The corporate governance & business organisation
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Its a Chapter of Legal and Regulatory Environment of Business...worth knowing

Its a Chapter of Legal and Regulatory Environment of Business...worth knowing

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The corporate governance & business organisation Presentation Transcript

  • 1. Chapter McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Corporate Governance AndCorporate Governance And Business OrganizationsBusiness Organizations
  • 2. 11-2 Corporate Governance How BusinessHow Business Organizations AreOrganizations Are Operated, Led,Operated, Led, GovernedGoverned How Law ProvidesHow Law Provides Regulation Of BusinessRegulation Of Business OrganizationsOrganizations REGULATIONS
  • 3. 11-3 Size Of Ownership Closely Held- FamilyClosely Held- Family And/Or FriendsAnd/Or Friends Publicly Held- TradedPublicly Held- Traded On Public StockOn Public Stock ExchangesExchanges
  • 4. 11-4 Selecting a Form Sole Proprietorship Forms of Legal Organization of Business Entities Partnership Corporation General Partnership Limited Partnership Regular C Corporation Subchapter S Corporation Limited Liability Company Limited Liability Company Limited Liability Partnership Limited Liability Partnership
  • 5. Starting a Business Some Other FormsSome Other Forms • Joint VentureJoint Venture • Strategic AllianceStrategic Alliance • FranchiseFranchise • CooperativesCooperatives • Master Limited PartnershipsMaster Limited Partnerships (M.L.P.) in some states, similar to(M.L.P.) in some states, similar to L.L.CsL.L.Cs
  • 6. Starting a Business Sole ProprietorshipSole Proprietorship • Business is operated as own personal propertyBusiness is operated as own personal property • Unlimited personal liability for all debts/obligationsUnlimited personal liability for all debts/obligations of the businessof the business • Over 2/3 of U.S. businesses are soleOver 2/3 of U.S. businesses are sole proprietorshipsproprietorships • They are usually small, about 99% have revenues ofThey are usually small, about 99% have revenues of less than $1,000,000.00 per yearless than $1,000,000.00 per year • Sole Proprietors are allowed to establish tax-Sole Proprietors are allowed to establish tax- exempt retirement accounts (e.g. Keough plans)exempt retirement accounts (e.g. Keough plans)
  • 7. 11-7 Sole ProprietorshipSole Proprietorship AdvantagesAdvantages  Ease of start/endEase of start/end  Be your own bossBe your own boss  Pride of ownershipPride of ownership  Retain profitRetain profit  No special taxesNo special taxes DisadvantagesDisadvantages  Unlimited liabilityUnlimited liability  Limited financialLimited financial resourcesresources  Difficulty in mgmt.Difficulty in mgmt.  Time commitmentTime commitment  Few fringe benefitsFew fringe benefits  Limited growthLimited growth  Limited life spanLimited life span
  • 8. Starting a Business PartnershipPartnership • Voluntary AssociationVoluntary Association • Between 2 or more legal competent personsBetween 2 or more legal competent persons • No Express Agreement RequiredNo Express Agreement Required • Typically governed by statutory law (e.g. Uniform PartnershipTypically governed by statutory law (e.g. Uniform Partnership Act, except Louisiana)Act, except Louisiana) • Sharing profits and losses = prima facie evidence ofSharing profits and losses = prima facie evidence of partnershippartnership • States differ on whether a partnership is viewed as a legalStates differ on whether a partnership is viewed as a legal entity or aggregate of individuals for the purpose ofentity or aggregate of individuals for the purpose of participating in legal actionsparticipating in legal actions • Extent and Nature of personal liability variesExtent and Nature of personal liability varies • General v.LimitedGeneral v.Limited
  • 9. 11-9 Types of Partnerships GeneralGeneral GPGP GPGP GPGP GPGP LimitedLimited GPGP PassivePassive InvestorInvestor PassivePassive InvestorInvestor PassivePassive InvestorInvestor
  • 10. 11-10 PartnershipPartnership AdvantagesAdvantages DisadvantagesDisadvantages More financial resources Shared mgmt. Longer survival Unlimited liability Division of profits Disagreements among partners Difficult to terminate
  • 11. 11-11 Sharing Workload Sharing Financial Burden Sharing Emotional Burden Procuring Executive Talent Companionship Interpersonal Conflicts Dilution of Equity Dissatisfaction with Partner Absence of One Clear Leader Frustration of Not Calling Own Shots Advantages Disadvantages Advantages and Disadvantages of Partnerships
  • 12. 11-12 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing An Opinion Survey About the Pros and Cons of Partnerships Why is a partnership good? Why is a partnership bad? Spreads the workload Spreads the emotional burden Buys executive talent not otherwise affordable Spreads the financial burden Makes company building less lonely Personal conflicts outweigh the benefits Partners never live up to one another’s expectations Companies function better with one clear leader Dilutes equity too much You can’t call your own shots 55 41 40 33 26 60 59 53 6 6 Question Perceived Pros and Cons Percentage Responding Source: “The Inc. Fax Poll: Are Partners Bad for Business?” Inc., Vol. 14, No. 2 (February 1992), p. 24.
  • 13. Partnerships • Choose your partners wisely!!!Choose your partners wisely!!! • A partnership is like aA partnership is like a marriage, easy to get into,marriage, easy to get into, sometimes difficult tosometimes difficult to maintain, and generally messymaintain, and generally messy to get out of!to get out of!
  • 14. Partnerships  A voluntary agreement by two or more persons to carry on, asA voluntary agreement by two or more persons to carry on, as co-owners, a business for profit.co-owners, a business for profit.  ““Persons” may be natural or artificial (e.g. corporations)Persons” may be natural or artificial (e.g. corporations)  Requires intent to become partners (Tarnavsky v. Tarnavsky, 8thRequires intent to become partners (Tarnavsky v. Tarnavsky, 8th Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App.Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App. Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002))Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002)) • Intent can be express or implied (based on words or actions)Intent can be express or implied (based on words or actions) • Though their must be an intent to carry on a business “forThough their must be an intent to carry on a business “for profit” the business does not have to actually make a profit toprofit” the business does not have to actually make a profit to be considered a partnership.be considered a partnership.  Partnership by estoppel may be found where one holds himselfPartnership by estoppel may be found where one holds himself out as, creates a reliance upon, or fails to dispel a knownout as, creates a reliance upon, or fails to dispel a known misrepresentationmisrepresentation
  • 15. Partnerships  Is There a Partnership?Is There a Partnership?  A father and son each owned land and raised seed potatoes.A father and son each owned land and raised seed potatoes. They each used their own equipment. Each raised about theThey each used their own equipment. Each raised about the same amount of potatoes, and they were stored together andsame amount of potatoes, and they were stored together and advertised for sale by Wilbur Kimm and Son. A loss arose.advertised for sale by Wilbur Kimm and Son. A loss arose. Issue: Are the father and son partners such that they must shareIssue: Are the father and son partners such that they must share this loss? Held: Yes. They were partners and must share thethis loss? Held: Yes. They were partners and must share the loss. Although intent of parties is a major factor, if facts bringloss. Although intent of parties is a major factor, if facts bring arrangement within definition of a partnership, parties cannotarrangement within definition of a partnership, parties cannot escape liability incident to that relationship merely by saying thatescape liability incident to that relationship merely by saying that no such relationship exists. If intended action of parties createsno such relationship exists. If intended action of parties creates a partnership in fact, what parties call their arrangement ora partnership in fact, what parties call their arrangement or intend their arrangement to be is irrelevant. The fact that theintend their arrangement to be is irrelevant. The fact that the father and son split profits in a joint account that containedfather and son split profits in a joint account that contained proceeds from their sale of seed potatoes was prima facieproceeds from their sale of seed potatoes was prima facie evidence that a partnership existed between father and son.evidence that a partnership existed between father and son. Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 (Mont. 1984).(Mont. 1984).
  • 16. Partnerships  Sharing in profits or losses is primaSharing in profits or losses is prima facie evidence of participation in afacie evidence of participation in a partnership but receipt of funds:partnership but receipt of funds: • in repayment of a debt orin repayment of a debt or • as interest on a debt oras interest on a debt or • as wages oras wages or • as rent oras rent or • as an annuity to heirs of a deceased partner oras an annuity to heirs of a deceased partner or • as consideration for the sale of goodwillas consideration for the sale of goodwill  does not constitute evidence ofdoes not constitute evidence of participation in a partnership.participation in a partnership.
  • 17. Partnerships Co-owners must register withCo-owners must register with the state.the state. Co-owners may need anCo-owners may need an occupational license.occupational license.
  • 18. Limited Partnerships  Partnership consisting of one orPartnership consisting of one or moremore general partnersgeneral partners (who manage(who manage the business and are liable to thethe business and are liable to the full extent of their personal assetsfull extent of their personal assets for debts of the partnership) & onefor debts of the partnership) & one or moreor more limitedlimited partnerspartners (who(who contribute only assets and are liablecontribute only assets and are liable only up to the amount contributedonly up to the amount contributed by them).by them).
  • 19. Limited Partnerships  General PartnerGeneral Partner - In a limited partnership, a partner- In a limited partnership, a partner who assumes responsibility for the management ofwho assumes responsibility for the management of the partnership and liability for all partnership debts.the partnership and liability for all partnership debts.  Limited PartnerLimited Partner - In a limited partnership, a partner- In a limited partnership, a partner who contributes capital to the partnership but haswho contributes capital to the partnership but has no right to participate in the management andno right to participate in the management and operation of the business. The limited partneroperation of the business. The limited partner assumes no liability for partnership debts beyondassumes no liability for partnership debts beyond the capital contributed.the capital contributed.  Note: Failure to comply with statutory requirementsNote: Failure to comply with statutory requirements in forming a limited partnership results in thein forming a limited partnership results in the creation of a general partnership.creation of a general partnership.
  • 20. Limited Partnerships  The exercise of substantial controlThe exercise of substantial control by a limited partner may result inby a limited partner may result in his being declared a generalhis being declared a general partner.partner.
  • 21. Limited Partnerships Not equal exercise of substantialNot equal exercise of substantial control if only:control if only: • Contractor for an agent or employee of theContractor for an agent or employee of the partnershippartnership • Consulting/AdvisingConsulting/Advising • Acting as a suretyActing as a surety • Approving or disapproving an amendmentApproving or disapproving an amendment to a partnership agreementto a partnership agreement • VotingVoting
  • 22. 11-22 Partnerships  Partnership Agreements (Sometimes calledPartnership Agreements (Sometimes called Articles of Partnership)- An agreement listingArticles of Partnership)- An agreement listing and explaining the terms of the partnership.and explaining the terms of the partnership. • Critical for preventing and resolving potential disputesCritical for preventing and resolving potential disputes • Should state (at least)Should state (at least)  Who will make final decisions.Who will make final decisions.  What each partner’s duties are.What each partner’s duties are.  How much each partner will invest.How much each partner will invest.  How profits and losses will beHow profits and losses will be apportioned to each partner.apportioned to each partner.  Methods for dispute resolution (e.g. arbitration)Methods for dispute resolution (e.g. arbitration)  How the partnership can beHow the partnership can be expanded or dissolved.expanded or dissolved.
