Types of businesses:
1. Sole proprietorship
Cost of setup and maintenance is minimal
File a Schedule C
Civil liabilities
Tort
Contract. Implied warranty of merchantability, a customer assumes that a product is good, and it isn’t.
2. Partnership
Partnership agreement is not requirement, therefore, there may be no costs.
Form 1065 is filed. It’s an information return. A partner can be held liable if another is liable.
3. Corporations
Cost of setup may be yearly. Maintenance may be significant.
It’s a separate taxable/legal entity. General rule is that its owners cannot be held liable past their contributed capital.
Partnership. An association of 2 or more persons engaged in business as co-owners for profit.
It is voluntary.
It can be between 2 or more corporations. X Inc. and Y Inc.
If there’s sharing of profit between 2 or more persons, there’s evidence of a partnership. The burden of proof of non-partnership then shifts to the defendants.
Name is not suppose to be another legal entity.
Illinois Assumed Name Act must be followed if the owners do not want to name their partnership with their own names. You must publish this for approximately three weeks in any periodic journal, such as a newspaper.
Technically, a partnership is not a legal entity. But, for accounting or others, it is treated as a legal entity.
6 types of transactions in the
Statute of Frauds. MYLEGS
Marriage
Year – If a contract cannot be
performed within one year, it must be in writing.
Land
Executor’s contracts
Goods 500 or more
Suretyship
A written partnership agreement is not required. Uniform Partnership Act.
Elements that should be in a partnership agreement.
Identity of firm property.
Capital call. If in the agreement, partners can order one partner to give capital.
A partner to manage the partnership.
Dissolution
Continuation agreement in the event of a death of a partner.
Majority controls for ordinary business matter, however, a unanimous vote is required for extraordinary items.
Admitting a new partner
Changing capital structure of the partnership
Changing nature the business
Assigning partnership property
Disposing of goodwill
Confessing judgment against the partnership
Submitting to arbitration
Fiduciary duty to the partnership and to the partners. Very strict duty. Partners cannot cheat other partners. It’s a breach of fiduciary duty.
Cannot divert any partnership duty to himself.
Cannot take partnership assets for his own benefit.
Cannot compete against his partnership
Must expose conflicts of interest
Technically, a partner cannot sue your partners. But there’s a suit for accounting, it’s to dissolve the partnership.
Partnership property. All partners are tenants in partnership. All partners have a right to use 100% of the property 100% of the time for partnership purposes only. No partner has a right assign partnership property to anyone. You can assign your partnership interest.
A partner’s wife, in the event of a partner’s death, is entitled to her husband’s interest in the partnership.
Community of interest test.
Was it purchased by the partnership?
Was it carried on the books of the partnership?
Was there an agreement?
Partners’ liability. Joint and several (individually) liability in tort and contract. If a 3rd party asserts partnership, he has the burden of proof.
Authority. Actual express authority
Implied authority. This reasonably flows from the express grant of authority.
Apparent authority. There’s a reasonable test.
Holding out concept. If a person tells others he is an expert CPA, he’ll be expected to be above ordinary CPAs, and he’ll be held to a higher standard than ordinary CPAs.
Criminal liability (same as agency law).
Termination of partnership. Any fundamental change in the relationship between the parties cause a dissolution of the partnership.
Act of the parties
Expulsion of a partner
Withdrawal of a partner, rightfully or wrongfully.
Agreement in contract
Operation of law
Death of a partner, unless there’s a written continuation agreement
Bankruptcy
Dissolution by order of the court
Winding up process. Liquidation. Distributions. All outside creditors first. Subordination - inside creditors (a partner) second. (An employee is considered an outside creditor.) Capital contributions are third. Profits are fourth. Lingering apparent authority. Outsiders need actual notice of dissolution. In the winding up process, an ex-partner can be entitled to a salary.
Past debts. New partners are liable for past debts only to the extent of capital contribution. New partners inherit, IN FULL, in continuing liabilities (rent).
