Business Law Case Study

Case Study

jack and his friend, A.G. Pennypacker, have come up with a great idea: they have developed a fluoroelastomer liner (a rubber lining) for oil tankers. With this innovation, they believe they can eliminate most oil spills that result from tanker accidents. The liner is highly resistant to fluctuations in temperature as well as physical punctures.

jack wants to set up a company, but is unsure of his options and has come to you for advice for the type of business entity formation he should select. He has the following concerns:

1. He does not want his other business concerns being held liable should there be a lawsuit arising from use/sale of this product.
2. He wants an entity form that will minimize his tax liability.

Based on the entity forms detailed in Chapter 35, select one you feel satisfies his concerns. Make sure to explain why it is the best for jack and Pennypacker.

Action Items

1. Read the case study above.
2. Justify your answers

Notes Frome the teacher :

– which business formation would result in the least liability?

Sole proprietorship , general or limited partnership , or corporation.

– Which business formation best minimize tax liability ? ask how profits are taxed in each formation

CHAPTER
PA R T 6
34
Liability to Third Parties
and Termination
LEARNING OBJECTIVES
1
2
3
CASE OPENER
Liability and the “Wardrobe Malfunction” of Super Bowl XXXVIII
In the preceding chapter, we discussed how an agency relationship and its resulting
authority could be created. We also introduced (1) expressed agency, or agency by agreement; (2) implied agency; and (3) agency by estoppel. Each of these avenues for creating
agenc
.
Contractual Liability of the Principal and Agent
LO1
y relationship’
authorized the actions of the agent. A special type of express agent authority is known as a
power of attorney. The po
xpress authority, usually in
ic powers.
o basic types of power of attorney:
special and general. A special power of attorney grants the agent express authority over
general power of attorney allows the agent to
conduct all business for the principal.
wers of attorne
principal’s death or incapacitation, a durable power of attorney
s
authority is intended to continue beyond the principal’s incapacitation.
Even with e
v
arise between principal-agent relationships in po
y. Case 34-1 examines how
a court determines the extent of po
y. What links this chapter with the preceding chapter is the necessity of being careful about the allocation of legal responsibility in
an agency relationship.
C A S E 3 4 -1
S H A R O N D . JO N ES v. R EN E E S . B R A N D T
SU P RE M E C OU RT OF V I R G I N I A
2 74 VA. 13 1 ; 6 4 5 S . E . 2 D 3 1 2 ( 2 0 0 7 )
stances might a principal be held liable to a
third party on a contract
negotiated by an agent?
[continued]
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
C LA S S IFI CATI ON OF TH E PR I N C IPA L
We classify principals from the perspectiv
s kno
The
law of agency places special weight on this viewpoint of the agency relationship.
When the third party is aw
ws who the principal is, the principal is a disclosed principal. If the
party is aw
s existence but not his or her identity, we classify the
753
754
Part 6
Agency
principal as a partially disclosed principal or an unidentified principal. Finally, if the
w that an agent is acting on behalf of a principal, we have an
undisclosed principal.
mine the principal’s liability.1
the other.
A U T HO R IZ E D AC T S
disclosed principal is not liable for the acts of the principal.2
s behalf. W
partially
3
ve, the principal is liable for the
tially disclosed, apart from an
.
w
will likely hold her liable for the agreement. In the eyes of the third party, the agent is the
only person who could be liable. Y
, then the undisclosed principal is liable to the agent. However, in certain situations the agent is the only
These situations are:
1. The contract expressly e
as not
2. The agent enters into a contract that is a negotiable instrument. The Uniform Commercial Code (UCC) governs negotiable instruments and states that other parties,
that is, principals, cannot be liable for them if their name is not on the instrument
or if the agent’s signature does not indicate that it was made in a representative
capacity.4
3. The third party enters into a contract with the agent such that the agent’
or
e
without disclosing this f
the contract by taking the third party’s picture.
4.
cipal if the principal’s identity were disclosed but the agent does so anyway. The agent
w of the undisclosed principal’s identity, a judg.5 A judgment
against a previously undisclosed principal likewise frees the agent from liability.6
Exhibit 34-1
the agent.
1
Restatement (Second) of Agency, sec. 4.
Restatement (Second) of Agency, sec. 320.
3
Restatement (Second) of Agency, sec. 321.
4
UCC § 3-402(b)(2).
5
Restatement (Second) of Agency, sec. 210.
6
Restatement (Second) of Agency, sec. 337.
2
Chapter 34
Liability to Third Parties and Termination
755
Exhibit 34-1
Contractual
to Third Parties for
Authorized Agent Acts
WHO IS LIABLE FOR THE AGENTS ACTIONS?
If the action was
authorized by the
principal
Disclosed
principal
The principal is
liable instead of
the agent
If the action was not
authorized by the
principal
Partially
disclosed
principal
The agent
unless the
principal
ratifies the
agreement
Undisclosed
principal
Generally the
agent is not held
liable and the
principal is but
the agent may be
held liable for
contractual
nonperformance
The agent is liable, but
the principal is liable to the
agent unless the contract
excludes the principal,
the contract is a negotiable
instrument, or the agent knows
that if the principal’s identity
was revealed, the third party
would not enter into a contract
U N A U THO R IZ E D A CT S
If an agent has no authority to act on behalf of a principal but still enters into a contract
with a third party
ely
.Y
w
v
the la
wingly
Agents who go be
.
y were nev
ven when e
ity.
wing misrepresens alle
LO2
Legal Principle:
the principal is neither bound to the contract nor liable.
stances might a principal be held liable for the
Tort Liability and the Agency Relationship
actions, re
7
Restatement (Second) of Agency, sec. 343.
7
The principal
agent or independent
contractor?
COMPARING THE LAW OF OTHER COUNTRIES
Respondeat Superior in Iraq
may also be held liable for the agent’
. Finally
employee and the principal/employer controls the employee’s behavior, the principal can
be found liable. The ne
.
P R IN C I PA L’ S T ORT I O U S C O N D U C T
The la
o
8
agent’s unlawful behavior and thus is liable for an
,
the principal who ratifies an agent’
wing that the agent acted illegally is
liable, even if she does not condone the agent’s conduct.9
Second, if the principal fails to pro
ves inadequate
y competent agents, the law
holds the principal liable to a third party for negligent hiring of an agent. If an agent comgues that the principal is liable because
she should have tak
Respondeat Superior. The doctrine of respondeat superior (a Latin phrase meanemployee relationship.
yer holds vicarious liability, which is liability
assigned without f
yee causes while w
principal. In other w
yer is liable not because he was personally
at fault but because he negligently hired an agent. The rationale is that if the employer is
ork of the employee, the emplo
harms the employee caused.
gligence of an employee can sue either the
employee or the employer.10 To establish employer liability
w that
the wrongful act occurred within the scope of the employment.
11
follo
1. Did the employer authorize the employee’s act?
2.
8
Restatement (Second) of Agency, sec. 212.
Restatement (Second) of Agency, sec. 218.
10
Restatement (Second) of Agency
11
Restatement (Second) of Agency, sec. 229.
9
756
yment?
Chapter 34
3.
4.
5.
6
7.
8.
Liability to Third Parties and Termination
W
yer?
To what e
yer’s interests advanced by the act?
To what e
vate interests of the employee involved?
Did the employer provide the means (tools) by which the act occurred?
Did the employee use force not expected by the employer?
Did the employer know that the act w
If a deliv
ver ne
veries on behalf
of the employer, both the employee and the employer will be held liable. Suppose the
ver is using the company vehicle when he stops at a drive-through to get coffee. Could
ver? If an agent
makes a substantial departure from the course of the employer’s business, the employer is
not liable.
yee’
wn.” However, if the deviation from the employer’s business is not substantial, the employer can be
held liable. In Case 34-2, the court considers the scope of the employment relationship.
Legal Principle:
of his or her agent.
C A S E 3 4 -2
or the actions
I G L E S I A C RI S T I A NA L A CA S A D E L S E N O R , I NC . ,
E T C . v. L. M .
C OU RT O F A P P E A L O F F LO R I D A , T H I R D D I S T R I C T
7 83 SO . 2 D 3 5 3 ( 20 0 1 )
757
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
yee negligence such that the employer is
liable, the employer has the right to recover from the employee any damages he paid
yee’s negligence.
ver damages is
However, if the employee is innocent of negligence, the employer is also free of liability.
Intentional T
Respondeat Superior.
he or she commits. In the same w
gligent acts of
the emplo
respondeat superior, the principal may also be liable
for an
yee. Furthermore, an employer may be responsible
for an
yee if the emplo
w or should hav
wn that the
employee had a tendenc
gliemployees.
The principal of an employee with a criminal background may be held liable for torven though the employee may not recognize the
wrongfulness of his act. Therefore, employers will most likely purchase liability insurance
yees eng
vities.
A G E N T MIS R E P R E S E N TAT I ON
Unlik
, which is based on whether the agent/employee was acting in the scope
of employment, misrepr
depends on whether the principal authorized
the agent’
758
Chapter 34
Liability to Third Parties and Termination
759
w
to someone who relied on the agent’s misrepresentation.
o options:
1.
2. Af
y money lost.
ver damages.
Legal Principle: As a general rule, if a principal authorizes an agent to misrepresent himself or herself, the principal is always liable.
Principal’s Liability and the Independent Contractor
As we discussed in the preceding chapter, an independent contractor is not an employee
of the individual who hires him or her to do work. The individual doing the hiring does
not control the details of the independent contractor’
, an inditractor’
respondeat superior.
Suppose that while working on the outside of the building he is renovating, an indepenThe owner of the building is not liable for the innocent bystander’s injuries; the independent contractor is liable.12 In the Case Opener
T
yees
of CBS. If the
through respondeat superior. However, if they are independent contractors, CBS cannot be
held liable.
If the independent contractor engages in e
vities, such as blasty damages by the
. Certain acti
dangerous nature; an employer cannot escape this liability simply by hiring an independent contractor to complete them. Nor can the employer escape liability for an indepen.
Crime and Agency Relationships
s crime. Remember, one of the elements establishintent.
w
.
The only time the principal can be liable for the crime of an agent is when the principal has
Legal Principle:
without authorization from the principal, the principal is not liable for the crime.
Termination of the Agency Relationship
y relationship, or it may terminate automatiw. (Exhibit 34-2 lists
12
Restatement (Second) of Agency, sec. 250.
LO3
tionship be terminated?
CASE NUGGET
Liability When Hiring Independent
Contractors
the ways that agenc
wever,
the agent’
relationship has ended.
ve. Actual notice must be given to
ve had business interactions with the agent; it directly informs them,
orally or in writing, that the agency agreement has terminated.13
s authority w
ven in writing. P
related to an agency agreement may receive constructive notice, which is how the termination of an agency agreement is generally announced.14
ve notice usually
Exhibit 34-2
Ways That an Agency
Relationship Can Be
Terminated
13
14
760
Restatement (Second) of Agency, sec. 136(2).
