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Law Chapter 12

Terms in this set (57)

Sole Proprietorships
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
Partnerships...how may they be sued
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.
Partnerships
No required to enter into a
formal agreement for a partnership to exist at law

However, agreements are preferable, especially regarding finances, management and dissolution issues
Each of the partners has a fiduciary duty to other partner(s)
: 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.
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.

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.
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
Limited Partnership
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).
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.

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.
Terminating a Limited Partnership
Similar to the termination of a general partnership
Death, insanity, withdrawal of a limited or general partner will terminate
Bankruptcy of a general partner = termination
Bankruptcy of a limited partner does not
Organization must wind up the business
Creditors are paid and profits are dispersed according to agreement
Corporations
Legal "entities"/"persons"
Can sue & be sued
It has liability
It has constitutional rights
-Except the privilege against self-incrimination (only officers & employees have that right)
Corporations
MUST meet what
liable for what
formal requirements according to state statutes
-States issue corporate charter.

Liable for agents' actions and contracts

Each state has its own corporation laws; federal government places very limited role
Creating a Corporation
Articles of Incorporation and an application are sent to the appropriate state office

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
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
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
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.
HELD: Affirmed.
There is a fiduciary duty of directors to the corporation.
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.
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.
Gurland had a conflict as an aggrieved former employer and his duty as director of the corporation.
Gurland's seeking $150,000 severance pay was not in corporation's best interest, HOWEVER
Gurland notified Storetrax sufficiently of imminence of lawsuit.
Gurland's notification gives him the protections of "safe harbor".
HELD: Gurland receives severance pay.
Terminating the Corporation
Voluntary
Approval of the shareholders and the Board of Directors
Articles of Dissolution are filed with the state
Terminating the Corporation
Involuntary
The state dissolves it
Bankruptcy
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)
S Corporation
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
Professional Corporations
Created by state laws
Owners of PC can only be professionals involved in the firm itself (i.e. MD's whose practices are tied together
Created to have limited liability for its members
Example: Doctors join to reduce liability risk for malpractice of a member-doctor
Stock usually not sold to outside investors
Has special tax treatment with IRS
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
benefit corp...note about leadership
This entity gives its leadership greater leeway in making decisions that may not comport with traditional standard of maximizing financial interest of the firm.
Limited Liability Companies
LLC is treated like a corporation for liability purposes but like a partnership for federal tax purposes.

Usually is formed by two or more members
Members have a membership interest
Limited liability of owners - the same as a corporation
State laws have procedures to create LLC's
Filing a document: Articles of Organization
State issues a Certificate to operate as an LLC
Members enter into an
Operating Agreement
Similar to bylaws of a corporation
life of an LLC
members
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 of an LLC
There is a period of winding up, followed by payment of creditors and distribution of profits.
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.

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.
Key Organizational Features
Limited liability
Control
Capital considerations
Taxation
Transferability of ownership interests
Method of creation
Entity as a distinct status separate from its owner
Each owner must make his/her own choice
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.
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 of Piercing the corporate veil
: Owners are personally liable for all corporate liability - torts, contracts, debts
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.

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.
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.
Nontraded Entities
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
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.)
Franchises
three types
Product distributorships (i.e. Ford Dealership)
Trademark/trade-name licensing (i.e. Coca-Cola)
Business format franchising (i.e. McDonald's)
Franchisor/franchisee
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
Franchises
laws
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
state franchise laws...who has extra rights
Some states have laws to regulate franchises as well - for example, California.
Many states have business opportunity disclosure filing requirements.
Most states use the Uniform Franchise Offering Circular (UROC) as basis of reporting.
State agencies have authority to investigate franchise fraud and other bad business practices.
Some franchisees given extra protection by state laws:
Example: auto dealers and gas stations - often have extra rights over other 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
Case Dunkin' Donuts Franchised Restaurants v. Sanlip
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.
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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