  • 23. 11-23 Partnerships The Uniform Partnership Act, asThe Uniform Partnership Act, as enacted by a particularenacted by a particular jurisdiction, has default rulesjurisdiction, has default rules covering matters not addressedcovering matters not addressed in partnership agreementsin partnership agreements
  • 24. Partnerships - Management/Authority  General rule giving equal voice to all partners inGeneral rule giving equal voice to all partners in management (even if differing contributions)management (even if differing contributions) • Can be altered by agreementCan be altered by agreement  Why alter?Why alter?  In large/complex partnership may beIn large/complex partnership may be cumbersome/inefficientcumbersome/inefficient  Decisions that significantly impact the nature of theDecisions that significantly impact the nature of the partnership generally require unanimous consentpartnership generally require unanimous consent  Partnerships are generally not liable for agreements ofPartnerships are generally not liable for agreements of individual partners acting outside of scope of theindividual partners acting outside of scope of the partnership’s normal business, unless ratify,partnership’s normal business, unless ratify, expressly or implicitlyexpressly or implicitly
  • 25. Partnerships Partnership PropertyPartnership Property • All property originally contributed toAll property originally contributed to • All property purchased on behalf ofAll property purchased on behalf of • Purchasing property with partnership fundsPurchasing property with partnership funds implies that it becomes partnership propertyimplies that it becomes partnership property (unless contrary intention can be proved)(unless contrary intention can be proved) • Any conveyance to the partnership by nameAny conveyance to the partnership by name
  • 26. Partnerships  3 rules for liability in a partnership are:3 rules for liability in a partnership are: • 1. Every partner is liable for his or her1. Every partner is liable for his or her own actions.own actions. • 2. Every partner is liable for the2. Every partner is liable for the actions of the other partners (inactions of the other partners (in course of business)course of business) • 3. Every partner is liable for the3. Every partner is liable for the actions of the employees of theactions of the employees of the business (in course of business)business (in course of business)
  • 27. Partnerships  Distribution of partnership incomeDistribution of partnership income • How should the shares of partnershipHow should the shares of partnership income be distributed?income be distributed? Pro-rata?Pro-rata? Based on financial contribution?Based on financial contribution? Based on work performed on behalfBased on work performed on behalf of?of? • Usually determined by writtenUsually determined by written agreementagreement
  • 28. Partnerships Creditors RightsCreditors Rights • Can obtain the debtor’s share of theCan obtain the debtor’s share of the income of a partnership, or in someincome of a partnership, or in some cases can get the court to order thecases can get the court to order the sale of the debtor’s share (Chargingsale of the debtor’s share (Charging Order)Order) • This does not give the creditor a voiceThis does not give the creditor a voice in the management of the partnershipin the management of the partnership • This does not give the creditor theThis does not give the creditor the right to dissolve the partnershipright to dissolve the partnership
  • 29. 11-29 Partnership DutiesPartnership Duties  DutiesDuties • Loyalty/Good FaithLoyalty/Good Faith • Care in PartnershipCare in Partnership • To Inform/AccountTo Inform/Account Note: However, partners can beNote: However, partners can be compelled to sign confidentialitycompelled to sign confidentiality agreements (Madison Ave. Investmentagreements (Madison Ave. Investment Partners, L.L.C. v. American First RealPartners, L.L.C. v. American First Real Estate Investment Partners, L.P., 2002Estate Investment Partners, L.P., 2002 Del. Ch. LEXIS 97 (Del. Ch. New CastleDel. Ch. LEXIS 97 (Del. Ch. New Castle 2002)2002)  DutiesDuties • Loyalty/Good FaithLoyalty/Good Faith • Care in PartnershipCare in Partnership • To Inform/AccountTo Inform/Account Note: However, partners can beNote: However, partners can be compelled to sign confidentialitycompelled to sign confidentiality agreements (Madison Ave. Investmentagreements (Madison Ave. Investment Partners, L.L.C. v. American First RealPartners, L.L.C. v. American First Real Estate Investment Partners, L.P., 2002Estate Investment Partners, L.P., 2002 Del. Ch. LEXIS 97 (Del. Ch. New CastleDel. Ch. LEXIS 97 (Del. Ch. New Castle 2002)2002)
  • 30. Partnerships - Dissolution  Dissolution methodsDissolution methods • Automatically after an agreed upon period of timeAutomatically after an agreed upon period of time • Automatically when set objective has been attainedAutomatically when set objective has been attained • By mutual agreementBy mutual agreement • By unilateral decision of any partner (if at will)By unilateral decision of any partner (if at will) • By court order (including by Bankruptcy)By court order (including by Bankruptcy) • By death or incompetence of a partnerBy death or incompetence of a partner • By disability of a partner that substantially impairsBy disability of a partner that substantially impairs his ability to carry on dutieshis ability to carry on duties • By wilful breach of a partnership agreementBy wilful breach of a partnership agreement • By illegal acts of the partnership businessBy illegal acts of the partnership business
  • 31. Partnerships - Dissolution  Dissolution of a partnership does notDissolution of a partnership does not necessarily end the operation of anecessarily end the operation of a business (e.g. it may continue as a solebusiness (e.g. it may continue as a sole proprietorship, etc.)proprietorship, etc.)  The value of interests at dissolution isThe value of interests at dissolution is usually determined by settlementusually determined by settlement agreementsagreements  There are notice requirements uponThere are notice requirements upon dissolution (Phillip Lithographing Co. V.dissolution (Phillip Lithographing Co. V. Babich, 135 NW.2nd 343 (Wis. 1965))Babich, 135 NW.2nd 343 (Wis. 1965))
  • 32. 11-32 Distribution of AssetsDistribution of Assets Order/PriorityOrder/Priority • Outside CreditorsOutside Creditors • Debts to Partners forDebts to Partners for Loans/Capital AdvanceLoans/Capital Advance • Capital ContributionCapital Contribution • Remaining Assets AccordingRemaining Assets According to Partnership Agreementto Partnership Agreement Order/PriorityOrder/Priority • Outside CreditorsOutside Creditors • Debts to Partners forDebts to Partners for Loans/Capital AdvanceLoans/Capital Advance • Capital ContributionCapital Contribution • Remaining Assets AccordingRemaining Assets According to Partnership Agreementto Partnership Agreement
  • 33. 11-33 Seven Trigger Points That Can Destroy a Partnership 1. A partner that is going through a divorce. 2. A partnership that is experiencing growing pains due to rapid growth. 3. A partner brings a spouse or a relative into the business. 4. A partner that wants to withdraw more money from the business. 5. A partner makes sexual advances toward another partner. 6. A partner experiences serious medical problems. 7. A partner begins doing business on the side with the partnership’s customers. Source: Used with permission, Inc. magazine, February 2001. Copyright 1998 by Gruner + Jahr USA Publishing, 38 Commercial Wharf, Boston, MA 02110. Inc. is a registered trademark of Gruner + Jahr Printing and Publishing.
  • 34. Corporations A legal entity formed inA legal entity formed in compliance with statecompliance with state statutory requirements. Thestatutory requirements. The entity is treated as a legalentity is treated as a legal “person”, distinct from its“person”, distinct from its shareholders.shareholders.
  • 35. Starting a Business CorporationCorporation • Separate Legal EntitySeparate Legal Entity • Ongoing Enterprise/LifecycleOngoing Enterprise/Lifecycle • Limited LiabilityLimited Liability • Close v.PublicClose v.Public • ““C” v.“S”C” v.“S” • Profit v.Non-ProfitProfit v.Non-Profit • Domestic, Foreign, AlienDomestic, Foreign, Alien • De Jure v. De FactoDe Jure v. De Facto
  • 36. 11-36 CorporationCorporation AdvantagesAdvantages DisadvantagesDisadvantages More money for investment Limited liability Separation of ownership/mgmt. Ease of ownership change Perpetual life Size Initial cost Paperwork Two tax returns Termination difficult Double taxation
  • 37. Corporations  A Corporation is “anA Corporation is “an artificial being, invisible,artificial being, invisible, intangible, and existingintangible, and existing only in the contemplationonly in the contemplation of law. Being the mereof law. Being the mere creature of law, itcreature of law, it possesses only thosepossesses only those properties which theproperties which the charter of creation conferscharter of creation confers upon it, either expressly orupon it, either expressly or incidental to its veryincidental to its very existence.” - Chief Justiceexistence.” - Chief Justice Marshall, Dartmouth v.Marshall, Dartmouth v. Woodard (1819)Woodard (1819)
  • 38. Corporations  Historical OriginsHistorical Origins • Roman royal fiat.Roman royal fiat. • 17th century English Royal Charter.17th century English Royal Charter. • 1814, Francis Cabot Lowell, a Boston Merchant,1814, Francis Cabot Lowell, a Boston Merchant, founded the first publicly traded company infounded the first publicly traded company in America, a textile company. Lowell had smuggled aAmerica, a textile company. Lowell had smuggled a plan for a power loom out of England and plannedplan for a power loom out of England and planned to compete with the British Lancashire Mills. Sinceto compete with the British Lancashire Mills. Since he personally lacked the capital to build and installhe personally lacked the capital to build and install the machinery, he sold shares in the company to 10the machinery, he sold shares in the company to 10 other people.other people. • The publicly traded company model also played aThe publicly traded company model also played a key part in the financing of America’s railroads.key part in the financing of America’s railroads.
  • 39. Corporations  Close corporationClose corporation——a corporationa corporation whose stock is owned by awhose stock is owned by a relatively few people and is not soldrelatively few people and is not sold to the general public.to the general public.  Public/Open corporationPublic/Open corporation——aa corporation whose stock is boughtcorporation whose stock is bought and sold on security exchanges andand sold on security exchanges and can be purchased by any individual.can be purchased by any individual.
  • 40. Corporations  TypesTypes • For ProfitFor Profit • Non-Profit (e.g. Hospitals,Non-Profit (e.g. Hospitals, Charities, Some Insurance Co.) -Charities, Some Insurance Co.) - exempt from Corp. income taxexempt from Corp. income tax • Municipal (e.g. Sewer Authority)Municipal (e.g. Sewer Authority) (often have tax authority)(often have tax authority)
  • 41. 11-41 Close CorporationsClose Corporations  ShareholdersShareholders • FewFew • Live Near Each Other Know One Another &Live Near Each Other Know One Another & SkillsSkills • Active in BusinessActive in Business • No Market for SharesNo Market for Shares  Transferability of SharesTransferability of Shares • Right of First RefusalRight of First Refusal • Buy/Sell AgreementBuy/Sell Agreement • Consent RestraintConsent Restraint  ShareholdersShareholders • FewFew • Live Near Each Other Know One Another &Live Near Each Other Know One Another & SkillsSkills • Active in BusinessActive in Business • No Market for SharesNo Market for Shares  Transferability of SharesTransferability of Shares • Right of First RefusalRight of First Refusal • Buy/Sell AgreementBuy/Sell Agreement • Consent RestraintConsent Restraint
  • 42. 11-42 Corporations • Types by place of incorporationTypes by place of incorporation Domestic corporationDomestic corporation - a business- a business incorporated in a stateincorporated in a state Foreign corporationForeign corporation—a business—a business incorporated outside of the state.incorporated outside of the state. Alien corporationAlien corporation—a business—a business incorporated in a foreign countryincorporated in a foreign country and operating in the United States.and operating in the United States.
  • 43. Corporations- “S” Corp ““S” CorporationS” Corporation • A Federal Tax ElectionA Federal Tax Election • Owners have limited liability, but areOwners have limited liability, but are taxed as if the firm were a partnershiptaxed as if the firm were a partnership
  • 44. Corporations- “S” Corp  ““S” Corporation RequirementsS” Corporation Requirements • Firm has 75 or fewer ownersFirm has 75 or fewer owners • All stockholders must be individuals,All stockholders must be individuals, estates, or certain trusts (not otherestates, or certain trusts (not other corporations)corporations) • Only one class of stock outstandingOnly one class of stock outstanding • Must be a domestic corporationMust be a domestic corporation • Must operate on a calendar year basisMust operate on a calendar year basis • No nonresident alien stockholdersNo nonresident alien stockholders • All shareholders must consent to havingAll shareholders must consent to having the corporation taxed as a partnershipthe corporation taxed as a partnership
  • 45. Corporations- “S” Corp  Tax Reasons for “S” Corp.Tax Reasons for “S” Corp. • Corporation is losing moneyCorporation is losing money- Valuable to have losses- Valuable to have losses flow through to individual tax return, but onlyflow through to individual tax return, but only valuable if have other personal income to offsetvaluable if have other personal income to offset against. Losses are limited to basis. Basis is stockagainst. Losses are limited to basis. Basis is stock investment and loans to corporationinvestment and loans to corporation • Corporation is highly profitableCorporation is highly profitable - Although double- Although double taxation rarely applies, there is always the risk thetaxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salariesIRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs.are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since nodividend doesn’t matter with S corp., since no corporate level taxcorporate level tax
  • 46. Corporations- Preincorporation  PromotersPromoters (also called Preincorporators) - persons(also called Preincorporators) - persons who bring the corporation into being by pre-who bring the corporation into being by pre- incorporation actionsincorporation actions • Has personal liability for pre-incorporationHas personal liability for pre-incorporation contracts (corporations may later adopt same)contracts (corporations may later adopt same) • Not agents of corporation or shareholdersNot agents of corporation or shareholders • But have fiduciary duties to both (e.g. full disclose,But have fiduciary duties to both (e.g. full disclose, dealing in good faith, etc.)dealing in good faith, etc.) • May be paid for reasonable chargesMay be paid for reasonable charges • May be paid with sharesMay be paid with shares
  • 47. Corporations-Preincorporation IncorporatorsIncorporators - those who sign- those who sign the articles of incorporationthe articles of incorporation and deliver them to the stateand deliver them to the state • May be a single personMay be a single person • May be an attorneyMay be an attorney
  • 48. Corporations-Preincorporation Shareholder Agreements shouldShareholder Agreements should address:address: • Conflicts of InterestConflicts of Interest • Key Man (e.g. Life Insurance)Key Man (e.g. Life Insurance) • Buy/Sell (e.g. Right of FirstBuy/Sell (e.g. Right of First Refusal to Purchase Shares)Refusal to Purchase Shares) • Profit AllocationProfit Allocation • IndemnificationIndemnification
  • 49. 11-49 IncorporationIncorporation StepsSteps • Select Where to IncorporateSelect Where to Incorporate • Prepare ArticlesPrepare Articles • Sign/Authenticate ArticlesSign/Authenticate Articles • File ArticlesFile Articles • Receive CertificateReceive Certificate • Hold Initial MeetingHold Initial Meeting StepsSteps • Select Where to IncorporateSelect Where to Incorporate • Prepare ArticlesPrepare Articles • Sign/Authenticate ArticlesSign/Authenticate Articles • File ArticlesFile Articles • Receive CertificateReceive Certificate • Hold Initial MeetingHold Initial Meeting
  • 50. 11-50 Corporations-Incorporation  Where to incorporateWhere to incorporate • Businesses can incorporate in any stateBusinesses can incorporate in any state they choose.they choose. • Some states offer fewer restrictions, lowerSome states offer fewer restrictions, lower taxes & fees, and other benefits to attracttaxes & fees, and other benefits to attract businesses to incorporate with their state.businesses to incorporate with their state. • Internet businesses present a sales taxInternet businesses present a sales tax collection problem for states in which thesecollection problem for states in which these businesses have no physical presence.businesses have no physical presence.