Restatement (Second) of Agency, sec. 136(3).
Chapter 34
Liability to Third Parties and Termination
consists of publication in a generally circulating ne
y
agreement existed.
P
y in a foreign jurisdiction should include the conA U.S. manager conducting business in the
Agency Relationship Law that focuses on termination. Released agents in the EU receive compensation
y hav
w customers from whom the principal continues to
y are unable to otherwise recov
the contract, or upon their death.
EU law prohibits the agent’s recei
contract due to the agent’s incapacity. EU law additionally blocks the compensation if the
le
wledgeable about such provisions and be able to
help managers avoid unnecessary legal battles.
Case 34-3 highlights the potentially disastrous consequences of not understanding how
C A S E 3 4 -3
A N G E L A & R A UL RU IZ v. F O RT U N E I N S U R A N C E
C O M PA N Y
C OU RT O F A P P E A L O F F LO R I D A , T H I R D D I S T R I C T
6 77 SO . 2 D 1 3 3 6 ( 1 9 9 6)
761
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
T E R M IN AT IO N B Y A C TS O F PA RT I E S
The agenc
sections.
Lapse of Time.
wing
If an agenc
xist for a
xpires.15 An agency agreement might
state that the relationship will begin on September 1 and end on September 30. While the
, they will have
e a new agreement to cover it. The agent’s e
act on the principal’s behalf.
Fulfillment of Purpose. Suppose John, a homeowner, enters into an agreement
with Claire, a real estate agent, to sell his house. Once Claire succeeds in selling the house,
agency relationship.16
y relationvent. John employs Claire as an
Mutual Agr
Agency is a consensual agreement between
two parties. Consequently, if John and Claire both decide they do not wish to continue in
the agency relationship, the
. A principal can revoke an agent’
However, such rev
principal liable for damages.18 If the agent has someho
principal, however, the principal can revoke the agent’
y time.17
ving the
.
Renunciation by the Agent. An agent can terminate the agency relationship by
renouncing the authority given him or her. The agent can be liable for breach of contract
if the agenc
xist.
15
Agency, sec. 105.
Agency, sec. 106.
17
Agency, sec. 119.
18
Restatement (Second) of Agency, sec. 118.
16
762
COMPARING THE LAW OF OTHER COUNTRIES
Termination in the Netherlands
Agency Coupled with an Interest. An agency coupled with an interest is a
y relationship created for the agent’
s.
The principal may not terminate this relationship, which is also called power given as
. Rather, it is terminated when an ev
ges the principal’s
obligation.
T ER M I NAT I ON B Y O P E R ATI O N O F L AW
y relationship can occur when the agent is unable to
s objectives would be illegal.
Death. If the principal or the agent dies, the agency relationship is automatically terminated. Ev
w
s death, the relationship no longer
e
uy antiques on behalf of a principal and continues to purchase items without knowing the principal has died. Those transactions are not
binding on the principal’s estate, because as soon as the principal died, the agent’s authority to act was gone.
. If a principal or agent becomes insane, the agenc
Some states hav
w so that the agency contract still exists unless the person
has been adjudicated insane.
Bankruptcy.
ship is generally no longer in e
y petition, the agency relationy
y relationship. Insolvency, the inability to pay
the termination of the agency relationship.19
Changed Circumstances. If an unusual change in circumstances leads the agent to
believ
, the agency relationship terminates.20
Suppose Danielle contracts Gre
great-aunt’
wever, in the course of showing the painting to several buyers, Gre
Van Gogh original.
Because the painting is w
gory should infer that Danielle
does not w
y to continue.
19
20
Agency, sec. 113.
Agency, sec. 109.
763
E-COMMERCE AND THE LAW
Electronic Contracts in Singapore
Change in Law. When a new la
xisting agency
agreement ille
o
green. Then the city council passes a law making it illegal to paint houses green. The new
la
y agreement.
. Suppose that while Gre
s painting, there
is a fire in her house and the painting is destroyed. Because it is impossible for Gregory to
sell the painting, the agency relationship cannot continue.21
y
relationship also ends because of impossibility. Jackson hires a lawyer to serve as his
Because the lawyer can no longer fulf
the agenc
An agenc
ver the agent,
unkno
s interest. It is also ter22
minated if the agent breaches the duty of lo
is
an attorney representing Lola in her suit against a pharmaceutical company. If the pharmaceutical company of
y agreement terminates
s interests.
War.
principal’s behalf.23 If the United States goes to w
will no longer be in existence because there is no w
21
22
23
764
Agency, sec. 124.
Agency, sec. 112.
Agency, sec. 115.
usiness dealings on the
y relationship
CASE OPENER WRAP-UP
CBS and Janet Jackson’s On-Screen Nudity
Key Terms
Summary of Key Topics
Point / Counterpoint
Should the Principal/Employer Be Indirectly Liable for the Actions of the Agent/Employee
under the Doctrine of Respondeat Superior?
YES
NO
Questions & Problems
Looking for more review material?
CHAPTER
PA R T 7
35
Forms of Business Organization
LEARNING OBJECTIVES
1
2
3
CASE OPENER
The Dunkin’ Donuts Franchise Agreement
Chapter 35
Forms of Business Organization
771
Suppose you come up with an idea to produce a novel product you think could lead to
ay to produce this product? Should you do it
yourself by creating your own business? Do you have enough money to create your own
business? What are the le
usiness is not successful? What legal
responsibilities do you have with respect to your business?
o of you
its associWhat are the disadvantages?
business you should consider?
Choosing the form of b
es. The extent of liability and control the owner will have depends on
the form of the business. The business world is not static, however, and businesses can
and do change form over time, so this chapter relates not only to new businesses but
also to existing ones. The first section introduces the major types of business organizations, describing how these forms are both created and ended. The second section considers several types of business or
wn, b
nev
Major Forms of Business Organization
S OL E P RO P RI E T O R SH I P
If you decide to go into business on your o
sole proprietorship, a
business organization in which you, as the sole proprietor, are in sole control of the manThus, if you wanted to open a lawn-mowing business or a sewing
shop, you would likely be creating a sole proprietorship.
ver other forms
of business or
ery few legal
ganization, with freedom to hire emplo
usiness hours, and expand or change
the nature of the business.
usiness.
ed as the personal income of the sole proprietor.
However
ve disadv
usiness. You are
personally liable for an
large debts because of your business, you might have to sell your home to cover them.
Moreover, because the sole proprietorship is not considered a separate legal entity, you, as
the o
automatically when the sole proprietor dies.
Funding for your b
y
have lar
v
y make.
Exhibit 35-1 summarizes the advantages and disadvantages of the sole proprietorusiness organization in
the United States. As the Comparing the Law of Other Countries box illustrates, they are
popular in German
”
v
usiness or
y adv
proprietorship but addresses its funding dra
LO1
forms of business
organization, and what
are the differences
among them?
772
Part 7
Business Organizations
Exhibit 35-1
Advantages and
Disadvantages of the
Sole Proprietorship
Creation is easy
Proprietor is
personally liable for
all losses
Proprietor is in total
control of
management
Funding is limited to
personal funds and
loans
Proprietor keeps all
profits
PA RT N E R SH I P
Suppose you and your best friend from college decide to create a business to buy and sell
used books and CDs online. Both of you agree to share control of the business and split the
.
Act (UP
ve
created a partnership, a v
o or more persons who co-own
ab
w cases, a partnership is not considered a separate legal
ed when an
The Uniform P
Act gov
nerships in most states in the absence of an express agreement.
antages of a partnership? First, formation is easy.
ficial or
ev
is not considered a separate legal entity, income from the business is taxed as individual
.F
usiness losses from
their taxable income.
The major disadvantage of partnerships is that partners are personally liable for the
through the business, you will likely be held personally liable for that $50,000. Exhibit 35-2
summarizes the advantages and disadv
There are several types of partnerships (see Exhibit 35-3). In a general partnership the
s debts.
usiness example,
.
COMPARING THE LAW OF OTHER COUNTRIES
Sole Traders in Germany
Now imagine that your parents want to invest in your Internet business, sharing in its
profits b
Your parents can join your b
a limited partnership (LP), an agreement between at least one general partner and at
.
personal liability for the partnership’s debts, but your parents, the limited partners, assume
no liability beyond the capital they have invested in it and no part in its management. However, as limited partners, the
es on their share of the profit.
ner dies, however
ed.
–
ships. First, it must use the word limited
Exhibit 35-2
DISADVANTAGES
P
all losses. Including those of
Advantages and
Disadvantages of the
P
ADVANTAGES
Creation is easy.
Income of business is
personal income.
Business losses can be
deducted from taxes.
773
774
Part 7
Business Organizations
Exhibit 35-3
Types of Partnerships
fice to create it; otherwise, it e
as ne
y.
unlimited liability for professional malpractice. But will you and the other partners also be
held liable?
ve created a limited liability partnership (LLP),
s professional malpractice, but only to the extent of the
partnership’
en. Moreover, each
wn negligence and the negligence of those that she supervises.
This distinctive feature of the LLP is the reason many professionals who do business
Legal Principle: Every partner in a limited liability partnership has liability limited to the partnership’
airly new; in 1991, Te
their creation. Almost all states now hav
LLP has several special requirements. First, the b
artnership or an abbre
.
The LLP is not considered a separate legal entity
es on his or her
usiness. An alternative form of business organization, the corporation, separates business ownership from business control.
C O R P OR AT IO N
ord business,
eW
McDonald’s, and Nike. Perhaps the most dominant form of business organization is the
Chapter 35
Forms of Business Organization
775
corporation, a le
vestors, who then become
shareholders and the owners of the company. These shareholders elect a board of directors, which is responsible for managing the business.
icers to run the day-to-day business.
None of the other forms of business we have discussed are separate legal entities. How
gal entity? It must be created according to state law.
(Chapter 38 discusses the laws gov
What are the consequences of being a separate le
tion can be sued and can be held liable for its debts, shareholders cannot. Their liability is
y have invested in their share purchases, which supplies
the compan
Third, the corporation must pay tax
and its shareholders must pay taxes on
the dividends (distributions of those profits) they receive from it. Exhibit 35-4 summarizes
the advantages and disadv
usiness.
One way to avoid the double taxation is by forming an S corporation, which is a
w but is taxed like a partnership as long as it follows certain regulations. For e
ve more than 100 shareholders.
Its income is taxed only when distributed to the shareholders, who must report the
income on their personal income tax forms. S corporations are often, though not always,
formed under federal law. Alternatively, other forms of corporation are created under
state law.
Legal Principle: A corporation is a separate legal entity and can be sued.
