REG 22 - Business Structure 1 - Bus Entity/Formation/Operation/Termination

Question 1

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?
A. Working for the partnership as a file clerk.
B. Attending meetings of the partners.
C. Guaranteeing a partnership loan.
D. None of the above.

Answer 1

D. 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.
None of the activities listed are considered taking part in control of the business.

Question 2

Which of the following parties generally has the most management rights?
A. A minority shareholder in a corporation listed on a national stock exchange.
B. A limited partner in a general partnership.
C. A member of a limited-liability company.
D. A limited partner in a limited partnership.

Answer 2

C. Members of LLCs have substantial management rights, although they may choose not to exercise them.

Question 3

Which of the following forms of business generally provides all owners with limited liability, while avoiding federal taxation of income at the entity level?
	A.  A Subchapter C corporation.
	B.  A Subchapter S corporation.
	C.  Partnership.
	D.  Limited partnership.

Answer 3

B. If the requirements of a Subchapter S corporation are met, the corporate entity pays no federal income tax. All income is passed through to the shareholders. Although the shareholders enjoy limited liability, they do pay personal income tax on dividends received.

Question 4

Mario is a member of a small trucking firm organized as an LLC. For which of the following obligations would he likely be personally liable?
A. The firm owes $20,000 to a gasoline supplier.
B. The firm owes a $75,000 judgment to a pedestrian who sued after being hit by one of its trucks in a cross-walk.
C. Another driver owns a $100,000 judgment against the firm and Mario, that a jury handed down after finding that Mario was at fault for a collision at an intersection.
D. All of the above.

Answer 4

C. Most LLC statutes provide limited-liability protection from contract debts of the firm, as well as tort obligations.

Question 5

Jones, Smith, and Bay want to form a company called JSB Co., but are unsure about which type of entity would be most beneficial, based on their concerns. They all desire the opportunity to make tax-free contributions and distributions where appropriate. They want earnings to accumulate tax-free. They do not want to be subject to personal holding tax and do not want double taxation of income.

Bay is going to be the only individual giving management advice to the company and wants to be a member of JSB through his current company, Channel, Inc.

Which of the following would be the most appropriate business structure to meet all of their concerns?
	A.  	Proprietorship.
	B.  	An S corporation.
	C.  	A C corporation.
	D.  	A limited liability partnership.

Answer 5

D is the best answer, as an LLP can have multiple owners, corporate owners, and pass-through taxation.

Question 6

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?
	A. Sole proprietorship.
	B. A C corporation.
	C. General partnership.
	D. Limited partnership.

Answer 6

B. 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.

Question 7

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?
	A.  	LLP
	B.  	LLC
	C.  	Both of the above.
	D.  	Neither of the above.

Answer 7

D. No form of business organization excuses an accountant from liability for his or her own malpractice.

Question 8

Which of the following statements is correct concerning the similarities between a limited partnership and a corporation?
A. Each is created under a statute and must file a copy of its certificate with the proper state authorities.
B. All corporate stockholders and all partners in a limited partnership have limited liability.
C. Both are recognized for federal income-tax purposes as taxable entities.
D. Both are statutorily permitted to exist in perpetuity.

Answer 8

A. Both of these organizations require special steps in their creation. One of these steps is the filing of a certificate, usually with the Secretary of State.

Question 9

T/F: In corporations (Subchapter C), absent very unusual circumstances such as when the corporate veil is pierced, shareholders can lose no more than the amount of their investment.

Answer 9

True

Question 10

T/F: A and B bought a tavern, orally agreeing that A would manage the business at a stipulated salary and receive 50% of the profits as a limited partner and that he would not be responsible for any of the losses. Later, the IRS assessed a tax deficiency against the business. A claimed that as a limited partner, he was not liable for this deficiency. A is correct.

Answer 10

False.

A is in a position that is active in managing the tavern and is therefore liable for this deficiency.

Question 11

Y/N: Is a joint venture governed by partnership law?

Answer 11

yes

Question 12

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?
	A.  	Assignment.
	B.  	Novation.
	C.  	Delegation.
	D.  	Accord and satisfaction.

Answer 12

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.

Question 13

T/F: Wold hired Sally to be comptroller of a corporation he was in the process of forming, ABC Corp. Sally helped Wold finish incorporation procedures. At the first board of directors meeting, the board considered, but did not vote on, Sally’s contract that Wold had signed on ABC’s behalf. Six months later, the board fired Sally in breach of the contract. Sally sued. ABC defended, arguing that it was not liable to Sally because the board had never adopted her contract. ABC has a good defense.

Answer 13

False.
Because Wold had signed the contract and the board knew of the contract, it is implied that the corporation is liable to the contract, and not Sally because the contract was negotiated after ABC Corp was formed.

