II. Business Law-Business Structure Flashcards
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Selection of a Business Entity
Tim and Sarah wish to form an accounting firm. They are not confident in their own abilities and wish to choose a form of organization that will shield them from personal liability for their own malpractice.
Which of the following would succeed for them?
- LLP
- LLC
- Both of the above.
- Neither of the above.
No form of business organization excuses an accountant from liability for his or her own malpractice.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Selection of a Business Entity
Ted properly forms an LLP. The firm’s consulting business is going well until (a) one of its clerical employees causes a wreck while driving on firm business in the firm car, and (b) the firm finds it has insufficient assets to pay for a piece of real estate it has contracted to buy. The LLP should protect Ted from personal liability for:
- The tort lawsuit brought by the victim of the car accident.
- The breach of contract lawsuit brought by the seller of the real estate.
- Both A and B.
- None of the above.
3.
in most states, partners in LLPs are protected from contract-based obligations, as well as tort-based obligations.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Selection of a Business Entity
Consuelo is a limited partner who has become ensnared in various activities of her limited partnership. She is worried that her activities may cause her to be liable as a general partner. Which of the following activities may subject her to personal liability?
- Working for the partnership as a file clerk.
- Attending meetings of the partners.
- Guaranteeing a partnership loan.
- None of the above.
4.
None of the activities listed in A, B, and C is sufficient to render Consuelo personally liable; all are consistent with her role as a limited partner.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Selection of a Business Entity
Eaton is the sole owner of a construction company and is concerned about personal liability. Which of the following entities will best allow Eaton to limit personal liability?
- Sole proprietorship.
- A C corporation.
- General partnership.
- Limited partnership.
2.
Unless Eaton personally guarantees his firm’s debts or does something improper to cause the corporate veil to be pierced, he is not personally liable for its obligations, even if he is the sole shareholder.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Formation
Following the formation of a corporation, which of the following terms best describes the process by which the promoter is released from, and the corporation is made liable for, pre-incorporation contractual obligations?
- Assignment.
- Novation.
- Delegation.
- Accord and satisfaction.
2.
B is the best answer. The general rule is that promoters are liable on pre-incorporation contracts that they negotiate on the corporation’s behalf.
When the corporation comes into existence and adopts the contracts, the general rule is that both the promoter and the corporation are now liable under them.
However, if the other party agrees to release the agent from liability and to look only to the corporation for satisfaction, then a novation has taken place.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Operations: Nonfinancial Factors
Which of the following circumstances may permit the piercing of the corporate veil of a closely held corporation and therefore cause its shareholders to be held personally liable?
I. The corporation is thinly capitalized.
II. The corporation borrows money from a shareholder without giving the shareholder a security interest in corporate assets.
- I only.
- II only.
- Both I and II.
- Neither I nor II.
1.
Thin capitalization, which endangers the legitimate interests and expectations of third-party corporate creditors, particularly tort creditors, can be grounds for piercing the corporate veil.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Operations: Nonfinancial Factors
Which of the following statements is correct regarding a limited liability company’s operating agreement?
- It must be filed with a central state agency.
- It must be in writing.
- It is designed to forestall and resolve disputes among the owners.
- It is necessary for a limited liability company to exist.
3.
This is the purpose of an LLC operating agreement, which is why it is a good idea that these be in writing and filed with the state (although this is not required).
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Operations: Nonfinancial Factors
Elmo forms a corporation to run a retail store. He buys $100,000 worth of its stock, as does his mother. They are the only two shareholders. The store’s location was not favorable and the business does not take off. Over the course of five years, Elmo slowly burns through the $200,000 in capital, as the store posts losses every year. Near the end of the sixth year, the corporation takes bankruptcy, leaving creditors on the hook for $40,000; they had delivered inventory to the store for which the corporation had been unable to pay. The creditors sue Elmo and his mother personally. Given the facts presented, what should happen?
- The court should pierce the corporate veil, because the store was obviously undercapitalized.
- The court should pierce the corporate veil, because the creditors failed to have Elmo or his mother personally guarantee their extensions of credit.
- The court should not pierce the corporate veil.
- A and B.
3.
There is no evidence of commingling of funds, diversion of corporate assets, failure to maintain formalities, or any of the other factors that can induce a court to pierce the corporate veil. The mere fact that a business fails does not indicate that it was originally undercapitalized.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Operations: Nonfinancial Factors
D. Corporations
- Piercing the corporate veil
Factors
Factors—The following considerations (usually in combination) may induce a court to pierce the corporate veil:
- Commingling of funds and other assets of the corporation with those of individual shareholders
- Diversion of the corporation’s funds or assets for the personal use of shareholders
- Failure to maintain the necessary corporate formalities
- Failure to adequately capitalize the corporation for the reasonably foreseeable risks of the enterprise
- Use of the corporation as a mere shell or conduit to operate a single venture or some particular aspect of the business of an individual shareholder
- Absence of separately held corporate assets
- Formation and use of the corporation to assume the existing liabilities of another person or entity
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Financial Structure
A. Types of Corporate Securities
- Equity securities
- Common stock
- Preferred stock
- Treasury stock
- Debt securities
- Notes—Short-term unsecured debt instruments
- Debentures—Long-term unsecured debt instruments
- Bonds—Debt instruments secured by corporate property
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Financial Structure
An owner of common stock will not have any liability beyond actual investment unless the owner
- Paid less than par value for stock purchased in connection with an original issue of shares.