Limited partnership. Created by statute. Must be filed in the state. Limited partners are liable only to the extent of capital contribution. Limited partnerships only need to have ONE general partner. Limited partners, in liability only, can be held liable IN FULL if they stick their nose into the partners’ day-to-day activities.
Limited liability companies cannot protect limited partners in cases of fraud.
Corporations.
Advantages. Shareholders are shielded from contract and tort liabilities.
Public corporation, owned by public entity, such as a city, state. Tennessee Valley Authority.
Private corporation. IBM.
Not-for-profit. American Cancer Society
Closely-held corporation. One that’s controlled by few shareholders.
Reporting company. 500 or more shareholders and $500 million or more in assets - these require reporting to the SEC.
Professional corporations. Doctors.
Limited liability partnerships.
Setup.
Designations: Ltd., Corp., Inc. Name cannot be deceptively similar to another residing within the state unless there’s a certificate of authority to do business.
Centralized management
Free transferability of stock
Preincorporation contract
Promoter arranges capital; fully liable prior to incorporation. Minimizes liability by novation after the corporation comes into existence or upon the beginning
Adoption of the contract. The corporation can adopt a contract which will release the promoter.
The corporation can ratify the contract also, so that the promoter can be released from liability.
Preincorporation subscription agreement – irrevocable for 6 months or other stipulated time frame. General rule, upon incorporation of the company, the signer will take stock in the company. The signer gives money after incorporation.
Articles of incorporation. Required
Corporate name
Duration – can have perpetual (unlimited) existence
Corporate purpose – if it changes, the articles need to be amended (subject to shareholder approval). These days, it can be general, such as “If it’s legal, we’ll do it”.
Registered agent and address. Agent can be another corporation.
Number and value of shares authorized by the corporation. Par or non-par value (NPV) stock.
Initial number of stocks issued.
Signed by an incorporator. Incorporator can have the job for about 3 seconds, can be the lawyer.
Process
Articles must be submitted to the state.
Organizational meeting of shareholders.
Director will be elected.
Adopt the bylaws.
Directors will elect the officers.
Ultravirus Activity takes place when the corporation acts outside of its corporate purpose. Shareholders can file a suit with the Ultravirus Activity. The court can file an injunction prohibiting the corporation from taking Ultravirus Activities.
Ultravirus activity is not a defense to void a contract.
A corporation de jure is a corporation that complies with statute.
A corporation de facto has a technical defect or mistake. The parties made a good faith attempt to comply with all requirements of a corporate de jure. Even a de facto corporation can protect the shareholders.
Only the state can pierce the corporate veil, but sometimes other individuals can also pierce the corporate veil to hold the shareholders liable. These are conditions where the shareholders can be held liable.
Undercapitalization - to a reasonable extent
Failure to observe corporate formalities. If there are no corporate books, there’s a failure to observe corporate formalities. Minutes of director’s meetings. If you have this failure, you are treating this as a sole proprietor or partnership.
Commingling of funds and assets. Corporate funds were used to pay car payments, for example. Corporation is not pierceable if there’s embezzlement by one or few shareholders/employees.
The corporation is formed to perpetuate a fraud.
Management of the corporation
Shareholders elect the directors. Directors elect the officers.
Vote on extraordinary items
Vote on annual meetings stated in the bylaws
Quarm
Shareholder record date for dividends, voting.
Shareholders cannot manage.
Shareholder can only see the corporation’s books and records with a “proper purpose”
Voting systems
Per capita voting - one share, one vote
Cumulative voting - allow minority voters a chance to sit on the board of directors
Authorized shares
Treasury stock - issued, not outstanding stock; does not vote
Proxy - give someone else the right to vote your shares; revocable; expire on their own after 11 months
Voting trust - a formal document, irrevocable; cannot last more than 10 years; shareholders can use this to have the block of shares vote one way
Trustee - the legal holder
Beneficiary – the one who benefits; the receiver
Shareholders’ agreement - have no legal force or effect
Directors’ agreement - void as a matter of policy
Shareholders’ pre-emptive right - allows a shareholder to maintain his proportionate right upon the issuance of new stock of the company. The shareholder has the first right to purchase new stock for the purpose of maintaining his percentage of outstanding stocks.