  • 51. 11-51 Corporations-Incorporation  Issues to Consider when Selecting a State of Inc.Issues to Consider when Selecting a State of Inc. • How many incorporators are required by the state, and whetherHow many incorporators are required by the state, and whether the incorporator itself can be a corporation.the incorporator itself can be a corporation. • The minimum number of people required to form theThe minimum number of people required to form the corporation.corporation. • The minimum capital requirement, if any.The minimum capital requirement, if any. • The state's fees for filing the articles of incorporation.The state's fees for filing the articles of incorporation. • The state's annual corporate franchise tax.The state's annual corporate franchise tax. • The state's corporate income tax and whether earnings fromThe state's corporate income tax and whether earnings from operations outside the state are taxable. The State of Delawareoperations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations ontaxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on thetheir distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If apercentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, theseDelaware corporation has no Delaware source income, these taxes should not be an issue.taxes should not be an issue.
  • 52. 11-52 Corporations-Incorporation  Issues to Consider when Selecting a State of Inc. (Cont.)Issues to Consider when Selecting a State of Inc. (Cont.) • Whether the corporation is allowed to keep its books andWhether the corporation is allowed to keep its books and records outside the state.records outside the state. • The state's court system's reputation of fairness in businessThe state's court system's reputation of fairness in business cases.cases. • Whether the corporation is allowed to have its principal placeWhether the corporation is allowed to have its principal place of business outside the state.of business outside the state. • Whether there is a state inheritance tax on non-residentWhether there is a state inheritance tax on non-resident shareholders.shareholders. • Disclosure/privacy - whether the state requires publicDisclosure/privacy - whether the state requires public disclosure of the names of shareholders.disclosure of the names of shareholders. • Whether the state requires a corporate bank account in thatWhether the state requires a corporate bank account in that state (Delaware does not).state (Delaware does not).
  • 53. 11-53 Corporations-Incorporation  DelawareDelaware- Delaware often is the preferred state of incorporation.- Delaware often is the preferred state of incorporation. Initially, Delaware gave management better rights in the event ofInitially, Delaware gave management better rights in the event of a takeover, so in the 1940's and 1950's many corporationsa takeover, so in the 1940's and 1950's many corporations moved there. Delaware set up a court system that has expertisemoved there. Delaware set up a court system that has expertise in commercial transactions and well-developed corporate lawin commercial transactions and well-developed corporate law (equals predictability). Other states improved their corporate(equals predictability). Other states improved their corporate legal systems, but virtually every corporate attorney is familiarlegal systems, but virtually every corporate attorney is familiar with Delaware law. Delaware also has the Delaware Assetwith Delaware law. Delaware also has the Delaware Asset Protection Trust, which permits one to set up a trust that cannotProtection Trust, which permits one to set up a trust that cannot be touched by creditors but that allows one to get one's money.be touched by creditors but that allows one to get one's money. Most other states require irrevocable trusts that prevent oneMost other states require irrevocable trusts that prevent one from accessing one's money once it is in the trust. The state offrom accessing one's money once it is in the trust. The state of Alaska responded with a similar trust, but added spouses andAlaska responded with a similar trust, but added spouses and children to the list of creditors that could not get at the moneychildren to the list of creditors that could not get at the money in the trust. Delaware responded likewise.in the trust. Delaware responded likewise.
  • 54. 11-54 Corporations-Incorporation  Delaware v. Nevada-Delaware v. Nevada- • Taxes on corporate earnings:Taxes on corporate earnings: Delaware taxes the proportion ofDelaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless ofcorporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned.where the profits are earned. • Annual franchise tax:Annual franchise tax: Delaware and most other states have an annualDelaware and most other states have an annual franchise tax on corporations. Nevada does not.franchise tax on corporations. Nevada does not. • Annual disclosure:Annual disclosure: Delaware requires an annual report of stockholderDelaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and themeeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the currentnumber and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officerslist of officers and directors. In both Delaware and Nevada, the officers and directors can be one person.and directors can be one person. • Protection of officers and directors:Protection of officers and directors: Nevada provides broaderNevada provides broader protection against personal liability of officers and directors than doesprotection against personal liability of officers and directors than does Delaware.Delaware.
  • 55. 11-55 Corporations-Incorporation  Delaware v. Nevada- (Cont.)Delaware v. Nevada- (Cont.) • Shareholder disclosure:Shareholder disclosure: Nevada and Wyoming are two states that allow bearerNevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates wereshares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally waslike cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of thethe owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing thestock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of theshareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in theshareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearercorporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer sharesshares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearerlegally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not holdshares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as taxthe certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, butevasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. Forwhich often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you canexample, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction.truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxesFurthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general itare due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should notis best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate.be a major criterion in the decision of where to incorporate.
  • 56. 11-56 Corporations-Incorporation  Delaware v. Nevada (Cont.)Delaware v. Nevada (Cont.) • Disclosure to IRS:Disclosure to IRS: Delaware and most other states share taxDelaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares,information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evadenon-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate businesstaxes, so this should not be a criterion for legitimate business purposes.purposes. • Note: There is a flip side to some of Nevada's perceivedNote: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage ofadvantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, NevadaNevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than arecorporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state ofcorporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, butWyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangiblesa lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead ofto consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly moreNevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada'scredibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it atcorporation laws. This issue may have little or no ground, but it at least is worth considering.least is worth considering.
  • 57. 11-57 Corporations-Incorporation  Advantage of Incorporating in One's Own StateAdvantage of Incorporating in One's Own State • If the company does not plan to obtain ventureIf the company does not plan to obtain venture capital funding, it may be best to incorporate in thecapital funding, it may be best to incorporate in the state in which the company plans to do business.state in which the company plans to do business. Doing so has the following advantages:Doing so has the following advantages: • Local attorneys are familiar with the local lawLocal attorneys are familiar with the local law • One can have an intrastate securities lawOne can have an intrastate securities law exemption.exemption. • There is the convenience of geographicalThere is the convenience of geographical proximity.proximity. • The corporation does not need to register as aThe corporation does not need to register as a "foreign" corporation in the state of operation if it is"foreign" corporation in the state of operation if it is incorporated there.incorporated there.
  • 58. 11-58 Articles of Incorporation- ContentsArticles of Incorporation- Contents  Mandatory ElementsMandatory Elements • Name of CorporationName of Corporation • # Shares of Capital Stock Authorized to# Shares of Capital Stock Authorized to IssueIssue • Address of Registered Office/NameAddress of Registered Office/Name Registered Agent (for service of process)Registered Agent (for service of process) • Name/Address of IncorporatorName/Address of Incorporator  See N.C. Blank FormSee N.C. Blank Form  Generally should keep to a minimum becauseGenerally should keep to a minimum because must file amendments to changemust file amendments to change  Mandatory ElementsMandatory Elements • Name of CorporationName of Corporation • # Shares of Capital Stock Authorized to# Shares of Capital Stock Authorized to IssueIssue • Address of Registered Office/NameAddress of Registered Office/Name Registered Agent (for service of process)Registered Agent (for service of process) • Name/Address of IncorporatorName/Address of Incorporator  See N.C. Blank FormSee N.C. Blank Form  Generally should keep to a minimum becauseGenerally should keep to a minimum because must file amendments to changemust file amendments to change
  • 59. Corporations - Incorporation Other RequirementsOther Requirements • MeetingsMeetings • Corporate SealCorporate Seal • BylawsBylaws
  • 60. Corporations - Defective Incorporation De Jure v. De FactoDe Jure v. De Facto • Substantial compliance withSubstantial compliance with all steps of the incorporationall steps of the incorporation process = De Jureprocess = De Jure • If serious defect, but goodIf serious defect, but good faith effort and exercise offaith effort and exercise of powers, may be found to be Depowers, may be found to be De Facto.Facto.
  • 61. Corporations - Duties  Ultra vires doctrineUltra vires doctrine: shareholders could: shareholders could sue managers for embarking on projectssue managers for embarking on projects contrary to the corporate purpose.contrary to the corporate purpose.  However this doctrine is in declineHowever this doctrine is in decline because of the broad interpretation ofbecause of the broad interpretation of thethe Business Judgement RuleBusiness Judgement Rule whichwhich shields some managerial actions fromshields some managerial actions from substantive review by courts (especiallysubstantive review by courts (especially in Delaware)in Delaware)
  • 62. 11-62 Corporations- Dissolution  Types of Voluntary DissolutionTypes of Voluntary Dissolution • End at specified time found in ArticlesEnd at specified time found in Articles • Written consent of all shareholdersWritten consent of all shareholders • Majority Vote of shareholders at aMajority Vote of shareholders at a special meetingspecial meeting • Merger or consolidationMerger or consolidation • Vote of majority of incorporators ifVote of majority of incorporators if corporation has not begun businesscorporation has not begun business
  • 63. 11-63 Board of DirectorsBoard of Directors  Powers/DutiesPowers/Duties • GeneralGeneral • Actions RequiringActions Requiring InitiativeInitiative  OnlineOnline CommunicationsCommunications  Powers/Rights ofPowers/Rights of Director as anDirector as an IndividualIndividual  CompensationCompensation  Powers/DutiesPowers/Duties • GeneralGeneral • Actions RequiringActions Requiring InitiativeInitiative  OnlineOnline CommunicationsCommunications  Powers/Rights ofPowers/Rights of Director as anDirector as an IndividualIndividual  CompensationCompensation  ElectionElection • NumberNumber • QualificationsQualifications • NominationNomination • TermTerm • VacanciesVacancies  RemovalRemoval  MeetingsMeetings
  • 64. Board of Directors  In most jurisdictions, the board actingIn most jurisdictions, the board acting alone can:alone can: • Declare a dividendDeclare a dividend • Establish the price for sale of sharesEstablish the price for sale of shares • Elect and remove officersElect and remove officers • Fill vacancies on the BoardFill vacancies on the Board • Sell, lease or mortgage assets outsideSell, lease or mortgage assets outside the normal course of businessthe normal course of business
  • 65. Board of Directors  Actions byActions by Board InitiativeBoard Initiative areare regarded as proposals forregarded as proposals for shareholder approvalshareholder approval  Shareholders must all approveShareholders must all approve certain extraordinary actions suchcertain extraordinary actions such as amendment of articles, mergers,as amendment of articles, mergers, sale or lease of substantially allsale or lease of substantially all assets or dissolutionassets or dissolution
  • 66. Board of Directors  Recent statutes in manyRecent statutes in many jurisdictions now allow directors tojurisdictions now allow directors to communicate and conduct businesscommunicate and conduct business electronically.electronically. • But , not allow electronic boardBut , not allow electronic board meetingsmeetings Why the distinction?Why the distinction?
  • 67. Board of Directors There are statutory and/or bylawThere are statutory and/or bylaw requirements for qualification,requirements for qualification, nomination, election, term,nomination, election, term, vacancy filling, removal orvacancy filling, removal or directors and officers as well asdirectors and officers as well as for meeting frequency, notice,for meeting frequency, notice, formality, quorumformality, quorum
  • 68. Board of Directors Is it realistic to expectIs it realistic to expect directors to “manage” thedirectors to “manage” the corporation, or should theircorporation, or should their role be viewed as one ofrole be viewed as one of more ofmore of monitoring/evaluating themonitoring/evaluating the actions of corporate officers?actions of corporate officers?
  • 69. Board of Directors  The Board only has authority to act forThe Board only has authority to act for the corporationthe corporation as a groupas a group  Most state law mandates directors mustMost state law mandates directors must act in the best interests of theact in the best interests of the corporation and its shareholderscorporation and its shareholders • Courts have generally interpreted thisCourts have generally interpreted this to mean maximizing share price.to mean maximizing share price. • Is what’s best for the share priceIs what’s best for the share price always what’s best for the company?always what’s best for the company?