- Agreed to perform future services for the corporation in exchange for original-issue par-value shares.
- Purchased treasury shares for less than par value.
- Failed to pay the full amount owed on a subscription contract for no-par shares.
- When stock has a par value, it must be sold for at least that par value in an original issue. If it is sold for less, it is “watered stock.” A shareholder who buys watered stock is liable to the corporation for the difference between the price actually paid and the par value of the shares purchased.
- The services, although they may have value, are not “payment” of the par value. When stock has a par value, it must be sold for at least that par value in an original issue. If it is sold for less, it is “watered stock.” A shareholder who buys watered stock is liable to the corporation for the difference between the price actually paid and the par value of the shares purchased. So, if the services turn out to be worth less than the par value, the shareholder will have to pay the difference. The traditional rule has been that shares could not properly be issued in exchange for the promise to perform future services. However, the strong modern trend does allow shares to be properly issued for such promises. This choice is only incorrect if the traditional view is applied.
A.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Termination
Which of the following actions may be taken by a corporation’s Board of Directors without stockholder approval?
- Purchasing substantially all of the assets of another corporation.
- Selling substantially all of the corporation’s assets.
- Dissolving the corporation.
- Amending the articles of incorporation.
1.
Shareholders have the right to vote on many important corporate changes, including
- amendments to the articles of incorporation,
- dissolution,
- sale of all or substantially all of the corporation’s assets, and
- mergers & consolidations.
Choices B, C, and D are all on this list. Choice A is, therefore, the correct answer. Often, one corporation can buy all or substantially all of the assets of another company without there being any large qualitative change in the life of the purchasing corporation. Therefore, when a large corporation gobbles up the assets of a smaller corporation, the shareholders of the large buyer do not have the right to vote on the transaction. There would be a much greater impact on the life of the selling corporation and its shareholders would therefore have the right to vote on the transaction.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Termination
The partners of College Assoc., a general partnership, decide to dissolve the partnership and agree that none of the partners will continue to use the partnership name.
Under the Uniform Partnership Act, which of the following events will occur on dissolution of the partnership?
Each partner’s existing liability Each partner’s apparent
will be discharged. authority will continue.
- Yes Yes
- Yes No
- No Yes
- No No
3.
Simply deciding to dissolve a partnership does not dissolve liability. If money is owed on contracts, tort judgments, or otherwise, the partners are still responsible for them. Apparent authority does continue after partners have decided to dissolve the partnership. Notice must be given to others (by contact for those with which the partnership has actually done business and by publication for everyone else) before apparent authority stops.
II. Business Law-Business Structure
- Selection and Formation of Business Entity and Related Operation and Termination
- Termination
A CPA firm, operated as a general partnership, will dissolve by mutual agreement at the end of the year. During the year, distributions have been made to some partners in excess of their capital invested in the partnership. Which of the following statements is correct regarding the distribution of assets at the end of the partnership’s existence?
- Partners with negative capital accounts must contribute additional funds to the partnership.
- Creditors whose debts cannot be satisfied by the partnership assets will have no further recourse.
- The partnership must engage in additional activity to generate sufficient cash to pay all creditors.
- Bankrupt partners must contribute capital to resolve their bankruptcy proceedings.
- Correct! Absent agreement to the contrary, general partners are to share losses equally. Those whose accounts are in deficit when the partnership ends are generally liable to make up their share.
- Incorrect. Because general partners are generally liable for partnership debts, such creditors may pursue the general partners personally.
- Incorrect. There is obviously no guarantee that additional activity would generate any cash at all, let alone enough to pay all creditors. The partners are within their rights to terminate the partnership, but as general partners they remain personally liable for its obligations.
- Incorrect. The partners’ personal bankruptcy proceedings will be governed by bankruptcy law rather than partnership law.
II. Business Law-Business Structure
- Rights, Duties, Legal Obligations and Authority of Owners and Management
- Rights and Duties
A. Limited Partnerships: General/ Limited Partners
B. LLPs
- Partners in an LLP have roughly the same rights and duties as partners in a general partnership.
- The significant difference between an LLP and a general partnership is that partners in an LLP are not liable for the torts of other partners—only for their own and those of the people they supervise. And in many states, partners in an LLP are also sheltered from personal liability for partnership contractual obligations.
C. LLLPs
- Partners in an LLLP have roughly the same rights and duties as partners in a limited partnership.
- The key difference between an LLLP and a limited partnership is that even general partners may enjoy limited liability in an LLLP, whereas in a limited partnership, there must be at least one person or entity that bears general liability.
