Module-forming business entities

Question 1

Why establish a Business Entity

Answer 1

 Using the right business entity to operate
your business can be an essential tool to:
 Limit personal liability.
 Raise capital easily.
 Reduce tax burden.

Question 2

Sole Proprietorship

Answer 2

 Created without state filings or formal agreements
 Business Income or losses on personal income tax
 Proprietor bears personal liability for losses
 Hard to raise capital (i.e., no equity to sell, so must
generally rely on personal funds & loans)
 Terminates on death of the proprietor

Question 3

General Partnership

Answer 3

 Express or implied agreement between 2 or more people to carry on as co-owners a
business for profit.
 Profits/Losses shared equally unless otherwise agreed in PA.
 Unless agreed otherwise, each partner controls the business.
 Big Tax Advantage: Pass-through entity for tax purposes; so 1 level of tax only.
 GP will dissolve upon death or withdrawal of any partner (and face liquidation), unless
other partners elect to continue or take steps in P.A. to allow buy-outs.
 Although it’s a separate entity for some purposes (e.g., owning property in name of
partnership), General partners face joint and several personal liability for partnership
obligations, if partnership cannot satisfy its own debts.

Question 4

Limited Partnership

Answer 4

 LPs have 1 or more general partners (with same liability and power as partner in a GP), but also may have 1 or more Limited Partners.
 Limited Partners may not participate in control of partnership (otherwise they become GPs)
 But, Limited Partners’ liability is limited to their capital contribution (like a corp SH).
 Death of LP does not destroy partnership; the LP’s interest passes to heirs.
 Must have written partnership agreement
 Must file Certificate of LP with Sec’y of State.

Question 5

Limited Liability Companies

Answer 5

 LLC combines favorable federal tax treatment of Partnership with limited liability
advantages of a corporation.
 It’s a separate legal person, so it can own property, enter K’s, sue or be sued, etc.
 Owned by “members”
 Can be managed by members (“member-managed”) or by appointed managers.

Question 6

Corporations

Answer 6

 Separate legal person from its owners (SHs).
 Owned by Shareholders.
 Ease of capital accumulation because shares are easily transferred, unless subject to particular SH Transfer restrictions.
 Managed by Board of Directors, which delegates day-to-day operations to appointed Officers, who serve at pleasure of Board
 Perpetual Life, even if owners/directors/officers die.

Question 7

Piercing the Corporate Veil

Answer 7

 Generally, corporations and LLC are designed to insulate their shareholders from personal liability.
 However, sometimes plaintiffs will seek to “pierce the corporate veil” and hold shareholders liable:
 Alter Ego Theory
 Corp is dominated by one shareholder who treats the corporation not as a separate legal person, but rather an extension of the SH.
 Triggers: Comingled assets, failure to follow corporate formalities like having BoD resolutions for corporate action.
 Undercapitalization Theory
 Failure of the entity to have sufficient money/insurance on hand to cover reasonably anticipated liabilities
 Rationale: Prevent fraud on public
 Piercing more common in tort than contract cases.

Question 8

fiduciaries

Answer 8

persons in a position of trust

owe duty of loyalty (and good faith) and a duty of care to the corporation but not individual shareholders

Question 9

Duty of care

Answer 9

directors and officers must exercise due care in performing their duties
must act in good faith
must act as a reasonably prudent person would in same situation
must make informed decisions

Duty of care is more about due diligence - must exercise care when making decisions and performing duties, including making sure they are acting reasonably and making informed decisions (via due diligence, attending meetings/presentations, and acquiring information from professionals but not following that information blindly). Acting in good faith is part of duty of care, tho (edited)

Question 10

Business Judgment Rule

Answer 10

 Legal doctrine that shields Board decisions from judicial review (and effectively insulates directors from personal liability for bad choices) if:
 Board took reasonable steps to become informed
 Board had rational basis for decision
 No conflict of interest, no fraud, no bad faith

Question 11

Duty of Loyalty

Answer 11

 D&O’s must put their personal interests behind corporation/shareholders.
 In practice, this means they must avoid self-dealing:
 Competing with the corporation
 Usurping corporate opportunity
 Avoid undisclosed conflicts of interest
 Avoid insider trading
 Loyalty requires disclosure of material facts.
 Interested transactions (like exec comp) are voidable unless approved by
disinterested directors, or proven fair and reasonable.
 Note: Be careful about conflict positions (e.g., PE fund puts partner on
BoD of company in which it invests).