  • 70. 11-70 Officers of Corporation Officers of Corporation PowersPowers President/Chairman-President/Chairman- exex officioofficio Vice PresidentVice President Corporate SecretaryCorporate Secretary TreasurerTreasurer PowersPowers President/Chairman-President/Chairman- exex officioofficio Vice PresidentVice President Corporate SecretaryCorporate Secretary TreasurerTreasurer
  • 71. Officers Ex-officio authority =Ex-officio authority = authority by virtue of officeauthority by virtue of office Often a good idea to have anOften a good idea to have an Assistant Treasurer and/orAssistant Treasurer and/or Assistant Secretary forAssistant Secretary for reasons of expediencyreasons of expediency
  • 72. 11-72 Duties Directors/OfficersDuties Directors/Officers  Act WithinAct Within AuthorityAuthority  Due Care andDue Care and DiligenceDiligence • Prudent PersonPrudent Person • BusinessBusiness JudgmentJudgment • IncreasedIncreased Director LiabilityDirector Liability  Act WithinAct Within AuthorityAuthority  Due Care andDue Care and DiligenceDiligence • Prudent PersonPrudent Person • BusinessBusiness JudgmentJudgment • IncreasedIncreased Director LiabilityDirector Liability  Loyalty/GoodLoyalty/Good FaithFaith • Self-DealingSelf-Dealing • UsurpUsurp • Freeze-Outs,Freeze-Outs, etc.etc. • InsideInside InformationInformation  Right to DissentRight to Dissent
  • 73. 11-73 Duties Directors/OfficersDuties Directors/Officers Optional limitations onOptional limitations on liabilityliability • Charter Option Statute (breachCharter Option Statute (breach of duty)of duty) • Self-Executing Statute (willfulSelf-Executing Statute (willful or reckless)or reckless) • Cap on Money DamagesCap on Money Damages Optional limitations onOptional limitations on liabilityliability • Charter Option Statute (breachCharter Option Statute (breach of duty)of duty) • Self-Executing Statute (willfulSelf-Executing Statute (willful or reckless)or reckless) • Cap on Money DamagesCap on Money Damages
  • 74. 11-74 Duties Directors/OfficersDuties Directors/Officers  IndemnificationIndemnification • MandatoryMandatory (acting in good faith, pre-(acting in good faith, pre- existing agreement)existing agreement) • PermissiblePermissible (good faith, believed best(good faith, believed best interest, unaware illegal, disinterestedinterest, unaware illegal, disinterested agree)agree) • ImpermissibleImpermissible (liable or bad faith or(liable or bad faith or violate fed. Securities law)violate fed. Securities law)  IndemnificationIndemnification • MandatoryMandatory (acting in good faith, pre-(acting in good faith, pre- existing agreement)existing agreement) • PermissiblePermissible (good faith, believed best(good faith, believed best interest, unaware illegal, disinterestedinterest, unaware illegal, disinterested agree)agree) • ImpermissibleImpermissible (liable or bad faith or(liable or bad faith or violate fed. Securities law)violate fed. Securities law)
  • 75. Corporate Governance  ““Directors can be out of touch with aDirectors can be out of touch with a company's business and can fall prey to thecompany's business and can fall prey to the temptation to simply be polite to a chieftemptation to simply be polite to a chief executive while Rome is burning. A code ofexecutive while Rome is burning. A code of silence develops in the boardroom. By thesilence develops in the boardroom. By the time someone is willing to speak up, thetime someone is willing to speak up, the company is in deep trouble.” - Bill George,company is in deep trouble.” - Bill George, Former CEO, Medtronic Corp. in "AuthenticFormer CEO, Medtronic Corp. in "Authentic Leadership: Rediscovering the Secrets toLeadership: Rediscovering the Secrets to Creating Lasting Value," Jossey-Bass/Wiley,Creating Lasting Value," Jossey-Bass/Wiley, 2003.2003.
  • 76. Corporate Governance  The Board of Directors ofThe Board of Directors of Worldcom reportedly allowedWorldcom reportedly allowed CEO Bernie Ebbers to ruleCEO Bernie Ebbers to rule “practically unchecked”,“practically unchecked”, generally “rubber-stamping”generally “rubber-stamping” his decisions. Their auditshis decisions. Their audits “rarely scratched below the“rarely scratched below the surface” and they approvedsurface” and they approved multibillion dollar mergersmultibillion dollar mergers and acquisitions “with littleand acquisitions “with little discussion.” (Report:discussion.” (Report: Worldcom board passive, JimWorldcom board passive, Jim Hopkins,Hopkins, USA TodayUSA Today, June, June 10, 2003, p. 3B)10, 2003, p. 3B)
  • 77. Corporate Governance First Board usually appointedFirst Board usually appointed by incorporatorsby incorporators Who nominates/elects theWho nominates/elects the board thereafter?board thereafter? • Typically the ExecutiveTypically the Executive Officers by Proxy ElectionsOfficers by Proxy Elections
  • 78. 11-78 Make-up of Corporate Boards  Retired officer of another firmRetired officer of another firm 89%89%  CEO at another companyCEO at another company 87%87%  Major company shareholderMajor company shareholder 73%73%  Ex-government officialEx-government official 53%53%  AcademiciansAcademicians 50%50% Corporate boards average 11Corporate boards average 11 Directors.Directors. Most Directors byMost Directors by percentage are:percentage are:
  • 79. Corporate Governance  But, on April 14, 2003, the SEC said itBut, on April 14, 2003, the SEC said it would review rules that make it tough forwould review rules that make it tough for shareholders to nominate directors toshareholders to nominate directors to corporate boards. SEC Chairmancorporate boards. SEC Chairman William Donaldson asked staffers toWilliam Donaldson asked staffers to come with recommendations to make itcome with recommendations to make it easier for shareholders to run their owneasier for shareholders to run their own candidates. Changes may be adopted incandidates. Changes may be adopted in time for the 2004 proxy season.time for the 2004 proxy season.
  • 80. Corporate Governance  Criteria for Who should sit on the Board ofCriteria for Who should sit on the Board of Directors?Directors? • Competence?Competence? • Knowledge of/Experience in, the industry?Knowledge of/Experience in, the industry? • General business knowledge/experience?General business knowledge/experience? • Note: One of the requirements of Sarbanes-Note: One of the requirements of Sarbanes- Oxley is that a company must haveOxley is that a company must have individuals who are certified financialindividuals who are certified financial experts on the board.experts on the board.
  • 81. Corporate Governance Independence?Independence? • Inside vs. OutsideInside vs. Outside Self-Interest (Good or Bad?)Self-Interest (Good or Bad?) Some corporate bylaws requireSome corporate bylaws require board members to be shareholdersboard members to be shareholders Should the company maintain aShould the company maintain a certain % of independent directors?certain % of independent directors? If so, what %?If so, what %?
  • 82. Corporate Governance Independence?Independence? • In Britain, the 1992 CadburyIn Britain, the 1992 Cadbury Committee report recommendedCommittee report recommended that boards of directors of publicthat boards of directors of public companies include at least 3companies include at least 3 outside directors as members andoutside directors as members and that the CEO and chairman poststhat the CEO and chairman posts be held by different individuals.be held by different individuals.
  • 83. Corporate Governance Should There beShould There be PluralismPluralism onon Board (interest group reps. e.g.Board (interest group reps. e.g. Labor, Environmental,Labor, Environmental, Consumer Watchdogs, etc.)?Consumer Watchdogs, etc.)? • e.g. Volkswagon’s “Group Works”e.g. Volkswagon’s “Group Works” CouncilCouncil
  • 84. Corporate Governance Ethical Orientation?Ethical Orientation? - C-bridge,- C-bridge, a rapidly emerging leadera rapidly emerging leader among Internet-based businessamong Internet-based business solution providers, appointed tosolution providers, appointed to Joseph L. Badaracco, Jr.,Joseph L. Badaracco, Jr., Professor of Business Ethics atProfessor of Business Ethics at the Harvard Business School tothe Harvard Business School to its Board.its Board.
  • 85. Corporate Governance  Should a Chairman of the Board & CEO be the sameShould a Chairman of the Board & CEO be the same person?person? • In the UK, the role of chairman of the board andIn the UK, the role of chairman of the board and CEO are now generally held by different people,CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80%unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, oneof companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman.person wears the hats of both CEO and chairman. • However, recent studies suggest that companies inHowever, recent studies suggest that companies in which the chairman and CEO positions are held bywhich the chairman and CEO positions are held by two different people perform no better thantwo different people perform no better than companies in which the roles are combined. Incompanies in which the roles are combined. In other words, it’s no guarantee against futureother words, it’s no guarantee against future scandals.scandals.
  • 86. Executive Compensation Is CEOIs CEO CompensaCompensa tion Fair?tion Fair?
  • 87. Executive Compensation  The traditional argument is that executiveThe traditional argument is that executive responsibilities and skills call for higherresponsibilities and skills call for higher salaries (e.g. Michael Capellas recentlysalaries (e.g. Michael Capellas recently received judicial approval for “scaled down”received judicial approval for “scaled down” $20 million 3 year pay package. This was 23%$20 million 3 year pay package. This was 23% below originally proposed package. The judgebelow originally proposed package. The judge called the package “fair and eminentlycalled the package “fair and eminently reasonable”. The company had difficultyreasonable”. The company had difficulty attracting candidates. Capellas will make lessattracting candidates. Capellas will make less than could have earned elsewhere.)than could have earned elsewhere.)
  • 88. Executive Compensation  According to the judge, the packageAccording to the judge, the package was “Quite startling in itswas “Quite startling in its magnitude but reasonable for amagnitude but reasonable for a management challenge that wasmanagement challenge that was unprecedented. The challenge, tounprecedented. The challenge, to save tens of thousands of jobs andsave tens of thousands of jobs and satisfy tens of millions ofsatisfy tens of millions of customers.”customers.”
  • 89. Executive Compensation  According to Richard Lambert, AccountingAccording to Richard Lambert, Accounting Professor at Wharton Business School, if theProfessor at Wharton Business School, if the level of executive compensation is put in thelevel of executive compensation is put in the context of overall company finances, it seemscontext of overall company finances, it seems less of a problem. Compared with the value ofless of a problem. Compared with the value of most public companies, the amount of moneymost public companies, the amount of money being given to executives is not that large.being given to executives is not that large. “Even if you cut the CEO’s salary in half, the“Even if you cut the CEO’s salary in half, the effect on shareholder wealth would be veryeffect on shareholder wealth would be very small.”small.”
  • 90. Executive Compensation  If a company does well or poorly, toIf a company does well or poorly, to what extent is the CEO responsible forwhat extent is the CEO responsible for this?this? • It's clear that CEOs' pay has risen farIt's clear that CEOs' pay has risen far faster than the corporate profitsfaster than the corporate profits they're paid to generate. Profits rosethey're paid to generate. Profits rose 78% in the last decade, much less than78% in the last decade, much less than the 212% increase in CEO pay over thethe 212% increase in CEO pay over the same period.same period.
  • 91. Executive Compensation  The chief executives at 23 corporationsThe chief executives at 23 corporations under investigation for improperunder investigation for improper accounting pocketed $1.4 billion, or anaccounting pocketed $1.4 billion, or an average of $62 million each, in the lastaverage of $62 million each, in the last three years. Meanwhile, their companies'three years. Meanwhile, their companies' stock values plunged $530 billion, orstock values plunged $530 billion, or about 73% of their total value, and theirabout 73% of their total value, and their companies laid off a total of 162,000companies laid off a total of 162,000 workers.workers.
  • 92. Executive Compensation  TheThe Financial TimesFinancial Times recently reported on arecently reported on a study of what they called “The Barons ofstudy of what they called “The Barons of Bankruptcy” – a privileged group of topBankruptcy” – a privileged group of top business leaders who made extraordinarybusiness leaders who made extraordinary fortunes even as their companies werefortunes even as their companies were heading for disaster. They examined theheading for disaster. They examined the largest 25 business collapses since the startlargest 25 business collapses since the start of last year and, according to their figures, theof last year and, according to their figures, the executives and directors of these doomedexecutives and directors of these doomed companies walked away with over $3.3 billioncompanies walked away with over $3.3 billion in compensation and proceeds from stockin compensation and proceeds from stock sales.sales.
  • 93. Executive Compensation  Revenue at Tyco's electronics unit fellRevenue at Tyco's electronics unit fell from $13.6 billion in fiscal 2001 to $10.5from $13.6 billion in fiscal 2001 to $10.5 billion in the following year.billion in the following year. Nevertheless, division presidentNevertheless, division president Juergen W. Gromer earned a bonus ofJuergen W. Gromer earned a bonus of almost $3.4 million. Gromer's salary wasalmost $3.4 million. Gromer's salary was increased by $35,500, to $695,500. In theincreased by $35,500, to $695,500. In the previous year, Gromer earned a bonusprevious year, Gromer earned a bonus of $6.85 million.of $6.85 million.
  • 94. Executive Compensation  Former Kmart CEO CharlesFormer Kmart CEO Charles Conaway received nearly $23Conaway received nearly $23 million in compensation during hismillion in compensation during his 2-year tenure. When Kmart filed for2-year tenure. When Kmart filed for bankruptcy in 2002, 283 stores werebankruptcy in 2002, 283 stores were closed and 22,000 employees lostclosed and 22,000 employees lost their jobs. Their total severancetheir jobs. Their total severance pay: $0.pay: $0.
  • 95. Executive Compensation  In 2002, the total compensation ofIn 2002, the total compensation of CEO Scott McNealy of SunCEO Scott McNealy of Sun Microsystems, rose 31% to $31.7Microsystems, rose 31% to $31.7 million while his shareholders’million while his shareholders’ return plunged 74.7%, according toreturn plunged 74.7%, according to Equilar, an independent provider ofEquilar, an independent provider of compensation data.compensation data.
  • 96. Executive Compensation  At Honeywell, CEO David CoteAt Honeywell, CEO David Cote made $68.5 million, about 80% ofmade $68.5 million, about 80% of which was a sign-on bonus forwhich was a sign-on bonus for taking over the top job in Februarytaking over the top job in February 2002. Meanwhile, Honeywell2002. Meanwhile, Honeywell shareholders saw the value of theirshareholders saw the value of their investments slide by 27.3%.investments slide by 27.3%.