Exhibit 35-4
Advantages and
Disadvantages of the
Corporation
Profits are taxed as income
to the shareholders, not the
partners (if any)
Formalities are required in
establishing and maintaining
corporate form
It is easy to raise capital
by issuing stock
Corporate income is taxed
twice
Shareholders have limited
liability
776
Part 7
Business Organizations
L IM I T E D LI A B I LI T Y C O MPA N Y
One of the newest forms of business organization in the United States is the limited liability
company (LLC),
usiness organization that many people see
as combining the most adv
bines the tax adv
xibility of a partnership with the limited liability of a corporation.
First recognized in the United States in 1977 in Wyoming, the LLC is now recognized
in every state, although the rules on LLCs have not evolv
. To bring some uniw
La
y Act (ULLCA) in 1995. In 2006, the
commissioners revised the ULLCA. This act provides a model for states to follow, but it
w
ments in the state in which you wish to create your LLC.
Companies.
members) the same
e the corwnership
interests; nor is it required to hold an annual meeting and draft meeting minutes, so record
k
xible. Unlik
, an LLC member does not have to giv
management of the LLC. In fact, an additional adv
xibility it
of
ve w
The most frequently cited adv
e
As previously mentioned, the LLC offers its o
limited liability for b
, no separate tax is
assessed on the company itself, thereby allowing its members to av
wever, if the LLC
members prefer, they may elect to have the entity taxed lik
vested in the business, this option allows the
ed at the lo
avoid double taxation as a ke
act that
the members have the choice of how they wish to be taxed.
In our global environment, an increasingly important advantage of LLCs is that members need not be citizens or permanent residents of the United States. Other organizational
v
U.S. citizens. Finally
usiness e
paid to o
s income is
A limited
want to establish their LLC. While precise requirements v
include the name of the business, which must include the words
pany
LLC, its principal b
gistered agent for service, the names of the o
w the company’s
management will be structured.
LLCs typically want to do business in more states than just the state where the
formed, and they usually need to register in every additional state in which they intend
Chapter 35
Forms of Business Organization
777
Qualif
certif
usiness license, in each
additional state in which the business plans to operate.
a foreign company in the additional states, and under most state statutes the LLC is govas created, regardless of where it is transacting
business.
For purposes of jurisdiction, however, an LLC is considered a citizen of ev
volves more than $75,000, is the existence of diversity of
or determining
whether diversity exists, a corporation is considered a resident of the state in which it is
usiness. However, this rule does
not apply to LLCs, as their citizenship is determined by the residences of their members.
Consequently
elihood of ha
y may want to consider either limiting LLC membership to individuals of only
one or a few states or using a different form of business organization.
y typically draft an operating agreement, which is
the foundational contract among the entity’s owners. It spells out such matters as how the
company is to be managed, ho
w interests may
w and when the LLC may be dissolved. Any matter not covered in
the operating agreement will be resolved in accordance with the state LLC statute; if a
matter is not covered by the relev
w are generally
followed.
While there is no requirement for an LLC to have a detailed, written operating agreement, in order to ensure the smooth functioning of the company, it is a good idea to have
one. Failure to hav
LLC that may be very dif
company.
Exhibit 35-5
usiness organization discussed above.
Legal Principle: As a general rule, an LLC is f
of organization in the state in which members want to establish their LLC.
Precise requirements for formation vary by state. Moreover, an LLC needs
to register in every additional state in which it will do business.
www.mhhe.com/kubasek2e.
Specialized Forms of Business Organization
specialized forms hav
usiness organization we’ve mentioned above, some
ves, joint stock companies, business
entures, and franchises.
C OO P ERAT IV E
A cooperative is an organization formed by individuals who usually pool their resources
to gain an adv
et. Farmers might pool their yields of certain crops to
ensure a high mark
, members of the cooperative receive dividends in proportion to how many times per year they engage in business with the cooperative.
Cooperativ
v
ve’s actions.
LO2
specialized forms of
business organization?
778
Exhibit 35-5
Part 7
Business Organizations
Traditional Forms of Business Organizations
COMPARING THE LAW OF OTHER COUNTRIES
Limited Liability Companies in Mexico
ves, on the other hand, enjo
J OI N T ST OC K CO MPA NY
A joint stock company
y members hold transferable shares while all the goods of the compan
Thus, the joint stock compan
wn the joint stock company. As in the partnerve personal liability, and in most cases the company is not a
gal entity.
B U S I NE SS T R U ST
A business trust is a business organization gov
trustees, who operate
beneficiaries. A written trust agreement establishes the duties and pow, and in most states b
ed like
S YN D I CAT E
An investment group that comes together for the e
inancing a specific
ge project is a syndicate.
teams and are quite useful for their ability to raise large amounts of mone
The
enture; thus they are almost always governed
w.
J OI N T VE N TU R E
A joint venture is a relationship between tw
.
Joint ventures can be agreements between small or v
ge businesses. For example,
Penske Truck Leasing Co., L.P., is a joint venture among Pensk
e
Automotive Group, and General Electric with annual revenues of more than $4 billion.
779
E-COMMERCE AND THE LAW
Exploring Forms of Business Organization
on the Internet
COMPARING THE LAW OF OTHER COUNTRIES
Types of Business Organization in China
This joint venture operates more than 225,000 v
America, South America,
Europe, and Asia. From a legal standpoint, partnerships and joint ventures are virtually
the same.
w to joint ventures. Joint ventures
dif
wever, because they are usually created for making and sellusiness. The joint venmembers.
Also unlike a partnership, the joint venture is not automatically terminated when one of
the members dies. Members of a joint venture also hav
ners because they are not agents of the other members.
Joint-v
y have
come together, but they can agree to give one party greater management responsibilities.
sible for the liability of the other(s).
Lik
wing up a formal
agreement.
Case 35-1 provides a judicial discussion of the elements necessary for the establishment
of a joint venture.
780
C A S E 3 5 -1
MMK GROUP, LLC v. THE SHESHELLS COMPANY, LLC, ET AL.
U .S . D I STRI C T C O U RT F O R TH E N O RT H ER N D I S T R I C T
OF O HI O
5 91 F. S UP P. 2 D 94 4 ( 2 0 0 8)
[continued]
CRIT IC AL TH INKI NG
E T H I CA L DE CI S IO N M A KI N G
F R A N C H IS E
LO3
782
When you go into McDonald’s to eat lunch, what type of business are you patronizing?
Y
ely eating at a franchise. This form of business organization is a business that
e
franchisor, an owner of a trade name or
trademark, and the franchisee, a person who sells goods or services under the trade name
Exhibit 35-6
antages of a franchise for
the franchisor.
Generally, franchises fall into one of three cate
chain-style business
operation,
s and Bur
sor’s business name and is required to follow the franchisor’s standards and methods of
business operation.
Chapter 35
Forms of Business Organization
783
Exhibit 35-6
Starting a Franchise:
Advantages and
Disadvantages for
the Franchisor
Can become liable
for the franchise if
it exerts too much
control
Earns increased
income from
franchise
Has little control
over the franchise
Takes low risk in
starting a
franchise
In the second cate
, distributorships, the franchisor manufactures a product and
licenses a dealer to sell it in an exclusiv
.
xample of a
utorship.
Finally, the third category is the manufacturing
arrangement, in which the franchisor provides the franchisee with the formula or necessary ingredient to manuf
xample,
pro
then sell it, according to the franchisor’s standards.
Exhibit 35-7 indicates ho
for the market economy.
Look at Case 35-2 to see ho
e
Exhibit 35-7
The Top 10 Global Franchises, 2009
Source: Ranked by Entrepreneur Magazine
,
gro
te, and size of the system;
.entrepreneur.com/franchise500/index.html.
Franchising is one way to spread your business across the world.
C A S E 35 -2
M A RY K AY, I N C. , A /K / A M A RY K AY C O S M E T I C S , I N C .
v. J A N ET I SB EL L
SU P RE M E CO URT O F A R K A N S A S
3 38 A RK . 5 56 ; 999 S . W. 2 D 6 6 9 ; 1 9 9 9 A R K. L E X I S 4 4 3
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Franchise Law.
ger than franchisees and have
more resources, they often have the upper hand in franchise relationships. However, federal and state laws hav
A franchise is a contractual relationship between the franchisor and the franchisee.
Thus, contract law
, apply. If the terms of
In the franchise relationship, the parties make a
franchise agreement re
w, and method of termination of the franchise.
The franchise agreement usually sets out what the franchisee pays the franchisor
ge sum) for use of the trade name or trademark and what percentage of sales income
will go to the franchisor. If the franchise requires a building, the agreement will specify
who pays for buying or renting it or for b
The franchisor usually includes in the agreement business practices that are forbidden
and b
The franchisor can also
set sales quotas and record-keeping requirements.
ut the franchisor cannot establish
the price at which the franchisee sells the goods.
785
786
Part 7
Business Organizations
actor
in franchise agreements. Because man
usiness practices
quality
y reasonable time.
Although the franchisor has the le
exercises too much authority in the day-to-day affairs of the business, the franchisor could
be held liable for the torts of the franchisee’s employees.
Termination of the Franchise. Much of the litigation associated with franchises
regards wrongful termination of a franchise. The franchise agreement establishes how the
franchise will be terminated. The b
. If the franchisee does not meet the requirements in the agreement, the franchisor can
ut must give suf
ve cause.
For example, good cause exists if the franchisee repeatedly violates the franchise agreement. Additionally, the franchisor needs to have documented the warnings sent to the franchisee regarding the violations. The typical agreement gives the franchisor broad authority
wever, many states have been giving the franchisee greater
Legal Principle: When a franchisee does not uphold the franchise agreement, the
franchisor can terminate the r
The courts usually rely hea
franchise w
C A S E 35 -3
C O U S I N S SU BS S YS T E M S , I N C . v. M I C H A E L R .
McKINNEY
U .S . D I STRI C T CO U RT F OR T H E EA S T ER N D I S T R I C T
OF W I SC ONS IN
5 9 F. SU PP. 2 D 8 1 6 ( 1 9 9 9)
s
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
CASE OPENER WRAP-UP
Dunkin’ Donuts
Key Terms
Summary of Key Topics
Point / Counterpoint
Should a New Restaurateur Open a Franchise Rather than Become a Sole Proprietor?
YES
Questions & Problems
NO
Looking for more review material?
CHAPTER
Partnerships: Nature, Formation,
and Operation
1
2
3
4
CASE OPENER
Jax Restaurant Partnership
PA R T 7
LEARNING OBJECTIVES
36
Act (UPA) is the main statute gov
agreement, UP
The Uniform P
w. If there is no e
wing
chapter considers ho
w
partnerships are created, and how they function.
Nature of the Partnership
LO1
What e
tion of tw
According to UPA Section 6, a partnership is “an associawners a business for profit.” Let’s analyze
Exhibit 36-1.)
First, by “association,” UPA means that the partnership is a voluntary and consensual
.
o or more persons.” UP
persons as “individuals,
partnerships, corporations, and other associations.” Therefore, almost any individual or
e as a partner, but these persons must have the legal capacity to
voidable.
business.