Question 14

Which of the following statements is correct regarding a limited liability company’s operating agreement?
A. It must be filed with a central state agency.
B. It must be in writing.
C. It is designed to forestall and resolve disputes among the owners.
D. It is necessary for a limited liability company to exist.

Answer 14

C. 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).

Question 15

Sal wishes to form a business entity that he will own and control all by himself. Which of the following is not a good choice for him?
	A.  	Sole proprietorship.
	B.  	General partnership.
	C.  	LLC.
	D.  	Corporation.

Answer 15

B. A partnership requires at least one other person or entity to be Sal’s partner in ownership and management of the firm, so this is not a good choice.

Question 16

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.

Answer 16

I only. 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.

Question 17

T/F: Al, Bill, and Connie informally started a business together and called it the ABC store. Al put a lot more money into the business than Bill and Connie. Bill and Connie worked many more hours than Al. Bill and Connie wanted to buy a new larger location to increase sales volume. Al was fearful of the increased financial commitment and voted against the deal. But Bill and Connie voted for it. The partnership has approved the purchase and all three partners are bound.

Answer 17

True

Absent agreement to the contrary, majority vote governs all ordinary course-of-business matters.

Question 18

Which of the following actions may be taken by a corporation’s Board of Directors without stockholder approval?
A. Purchasing substantially all of the assets of another corporation.
B. Selling substantially all of the corporation’s assets.
C. Dissolving the corporation.
D. Amending the articles of incorporation.

Answer 18

A. 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.

Question 19

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 will be discharged.
Each partner’s apparent authority will continue.

Answer 19

No, Yes
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.

Question 20

T/F: When a partner leaves a partnership, RUPA endeavors to encourage the remaining partners to buyout the departing partner’s interest and continue the business.

Answer 20

True

RUPA = Revised Uniform Partnership Act

Question 21

Price owns 2,000 shares of Universal Corp.’s $10 cumulative preferred stock. During its first year of operations, cash dividends of $5 per share are declared on the preferred stock, but were never paid. In the second year, dividends on the preferred stock were neither declared, nor paid.

If Universal is dissolved, which of the following statements is correct?
A. Universal will be liable to Price as an unsecured creditor for $10,000.
B. Universal will be liable to Price as a secured creditor for $20,000.
C. Price will have priority over the claims of Universal’s bond owners.
D. Price will have priority over the claims of Universal’s unsecured judgment creditors.

Answer 21

A. Cumulative preferred stock gives the holder the right to payment of dividends before common shareholders are paid. It does not guarantee that dividends will be declared, but if dividends are declared, they must be paid.

Once a corporation declares dividends, the payments become corporate debt. Here, Price is owed $5 x 2,000 shares = $10,000.
He is an unsecured creditor, because this debt has not been secured by a separate agreement that creates a security interest. His debt does not have priority over judgment creditors, bond owners, or secured creditors.

Question 22

Carr Corp. declares a 7% stock dividend on its common stock. The dividend
A. Must be registered with the SEC pursuant to the Securities Act of 1933.
B. Is includable in the gross income of the recipient taxpayers in the year of receipt.
C. Has no effect on Carr’s earnings and profits for federal income-tax purposes.
D. Requires a vote of Carr’s stockholders.

Answer 22

C. The tax on corporate profits is the same, whether the profits are reinvested in the company or distributed to shareholders in the form of dividends.

Question 23

An owner of common stock will not have any liability beyond actual investment unless the owner
A. Paid less than par value for stock purchased in connection with an original issue of shares.
B. Agreed to perform future services for the corporation in exchange for original-issue par-value shares.
C. Purchased treasury shares for less than par value.
D. Failed to pay the full amount owed on a subscription contract for no-par shares.

Answer 23

A. 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.

Question 24

Which of the following statements is (are) correct regarding corporate debt and equity securities?

I. Both debt and equity security holders have an ownership interest in the corporation.

II. Both debt and equity securities have an obligation to pay income.

Answer 24

Neither, both are false.

Question 25

T/F: An option to purchase a debt instrument is called a warrant.

Answer 25

False.
Warrants, rights, and options are legal entitlements to purchase EQUITY (not debt) securities at a specified price and time at the request of the holder.

Question 26

T/F: Tim and Tam agreed that they would be partners, with Tim receiving 60% of the profits and Tam 40%. They did not make any agreement regarding losses. Unfortunately, the partnership did sustain losses. Tim is responsible for 60% of the losses.

Answer 26

True

Question 27

T/F: A redeemable note is one that must be repurchased by the issuer from the holder at the holder’s option.

Answer 27

True