  • 97. Executive Compensation  Steve Jobs of Apple Computer,Steve Jobs of Apple Computer, pulled in $78.1 million while hispulled in $78.1 million while his investors’ return slumped by 34.6%.investors’ return slumped by 34.6%.  In 2002, while the S&P 500 plungedIn 2002, while the S&P 500 plunged 22%, median CEO compensation22%, median CEO compensation rose 14% .rose 14% .  Bottom Line:Bottom Line: There is little correlationThere is little correlation between pay and performance, nobetween pay and performance, no linkagelinkage
  • 98. Executive Compensation  Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity • 20 years ago the CEO got about20 years ago the CEO got about 40 times what the average worker40 times what the average worker did. It's now, according to them,did. It's now, according to them, 541 times.541 times. • The earnings of CEO's haveThe earnings of CEO's have grown 10 times faster than thosegrown 10 times faster than those of the average worker.of the average worker.
  • 99. Executive Compensation  Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity • Among Fortune 500 companies CEOs earn moreAmong Fortune 500 companies CEOs earn more than 100 times the average employee’s salary.than 100 times the average employee’s salary. • Compensation for CEO’s rose at 27 out of 30Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions.companies in 1993 with the largest staff reductions. • 60% of managers recently surveyed said CEOs60% of managers recently surveyed said CEOs make too much.make too much. • 64% of respondents to a recent SHRM online poll64% of respondents to a recent SHRM online poll indicated that they did not believe that executiveindicated that they did not believe that executive pay in their organization was in line in comparisonpay in their organization was in line in comparison to pay in the rest of the organization.to pay in the rest of the organization.
  • 100. Executive Compensation  Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity • Hershey CEO Richard Lenny was paid moreHershey CEO Richard Lenny was paid more than $22 million last year. An average unionthan $22 million last year. An average union worker at Hershey makes $18 per hour,worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensationabout $37,440 a year. Lenny's compensation could support 598 of these averagecould support 598 of these average workers. Hershey employees went on strikeworkers. Hershey employees went on strike earlier this year when management doubledearlier this year when management doubled the cost of co-payments for health care.the cost of co-payments for health care.
  • 101. Executive Compensation  Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity • Gaps between exec/worker increasing.Gaps between exec/worker increasing. • The growing disparity between executiveThe growing disparity between executive compensation and that of other employeescompensation and that of other employees is leading to a trust gap, which threatens tois leading to a trust gap, which threatens to seriously impair morale.seriously impair morale. • Bottom Line: When executive pay increasesBottom Line: When executive pay increases faster than the economy other people'sfaster than the economy other people's share decreases.share decreases.
  • 102. Executive Compensation  Perks/Other non-salary compensationPerks/Other non-salary compensation • Stock OptionsStock Options Options allow executives to buy theirOptions allow executives to buy their company's stock in the future at thecompany's stock in the future at the current price.current price. After less than six months on the job,After less than six months on the job, Tyco International Ltd.'s chief executiveTyco International Ltd.'s chief executive Ed Breen earned $49 million in paperEd Breen earned $49 million in paper profits just in his Tyco stock options,profits just in his Tyco stock options, according to the company's proxyaccording to the company's proxy statement.statement.
  • 103. Executive Compensation Qwest's CEO JosephQwest's CEO Joseph Nacchio, cashed out $300Nacchio, cashed out $300 million in stock options whilemillion in stock options while the company's stock droppedthe company's stock dropped from $51 a share to $8. At thefrom $51 a share to $8. At the same time he fired 17,000same time he fired 17,000 employees and shut down aemployees and shut down a $25 million charity program.$25 million charity program.
  • 104. Executive Compensation Life insurance, pension plan,Life insurance, pension plan, IRA, club memberships, carIRA, club memberships, car allowances, stock options.allowances, stock options. Jack Welch from GE got luxuryJack Welch from GE got luxury apartment, entertainment and aapartment, entertainment and a private jet.private jet. ““Golden parachutes”Golden parachutes”
  • 105. Executive Compensation Under his current contract, ifUnder his current contract, if Home Depot CEO RobertHome Depot CEO Robert Nardelli is fired he willNardelli is fired he will receive an $82 millionreceive an $82 million severance package (Fortuneseverance package (Fortune Magazine)Magazine)
  • 106. Executive Compensation  SERP (supplemental executive-retirement plan) is aSERP (supplemental executive-retirement plan) is a steroid-enhanced version of the traditional defined-steroid-enhanced version of the traditional defined- benefit pension plan, in which a company sets aside abenefit pension plan, in which a company sets aside a given % of an executive's pay every year to produce agiven % of an executive's pay every year to produce a guaranteed payout. SERPs are now offered by aboutguaranteed payout. SERPs are now offered by about 1/2 of all big publicly traded companies, usually only1/2 of all big publicly traded companies, usually only to the CEO and the next dozen or so officers. Andto the CEO and the next dozen or so officers. And while the combination of a collapsing stock marketwhile the combination of a collapsing stock market and low interest rates have placed pension plans forand low interest rates have placed pension plans for ordinary Joes in jeopardy that's not the case for topordinary Joes in jeopardy that's not the case for top execs. In fact, now that the stock market bubble hasexecs. In fact, now that the stock market bubble has burst, compensation experts predict that companiesburst, compensation experts predict that companies will actually increase their use of SERPs to pick up thewill actually increase their use of SERPs to pick up the slack. ” (Fortune, April 28, 2003)slack. ” (Fortune, April 28, 2003)
  • 107. Executive Compensation  How did this happen?How did this happen? • Who usually decides on compensationWho usually decides on compensation packages?packages? Compensation Committees of CorporateCompensation Committees of Corporate BoardsBoards • Based on what?Based on what? Fair Market Value as demonstrated byFair Market Value as demonstrated by disclosed information, recommendationsdisclosed information, recommendations ofof executive search firmsexecutive search firms and “other”and “other” factors.factors.
  • 108. Executive Compensation  Collusion?Collusion? • When most big companies name outsideWhen most big companies name outside directors they tend to draw from a familiardirectors they tend to draw from a familiar pool of corporate luminaries close to home.pool of corporate luminaries close to home. • A University of Michigan Business SchoolA University of Michigan Business School study determined that there is about 4.6study determined that there is about 4.6 degrees of separation on average ondegrees of separation on average on corporate boards. Business is run by thecorporate boards. Business is run by the “connected few”.“connected few”.
  • 109. Executive Compensation What about the shareholders,What about the shareholders, the supposed “owners” of thethe supposed “owners” of the corporations?corporations? • Vodafone recently putVodafone recently put executive compensation up forexecutive compensation up for a shareholder vote.a shareholder vote. • Good idea?Good idea? • This is highly unusual.This is highly unusual.
  • 110. Starting a Business  Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.) • A hybrid form of business enterprise that offers theA hybrid form of business enterprise that offers the limited liability of the corporation but the taxlimited liability of the corporation but the tax advantages of a partnershipadvantages of a partnership • 47 States permit (including N.C.)47 States permit (including N.C.) • Separate Legal Entity like corporationSeparate Legal Entity like corporation • Require filing Articles of IncorporationRequire filing Articles of Incorporation • All investors able to share in managementAll investors able to share in management • No restrictions on number or types of membersNo restrictions on number or types of members • No one member has liability for wrongful acts ofNo one member has liability for wrongful acts of others (makes attractive to doctors, lawyers, etc.)others (makes attractive to doctors, lawyers, etc.)
  • 111. Starting a Business  Limited Liability Partnership (L.L.P.)Limited Liability Partnership (L.L.P.) • Similar to L.L.C., but designed forSimilar to L.L.C., but designed for professional groups who normally doprofessional groups who normally do business as partnersbusiness as partners • Started to shield uninvolvedStarted to shield uninvolved professionals’ personal assets fromprofessionals’ personal assets from malpractice claimsmalpractice claims • Must maintain adequate professionalMust maintain adequate professional liability insuranceliability insurance
  • 112. Starting a Business Joint VentureJoint Venture • A joint undertaking of a specific commercialA joint undertaking of a specific commercial enterprise by an association of persons (.e.g.enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958)P2d 49 (Ore. 1958) • A joint venture is normally not a legal entity and isA joint venture is normally not a legal entity and is treated like a partnership for federal income taxtreated like a partnership for federal income tax purposespurposes • Normally lasts until venture is completed orNormally lasts until venture is completed or becomes impossible to completebecomes impossible to complete
  • 113. Starting a Business Strategic AllianceStrategic Alliance • A strategic alliance is anA strategic alliance is an organizational relationship thatorganizational relationship that links two or more independentlinks two or more independent business entities in a commonbusiness entities in a common endeavorendeavor
  • 114. Starting a Business FranchiseFranchise • Business owner (franchisor), usually a corporation,Business owner (franchisor), usually a corporation, allows another (the franchisee) to use itsallows another (the franchisee) to use its trademark, trade name, or copyright, undertrademark, trade name, or copyright, under specified conditions.specified conditions. • Each franchise operates as an independentEach franchise operates as an independent business.business. • Franchise Agreements are often viewed as one-Franchise Agreements are often viewed as one- sided or “Contracts of Adhesion” (Body Shopsided or “Contracts of Adhesion” (Body Shop Example)Example) • Clayton Act “tie-in sales” questionsClayton Act “tie-in sales” questions • Sherman Act price control questionsSherman Act price control questions
  • 115. Starting a Business Franchise (Cont.)Franchise (Cont.) • Government disclosure requirementsGovernment disclosure requirements • Law of state of franchisor typically controls inLaw of state of franchisor typically controls in contract disputes (e.g. Burger King, Florida)contract disputes (e.g. Burger King, Florida) • Often “turn-key” operationsOften “turn-key” operations • Typically owned by a sole proprietor.Typically owned by a sole proprietor. • Examples (McDonald's, Dairy Queen)Examples (McDonald's, Dairy Queen) • Advantages - Proven management style, NameAdvantages - Proven management style, Name recognition, Strong marketing resources, Oftenrecognition, Strong marketing resources, Often involve financial supportinvolve financial support • Beware, overblown or “fly-by-night” franchises!Beware, overblown or “fly-by-night” franchises!
  • 116. Starting a Business Types of FranchisesTypes of Franchises • DistributorshipDistributorship- Dealer is allowed to sell a- Dealer is allowed to sell a product produced by a manufacturer.product produced by a manufacturer. • Chain-Style BusinessChain-Style Business - Firm is allowed to use- Firm is allowed to use the trade name of a company and followsthe trade name of a company and follows guidelines related to the pricing and sale ofguidelines related to the pricing and sale of the product.the product. • Manufacturing ArrangementManufacturing Arrangement- Firm is allowed- Firm is allowed to manufacture a product using the formulato manufacture a product using the formula provided by the franchisorprovided by the franchisor
  • 117. Starting a Business CooperativesCooperatives • Group of 2 or more independentGroup of 2 or more independent persons that cooperate for a commonpersons that cooperate for a common objective (e.g. farmers poolingobjective (e.g. farmers pooling produce for sale)produce for sale)
  • 118. Starting a Business  Factors in Selecting a FormFactors in Selecting a Form • LiabilityLiability • Tax TreatmentTax Treatment • Formalities/ComplexityFormalities/Complexity • Access to Funds/FinancingAccess to Funds/Financing • Distribution of Profits/LossesDistribution of Profits/Losses • Management/ControlManagement/Control • LifecycleLifecycle • Liquidity/Ease of TransferLiquidity/Ease of Transfer • PrivacyPrivacy • Fringe BenefitsFringe Benefits
  • 119. Starting a Business LiabilityLiability • Why Limit Liability?Why Limit Liability? Incentive to InvestIncentive to Invest LawsuitsLawsuits • Can’t insurance cover liability?Can’t insurance cover liability? • Personal Guarantees/Co-Signing CanPersonal Guarantees/Co-Signing Can Expand/Reimpose Liability (Often requiredExpand/Reimpose Liability (Often required by lenders, especially with new, smallby lenders, especially with new, small companies)companies)
  • 120. Starting a Business  LiabilityLiability • Sole ProprietorSole Proprietor  Sole and complete unlimited liabilitySole and complete unlimited liability • General PartnershipGeneral Partnership  Joint liability for debts and contracts (“in theJoint liability for debts and contracts (“in the ordinary course of business”, Help instill v.ordinary course of business”, Help instill v. Regions Bank, Texas Court of Appeals, 2000, 33Regions Bank, Texas Court of Appeals, 2000, 33 S.W.3d 401)S.W.3d 401)  Joint and several unlimited liability for tortsJoint and several unlimited liability for torts (unless “marshalling” requirement(unless “marshalling” requirement • Marshalling = liabilities first paid out of theMarshalling = liabilities first paid out of the partnership assetspartnership assets
  • 121. Starting a Business  Partnership LiabilityPartnership Liability  Orel Koelling was a partner in a partnershipOrel Koelling was a partner in a partnership that employed Martin Martinez. Mr. Martinezthat employed Martin Martinez. Mr. Martinez died as the result of an accident whichdied as the result of an accident which occurred in the course of the partnership'soccurred in the course of the partnership's business. Mrs. Martinez filed suit againstbusiness. Mrs. Martinez filed suit against Koelling to recover for her husband's death.Koelling to recover for her husband's death. Koelling moved for summary judgment on theKoelling moved for summary judgment on the grounds that the partnership was the employergrounds that the partnership was the employer and liable, if anyone was. Issue: Shouldand liable, if anyone was. Issue: Should Koelling be dismissed from this litigation?Koelling be dismissed from this litigation? Held: No. Partners are jointly and severallyHeld: No. Partners are jointly and severally liable for the actions of the partnership. Thus,liable for the actions of the partnership. Thus, Koelling, as a partner, was a proper defendant.Koelling, as a partner, was a proper defendant. Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).