Finally, the partners must serve as co-owners. Being co-owners means that they must
usiness.
Exhibit 36-1
Characteristics of a
P
794
Chapter 36
Partnerships: Nature, Formation, and Operation
”
T
•
•
•
•
•
V
and consensual relationship.
Between two or more individuals, partnerships, corporations, or other forms of business organization.
Who engage in numerous business transactions ov
Intending to make a pr
And sharing the pr
and management of the business.
xists.
e
several e
ship. For example, when an emplo
ment for w
A has established
yee as payv
y of the
follo
•
•
•
•
Payment of a debt.
Payment of an annuity to a widow or representativ
Payment from the sale of goodwill of a b
Payment of interest on a loan.
www.mhhe.com/kubasek2e.
.
.
Legal Principle: Perhaps the most important factor in determining whether a
partnership exists is whether the pr
e shared. Furthermore, this sharing of
pr
A exceptions.
Case 36-1
C A S E 3 6 -1
xists.
I N G R A M v. D EE R E
SU P RE M E C OU RT OF T E XA S
5 2 T E X. S UP. J . 1 03 0 ( 2 00 9 )
795
[continued]
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
or example, before actress Vanessa Hudgens became
f
High School Musical movie series, she worked
with business manager Johnny Vieira. During their time together, V
. However, once Hudgens became a teen star, Vieira
claims that she stopped w
its. Consequently, Vieira filed a la
tive damages. In his lawsuit, Vieira noted a signed photograph on which Hudgens wrote
“Johnny, thank you for ev
ould be no where, we will make it
797
E-COMMERCE AND THE LAW
Forms of Partnerships in the ICT Sector
in Developing Countries
BIG—Vanessa Hudgens.”1 The case was set to go to trial; however, two weeks before
trial, Hudgens and V
No
w ho
of le
ve? They can be either legal entities or aggregates of the
PA RT N E R SH I P A S A L EG A L E N T I T Y
le
,
wn.
First, a partnership is often considered a legal entity when it is sued or being sued.
any outstanding debts. P
v
individual personal creditors have first priority on the assets of the indi
ept separate from the indi
Finally, ev
relationship with the others.
PA RT N E R SH I P A S A L EG A L A G G R EG AT E
Sometimes a partnership is considered a legal aggregate of the partners, such as when
ventually become the debts of the indi
es on the income
xist when
gate of the indi
LO2
ways in which a
partnership can be
formed?
Formation of the Partnership
1
798
www
Chapter 36
Partnerships: Nature, Formation, and Operation
799
you and your partner orally agree you will receiv
wever
v
ve a dif
ute the funds,
Without a writavor.
articles of partnership.
the duration of the partnership, such as the date or event that signals the agreement’s expiThird, the agreement should
state the di
vision of
management duties. Fifth, the agreement should state e
utions
e.
Legal Principle: A written agreement, although not legally mandatory, should be
created when a partnership begins. This way, both parties can be protected if a dispute occurs or if an issue is brought to court.
PARTN E RS H I P B Y E ST OP PE L
P
w? Suppose
Y
usiness. On the basis of your parents’
participation, she decides to place an order with you. Your parents discover that you have
ut the
When your business cannot afford to purchase the goods to sell them to the
customer, the customer sues you and your parents. Because your parents were aw
ut did not correct it, they will be estopped from denying they are your
partners. While the
its), in many states they could be held liable for damages to the
customer.
Most states recognize tw
xists: (1) as in
the example abov
w
a third party reasonably relies on this information to his or her detriment.
s damages.
Exhibit 36-2
w a partnership can be created.
Exhibit 36-2
Formation of a
P
800
Part 7
Business Organizations
Interactions between Partners
LO3
partners as they interact
with each other?
o types of interactions: those between
The partners have certain
D U T I E S OF PA RT N E RS TO O N E A N O T H E R
yal. The duty to be loyal funcduty of obedience. The duty of obedience is an e
Perhaps the most important type of duty partners have tow
. P
ork for the benef
They
should not take any action that will undermine it, such as engaging in business that competes with it.
P
y material f
usiness.
ves
benef
Case 36-2 considers ho
s
.
C A S E 36 -2
C O L E T T E B O HAT C H v. B UT L E R & B I N I O N
SU P RE M E CO URT O F T EX A S
9 77 S. W.2 D 54 3 ( 19 9 8)
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
v
A partner who
makes an honest mistake in fulf
liable for the mistake.
Exhibit 36-3
.
801
802
Part 7
Business Organizations
Exhibit 36-3
Duties of P
to One Another
R I G H T S O F T H E PA RTN E R S I N T H E I R I N T E R A C T I O N S
W I T H OT H E R PART N ER S
According to the law, partners have certain rights regarding their interactions with other
ment, all
v
Ev
ner will have one v
ment, they all must agree with the change. Other decisions that require a unanimous vote
include the admission of ne
usiness.
Right to Shar
di
If the partnership agreement does not establish another
Right to Compensation.
usiness re
ve a salut no partner
usiness
acti
wever
s business affairs.
Pr
P
v
the management of the business, (2) the right to specific partnership property, and (3) the
Exhibit 36-4.) We’v
ve;
here we discuss the other two.
tenants in pr
, which means they
own it as a group. An
ut purchased
.
One w
usiness
of the partnership, it will lik
. However, a partner cannot
Chapter 36
Partnerships: Nature, Formation, and Operation
803
Exhibit 36-4
A Partner’
Rights
According to the right of
survivorship,
However, the survi
s estate for the value
.
This interest, composed of a
uted by the
partner
s personal property
in the partnership to a creditor.
s personal creditor cannot seize specific items of
wever, the creditor can obtain a charging order, which entitles the
usiness.
Right to Inspect Books.
ve full information
re
disclose any information af
ve access to all
partnership books and records and be allowed to make copies of them. Unless otherwise
agreed, the records must be kept at the principal business office.
Right to an Account.
An accounting is a review and listing of all partnership assets
partner has a right to an accounting in four circumstances:
•
•
•
•
Whenever the partnership agreement provides for an accounting.
Whenev
access to the books.
Whenever an
.
Whenever circumstances render an accounting “just and reasonable.”
Legal Principle: Unless otherwise stated in the partnership agreement, a partner’s
rights include the right to share in management, the right to share in pr
right to compensation, property rights, the right to inspect books, and the right to an
account.
804
Part 7
Business Organizations
Interactions between Partners and Third Parties
LO4
partnership liable for
interactions with third
parties?
Each partner can serv
As
long as the partner has authority to act, each partner’s act in performing business duties as
personal liability for the obligation.
A C T UA L A U T H O R IT Y O F T H E PA RT N E R S
According to UPA, general agenc
v
, following normal business procedures,
Suppose Brittan
While alle
usiness, she engages in a b
Yet suppose Brittany really didn’t hav
with the third party. In this case, both Brittany and the firm are liable for the obligation.
However
as aw
y did not hav
y will be held liable for the obligation b
ship will not.
I MP L I E D A U TH O R I T Y O F T H E PA RTN E R S
v
than do typical agents. Their implied authority is usually determined by the nature of the
b
business.
business. However
v
L IA B I L IT Y TO T H IR D PA RT IE S
According to UP
.
jointly liable for the partnership’s debts. To bring a claim, a party
ment, the other partners must indemnify, or reimburse, him or her. In the Case Opener, the
gued that they should not be held jointly liable
because it was the negligence of one partner that caused her own son’s injury. They argued
that if they were liable, Moren should have to indemnify the other partners as a result of
her negligent behavior
ververally liable for the entire amount of any
judgment rendered. Joint and several liability means that a third party can choose to sue
William sues your
W
irst
W
.
However, if in the f
as not liable in any
W
s liability.
Chapter 36
Partnerships: Nature, Formation, and Operation
If W
.
damages it pays to William. Case 36-3 considers how other partners can be held liable for
the ne
.
C A S E 3 6 -3
E R I C J O H N S O N & L O R I J OHN S O N v. S T. T H E R E S E
M E D I C A L CE N T E R
A PP E L L ATE C OU RT OF I L LI N O I S , SE C O N D D I S T RI C T
2 96 I L L . APP. 3 D 3 4 1; 6 94 N . E . 2 D 1 0 8 8 ; 1 9 9 8 I L L . A P P.
L E XI S 3 0 1
805
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Legal Principle: As a general rule, if the partnership is liable, all partners are
liable for the debts of the partnership. Furthermore, all partners are liable for a tort
or breach of trust committed by a single partner.
L IA B I L IT Y OF IN C OMI N G PA RT N E R S
, the ne
an
as added. The ne
personally liable for them, but the capital the ne
f.
, the dates of agreements,
as well as the date the ne
806
COMPARING THE LAW OF OTHER COUNTRIES
Silent Partnerships in Germany
The Revised Uniform Partnership Act
Act gov
express agreement, the Revised Uniform P
Act (RUP
several la
ved in 1996, RUPA has been
adopted in roughly half the states, so it is wise to determine whether the state in which a
partnership was formed operates under UPA or RUPA. Although RUPA generally serves
to expand UP
CASE OPENER WRAP-UP
Crushed Hand in the Dough Press at Jax Restaurant
Key Terms
Summary of Key Topics
Point / Counterpoint
Should a Minor Be Allowed to Enter into a Business Partnership?
YES
Questions & Problems
NO
Looking for more review material?
CHAPTER
PA R T 7
37
Partnerships: Termination
and Limited Partnerships
LEARNING OBJECTIVES
1
2
3
CASE OPENER
Partnership Problems of Wildmeadow Village
Termination of the Partnership
LO1
dissolution stage and the winding-up stage. Dissolution is complete when an
usiness (by choice or default). P
plete the winding-up
The sections below explain the steps that
must occur in the dissolution and winding-up stages for the termination to be complete.
(Exhibit 37-1
The Life of a Partnership
Formation
the termination of a
partnership?
Exhibit 37-1
The Life Cycle of a
P
Performance
Dissolution
Winding Up
Termination or Continuation
813
814
Part 7
Business Organizations
Dissolution of the Business
Section 29 of UP
by an
winding up”—the acti
dissolution
usiness, collecting and
v
usiness.” It is
important to note that dissolution does not necessarily mean that the b
What might cause the dissolution of the partnership? The dissolution may occur by
an act of the partners, an operation of the law, or an act of the court (see Exhibit 37-2).
Wildmeadow V
as whether the
dissolution of the b
. As you read this section, keep the chapter
opener in mind to decide for yourself how Wyller’
as dissolved.
A C T O F PA RT N E R S
ve the power
to dissolve it at almost any time. The
time. Suppose Soo and Gerarldo, two partners in a college preparation business, are graduating from college. The
irms; neither expects to continue
the college preparation business. When they created this business, they might have agreed
to dissolv
ge. However, if the
b
xtend its term after graduation.