Directors.
Elected by the shareholders to serve, generally one year term
make policy decisions
appoint the officers who serve at the pleasure of the board of directors
give raises
only ones who authorize dividends
resolutions to do things
one or more are required
staggered terms
shareholders can go to the court to dissolve the directors
vacancies
can be allowed to continue
special meeting of shareholders
directors can appoint a replacement
can be removed only by the shareholders - without cause
can amend bylaws, but not the articles
can delegate some things to committees
Formalities
Meetings, check the bylaws
Board votes as a board, there’s no 3 to 2
Director can have personal liability in gross negligence
Dissent on the vote can remove a director from personal liability
Business judgment rule. No liability when there’s a mistake.
Manage day to day affairs
Agent of the corporation
Serve at the pleasure of the board
Duties of management
Duty of care
Loyalty in good faith; conflict of interest - burden of proof is on the officer
Corporate opportunity doctrine. “Serp a corporate opportunity” means that an employee takes responsibility for something for which he has no authority. If the employee gives full disclosure, he is absolved from liability.
Interlocking directorate. A person can be a director in two competing companies, but there may be a breach of fiduciary duty. Burden of proof is on the director to show there is no conflict.
Share - a representation in the voting in a company; in differences, think risk
Common stock - greatest risk, greatest reward
Redeemable common stock
Par value - corporation must receive par value, no less
Preferred stock - ownership subject to contract rights
Straight (regular) non-cumulative preferred stock - will get paid before common shareholders; dividends that could’ve been paid are not accumulated
Cumulative preferred stock - dividends that could’ve been paid are accumulated
Cumulative and participating preferred stock - can enjoy the rewards of the common shareholders
Redeemable preferred stock - similar to a call option
Convertible preferred stock – can be converted to common stock
Restricted or lettered stock - prevents holders from transferring stock to others; printed on the front of the stock; transferability must first be toward the corporation, in accordance with the Shareholders’ Agreement
Option – a right but not the obligation to purchase at a later date upon vesting date and before termination date
Watered stock, stock less than FMV, dilutes the other shares, responsibility on the difference between FMV and issued price is on the directors.
Debt instruments, both are issued under indenture
Bond is secured by corporate property
Debenture is not secured
Restriction: Board cannot pay the dividend if the company’s insolvent; violate the articles of incorporation
Extraordinary actions of a corporation; Board must pass a resolution, then the shareholders vote
Merger
Sale or lease outside the course of the business
Dissolution of the company
Amend the articles of incorporation
Dissenters rights: results of the appraisal remedy. Dissenters can demand the FMV of the stock if they dissent
Merger. Merged company dissolves
Consolidation: Company A and company B consolidating into company C.
If there’s 90% ownership, shareholder approval’s not required; 75% ownership requires shareholders’ approval
If a shareholder loans the corporation money, there has to be a loan agreement and imputed interest rate, according to the IRS.
Involuntary dissolution. Done by the Secretary of State or the shareholders, through action of the courts
Direct action lawsuit. Shareholder looks for the individual benefit against the corporation
Shareholders’ derivative action. Shareholder brings suit in the name of the corporation. Shareholder must be there throughout the case. Shareholder does not benefit. Corporation benefits.
Subchapter S of the internal revenue code. For taxes only. If the corporation makes a subchapter S move, dividends are not double-taxed. No more than 75 shareholders for subchapter S
LLC – Limited liability corporation, do not have the restrictions that the subchapter S has; created by statute; must be filed with the state
Statutes, 1933 Act deals with the initial public offering (IPO) of the company
Security - a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of a promoter or 3rd party
Prohibit the offer or a sale of securities unless they’re properly registered.