  • 122. Starting a Business  Liability (Cont.)Liability (Cont.) • Limited PartnershipLimited Partnership  Some partners have personal liability that is limitedSome partners have personal liability that is limited to the cash or property they invested in the firm.to the cash or property they invested in the firm. One or more general partners who actively manageOne or more general partners who actively manage the business, receive a salary, share in profits andthe business, receive a salary, share in profits and losses, have unlimited liability.losses, have unlimited liability. • Limited Liability PartnershipLimited Liability Partnership  Unlimited liability for general obligations, limited forUnlimited liability for general obligations, limited for malpracticemalpractice • Corporation, S Corporation, Limited LiabilityCorporation, S Corporation, Limited Liability CorporationCorporation  Liability limited to the assets of the CorporationLiability limited to the assets of the Corporation
  • 123. Starting a Business  TaxationTaxation • Sole ProprietorSole Proprietor  Reports profits on personal income tax returnReports profits on personal income tax return • Partnership/”S”Corp./L.L.C./L.L.P.Partnership/”S”Corp./L.L.C./L.L.P.  Pass through (not taxed at business entity level) -Pass through (not taxed at business entity level) - Personal earnings received from the partnership arePersonal earnings received from the partnership are subject to personal income taxes.subject to personal income taxes. • ““C” CorporationC” Corporation  ““Double Taxation” - Corporation pays tax on its incomeDouble Taxation” - Corporation pays tax on its income and Shareholders pay income tax on dividends (Possibleand Shareholders pay income tax on dividends (Possible solution: Don’t pay dividends. Profits can be paid out assolution: Don’t pay dividends. Profits can be paid out as salary or other forms of deductible compensation)salary or other forms of deductible compensation) • ““Income Splitting”Income Splitting”  Always good idea to seek advice of Accountant or Tax AttorneyAlways good idea to seek advice of Accountant or Tax Attorney on this!on this!
  • 124. Starting a Business Formalities/ComplexityFormalities/Complexity • Sole ProprietorSole Proprietor Least formalities/complexityLeast formalities/complexity • PartnershipPartnership Formalities/complexity variesFormalities/complexity varies
  • 125. Starting a Business  Formalities/Complexity (Cont.)Formalities/Complexity (Cont.) • Limited Partnership, L.L.P., S Corporation, L.L.C., CorporationsLimited Partnership, L.L.P., S Corporation, L.L.C., Corporations  All have statutory requirements and require writtenAll have statutory requirements and require written agreements.agreements. • Corporation has the most required formalities/complexityCorporation has the most required formalities/complexity (Must file Articles of Incorporation, Adopt Bylaws, Hold(Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure toperiodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolutionmaintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio,and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rdArkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834)834) • Limited Partnerships covered under N.C.G.S. 59Limited Partnerships covered under N.C.G.S. 59 • L.L.C.s are covered under N.C.G.S. 57CL.L.C.s are covered under N.C.G.S. 57C • Corporations covered under N.C.G.S. Chapter 55Corporations covered under N.C.G.S. Chapter 55 (Professionals under, 55B Non-Profits, under 55A)(Professionals under, 55B Non-Profits, under 55A)
  • 126. Starting a Business  Access to Funds/FinancingAccess to Funds/Financing • Sole ProprietorSole Proprietor  Generally has the least access toGenerally has the least access to funds/financingfunds/financing • PartnershipPartnership  Generally has a greater access toGenerally has a greater access to funds/financing than Sole Proprietorshipfunds/financing than Sole Proprietorship • L.L.P’s, S CorporationsL.L.P’s, S Corporations  Generally somewhat better access to fundsGenerally somewhat better access to funds
  • 127. Starting a Business  Access to Funds/FinancingAccess to Funds/Financing • Limited Partnerships and L.L.C.sLimited Partnerships and L.L.C.s  Generally better access to fundsGenerally better access to funds  Note: Limited Partnerships often offer the bestNote: Limited Partnerships often offer the best tax shelters for investors!tax shelters for investors! • CorporationCorporation  Generally has greatest access to funds/financingGenerally has greatest access to funds/financing (e.g. Can sell equity/debt securities (stocks &(e.g. Can sell equity/debt securities (stocks & bonds),, limited liability encourages investors,bonds),, limited liability encourages investors, stock can be offered as collateral, etc.)stock can be offered as collateral, etc.)
  • 128. Starting a Business  Distribution of Profits/LossesDistribution of Profits/Losses • Sole ProprietorSole Proprietor Gains all profits, suffers all lossesGains all profits, suffers all losses • PartnershipPartnership Distribution of profits and lossesDistribution of profits and losses generally set by agreement or pro-ratagenerally set by agreement or pro-rata • CorporationCorporation Distribution of profits determined byDistribution of profits determined by management/market, received asmanagement/market, received as dividends or increased value of stock.dividends or increased value of stock.
  • 129. Starting a Business Management/ControlManagement/Control • Sole ProprietorSole Proprietor Sole & complete management/controlSole & complete management/control • PartnershipPartnership Management/control determined byManagement/control determined by agreementagreement Partnership books and records must bePartnership books and records must be kept accessible to all partnerskept accessible to all partners
  • 130. Starting a Business Management/Control (Cont.)Management/Control (Cont.) • CorporationCorporation  Nature of control/management determined by bylaws,Nature of control/management determined by bylaws, actual persons in control determined by vote.actual persons in control determined by vote.  Corporate shareholder have no management authorityCorporate shareholder have no management authority unless elected to board or as officerunless elected to board or as officer  ““Freeze-outs” are a common problem in CloseFreeze-outs” are a common problem in Close CorporationsCorporations • L.L.P.L.L.P.  Management shared unless altered by agreementManagement shared unless altered by agreement  Purchasing an existing members interest does notPurchasing an existing members interest does not automatically confer managerial authority. Other partnersautomatically confer managerial authority. Other partners must unanimously agree to.must unanimously agree to.
  • 131. Starting a Business LiquidityLiquidity • Sole ProprietorshipSole Proprietorship  Poor liquidityPoor liquidity • Limited partnershipLimited partnership  Interest sales are technically easy, but generallyInterest sales are technically easy, but generally not particularly attractivenot particularly attractive • General partnershipGeneral partnership  Interest sales are difficult, requiring agreement ofInterest sales are difficult, requiring agreement of other partnersother partners
  • 132. Starting a Business Liquidity (Cont.)Liquidity (Cont.) • ““S” CorporationS” Corporation  Fair liquidity, but it may be restrictedFair liquidity, but it may be restricted • CorporationCorporation  Easy transfer, sell shares (note: minority interestEasy transfer, sell shares (note: minority interest shares less attractive in close corporation)shares less attractive in close corporation) • L.L.C.L.L.C.  Transfer restrictionsTransfer restrictions
  • 133. Starting a Business LifecycleLifecycle • Sole ProprietorshipSole Proprietorship  Often ends with the death or incapacity of theOften ends with the death or incapacity of the sole proprietorsole proprietor • CorporationCorporation  Continues to function unless/until formallyContinues to function unless/until formally dissolved, voluntarily or involuntarily, regardlessdissolved, voluntarily or involuntarily, regardless of the death or incapacity of individualof the death or incapacity of individual shareholders (makes easier to preserve goodwill)shareholders (makes easier to preserve goodwill) • L.L.C.L.L.C.  Often required to have a stated durationOften required to have a stated duration
  • 134. Starting a Business LifecycleLifecycle General Partnerships, L.L.P.’s, L.L.C.’sGeneral Partnerships, L.L.P.’s, L.L.C.’s  Often dissolved by loss of any member, butOften dissolved by loss of any member, but remaining members can unanimously agree toremaining members can unanimously agree to continue operationscontinue operations • Limited PartnershipsLimited Partnerships  Often dissolved by loss of a general partner, butOften dissolved by loss of a general partner, but remaining members can unanimously agree toremaining members can unanimously agree to continue operationscontinue operations  Life Insurance, especially for a “key man” canLife Insurance, especially for a “key man” can be a key factor in maintaining operations!be a key factor in maintaining operations!
  • 135. Starting a Business PrivacyPrivacy • Sole Proprietorships, Partnerships andSole Proprietorships, Partnerships and Close CorporationsClose Corporations Have very limited requirements forHave very limited requirements for disclosure of private/financialdisclosure of private/financial information.information. • Public CorporationsPublic Corporations Have extensive requirements forHave extensive requirements for disclosure of private/financialdisclosure of private/financial information.information.
  • 136. Starting a Business Fringe BenefitsFringe Benefits • Historically, fringe benefit lawsHistorically, fringe benefit laws have favored “C” corporationshave favored “C” corporations For example, generally, healthFor example, generally, health insurance is fully deductible forinsurance is fully deductible for a “C” corporation, partiallya “C” corporation, partially deductible for sole proprietor,deductible for sole proprietor, not deductible for partners ornot deductible for partners or for an “S” corporationfor an “S” corporation
  • 137. 11-137 Organizational Choices TypeType CreationCreation ContinuityContinuity ControlControl LiabilityLiability TaxTax ProprietorshipProprietorship Do It!Do It! ProprietorProprietor ProprietorProprietor Unl’dUnl’d SingleSingle PartnershipPartnership AgreementAgreement EasilyEasily DissolvedDissolved (Buy/Sell)(Buy/Sell) EqualEqual AmongAmong PartnersPartners Unl’dUnl’d SingleSingle LimitedLimited PartnershipPartnership Agree &Agree & RegisterRegister GeneralGeneral PartnerPartner GeneralGeneral PartnerPartner Gen’l- Unl’dGen’l- Unl’d Ltd.- Ltd.Ltd.- Ltd. SingleSingle LLPLLP Articles &Articles & RegistrationRegistration EasilyEasily DissolvedDissolved EqualEqual PartnersPartners LimitedLimited SingleSingle LLCLLC Articles &Articles & RegistrationRegistration DissolvedDissolved (90 Days)(90 Days) EqualEqual MembersMembers LimitedLimited SingleSingle S CorporationS Corporation ArticlesArticles (<75 People)(<75 People) PerpetualPerpetual (Ease Of(Ease Of Transfer)Transfer) ShareholdersShareholders DirectorsDirectors OfficersOfficers LimitedLimited SingleSingle CorporationCorporation Articles OfArticles Of IncorporationIncorporation PerpetualPerpetual (Ease Of(Ease Of Transfer)Transfer) ShareholdersShareholders DirectorsDirectors OfficersOfficers LimitedLimited DoubleDouble
  • 138. 11-138 Basic Forms of Ownership  Sole ProprietorshipSole Proprietorship  PartnershipPartnership  CorporationCorporation NumberNumber SalesSales 74%74% 5%5% 8%8% 5%5% 18%18% 90%90%
  • 139. 11-139 Basic Forms of Ownership Basic Forms of Ownership 18% 5% 74% 5%8% 90% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Number Sales Sole Proprietorship Partnership Corporation
  • 140. 11-140 Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S. Sole proprietorships 16,955,000 73.0% Corporations 4,631,000 19.9% Partnerships 1,654,000 7.1% Sole proprietorships, the most widespread form of business ownership, are most common in retailing, agriculture, and the service industries. Source: U.S. Bureau of the Census, Statistical Abstract of the United States, 119th ed., Washington, D.C., 1999, p. 545.
  • 141. Changing Popularity of Business Forms 0 2000 4000 6000 8000 10000 12000 14000 16000 S. Prop C Corp S Corp Part. 1980 1992
  • 142. Corporations 0 500 1000 1500 2000 2500 C Corp S Corp 1980 1992
  • 143. Some Form Trends  Historically, maximum individual tax rate >Historically, maximum individual tax rate > than maximum corporate rate createdthan maximum corporate rate created incentive to keep income in corporate formincentive to keep income in corporate form  1986 Tax Act made maximum individual rate <1986 Tax Act made maximum individual rate < maximum corporate rate & companies becamemaximum corporate rate & companies became ” S” corps in droves” S” corps in droves  But 1993 Tax Act increased individual rates,But 1993 Tax Act increased individual rates, thus, “S” corps no longer as advantageousthus, “S” corps no longer as advantageous  New kid on block - L.L.C., more flexible thanNew kid on block - L.L.C., more flexible than “S” Corp and better that L..L.P. in that not“S” Corp and better that L..L.P. in that not require a general partnerrequire a general partner
  • 144. 11-144 Aspects of Business That May Require Legal Help 1. Choosing either the sole proprietorship, partnership, or corporate form of ownership 2. Constructing a partnership agreement 3. Establishing a corporation 4. Registering a corporation’s stock 5. Obtaining a trademark, patent, or copyright 6. Filing for licenses or permits at the local, state, and federal levels 7. Purchasing an existing business or real estate 8. Leasing real estate or equipment 9. Hiring employees and independent contractors 10. Handling labor disputes and customer lawsuits 11. Extending credit and collecting debts 12. Handling bankruptcy and reorganization Source: Adapted from Seth Godin, ed., 1997 Business Almanac. Copyright © 1996 by Houghton Mifflin Company.