Alternatively, partners might agree to dissolv
y achieve a certain objectiv
v
homes hav
e the partnership.
rightfully dissolved, meaning the dissolution does not vioWe have established tw
ve (after meeting an established objectiv
Here are others:
1. A partner withdraws from the partnership at will. (A partnership at will is an agreement that does not specify the objectiv
Exhibit 37-2
Causes of a Partnership
Dissolution
CASE NUGGET
Partnership Dissolution
2. A partner withdraws in accordance with the partnership agreement. The partnership
w.
3. A partner is expelled from the partnership in accordance with the partnership agreement.
the partnership.
may be remov
ed, all partners can demand that it be wound up and can
participate in that process. Moreover
y can continue
the business using the partnership’
However, a partner who dissolv
ment can be held liable for wrongful dissolution.
business be wound up b
They
can choose to continue the b
In the chapter opener, if Wyller dissolv
, he could be liable for damages resulting from the f
vations.
Because none of the partners withdre
Wildmeadow V
as dissolved wrongfully. No
as responsible for the dissolution
and whether it was indeed Wyller who dissolv
. If Wyller is
815
816
Part 7
Business Organizations
y.
Legal Principle:
partnership at almost any time.
ve the power to dissolve the
O P E R AT IO N O F L AW
Several circumstances provided by law can dissolve a partnership: if a partner dies, if a
vity that
suddenly becomes ille
gal.
that manufactures and sells cigarettes will be automatically dissolved.
A C T O F T HE CO U RT
y of the following reasons:
•
•
•
•
agreement.
Other special circumstances e
how the b
nership to e
gin bitterly disagreeing about
v
Case 37-1
C A S E 37 -1
L I EM P H A N V U v. DAV IS HA E T A L.
SU P E RIO R C OURT OF C ON N E C T I C U T
1 99 7 CO NN. SU PE R . LE XI S 2 5 9
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Consequences of Dissolution
e or withdra
ve the other
partners notice of this intent. Once the partnership is dissolv
actual authority to bind the partnership. However, if the partnership does not notify third
ve implied authority to bind the partnership. Suppose one of the partners in the college preparation business intends to dissolve
the partnership. Before Soo can notify Geraldo of her intent, he makes an agreement to
begin w
ive new students to prepare them for college. Because Soo has not
yet given notice of her intent to dissolve, she is still liable for the agreement Geraldo
has made.
T
e active steps to notify third parties about the dissolution, often by
placing an advertisement in the newspaper. However, firms must provide direct verbal or
Read the
w of Other Countries box on Scotland. What ethical behavior does the Scottish law encourage that might not be encouraged under U.S. law?
817
COMPARING THE LAW OF OTHER COUNTRIES
Termination of Partnerships in Spain
the b
ness
usiness. We’
xt step is either winding up
usi-
Winding Up the Business
gin the process of winding up,
the activity of completing unfinished partnership business, collecting and paying debts,
ventory
still fulf
nership assets. However, they can engage in business that competes with the partnership
business. Case 37-2 e
the termination of the partnership.
COMPARING THE LAW OF OTHER COUNTRIES
Effects of Dissolution in Scotland
818
C A S E 3 7 -2
J A C K A. K A HN A ND D E NI SE W. K A H N v. S T E WA RT
M E S H E R A N D LI E S E L OT T E M E S H E R
C OU RT O F A P P E A L S OF WA SH I N G T O N , D I V I SI O N O N E
2 00 0 WA SH . A P P. L EX I S 20 9 0 ( 2 0 0 0 )
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
has been rightfully dissolved, an
dissolv
an accounting in the winding-up phase.
C A S E 37 -3
gin? We’v
wever
Case 37-3, the court considers a demand for
R OB E RT M . TA FO YA v. D E E S . P E R K I N S ,
NO. 95CA0408
C OU RT O F APP E A L S OF C OL O R A D O , D I V I S I O N F O U R
9 32 P. 2D 8 3 6 ; 1 99 6 C O L O . A P P. L E XI S 2 0 6 ; 2 0 B T R 1 1 1 5
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
v
uted to the
v
(it has very little or no debt), the order of distrib
wever, if a dissolved partnership has many creditors, the order of distribution of the assets
is immensely important. According to UPA, distribution of liquidated assets
e the following order:
1.
2.
3.
4.
Payment to creditors of the
P
P
Payment of profits distrib
agreement.
www.mhhe.com/kubasek2e
y invested.
821
CASE NUGGET
Continuing Partnership after Dissolution
ner cov
ution
.
C O N T I N UI NG T HE PART N ERS H IP A F T ER D IS S O L U T IO N
ve several options, one of
ve his or her interest in
, 20 percent of the partnership in
the partnership.
alued at $10,000 must receiv
Legal Principle: After the dissolution of a partnership, the remaining partners
may continue the partnership.
Perhaps the best w
continuation agreement. This agreement states that continuing partners can keep partner-
Limited Partnerships
LO2
partnership formed?
822
Limited partnerships, introduced in Chapter 35 and also known as special partnerships,
originated in Europe more than 500 years ago and have existed in the United States for
nearly 200 years. Recall that the limited partnership is an agreement between at least
one general partner and at least one limited partner. The general partner has management responsibility for the partnership and assumes unlimited personal liability for the
COMPARING THE LAW OF OTHER COUNTRIES
Dissolution of Partnership in Germany
debts of the partnership. In contrast, the limited partner assumes no liability for the
partnership beyond the capital he or she invested in the business. Limited partnerships
are attractive to potential investors because of the limited liability and tax advantages
they offer.
Functioning as the equivalent of RUPA, the Revised Uniform Limited P
Act (RULPA) is the law governing limited partnerships. Like all law, RULPA is not
static; it changes as lawmakers revise it to handle new issues that arise and to better achieve social goals. RULPA was originally drafted in 1976, revised in 1985, and
revised again in 2001. About one-fourth of the states have adopted the 1976 version of
RULPA, and about three-fourths have adopted the 1985 version. Only a handful of states
have adopted the 2001 version. Louisiana is the only state not to have adopted any version of RULPA.
F OR M AT I ON OF T H E LI M I TE D PA RT N E R S H I P
Ho
vious chapter
follow v
certificate of limited partnership
liability.
v
R I G H T S A N D L I A B I L I TI E S OF T H E L I M IT E D PA RT N E R S
A N D T H E G E N E R A L PART N ER S
v
discussed in the previous chapter.
ship.
LO3
v
usiness and to receiv
ants to add a partner must hav
y often
recover their inv
However
the limited partner’s liability
the business.
privileges of a limited
partner and a general
partner?
ULPA. For example, if a
The general partner has unlimThis broad liability is in contrast to
vested in
uting $10,000 to it, as
823
E-COMMERCE AND THE LAW
How the Internet Assists Business
Owners Who Use Limited Partnerships
A limited partner’
conditions:
s maintaining three
1.
icate of
2.
3. The limited partner’
If an
liability. For e
usiness.
xclusive control and manage.
Exhibit 37-3 distinguishes sev
D I S S OL U T IO N O F T H E L IM I T E D PA RT N E R S H I P
nership.
wer to dissolv
While the
According to
RULPA, a limited partnership can be dissolved for any of the following reasons:
1. The e
2. The completion of the objectiv
3.
4.
w
general partners will continue).
5. An act of the
Exhibit 37-3
Comparison of General
P
P
824
icate establishes that other
Chapter 37
Partnerships: Termination and Limited Partnerships
uted in
ment to partners who hav
ing to their inv
y
Limited Liability Companies
v
company (LLC) is relatively new.
vestment he or she makes, while still
receiving the tax breaks often af
ship, the LLC is created with an agreement between members. Each member also gets a
say in the management of the company
e management decisions. Basically
obtain limited liability, the owner (referred to as a member) does not have to give up his
right to participate in management of the LLC. In fact, an additional advantage of the LLC
xibility it offers members in terms of alternative w
ture its management.
However, because LLCs are new
y
Act that has been drafted to govern them has not been accepted by many states.
ws with
re
y established in one state continue to apply when conductwww.mhhe.com/kubasek2e.
ing business outside that state.
CASE OPENER WRAP-UP
Wildmeadow Village Partnership Problems
825
Key Terms
Summary of Key Topics
Point / Counterpoint
Should a Partnership Be Allowed to Expel a Partner on the Basis of Illegal Conduct Unrelated
to the Terms of the Partnership Agreement?
YES
NO
Questions & Problems
Looking for more review material?
CHAPTER
PA R T 7
38
Corporations: Formation
and Financing
LEARNING OBJECTIVES
1
2
3
4
5
6
CASE OPENER
The Formation of the Facebook Corporation
Chapter 38
Corporations: Formation and Financing
This chapter e
generally gov
the Revised Model Business Corporation
More than 25 states have adopted at least part of RMBCA.
ut remember that not all states follow them.
o sections of this chapter e
ers.
e
section cov
831
. Although state law
gulatory statutes,
wThe next section
Characteristics of Corporations
Ho
ferent from other forms of business organization? We addressed
some of their characteristics in Chapter 35. Let’s no
e a closer look.
L EG AL EN T I T Y
Under U.S. law
their shareholders.
ye
R I G H T S A S A P E R S ON AN D A C I T I ZE N
woman w
gal persons.” For e
ver her. The ceiling was fastened
wers Fasteners.
wn to “creep,” that is, to slowly loosen. The
company never informed an
The Massachusetts attorney general decided to take
vidual w
ges. Also, lik
v
, the Fifth and F
v
v
ve
v
Amendment and thus prove free speech rights
Amendment. As Chapter 5 e
wever, the First
commercial speech to a lesser de
political speech.
In Case 38-1, the Supreme Court considered whether the Federal Election Commission’s re
C A S E 3 8 -1
F E D ER A L E LE CT I O N C O M M ’N v. B E A U M O N T
U NI T ED STATE S SU P R EM E C O U RT
5 39 U . S. 1 46 ( 2 00 3 )
LO1
characteristics of
corporations?
[continued]
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
C R EATU R E OF TH E STATE
L I M I T E D L I AB ILI T Y
Because corporations are le
inv
T
Tire & Rubber
Company for copying its Bigfoot trademark on new tires.
w
Big O Tire sev
individual Goodyear shareholders, paid. Although these damages may have reduced the
di
v
vidually liable for an
w
F RE E TR A N SF E R A B I L IT Y OF C O R P O R AT E S H A R ES
Generally
their shares or giv
That is, they can sell
.
P ER P ET U A L EX I S T E N C E
of
incorporation,
or
xist. The articles of
xplaining its
xist indefinitely. A few states, however,
y must formally
rene
www.mhhe.com/kubasek2e.
xistence.
C E N TRA LI Z E D MA N AG E M EN T
to manage the day-to-day b
C OR PO RAT E TA X AT I O N
gal entities, gov
833
834
Part 7
Business Organizations
state taxes on their income, but they have control over that income. They can distribute it
dividends, although they do not receiv
doing so. In f
es on dividends they receiv
pays taxes on its income and the shareholders pay taxes on their dividends, di
subject to double taxation, a disadv
eep
retained earnings, to reinvest.
shareholders when they sell their stock.
