
-
Director -
Fundamental Matters
Policy
(Fiduciaries)
Officers
-
Day-to-Day
(Agents & Fiduciaries)
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Corp. – Management Structure
Traditional
Shareholders – Directors – Officers
Non-Traditional
CHC can approximate “partnership” no directors –
“statutory close corp.”
PHC – power in management
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Statutory Governance Model
Shareholder----> Directors ----> Officers
Legal Flow of Authority/Power ---->
? Reality = -----> Or <----? CHCs
? PHCs
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Rights/Protection of Shareholders-Owners
• Equity Owners
• Voting – directors and major changes
• Preemptive rights: maintaining proportionate ownership
interests
• Cumulative voting - minority representation
• Liquidation rights
• Dividends (not mandatory)
• Information – limited under state law
broad if a P+C under Fed Sec. Law
• Derivative Litigation
• Case-law – particularly fiduciary duties and judicial gloss
on freeze-out
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General Shareholder Voting
• Requirement of State Law
– Annual Meeting – Election of Directors
– Meetings – Fundamental Changes
• Management Initiate >
Shareholder Contact
• Practical Realities = Use of Proxies
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Statutory Gaps
• In General
–
–
–
–
–
Conflicts of laws / fiduciary duties?
Disclosure
Special treatment of larger corporations
Special treatment for CHCs
Significance of legal status
• Selected problem areas
– Promoter problems
– Disregard of corporate entity and limited liability shield
– Relationship of controlling to minority shareholders
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Foreign Corporations
• Internal Affairs Rules
• Pseudo Foreign Corporation Laws
• Qualification Statutes
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Importance of Structuring/Planning
(see Building Block No. 6- Twen)
• Basic allocation and maintenance of
control issues (e.g., ownership
interests; other financial interests;
managerial control; exits, dispute
resolutions)
• Use of Articles, Bylaws, Share
Instruments, Shareholder Ks etc
• Tax Issues
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Redux- Legislative and Judicial Trends
• Legislative- greater flexibility options; greater
party autonomy; greater protection of limited
liability shield.
• Statutory “objectification” of fiduciary standards
• Judicial- looking at CHC more as a
“partnership”; greater protection in “shareholder
oppression “ situations; judicially crafted
remedies; exercise of its equity powers. Can
vary among jurisdictions (e.g., compare Mass. V.
Delaware)
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Corporation - Taxation
• Separate taxpayer – separate tax
schedule/rates
• Subch C – IRC - standard
• No Pass – thru (except with subch S); but
often can “Zero-out”
• “Double Taxation” (indiv. Shareholders)
• §351 tax free incorporation
• Cannot use “check-the-box” rules
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Tax Status-C Corp. v. S Corp
• “C” corp.- usual – taxable entity- double taxation
• “ S Corp.”- special tax status-partnership-like
 A Corporation under state law code
But taxed similar to (but not exactly) as a partnership – modified
conduct treatment
Formal election; can be lost (serious adverse practical
consequences-re-characterization for tax purposes as a C corp.)
Max. of 100 individual shareholders (limited exception for estates of
decedents and certain trusts). Most, though, are sole owner entities.
No non-resident aliens
One class stock (except can have common with different voting
rights- no pfd stock).
Can now have subsidiaries; No maximum asset size.
All shareholders must consent in writing to election
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The Selection Process – General Considerations
• The Players (owner, other financing sources including future
investors and external sources, key employees)
• Purposes and Objectives – Business – Non-Business
• Financing Requirements
• The Risks – Business & Legal
• Basic Liability Issues
• Basic Tax & Securities Concerns
• Employee benefits
• Advisers – Lawyers, Accountants, Fin. Planners
• Basic Ethical Concerns
• Time Frame
• Costs
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Some Key Selection Factors- See
Egan Article (Twen)
•
•
•
•
•
•
•
•
•
•
•
•
Legal Restrictions & Burdens
Limited Liability
Tax Status- federal and state (e.g. Texas Margin/Franchise tax)
Securities Status
Informality v. Formality
Simplicity v. Complexity
Costs
Flexibility – Double Edged
Continuity of Life
Centralization or Diffusion of Management
Exit Options other than ownership interest
Transferability of Ownership Interest;
Concentration – Non-Transf.
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Characteristics of Alternative Forms of Business Organizations*- Hamilton
Sole Proprietorship
General Partnership Limited Partnership
Limited Liability
Company
Formation
No filing required.