  • 145. Naming a Business Some Key QuestionsSome Key Questions • Statutory requirements?Statutory requirements? • Is your proposed business nameIs your proposed business name available?available? • Will your business name receiveWill your business name receive trademark protection?trademark protection? • If your business will have a website,If your business will have a website, is a similar domain name available?is a similar domain name available?
  • 146. Naming a Business  If you're starting a corporation, LLC orIf you're starting a corporation, LLC or limited partnership, you must complylimited partnership, you must comply with statutory requirements for namingwith statutory requirements for naming your businessyour business  Naming Convention for CorporationsNaming Convention for Corporations (Incorporated, Inc., Corporation, Corp.,(Incorporated, Inc., Corporation, Corp., Company, Co.)Company, Co.)  L.L.P. or L.LC. (Limited or Ltd..)L.L.P. or L.LC. (Limited or Ltd..)  Fictitious/Assumed/Trade Name (or dba)Fictitious/Assumed/Trade Name (or dba)
  • 147. Naming a Business  Name available?Name available? • Corporate/L.L.C./Limited Partnership NameCorporate/L.L.C./Limited Partnership Name Search – Secretary of StateSearch – Secretary of State • Fictitious/Assumed Name Search – RegisterFictitious/Assumed Name Search – Register of Deedsof Deeds • Trademark Search – U.S. Patent OfficeTrademark Search – U.S. Patent Office  Basic ConcernsBasic Concerns • Is it the same?Is it the same? • Is it similar enough to cause confusion?Is it similar enough to cause confusion?
  • 148. Naming a Business  TrademarkTrademark • A trademark (sometimes called simply a "mark") isA trademark (sometimes called simply a "mark") is any word, phrase, design or symbol used to marketany word, phrase, design or symbol used to market a product or service.a product or service. • Technically, a mark used to market a service, ratherTechnically, a mark used to market a service, rather than a product, is called a service mark, though thethan a product, is called a service mark, though the term "trademark" is commonly used for both typesterm "trademark" is commonly used for both types of marks because they refer to the same group ofof marks because they refer to the same group of legal protections.legal protections. • Owners of trademarks have rights under bothOwners of trademarks have rights under both federal and state law that give them the power infederal and state law that give them the power in many cases to prevent others from using the samemany cases to prevent others from using the same or confusingly similar trademarks.or confusingly similar trademarks.
  • 149. Naming a Business  Trademark (Cont.)Trademark (Cont.) • When picking a business name, takeWhen picking a business name, take care to choose a name that will becare to choose a name that will be likely to receive trademark protectionlikely to receive trademark protection • There are specific steps to protectThere are specific steps to protect your business name as a trademarkyour business name as a trademark • Document first & continuous useDocument first & continuous use • Aggressively warn/sue potentialAggressively warn/sue potential infringers (see Victor’s Little Secretinfringers (see Victor’s Little Secret case)case)
  • 150. Naming a Business Trademark (Cont.)Trademark (Cont.) • On the flip side, to make sure your businessOn the flip side, to make sure your business name won't step on someone else's rightsname won't step on someone else's rights to an existing trademark, you'll have to do ato an existing trademark, you'll have to do a trademark search.trademark search. • If your business is anything but a small,If your business is anything but a small, local service business or retailer, such as alocal service business or retailer, such as a dry cleaners or a fabric store, you'lldry cleaners or a fabric store, you'll probably want to take advantage ofprobably want to take advantage of trademark protection.trademark protection.
  • 151. Naming a Business  Trademark (Cont.)Trademark (Cont.) • Allowing businesses to have exclusive use of theirAllowing businesses to have exclusive use of their names helps consumers identify and recognizenames helps consumers identify and recognize goods in the marketplace.goods in the marketplace. • By allowing just one company to use a name,By allowing just one company to use a name, trademark law helps that company to build customertrademark law helps that company to build customer trust and goodwill.trust and goodwill. • Any business name you use to market and identifyAny business name you use to market and identify your products or services is a potential trademark.your products or services is a potential trademark. For example, McDonald's uses its business name toFor example, McDonald's uses its business name to market its hamburgers.market its hamburgers. • To qualify for trademark protection, your businessTo qualify for trademark protection, your business name should be what trademark law considersname should be what trademark law considers
  • 152. Naming a Business Distinctive NamesDistinctive Names • Examples of Distinctive NamesExamples of Distinctive Names (likely to receive trademark(likely to receive trademark protection): Xerox,protection): Xerox, Amazon.ComAmazon.Com • Not: Joe’s HardwareNot: Joe’s Hardware • One Theory - Make a new wordOne Theory - Make a new word
  • 153. 11-153 Agency Duties LoyaltyLoyalty Keep Principal InformedKeep Principal Informed Obey InstructionsObey Instructions Account For MoneyAccount For Money Partnership Liability- EachPartnership Liability- Each Partner Is AgentPartner Is Agent AndAnd PrincipalPrincipal
  • 154. 11-154 Creation of AgencyCreation of Agency Nature of Agency- OneNature of Agency- One Party (Agent) Acting forParty (Agent) Acting for Another (Principal)Another (Principal) • Usually formed byUsually formed by contract, but may be oralcontract, but may be oral
  • 155. 11-155 Creation of AgencyCreation of Agency • De facto agency may be found byDe facto agency may be found by court even where no intent to createcourt even where no intent to create Keys:Keys: • Indication/manifestation ofIndication/manifestation of consent by principalconsent by principal • Agent acceptance to act onAgent acceptance to act on behalf of principalbehalf of principal • Understanding of principalUnderstanding of principal controlcontrol Evidence: Word’s, Actions,Evidence: Word’s, Actions, CircumstancesCircumstances
  • 156. 11-156 Creation of AgencyCreation of Agency Capacity to BeCapacity to Be PrincipalPrincipal •Generally sameGenerally same capacity to act ascapacity to act as principalprincipal Capacity to Be AgentCapacity to Be Agent •Generally unrestrictedGenerally unrestricted
  • 157. 11-157 Duties of AgentsDuties of Agents  Some Duties of Principal may be non-Some Duties of Principal may be non- delegable (e.g. provide safe workdelegable (e.g. provide safe work environment, etc.)environment, etc.)  LoyaltyLoyalty • HonestyHonesty • Full discloseFull disclose • Notification and surrender of specialNotification and surrender of special compensationcompensation • No seizure of principal opportunitiesNo seizure of principal opportunities  Some Duties of Principal may be non-Some Duties of Principal may be non- delegable (e.g. provide safe workdelegable (e.g. provide safe work environment, etc.)environment, etc.)  LoyaltyLoyalty • HonestyHonesty • Full discloseFull disclose • Notification and surrender of specialNotification and surrender of special compensationcompensation • No seizure of principal opportunitiesNo seizure of principal opportunities
  • 158. 11-158 Duties of AgentsDuties of Agents  LoyaltyLoyalty • Conflict of Interest AvoidanceConflict of Interest Avoidance Even in re: the appearance of aEven in re: the appearance of a conflictconflict Dual role generally o.k. with fullDual role generally o.k. with full consent & disclosureconsent & disclosure  LoyaltyLoyalty • Conflict of Interest AvoidanceConflict of Interest Avoidance Even in re: the appearance of aEven in re: the appearance of a conflictconflict Dual role generally o.k. with fullDual role generally o.k. with full consent & disclosureconsent & disclosure
  • 159. 11-159 Duties of AgentsDuties of Agents  Those Specified by Contract, if anyThose Specified by Contract, if any  FiduciaryFiduciary • Strongly enforced by courtsStrongly enforced by courts  Obey InstructionsObey Instructions • Reasonable Belief ExceptionReasonable Belief Exception  Exercise Care and SkillExercise Care and Skill • Gratuitous Agent Factor (reduced expectations)Gratuitous Agent Factor (reduced expectations)  Communicate “Relevant” Information AffectingCommunicate “Relevant” Information Affecting a “Material Interest”a “Material Interest”  Protect Confidential InformationProtect Confidential Information  Not Perform Illegal ActsNot Perform Illegal Acts  Those Specified by Contract, if anyThose Specified by Contract, if any  FiduciaryFiduciary • Strongly enforced by courtsStrongly enforced by courts  Obey InstructionsObey Instructions • Reasonable Belief ExceptionReasonable Belief Exception  Exercise Care and SkillExercise Care and Skill • Gratuitous Agent Factor (reduced expectations)Gratuitous Agent Factor (reduced expectations)  Communicate “Relevant” Information AffectingCommunicate “Relevant” Information Affecting a “Material Interest”a “Material Interest”  Protect Confidential InformationProtect Confidential Information  Not Perform Illegal ActsNot Perform Illegal Acts
  • 160. 11-160 Duties of AgentsDuties of Agents  Account for Funds/PropertyAccount for Funds/Property • Keep Accurate RecordsKeep Accurate Records • Permit InspectionPermit Inspection • Not Commingle FundsNot Commingle Funds • Not embezzleNot embezzle • Not convert for own useNot convert for own use  Account for Funds/PropertyAccount for Funds/Property • Keep Accurate RecordsKeep Accurate Records • Permit InspectionPermit Inspection • Not Commingle FundsNot Commingle Funds • Not embezzleNot embezzle • Not convert for own useNot convert for own use
  • 161. 11-161 Duties of PrincipalsDuties of Principals CompensateCompensate • Contingent Compensation (e.g.Contingent Compensation (e.g. Contingency Fee or Commission)Contingency Fee or Commission) • Procuring Cause - when agent primaryProcuring Cause - when agent primary causecause • Duration of Employment - Where no setDuration of Employment - Where no set time, “reasonable time” to recover coststime, “reasonable time” to recover costs • Real Estate Commissions - Received atReal Estate Commissions - Received at “closing”“closing” • Insurance Commissions - On premiumsInsurance Commissions - On premiums paidpaid CompensateCompensate • Contingent Compensation (e.g.Contingent Compensation (e.g. Contingency Fee or Commission)Contingency Fee or Commission) • Procuring Cause - when agent primaryProcuring Cause - when agent primary causecause • Duration of Employment - Where no setDuration of Employment - Where no set time, “reasonable time” to recover coststime, “reasonable time” to recover costs • Real Estate Commissions - Received atReal Estate Commissions - Received at “closing”“closing” • Insurance Commissions - On premiumsInsurance Commissions - On premiums paidpaid
  • 162. 11-162 Duties of PrincipalsDuties of Principals Reimburse/Indemnify -Reimburse/Indemnify - for expenses onfor expenses on behalf of Principal,behalf of Principal, where no faultwhere no fault Keep AccountsKeep Accounts Reimburse/Indemnify -Reimburse/Indemnify - for expenses onfor expenses on behalf of Principal,behalf of Principal, where no faultwhere no fault Keep AccountsKeep Accounts
  • 163. 11-163 Enforcement of LiabilitiesEnforcement of Liabilities  Breach of Duty by AgentBreach of Duty by Agent • may reduce/eliminatemay reduce/eliminate compensationcompensation • may be grounds for terminationmay be grounds for termination of agencyof agency  Breach of Duty by PrincipalBreach of Duty by Principal • May create basis for lien of heldMay create basis for lien of held property or cause for legal actionproperty or cause for legal action  Breach of Duty by AgentBreach of Duty by Agent • may reduce/eliminatemay reduce/eliminate compensationcompensation • may be grounds for terminationmay be grounds for termination of agencyof agency  Breach of Duty by PrincipalBreach of Duty by Principal • May create basis for lien of heldMay create basis for lien of held property or cause for legal actionproperty or cause for legal action
  • 164. 11-164 Termination of AgencyTermination of Agency  By Will of Parties - As specified perBy Will of Parties - As specified per agreementagreement  Agency at Will- Power by either toAgency at Will- Power by either to terminate at any timeterminate at any time • Exceptions:Exceptions: Agency Coupled With Interest -Agency Coupled With Interest - power given as securitypower given as security Legislative RestrictionsLegislative Restrictions  By Will of Parties - As specified perBy Will of Parties - As specified per agreementagreement  Agency at Will- Power by either toAgency at Will- Power by either to terminate at any timeterminate at any time • Exceptions:Exceptions: Agency Coupled With Interest -Agency Coupled With Interest - power given as securitypower given as security Legislative RestrictionsLegislative Restrictions
  • 165. 11-165 Termination of AgencyTermination of Agency By Operation of LawBy Operation of Law • Death or insanityDeath or insanity • Bankruptcy affectingBankruptcy affecting • IllegalityIllegality • ImpossibilityImpossibility • Destruction of subject matterDestruction of subject matter • Material change in businessMaterial change in business conditionsconditions By Operation of LawBy Operation of Law • Death or insanityDeath or insanity • Bankruptcy affectingBankruptcy affecting • IllegalityIllegality • ImpossibilityImpossibility • Destruction of subject matterDestruction of subject matter • Material change in businessMaterial change in business conditionsconditions