L IA B I L IT Y FO R O F FI C E R S AN D EM P L O Y E ES
Because the relationship between corporations and their directors, of
is an agenc
yees
respondeat superior (Latin for “let the master answer”).
,
Corporate Powers
LO2
Because corporations are creatures of the state, they have only those powers that states
ration. Exhibit 38-1 lists the po
granted to corporations
by the states?
Legal Principle: The only authority possessed by corporations is respect to the
powers granted to them in their articles of incorporation.
E X P R E SS A ND I MP L I E D PO W E R S
wing express powers:
s name, to
w money, to lend money, to mak
e
whatever actions are necessary to execute these express powers. Thus, they also have
implied powers, usually giv
the power to hav
acquire property, to mak
Exhibit 38-1
Powers of the
Corporation
Chapter 38
Corporations: Formation and Financing
835
Corporations can be classified as public or priv
it; domestic,
foreign, or alien; publicly held or closely held; an S corporation; or a professional
organization.
LO3
Classification of Corporations
classified?
P U BL I C O R P RI VAT E
A public corporation
tions
v
v
v
versely
v
w.
ve
vate persons create private corporave government duties.
P RO F I T O R N ON P R O FI T
for-profit corporations. Their objectiv
e tw
Their
ve dividends
y paid.
Nonprofit corporations
ut the
ute them to shareholders. In fact, nonprofit corporations do not have shareholders, their objective is not to earn
y do not issue stock. Instead, nonprof
vide services to their
members (not shareholders) and reinvest most of their profits in the business. Churches
and charitable organizations are e
D OM ES TI C, F OR E I G N, AN D A L I E N C O R P O R AT I O N S
domestic corporation
icate of authority in
each state in which they do business. A corporation is a foreign corporation in states in
which it conducts business b
The McDonald’
porated in Delaware but does business in all 50 states.
Delaw
An alien corporation is a b
.
ants to do business in Canada or Me
P U BL I C LY H E L D O R C L OS E LY H EL D
The stock of publicly held corporations is available to the public. Thus, if you wanted
to inv
ve man
usually do not o
s stock. Shareholders wishing to
ace man
In contrast, closely held corporations (also called close, family, or privately held corporations
f
ve in or manage the business and maintain
restrictions on the transfer of shares to prevent outsiders from gaining control. Although
the
venues, most U.S. corporations are closely held corporations. In f
836
Part 7
Business Organizations
S U B C H A P T E R S CO R PO R ATIO N
S corporations (named after the subchapter of the Internal Revenue
Code that pro
ys the
tax status of partnerships.
fer two more tax advantages. First, shareholders may deduct corporate
losses from their personal income, reducing their taxes in case of loss. Second, when the
wer tax brack
poration’s income is tax
s lower rate, even if di
and not distributed. The lo
ve more than
100 shareholders. Second, only indi
can issue only one class of shares, although they need not have identical v
F
P R O F E S S I ON A L C O R PO R ATI O N
If a group of dentists, doctors, or other professionals w
ork, however
for medical malpractice performed under their oversight.
Formation of the Corporation
LO4
The creation of a corporation has two steps: general organizational activities and legal
activities.
formed?
O R G A N IZ I N G A N D P R O MO T I N G T H E C O R P O R AT IO N
Tw
promoters and subscribers. Promoters begin the corporate creation and organization proThe
inf
subscription agreements with subscribers (investors) who
agree to purchase stock in the ne
Promoters.
They can also
enter into contracts as needed, say, to purchase or lease b
Frank Seiberling was the promoter who founded the Goodyear Tire & Rubber Company.
wed
from his brother-in-law and established Goodyear workers’ hourly wages between 13 and
25 cents.
agents of the infant corporation, however, because the
that does not yet exist.
Ev
promoters liable for the contract.
Chapter 38
Corporations: Formation and Financing
In two cases, however, promoters are not personally liable. They can include a clause in
s adoption of the contract terminates their liability;
, and a third party can enter into a novation, agreeing to
the rights under it.
In Case 38-2, the Colorado appellate court considered whether a promoter was liable
C A S E 3 8 -2
C O OP ER S & LY B R A N D v. G A R RY J . F OX
C OU RT OF A P P EA L S OF C OL O R A D O , D I V I S I O N F O U R
7 58 P.2 D 683 ( 19 8 8)
837
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Subscribers.
ration process.
accepts his or her purchase offer, whichever occurs first.
o w
revoke at any time. In other states, courts view subscription agreements as contracts
among v
These contracts cannot be revok
voke subscription agreements for six months
unless the agreements pro
S E L E CT IN G A STAT E FO R I NC O R P O R AT I O N
Next, an inf
ferent laws gov
f
•
•
•
•
Ho
What rights do state statutes give to shareholders?
What restrictions does the state place on the distribution of dividends?
Does the state offer an
eovers?
y are located and do
most of their b
half of the F
xtremely lo
ment in the ev
ware. Decades ago, Delaware
xtensive rights to manageeover than did other states. Thus, in the 1940s and 1950s, many
ware. Although other states have
ws more attractive since then, man
porated in Delaw
w. Closely
wever, almost alw
ve.
ity to do business in other states. Some states f
of authority before conducting b
ficers
gin the formal legal process of
838
COMPARING THE LAW OF OTHER COUNTRIES
Corporate Structure in Germany
Legal Process of Incorporation
S E L EC TI O N O F C OR P OR ATE N A M E
All states require that corporations attach Corporation, Company, Limited, Incorporated,
oods Inc., The Hershey Company, Facebook Inc., and McDonald’s
e as e
usiness
within the state.
v
v
I N C O R P OR AT O R S
An incorporator is an indi
it permits more.
e as incorporators, RMBCA does not
act, RMBCA does not require
v
y
A RTI C L ES O F I N CO R PO RAT I O N
The articles of incorporation is a document pro
poration.
address of the registered of
gistered agent (the specific person who receives legal documents on behalf of the corporation), and (4) the names and
Man
veral additional elements, such as a clause
wer to engage in certain business activities. Many articles also describe
x
vern the corporation. Ne
issues a certificate of incorporation,
porated in the state and authorized to conduct business.
–
839
840
Part 7
Business Organizations
F I R S T O R G A N I Z AT IO N A L ME ET I N G
corporate b
or
gulations
bylaws,
that gov
who has the po
ws after the first organizational meeting:
ve
ve made in the corporation’s name.
Potential Problems with Formation of the Corporation
LO5
Most b
wever
the b
potential problems
with the formation
of corporations?
defective corporation.
s actions.
a defectiv
R E S P O N SE S T O D E FE CT I V E I N C O R P O R AT I O N
, courts may disregard it by recognizing the firm as a de jure or a de facto
Corporations. A de jure corporation (literally
w,”
or a la
still enjoy de jure
corporation.
Thus, ev
Exhibit 38-2 illustrates the process for creating a de jure
ould not revok
party can question a de jure corporation’
De Facto Corporation.
ous mistak
s limited liability. No
Suppose, however
de facto corporation
Exhibit 38-2
De Jure Corporation
Formation
Chapter 38
Corporations: Formation and Financing
(literally
act,” or a corporation in fact). A de facto
not substantially met the requirements of the state incorporation statute, b
void unf
it was properly incorporated. De facto corporations, re
general corporation statute, must meet the following requirements:
•
•
ved
aith attempt to comply
The organization has already conducted business as a corporation.
de facto
Exhibit 38-3.
Only the state can challenge a de facto
suit called an action of quo warranto
Corporation by Estoppel. Defectiv
status due to mistak
tion’
tors, managers, and shareholders are unaw
b
se
, in a
gistered agent and the direc-
corporation by estoppel; thus, they estop
status.
ing future business.
es a signif
de
jure or de facto
deny the organization corporate entity status. Thus, the organization does not enjoy limited
shareholder liability.
Piercing the Corporate Veil.
In some cases, courts will den
ve de jure or de facto status because shareholders
hav
Exhibit 38-3
De Facto Corporation Recognition Process
841
CASE NUGGET
De Facto Incorporation
eil” of limited liability to protect themselves from personal
liability. In these cases, courts pierce the corporate veil, or impose personal liability on
xists. Thus,
Legal Principle: The limited liability of corporate shareholders may not exist
when shareholders have acted in an illegal or wrongful manner.
eil when:
•
•
•
w statutory mandates re
corporation has no separate identity.
•
as Case 38-3 illustrates.
C A S E 38 -3
J – M A RT J EW E L RY O U T LE T S , I N C . v.
S TAN D AR D DE S IG N
C OU RT O F APP E A L S OF G EO R G I A
2 18 GA . AP P. 45 9 ( 1 9 95)
usiness.
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Corporate Financing
e other businesses, need a source of funding. The
debt securities, which represent loans
which represent o
LO6
funding?
D E BT S EC UR I T IE S
Debt securities, or bonds,
They frequently
ace amount of the loan.
843
844
Part 7
Business Organizations
wever
interest payments on a scheduled basis. Hence, bonds are sometimes called
securities.
wing types of bonds:
•
•
•
•
•
Unsecured bonds (debentures): No assets support corporations’ obligation to repay the
face value of unsecured bonds.
Secured bonds (mortgage bonds):
to repay secured bonds.
Income bonds: A corporation pays interest on income bonds in proportion to its
Convertible bonds:
company stock.
Callable bonds:
xchange their conv
E Q U I T Y S E C UR I T I E S
While bond owners have loaned mone
wners actually o
of the corporation, in the form of shares of stock called equity securities.
thus have a v
o major types.
Preferred Stock. Owners of preferred stock, or preferred shares, enjoy preferences
in the distribution of assets and dividends. They usually receive a percentage of dividends
associated with the face v
y will receive dividends
before o
wners’ voting rights.
Cumulative preferred stock requires that if a corporation cannot pay the required
dividends in a given year, it must pay them in the next year before it pays any common stock dividends. Convertible preferred stock allows its owner to convert shares
into common stock at any time. Redeemable preferred stock (also known as callable
preferred stock
uy shares back from shareholders in
certain circumstances. Participating preferred stock entitles its o
stock di
vidends, additional
dividends.
Common Stock. Owners of common stock, or common shares, own a portion of a
ut do not enjoy any preferences.
wner is entitled to corporate di
wns and has the right to
vote in corporate elections. Each share is usually worth one vote. Thus, if you own 20,000
common shares of a corporation, you have 20,000 votes. In some cases, however, most
cumulative
voting
wn a small number of shares. (The
next chapter discusses cumulative voting in more detail.)