No filing required;
agreement of parties
involved. No
permission required.
Usually filing
required to protect
limited partners.
Filing with state
official required.
Duration
Sole Proprietor
determines.
Dissolved by
Partner s death or
bankruptcy.
Same as general
partnership.
Sometimes limited by Perpetual.
state law.
Liability
Sole Proprietor has
unlimited liability.
Partners have
unlimited liability.
General partners have Members not
unlimited liability;
typically liable for
Limited partners
debts of the LLC.
limited to amount of
investment.
Shareholders are
typically not
personally liable for
the debts of the
corporation.
Shareholders are
typically not
personally liable for
the debts of the
corporation.
Simplicity of Operation Yes.
Yes.
Yes, but some
formality related to
limited partners.
More formal than sole
proprietorship, less
formal than
corporation.
Formality of board of
directors, officers,
annual meetings, and
annual reports.
Formality of board of
directors, officers,
annual meetings, and
annual reports.
Management
Sole Proprietor has
full control of
management and
operations.
Typically each partner General partners have
has an equal voice
control.
unless otherwise
arranged.
Members have
Operating Agreement
that outlines
management.
The corporation is
managed by or under
the direction of the
board of directors
who are elected by the
shareholders.
The corporation is
managed by or under
the direction of the
board of directors who
are elected by the
shareholders.
Taxation
Not a taxable entity.
Sole proprietor pays
all taxes.
Not a taxable entity.
Income or loss is
passed through to
partners.
Not a taxable entity.
Income or loss is
passed through to
partners.
Members may choose
whether to have LLC
be a taxable entity or
to have income or
loss passed through to
members.
Not a taxable entity.
Income or loss is
passed through to the
shareholders.
Corporation is a
taxable entity.
Double Taxation
No.
No.
No.
No.
No.
Yes.
Cost of Formation
None.
None.
May be filing fee.
State filing fee.
State filing fee.
State filing fee.
Raising Equity Capital
Not unless individual
puts in money.
Contributions from
partners or an
addition of more
partners.
Same as a General
Partnership.
Possible to sell
interest. Subject to
operating agreement.
Sell shares of stock to Sell shares of stock to
raise capital.
raise capital.
Transferability of
Interest
No.
No.
Some for limited
partners.
Possibly.
Yes, subject to
consent.
BE-Class- Intro to Corp
S-Corporation
Filing with state
official required.
Corporation
Filing with state
official required.
Perpetual.
Shares of stock are
easily transferable.
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Bromberg – Comparison of Business Forms
Characteristics*
LLP
LLC
Corp.
LP**
Must be subject to federal corporate tax
No
No
Yes
No
May be used by professional
Yes
Yes
Yes1
No
May be used by nonprofit firms
No
Some
Yes2
No
May be used by one-member firms
No
Yes3
Yes
No
Owners have limited liability for all debts of firm
Some
Yes
Yes
No4
Insurance requirement
Some
No
Some5
No
Distribution restrictions
Some
Yes
Yes
Yes
Decisions-making formalities
No
No
Yes
No
Centralization of decision-making power
No
Yes
Yes
Yes
Firm necessarily dissolves on member dissociation
Some6
No
No
No
Default buyout right
Yes
Some
No
Some
Federal Securities law apply
?
?
Yes
Yes
State securities laws apply
?
Some
Yes
Yes
Convert or register from other business form
Yes7
Some
Some
Some8
Formation state law governs
Yes
Yes
Yes
Yes
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Notes to Bromberg Chart
* Refers to characteristic determined wholly or
mostly by governing business association
statutes.
** Some of these features, notably including
partners’ liability, default buyout rights, and
conversion, may be changed by Re-RU.L.P.A.
Remember State Margin/Franchise Tax
Applicatility
Yes=Applies to firms governed by most or all
status.
No=Does not apply to firms governed by some
statues.
?=Application of feature is unsettled or varies from
state to state.
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Further Notes to Bromberg Chart
1.
2.
3.
4.
5.
6.
Applies under professional corporate statutes.
Applies under nonprofit corporate statutes.
All but Massachusetts.
Does not apply to limited partners or to LLLPs.
Applies to professional corporations.
Applies under U.P.A.-based but not R.U.P.Abased statutes.
7. Registration by existing general or limited
partnerships.
8. R.U.P.A. permits conversion from general
partnership.
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