  • 166. 11-166 Termination of AgencyTermination of Agency Notice to 3Notice to 3rdrd PersonsPersons • ActualActual • Constructive (e.g. inConstructive (e.g. in newspaper of generalnewspaper of general circulation in the area)circulation in the area) • Failure may = apparentFailure may = apparent authorityauthority Notice to 3Notice to 3rdrd PersonsPersons • ActualActual • Constructive (e.g. inConstructive (e.g. in newspaper of generalnewspaper of general circulation in the area)circulation in the area) • Failure may = apparentFailure may = apparent authorityauthority
  • 167. 11-167 Agent’s Authority to Bind Principal Agent’s Authority to Bind Principal  Actual AuthorityActual Authority • Express- Specifically DescribedExpress- Specifically Described Attorney-in-Fact if Power ofAttorney-in-Fact if Power of Attorney (General or Limited)Attorney (General or Limited) (Statutory Limitations)(Statutory Limitations) • Implied- Necessary to Complete TaskImplied- Necessary to Complete Task (Custom, Justifiable Belief of Agent,(Custom, Justifiable Belief of Agent, Emergency)Emergency)  Actual AuthorityActual Authority • Express- Specifically DescribedExpress- Specifically Described Attorney-in-Fact if Power ofAttorney-in-Fact if Power of Attorney (General or Limited)Attorney (General or Limited) (Statutory Limitations)(Statutory Limitations) • Implied- Necessary to Complete TaskImplied- Necessary to Complete Task (Custom, Justifiable Belief of Agent,(Custom, Justifiable Belief of Agent, Emergency)Emergency)
  • 168. 11-168 Agent’s Authority to Bind Principal Agent’s Authority to Bind Principal Apparent Authority-Apparent Authority- Reasonable Belief/PerceptionReasonable Belief/Perception by 3by 3rdrd PartyParty • Based on conduct of principalBased on conduct of principal • Justifiable Belief of 3rd PartyJustifiable Belief of 3rd Party TestTest • Duty of 3Duty of 3rdrd PersonsPersons Apparent Authority-Apparent Authority- Reasonable Belief/PerceptionReasonable Belief/Perception by 3by 3rdrd PartyParty • Based on conduct of principalBased on conduct of principal • Justifiable Belief of 3rd PartyJustifiable Belief of 3rd Party TestTest • Duty of 3Duty of 3rdrd PersonsPersons
  • 169. 11-169 Agent’s Authority to Bind Principal Agent’s Authority to Bind Principal  Apparent AuthorityApparent Authority  The shareholders of a closely held familyThe shareholders of a closely held family corporation filed suit to set aside a mortgage oncorporation filed suit to set aside a mortgage on certain real property. Held: The corporate presidentcertain real property. Held: The corporate president had apparent authority to mortgage the property ofhad apparent authority to mortgage the property of the corporation, and the bank relied on thatthe corporation, and the bank relied on that authority. The mortgage was proper because theauthority. The mortgage was proper because the family corporation had left the president in a virtuallyfamily corporation had left the president in a virtually unfettered managerial position of control. Theirunfettered managerial position of control. Their actions caused the bank to believe that the presidentactions caused the bank to believe that the president had authority to bind the corporation. Lettieri v.had authority to bind the corporation. Lettieri v. American Sav. Bank, 437 A.2d 822 (Conn. 1980).American Sav. Bank, 437 A.2d 822 (Conn. 1980).  Apparent AuthorityApparent Authority  The shareholders of a closely held familyThe shareholders of a closely held family corporation filed suit to set aside a mortgage oncorporation filed suit to set aside a mortgage on certain real property. Held: The corporate presidentcertain real property. Held: The corporate president had apparent authority to mortgage the property ofhad apparent authority to mortgage the property of the corporation, and the bank relied on thatthe corporation, and the bank relied on that authority. The mortgage was proper because theauthority. The mortgage was proper because the family corporation had left the president in a virtuallyfamily corporation had left the president in a virtually unfettered managerial position of control. Theirunfettered managerial position of control. Their actions caused the bank to believe that the presidentactions caused the bank to believe that the president had authority to bind the corporation. Lettieri v.had authority to bind the corporation. Lettieri v. American Sav. Bank, 437 A.2d 822 (Conn. 1980).American Sav. Bank, 437 A.2d 822 (Conn. 1980).
  • 170. 11-170 RatificationRatification  Could be where exceeded authority or no authorityCould be where exceeded authority or no authority  Intent may be express or implied by words orIntent may be express or implied by words or actionsactions  RequirementsRequirements • Principal must have had legal capacity both whenPrincipal must have had legal capacity both when act occurred and ratifiedact occurred and ratified • Affirm Act in its entiretyAffirm Act in its entirety • Knowledge of All Material Facts (Though notKnowledge of All Material Facts (Though not necessarily understanding)necessarily understanding)  Effect - Releases Agent of Liability to 3rd PartyEffect - Releases Agent of Liability to 3rd Party  Could be where exceeded authority or no authorityCould be where exceeded authority or no authority  Intent may be express or implied by words orIntent may be express or implied by words or actionsactions  RequirementsRequirements • Principal must have had legal capacity both whenPrincipal must have had legal capacity both when act occurred and ratifiedact occurred and ratified • Affirm Act in its entiretyAffirm Act in its entirety • Knowledge of All Material Facts (Though notKnowledge of All Material Facts (Though not necessarily understanding)necessarily understanding)  Effect - Releases Agent of Liability to 3rd PartyEffect - Releases Agent of Liability to 3rd Party
  • 171. 11-171 Principal’s Contractual LiabilityPrincipal’s Contractual Liability  Liability for Agent Representation- Limited byLiability for Agent Representation- Limited by Exculpatory ClauseExculpatory Clause  Liability for Notice/Payment to AgentLiability for Notice/Payment to Agent • Generally Notice to Agent = Notice toGenerally Notice to Agent = Notice to Principal, wherein scope of agent’sPrincipal, wherein scope of agent’s authorityauthority • Generally Payment to Agent = Payment toGenerally Payment to Agent = Payment to PrincipalPrincipal • A conflicts of interest may negate aA conflicts of interest may negate a principal’s liabilityprincipal’s liability  Liability for Agent Representation- Limited byLiability for Agent Representation- Limited by Exculpatory ClauseExculpatory Clause  Liability for Notice/Payment to AgentLiability for Notice/Payment to Agent • Generally Notice to Agent = Notice toGenerally Notice to Agent = Notice to Principal, wherein scope of agent’sPrincipal, wherein scope of agent’s authorityauthority • Generally Payment to Agent = Payment toGenerally Payment to Agent = Payment to PrincipalPrincipal • A conflicts of interest may negate aA conflicts of interest may negate a principal’s liabilityprincipal’s liability
  • 172. 11-172 Principal’s Liability for Acts of Subagents Principal’s Liability for Acts of Subagents  Agent’s Authority to AppointAgent’s Authority to Appoint Subagents - Implied unlessSubagents - Implied unless expressly excludedexpressly excluded • Agent ultimately liableAgent ultimately liable  Agent’s May Have Employees-Agent’s May Have Employees- Ministerial Acts - Principal boundMinisterial Acts - Principal bound • Concept: Liable as if agent hadConcept: Liable as if agent had performedperformed  Agent’s Authority to AppointAgent’s Authority to Appoint Subagents - Implied unlessSubagents - Implied unless expressly excludedexpressly excluded • Agent ultimately liableAgent ultimately liable  Agent’s May Have Employees-Agent’s May Have Employees- Ministerial Acts - Principal boundMinisterial Acts - Principal bound • Concept: Liable as if agent hadConcept: Liable as if agent had performedperformed
  • 173. 11-173 Agent’s Contractual Liability Only If: Agent’s Contractual Liability Only If:  Unauthorized ActionsUnauthorized Actions • Implied Warranty of AuthorityImplied Warranty of Authority • Intent, Knowledge & Good Faith of AgentIntent, Knowledge & Good Faith of Agent ImmaterialImmaterial  Nonexistent/Incompetent PrincipalNonexistent/Incompetent Principal  Agreement to Assume LiabilityAgreement to Assume Liability • Agent Should Fully Disclose I.D. of PrincipalAgent Should Fully Disclose I.D. of Principal • Agent Should Clearly Indicate Capacity as AgentAgent Should Clearly Indicate Capacity as Agent  Undisclosed/Partially Disclosed PrincipalUndisclosed/Partially Disclosed Principal • Frequently used in controversial real estate/stockFrequently used in controversial real estate/stock acquisitionsacquisitions • Creates expectation of liabilityCreates expectation of liability  Unauthorized ActionsUnauthorized Actions • Implied Warranty of AuthorityImplied Warranty of Authority • Intent, Knowledge & Good Faith of AgentIntent, Knowledge & Good Faith of Agent ImmaterialImmaterial  Nonexistent/Incompetent PrincipalNonexistent/Incompetent Principal  Agreement to Assume LiabilityAgreement to Assume Liability • Agent Should Fully Disclose I.D. of PrincipalAgent Should Fully Disclose I.D. of Principal • Agent Should Clearly Indicate Capacity as AgentAgent Should Clearly Indicate Capacity as Agent  Undisclosed/Partially Disclosed PrincipalUndisclosed/Partially Disclosed Principal • Frequently used in controversial real estate/stockFrequently used in controversial real estate/stock acquisitionsacquisitions • Creates expectation of liabilityCreates expectation of liability
  • 174. 11-174 Liability for TortsLiability for Torts  Direct Liability vs.Direct Liability vs. Respondeat SuperiorRespondeat Superior (Let the(Let the master respond, i.e., master is responsible formaster respond, i.e., master is responsible for servant.) = vicarious liabilityservant.) = vicarious liability  Employee vs. Independent ContractorEmployee vs. Independent Contractor • Within actual or apparent scope of employmentWithin actual or apparent scope of employment  Focus on words/actions/consent of principalFocus on words/actions/consent of principal • ““mere deviation” not take outside of scopemere deviation” not take outside of scope • Degree of Control over “Methods”Degree of Control over “Methods” • Loaned/Borrowed Employee - Whether “loaned”Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer oremployee within scope for original employer or other depends upon degree of controlother depends upon degree of control  Direct Liability vs.Direct Liability vs. Respondeat SuperiorRespondeat Superior (Let the(Let the master respond, i.e., master is responsible formaster respond, i.e., master is responsible for servant.) = vicarious liabilityservant.) = vicarious liability  Employee vs. Independent ContractorEmployee vs. Independent Contractor • Within actual or apparent scope of employmentWithin actual or apparent scope of employment  Focus on words/actions/consent of principalFocus on words/actions/consent of principal • ““mere deviation” not take outside of scopemere deviation” not take outside of scope • Degree of Control over “Methods”Degree of Control over “Methods” • Loaned/Borrowed Employee - Whether “loaned”Loaned/Borrowed Employee - Whether “loaned” employee within scope for original employer oremployee within scope for original employer or other depends upon degree of controlother depends upon degree of control
  • 175. 11-175 Liability for TortsLiability for Torts Intentional Torts by Agent -Intentional Torts by Agent - Generally = not within scopeGenerally = not within scope of employment, unlessof employment, unless encouraged by principalencouraged by principal Agent Generally Still LiableAgent Generally Still Liable even if acting with scopeeven if acting with scope (though may be indemnified)(though may be indemnified) Intentional Torts by Agent -Intentional Torts by Agent - Generally = not within scopeGenerally = not within scope of employment, unlessof employment, unless encouraged by principalencouraged by principal Agent Generally Still LiableAgent Generally Still Liable even if acting with scopeeven if acting with scope (though may be indemnified)(though may be indemnified)
  • 176. 11-176 Employee vs. Independent Contractor EmployeeEmployee Works ForWorks For Receives PaymentReceives Payment FromFrom Controlled WorkingControlled Working Conditions/MethodsConditions/Methods Employer Liable forEmployer Liable for ActsActs OmissionsOmissions EmployeeEmployee Works ForWorks For Receives PaymentReceives Payment FromFrom Controlled WorkingControlled Working Conditions/MethodsConditions/Methods Employer Liable forEmployer Liable for ActsActs OmissionsOmissions Independent ContractorIndependent Contractor Works ForWorks For Receives PaymentReceives Payment FromFrom Uncontrolled WorkingUncontrolled Working Conditions/MethodsConditions/Methods Employer Not LiableEmployer Not Liable
  • 177. 11-177 Liability for CrimesLiability for Crimes  Agent -LiableAgent -Liable  Principal - Old rule, hard to imposePrincipal - Old rule, hard to impose liability, but changing in someliability, but changing in some jurisdictionsjurisdictions Foreign Representatives (varies withForeign Representatives (varies with jurisdiction)jurisdiction) • Dependent Agents - greaterDependent Agents - greater liabilityliability • Independent Agents - lesserIndependent Agents - lesser liabilityliability  Agent -LiableAgent -Liable  Principal - Old rule, hard to imposePrincipal - Old rule, hard to impose liability, but changing in someliability, but changing in some jurisdictionsjurisdictions Foreign Representatives (varies withForeign Representatives (varies with jurisdiction)jurisdiction) • Dependent Agents - greaterDependent Agents - greater liabilityliability • Independent Agents - lesserIndependent Agents - lesser liabilityliability