Common stock owners have the lowest priority when a corporation distributes diviwners receive di
pays these groups, however, common stock owners hav
COMPARING THE LAW OF OTHER COUNTRIES
Company Law in France
CASE OPENER WRAP-UP
Facebook
Key Terms
Summary of Key Topics
Point / Counterpoint
Should Corporations Be Allowed the Status of “Legal Personhood” and Be Given
Full Protection under the Bill of Rights?
YES
Questions & Problems
NO
Looking for more review material?
CHAPTER
Corporations: Directors, Officers,
and Shareholders
1
2
3
4
5
CASE OPENER
Roles of Directors, Officers, and Shareholders
of Bank of America
PA R T 7
LEARNING OBJECTIVES
39
850
Part 7
Business Organizations
As the opening scenario demonstrates, many groups of individuals within a corporation
hav
To
ed, statutory laws dele
w gov
. In 1946,
Association (AB
ersion of the Model Business
Act (MBCA). Like almost all new laws, MBCA met with v
grees of
success, and over time legislatures have molded it to achieve certain objectives. The ABA
the
part of it.
When the law changes, however, it often changes at an uneven pace. A sudden refor-
the Re
visions, the ABA in 1984 discontinued its revisions of MBCA and drafted
Act (RMBCA). More than half the states have
This chapter e
w.
Importance of Regulating Interactions among Directors,
Officers, and Shareholders within a Corporation
LO1
directors,
s, and
shareholders. Each has different interests, and in man
regulate the interactions
among directors, officers, and shareholders
within a corporation?
Although directors and of
y share
the same goal. Both attempt to ensure that their institution surviv
y keep their
ant to raise the value of the company’s stock.
These dif
quickly raise the v
take it. But if the directors and officers believe that the decision might jeopardize their
jobs, they will resist. To resolv
w gives each group legal duties and
Roles of Directors, Officers, and Shareholders
LO2
f
they play. These roles are discussed below and outlined in Exhibit 39-1.
director, an officer, and
a shareholder?
D I R E C T O R S ’ R OL E S
what course of action it will take. Although their vital role gives directors considerable
power, no one director wields much by himself or herself. A director who wants the company to mov
val of other directors on the board
before the company will begin to shift.
Elections.
e
Typically, shareholders use a majority vote to elect directors. The only
gin-
Chapter 39
Corporations: Directors, Officers, and Shareholders
Exhibit 39-1 Roles of Directors, Officers, and Shareholders
Shareholders
Role: the Owners
The shareholders own the stock of the company.
Goal: to increase the value of the company’s stock
Directors
Role: the Decision Makers
The directors share in the power of deciding the course of action for the corporation. Directors also
appoint and supervise officers and declare and pay corporate dividends.
Goal: to ensure that the institution survives and that they keep their jobs
Officers
Role: the Managers
The officers manage the day-to-day activities of running business, including acting as
agents for the corporation.
Goal: to ensure that the institution survives and that they keep their jobs
This first board serves until the f
elect a new board. The corporate articles or bylaws specify the number of corporate
directors. In the past, the minimum required was three, but today many states allow
fewer. In fact, if a corporation has fewer than 50 shareholders, Section 7.32 of RMBCA
allows companies to eliminate the board of directors altogether. This change illustrates
how the need for practicality can stimulate change in the law. The benefits of the corporate form of business organization have drawn an enormous number of businesses,
especially small businesses, to incorporate in recent years. The requirement of at least
three directors, however, b
ficient
business to warrant three directors. Thus, many states eased or removed the threedirector requirement.
Interestingly, almost anyone can become a director. The legal requirements are lax, and
ven required to o
cases, however
ws require not only ownership but also a
,b
w longer terms if they
ved for cause—for f
.
Removal is typically a result of shareholder action, but in some cases directors can remove
other directors for cause. Directors remov
view the
legality of their removal. Only a few states allow removal without cause, and then only if
shareholders reserv
Meetings and Voting.
quorum, must be present at each directors’ meeting for decisions to be v
ferent in each state, but most states leave the decision up to the corporation itself. Because a
quorum is required at each meeting, directors are notified whenever special meetings are
851
852
Part 7
Business Organizations
called. Directors v
ote.
majority vote, more important decisions sometimes require a two-thirds vote.
Directors as Managers. Although directors vote on major decisions about the
y day-to-day managerial activities. They
appoint, supervise, and remov
y see fit, and they declare and
vidends to shareholders. The
decisions and authorizing corporate polic
employees of the corporation; the
inside directors.
employees are outside directors.
vided into
ectors and
ectors. Af
ve b
tion, while unaf
v
xecutive committee to handle
day-to-day responsibilities.
O F F IC E R S’ R OL E S
Officers are executive managers whom the board of directors hires to run the day-to-day
b
. Officers
y apply to their work. (Refer to
Chapter 33 for the rules of agency.)
ws
ut in most cases an indi
e as both a director and an
of
. Man
directors can stay in touch with day-to-day operations.
S H A R E H OL D ER S ’ R O L ES
Shareholders o
di
As soon as an indi
wner of the corporation. However, there is a major
There are majority shareholders and
A minority shareholder is one who controls fewer than half of the outstanding shares of a corporation.
gally recognized as an o
, ev
shareholder has an equitable, or ownership, interest in the company
directly responsible for the daily management of the corporation, but they elect the direc-
Power of Shareholders.
poration, and general incorporation la
wers.
ve major board decisions, the
wered to mak
wer, however, is to
elect and remove directors.
For example, in 2008 and 2009, Bank of America chairman and CEO Ken Lewis
approved the questionable acquisitions of two financially troubled companies, Couny shareholders disagreed with Lewis’s decisions and lost confidence in his ability to lead the company. Consequently, to remedy the
Chapter 39
Corporations: Directors, Officers, and Shareholders
situation, Bank of
oted to remove Le
board position and opted to find a new leader. Lewis was able to retain his position as CEO
but was no longer permitted to head the board of directors.
ve the po
The Securities and Exchange Commission has established that an
wns more than
$1,000 w
proxy
materials
Meetings. Shareholders typically meet once a year, but in emergencies they can meet
more often.
wn at least 10 percent of the corporation’s outstanding shares, and others authorized in the articles of incorporation may call
a special shareholder meeting.
Lik
A majority
vote of the shares represented is then required to pass resolutions. Occasionally, however,
visions, which state that more than a
ger
or dissolution.
Because shareholders cannot alw
ote in their place.
proxy. Under
wn at any time
vocable.
An indi
titles to a trustee in exchange for a
. The trustee is then responsible
for v
s discretion. The
shareholder, however
w).
Before a meeting, shareholders can sign a shareholder voting agreement in which
y agree to v
.
enforceable.
Voting. Like directors, each shareholder is entitled to one v
oting processes, however
of each shareholder’s v
such process required in most states, cumulative voting,
have a v
v
otes to cast by multiplying the number of shares the
group owns by the number of open director positions. If a company is electing eight direcv
wn 8,000
y get 64,000 votes.
v
tion, cumulative voting permits them to vote at least one director onto the board because
ant to elect all
eight directors from their nominees, each nominee must receive more than 16,000 votes
in order to beat the 16,000 v
holders have only 64,000 votes to cast, the
otes for each of
eight candidates (16,000 × 8 = 128,000).
16,000 votes for one candidate, they can guarantee that candidate’s election.
Cumulative voting is more eg
oting because it ensures
that every v
oices of those with the most
853
854
Part 7
Business Organizations
power. W
disre
in RMBCA, however; rather
provide for it.
y and
ve voting is not guaranteed
Duties of Directors, Officers, and Shareholders
LO3
Because all indi
gal responsibilities called
directors, officers, and
shareholders?
D U T I E S OF DI R E C T O R S A N D O F F I C E R S
, the law gives them
Shareholders hav
y trust the
directors and off
y to the best of their ability. Thus, directors and
officers hav
Their tw
duties are the duty of care and the duty of loyalty.
e. The
ous, and v
v
requires ex
ment of his or her own assets. In other w
faith and in the best interest of the company.
e
xerdue care
ferently over time. In general, however, it
ould exercise in the manage-
Legal Principle: The dir
or failure to exercise a
duty of care with respect to the management of shareholder assets.
Given their duty to act in the best interest of the company
supervise employees who w
xtent. The
ve
a duty to attend director and corporate b
wever, they
have a fiduciary duty to mak
usiness decisions.
The directors and off
ailed in their duty of care with re
y. They continued to advocate
that employees invest in the employee stock-sharing options, even though it appears that
the
w the stock was drastically ov
y failed in their duty of
care regarding oversight.
see the collapse of their stock coming or they purposely k
way, the
ers, many of whom were Enron employees.
y Citigroup brought action against the
company’
ged liabilities of the directors was
af
y
faced in the subprime lending market were not properly managed or monitored. The shareholders explained that there were signs of sev
markets beginning in 2005 that should hav
Essentially
as that the directors failed
in their duty of care re
versight. The directors did not seem to pay enough attenet that were going to directly affect the
company.
Directors and off
ters and obtain information about business transactions, review contracts, read reports,
E-COMMERCE AND THE LAW
When a B2B Company Cooks the Books
and attend presentations. After all, if directors and of
y cannot
make decisions in the best interest of the company. RMBCA does allow directors to
make decisions based on information gathered by other employees. Interestingly, however, most corporations do not allow directors’ decisions to be based on secondhand
information.
e must not only be informed; they
must also be reasonable. If a director or of
en to court for breaching the duty of
had any rational b
ords, w
sion could have helped the company?
P
oice dissent when the corporation is doing something
a director or officer does not think is in its best interest. It is unusual for a dissenting
mismanagement.
. Because directors and officers hav
they have the power to make b
es while harming the company.
ve a fiduciary
,
s interest abov
usiness
decisions.
yalty, they are self-dealing. There
o types of self-dealing. The first, business self-dealing, occurs when a director or
The second, called personal self-dealing,
.
es business
ond complaint w
benefit and payment package for the CEO of Citigroup in 2007. Those in charge of a compan
vities that benefit them before the rest
of the company.
A director or of
air business
deals. Directors and of
iduciary duty of loyalty, however, by
preventing
. This breach usually happens when directors or officers
o
855
CASE NUGGET
Duty of Care
business, goes into the same line of business, or uses her position to develop a new business that the company might have pursued, she is prev
yalty.
A director or of
victed of breaching the duty of lo
its earned as a result of the breach. The corporation need not have been
able to earn those profits in the absence of the breach.
breaches of the duty of lo
Without them, directors and
of
wn interests at the expense of others.
is the legal system using when it dele
est. Because individual directors and of
y hav
, that director
is required not only to disclose the self-interest but also to abstain from voting on that
disinterested shareholders approve it.
D U T I E S OF SH A R E H O LD ER S
Although shareholders typically have few legal duties, in rare instances majority shareholders hav
corporations, the majority shareholder o
tion’
When that individual sells his shares,
control of the company shifts to another individual. Thus, the majority shareholder in
this situation has a fiduciary duty to act with care and loyalty when selling the shares.
wn as oppressive
conduct.