Covered by the 1933 act: underwriters, issuers, and dealers (sells the stocks)
Concept behind the 1933 act – provide the buying public with information
Prefiling date: Nothing needs to be done
Filing period: between filing date to effective date; cannot sell anything
Tombstone add: name of the company, everything else but the financial statements
After the effective date, CPAs must be paid; balance sheet must be disclosed; everything else must be disclosed
Accuracy not investigated by the SEC.
Exemptions:
Regulation A: Partial exemption; not a complete exemption for registration; issuer cannot sell more the $5 million of stock in a 12 month period; file with the SEC a notice.
Regulation D: 4 general requirements
1. Shares cannot be immediately resold to the public
2. General solicitation to sell is not allowed except under rule 504
3. Any buyer of the securities has to given an audited balance sheet unless the sale is under an accredited investor of rule is under 504
Accredited investor: banks, deep pockets
4. SEC has to be notified within 15 days
Rule 504: Offering cannot be more than 1 million for more than 12 months; unlimited number of investors; do not have to give anybody information
Rule 505: maximum dollar mount: 5 million in a 12 month period; no more than 35 unaccredited investors; unlimited accredited investors; financial information (balance sheet) to unaccredited investors only
Rule 506: unlimited dollar amount to offering; no more than 35 sophisticated investors (sufficient knowledge of information to evaluate); no unaccredited investors; unlimited accredited investors
CPA liability:
Section 11: Civil liability can be used in the event of an untrue statement or omission of a material fact even though it was perfectly innocent; also applies to underwriters, issuers, and dealers; no negligence required
Defense is due diligence, but not a guarantee
Section 12: Fraud; punitive damages can be awarded - no limit; when there’s criminal intent, there’s criminal liability; intent to deceive
1934 Act. Regulates the exchanges; $5 million in assets and 500 or more shareholders - become a reporting company under the 1934 Act
Rule 10b5: antifraud provisions; Always show that he bought or sold the securities
Insider trading - own 10% or more of the company? you are an insider. Insider traders have to give back their profits
Section 13D Tender offers: File a notice of the SEC if they want to purchase 5% or more
Section 16B Short-swing profits - owners of 10% or more of a company, officers, or directors who buy or sell stock with 6 months and make a profit must give back profits; have absolute liability, even with no intent to defraud; must file a 104
1933 Act Exemptions: exempt securities from registration: banks and savings and loans; charitable, non-for-profits corporation, railroads; U.S. or state and local governments; short-term commercial paper; issuance of insurance policies
1934 Act Exemptions: Investment companies, savings and loans, charitable organizations
Security interest; interest that a creditor has in property of a debtor recognized by law
Security agreement: contract between the debtor and creditor; creditor gives value; debtor has rights
Types of security interest
Possessory security interest: security interest by possession. Creditor takes physical control over the collateral (pawn shop)
Nonpossessory security interest: Debtor has possession of collateral, but creditor has the rights
Purchase money security interest (PMSI): Seller or bank retains security interest; funds are actually made to purchase the collateral
Collateral: specific property of a debtor which the secured party has a security interest
Must describe the collateral sufficient enough to allow a reasonable person would know it if they looked at it
How is it being used?
Tangible:
Consumer goods: for personal, family, or household use
Farm products: corn
Inventory: generally held to public for sale or lease
Equipment: any type of good that is not inventory of consumer goods
Intangible: Accounts receivable, patents, copyrights, goodwill
Semi-tangible: indispensable paper: documents of title, chattel paper (promissory note), instruments (stocks)
Process
Attachment, relationship between debtor and creditor. Security interest has to have attachment: has to have in writing unless it’s a possessory security interest
Only the debtor has to sign, the creditor does not have to sign
There must have intent to create a security interest
After-acquired property clause
Commercial transactions, it’s OK, but not in consumer transactions