856
CASE NUGGET
Duty of Loyalty
w
when Delaw
for e
Thus,
ve a far-reaching impact. In Case 39-1, brought before
w
C A S E 3 9 -1
F R I E D A H . R A B K IN v. P H IL IP A . H UN T
C H E M I C A L C O R P.
SU P RE M E C OU RT OF D E L AWA R E
4 98 A .2 D 1 09 9 ( 19 85 )
[continued]
CRIT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Liabilities of Directors, Officers, and Shareholders
LO4
director, officer, and
shareholder be held
liable?
Because almost all individuals within a corporation have le
can be held liable for harming the business by violating these duties.
y
wever,
usiness.
L IA B I L IT Y OF DI R E C T O R S AN D O F F I C E R S
sonally responsible for their o
whom they have failed to adequately supervise.
ficers can be held perven for those of other employees
inally liable regardless of the extent to which the off
vity.
Ev
vity can be held criminally liable
ould have known about and could have
prevented it.
Directors and officers who use inside information to trade the corporation’s stock for
personal prof
from whom they purchase or to whom they sell the stock.
Legal Principle: As a general rule, dir
many of the same actions because they hav
corporation.
e held liable for
Business Judgment Rule. Although directors and officers are expected to
make decisions in the best interest of the corporation, they are not expected to make
perfect decisions all the time. Many decisions harm the corporation inadvertently.
858
CASE NUGGET
The Business Judgment Rule
Although shareholders may want to hold their directors and of
decisions, the business judgment rule does not allow them to do so. This rule says that
directors and officers are not liable for decisions that harm the corporation if they were
acting in good faith at the time. In other words, if there was reason to believe that the
decision was a good one at the time, the directors and officers are not liable for the
resulting harm.
Exhibit 39-2 summarizes the liability of directors and officers.
Although the b
w recognized by
very court in the country. The rule is practical because it grants directors freedom
to w
. It also encourages individuals to serve
as directors by removing the threat of personal liability for inadv
es. Case 39-2
illustrates ho
usiness judgment rule.
Exhibit 39-2
Can be held personally liable for their own torts and crimes
Can be held personally liable for the torts and crimes of
other employees that they supervise
Can be held liable for wrongful transactions involving
company stock
Cannot be held liable for decisions that harm the company
if they were acting in good faith at the time of the decision
859
C A S E 39 -2
S TAT E OF W I S CO N S I N I NV ES T M E N T B O AR D
v. W I L L I A M B A RTL E T T
C OU RT O F CHAN C ERY O F D E L AWA R E , N EW C A S T L E
C .A . NO . 17 7 27 ( 2 00 0)
CRIT IC AL TH INKI NG
E T H I CA L DE CI S IO N M A KI N G
L IA B I L IT Y OF SH A R E H O L D E R S
xtent
of their investment when the company loses money. In rare instances, however, shareor e
viduals sometimes sign stock subscription
860
Chapter 39
or par-value shares,
Corporations: Directors, Officers, and Shareholders
861
v
ed face value noted on the stock
alue of the stock. For
no-par shares, or shares without a par value, the shareholder must pay the fair market
value. A shareholder who does not buy the shares is personally liable for breach of contract.
A shareholder who receives watered stock, or stock issued below its f
et value,
is also individually liable for the dif
their stated corporate value.
Finally, a shareholder can also be held personally liable for receiving illegal dividends. State statutes mandate that corporations pay dividends from only certain funds.
Also, dividends are always illegal if they are paid when the corporation is insolvent or
if they cause the corporation to become insolvent. A shareholder who knew that a dividend was illegal when he received it is personally liable and must return the funds to the
corporation.
Exhibit 39-3
Rights of Directors, Officers, and Shareholders
Because shareholders are in a position of limited decision-making power, they have rights
that allo
ficers also have specific rights that allo
D I R E C TO RS ’ R IG H T S
There are four: the
LO5
directors, officers, and
shareholders?
All corporate directors have a right to compensation for their work, which different
ferent ways. Most directors hold other managerial positions within
their companies and receive their compensation through those positions. Another common
utions. In some
wn compensation.
Because directors are required to make informed business decisions, they have the rights
of participation and inspection. They can get involved in and understand every aspect of
the business.
to all books and records.
Exhibit 39-3
Are liable for the debts of the corporation, to the
extent of their investment
Are liable for a breach of contract if a stock subscription
agreement was signed and yet no stock was purchased
Are liable for watered stock
Can be held personally liable for receiving illegal dividends
Liability of Shareholders
COMPARING THE LAW OF OTHER COUNTRIES
Assigned Directors in Japan
Finally, because of their great legal vulnerability, directors have the right to indemniIn other words, they can be reimbursed for any le
wsuits
O F F IC E R S’ R IG H T S
ficers are technically emplo
by employment contracts dra
ficers
y are removed in violation
S H A R E H OL D ER S ’ R I G H T S
werful right is the right to vote at shareholders’ meetings,
they also possess many other rights.
proof of o
stock certificates to shareholders as
s name
wn in Exhibit 39-4.
s ownership in the corporation, however, does not depend on possession of
s ownyed.
In most states, however
receive a letter from the corporation gi
ve a right to
ace
Under common law, shareholders have preemptive rights,
which giv
w issue of stock. Each
shareholder receiv
wns.
Suppose Manuela o
or 30 percent of the outstanding stock.
10,000 shares. If it does not grant preemptiv
gree of Manuela’s control of
862
Chapter 39
Exhibit 39-4
Corporations: Directors, Officers, and Shareholders
Example of a Stock Certificate
all because she now owns 1,500 of 15,000 shares, or only 10 percent
of its stock. With preemptiv
newly issued stock, she owns 4,500 of 15,000 shares and retains her 30 percent control.
s bylaws can negate preemptiv
determines whether to grant them. Preemptiv
viduals who o
vely small number of issued
shares. If a close corporation issues additional shares, an individual shareholder may lose
v
uy ne
ve
rights exist, all shareholders receive stock warrants, which the
number of shares at a specif
ven time period. Like shares of stock, stock
w
xchanges.
Dividends. If directors f
ute dividends, shareholders hav
e legal action to force them to do so. In many cases,
however, directors have good reason to hold dividends for a limited amount of
time to f
xpansion. Thus, shareholders must sho
using their
discretion in withholding the dividend.
www.mhhe.com/kubasek2e.
863
864
Part 7
Business Organizations
Inspection Rights. All shareholders have the right to inspection in both statutory
and common law.
ver, appoint an agent to conduct the inspection
on her behalf. To prevent abuse, however
inspect records and books only if they ask in advance and have a proper purpose. Some
states allo
that shareholders o
tions can deny shareholders the right to inspect conf
trade secrets.
tak
Share Transfer. The la
. In
closely held corporations, however
s other shareholders; they enjo
valent of
delectus personae (this allows partners to choose the individuals with
whom they will go into business). Restrictions on transferability must be included on the
f
right of first refusal.
tion establishes this right in its byla
v
purchase an
of time.
Corporate Dissolution.
solv
v
. According
y of the following behaviors,
ve a legal right to initiate dissolution:
1.
2.
ve, or fraudulent ways.
3. Assets are being wasted or used improperly.
4. Shareholders are deadlocked and cannot elect directors.
Once dissolution has tak
shareholders have a right to receive the remaining assets of the compan
y own. Case 39-3 pro
dissolution.
C A S E 39 -3
M O U Z A KI TI S v. PE A R L N I G HT L IF E , I N C . , E T A L .
N E W YO RK SU P RE M E C O U RT, Q U E E N S C O U N T Y
AVA I L A BL E AT h t t p : / / d e c is i on s . c o u r t s . s t a t e. n y. u s / f c a s / f c a s _
d oc s / 20 0 9m a r / 4 00 02 8 4 202 0 0 8 1 0 0 s c i v. p df ( 2 00 9 )
[continued]
CR IT ICA L TH INK ING
E T H I CA L DE CI S IO N M A KI N G
Shareholder’s Derivative Suit.
ail to sue when the
vidual, another corporation, or a director, individual shareholders (who held stock at the time of the alle
shareholder’s derivative suit
ers must f
y can prove brought shareholder’
vative suits against
various directors and officers. The Case Opener presented an example of a shareholder’s
derivative suit. The Bank of
Bank of
versial Merrill
Lynch bonuses was never disclosed. Such information should have been disclosed to the
ote over whether to acquire
Merrill Lynch.
It seems highly unlikely that directors will sue themselves for damages they caused.
Thus, the shareholder’s derivative suit is an important way for shareholders to hold
directors accountable for their behavior
tion’s behalf, all damages recovered are given to the corporation, not the individual
.
Shareholder’s Direct Suit. Shareholders can also bring a direct suit against
the corporation. In a shareholder’s direct suit, the shareholder alleges damages caused
by the corporation. For example, a shareholder may allege that the board of directors
is improperly withholding dividends or wrongly denying the shareholder’s right to
865
866
Part 7
Business Organizations
inspect corporate records. However, in some instances a direct suit it not appropriate.
For e
ging that an officer has violated
. In such a circumstance, the violation would engage all shareholders. If a
court aw
s direct suit, the
personally.
Legal Principle: Damages recovered from a derivative suit go to the corporation.
In contrast, damages recovered from a direct suit go only to the shareholder.
A class
action suit is brought by one shareholder on behalf of a group of shareholders to recover
damages for the entire group.
CASE OPENER WRAP-UP
Bank of America
Key Terms
Summary of Key Topics
Point / Counterpoint
Should Both Majority and Minority Shareholders Have a Fiduciary Duty to Sell Their Shares
in Ownership of the Corporation “with Care”?
YES
Questions & Problems
NO
Looking for more review material?
Chapter 40
Corporations: Mergers, Consolidations, Terminations
873
Procedures for Mergers and Consolidations
LO2
ger or consolidation, the procedures govExhibit 40-1 explains the process of mergers and
consolidations.
State statutes gov
mer
for mergers and
consolidations?
ferent from acquisitions
between corporations from different states, different laws govern acquisitions between
Although these laws
vary across states, several requirements apply universally:
1. The boards of directors of all involv
ve the merger or consolidation plan.
2. The shareholders of all involv
ve the plan by a vote at a
shareholder meeting. Most states require the approval of two-thirds of the outstanding
shares of voting stock. If, however, a merger increases the number of the surviving corporation’
val of
the survi
s shareholders.
3. The involv
ger or consolidation plan to the secretary of state.
4. After reviewing the plan to ensure that the corporations hav
gal requireicate to grant approval for the merger or
consolidation.
Exhibit 40-1 Process for Mergers and Consolidations
Boards of directors of
all involved
corporations must
approve the plan
Shareholders must
approve the plan
through a vote at a
shareholder meeting,
unless it’s a shortform merger—then no
approval is necessary
The corporations
must submit their
plan to the secretary
of state
The state reviews the
plan and grants an
approval certificate