cpa prep windsor business environment and concepts business structure june 7, 2009 © leo muzzatti...
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CPA Prep WindsorBUSINESS ENVIRONMENT AND CONCEPTS
BUSINESS STRUCTURE
JUNE 7, 2009
© Leo Muzzatti 2007/08
Instructor:
Leo Muzzatti LL.B. 1983, B.Ed. 2004
• Contact info:
Tel. 519-252-3421519-252-3421
E-Mail: [email protected]@primus.ca
Business Structure Overview:
• Chapter 48: Partnerships Nature & Formation Partners & 3rd Parties - relationships Dissociation Limited Partnerships Limited Liability Companies
• Chapter 49: Corporations Nature & Formation Financing Stockholders Income Tax implications Agency
Chapter 48 PartnershipsNature & Formation
• Revised Uniform Partnership Act (RUPARUPA) enacted in 1997• Defines partnershippartnership: association of 2 or more persons to carry
on business for profit as co-owners– Different from agency: agency: where agent only receives share of profits, but
is not a proprietary co-owner
• Partnership is seen as a business entityentity for some purposes (e.g. title to partnership property or legal actions); partner’s interest in the property (share in profits/losses) is personal and can be transferred (assigned)
• Partnership not seen as entity for other purposes (e.g. income tax levied against individual partners)
Chapter 48 Partnerships
Partnership Classifications:
General Partnership: formed under RUPA or common law – consists only of general partners who share in management and profits/losses; unlimited liability to partnership creditors
Limited Partnership: 1 or more general partners and 1 or more limited partners (contribute capital, but no management authority); lim partner’s liability to creditors is limited to amount of capital contributed
Silent Partner: unlimited liability but not involved in managing Ostensible or Nominal Partner: not formally a partner, but actions
may compel responsibility (held out or appears to be partner) Dormant Partner: right to management, but undisclosed and generally
inactive; once disclosed, becomes unlimited liability Secret Partner: participates in management but remains undisclosed –
if disclosed, becomes unlimited liability Limited Liability Partnership (LLP): general partners have limited
liability; limitation is statutory – invoked by election; many states allow professional partnerships to use LLPs
Chapter 48 Partnerships
Fed Income Tax Implications:• individual partners taxed on share of
partnership gain/income (Form 1065)
• General and limited partnerships, LLCs are not taxable entities – merely report shares of gain/loss or income/loss attributable to partners
Chapter 48 Partnerships
Partnership Property:• All property brought in or acquired on account
of partnership becomes partnership property• Includes capital, good will and partnership
name• RUPA permits acquisition of real property in
partnership name• Partner’s interest in partnership is his/her share
of profits/surplus; • assignable unless stipulated otherwise; • creditors of partner generally may not seize/attach
partner’s interest until general distribution of all partnership assets
Chapter 48 Partnerships
Formation of Partnership:• Can be by express or implied agreement• Generally, need not be in writing, but some
situations require (e.g. Statute of Frauds)
• Intention is the key determinant as to whether partnership created or exists co-ownership of property, contribution of capital to business and
even designation of “partnership”: all all do do notnot, alone, alone conclusively conclusively determine statusdetermine status
• Most states require filing of name used publicly by partnership
Chapter 48 Partnerships
Relationship Between Partners:• Fiduciary: duty of loyalty and care to
partnership and partners (cannot be waived/eliminated by agreement); RUPA establishes duty of care – no gross negligence; good faith and fair dealing
• Partnership agreements are still subject to RUPA re: rights between partners; RUPA supplants if no agreement (presumption of equal rights/share in profits/losses/assets)
• Principal remedy available to aggrieved partners is suit in equity for dissolution and accounting
Chapter 48 Partnerships
Relationship With 3rd Parties:• Every partner is an agent of the partnership and for all other
partners, and binding if action within scope of partner’s actual or ostensible authority
• Generally, partners may not:• assign partnership property in trust for benefit of partner’s creditors• dispose of goodwill of business• perform action resulting in frustration of business activities• Confess a judgment• Submit partnership claim or liability to arbitration
• Partners are jointly/severally liable for contracts and actions in tort/fraud arising out of partnership business against any partnership member (if not a limited liability partnership)
• All partners are jointly/severally liable for actions in tort arising from activity authorized by other partners or in normal course of business; partner adjudicated guilty of tortious conduct liable to co-partners
Chapter 48 Partnerships
Dissociation:• Partner ceases to be associated with partnership; does not necessarily
mean the partnership is at an end• Will always result in either
• buyout of dissociated partner’s interest, or• dissolution and winding up of business
• Can occur upon:• term of partnership agreement that it is dissolved on occurrence of certain events
(ore even on completing a specified project);• partner expressly decides to dissociate – may be subject to damages if in
violation of partnership agreement• if partnership is at will, partner may dissociate at any time, but must act in good
faith;• express will of all partners• expulsion of a partner by majority, if authorized by the agreement and bona fide• illegal event/activity has taken place• partner death, withdrawal, bankruptcy or incompetency, unless agreement
provides otherwise• Court judgment upon application by partner if partner declared insane, otherwise
incapable of performing responsibilities under partnership, or guilty of conduct prejudicial to conduct of business
Chapter 48 Partnerships
Dissociation (cont’d):• Generally, dissociation from partnership does
not discharge existing liability of any partner
• Agreement can supersede this, or liability could be assumed by existing or new partner
Chapter 48 Partnerships
Limited Partnerships:• Partnership of both general and limited partner(s)• Permits persons who do not have desire/ability to assume
responsibilities of management to invest in partnership business
• State statutes determine formalities of creation• General partners: responsible for management and control –
personally liable for debts; must be at least 1 general partner• Limited partners:
• generally only make capital (cash or property – not services) contribution to partnership
• Same rights as gen partners, except management/control• Surname may not appear in partnership name, unless identified as
limited partner• Liability ordinarily limited to capital contribution to partnership• Interest generally assignable, but rights are not, unless to a new limited
partner; death of lim partner does not dissolve partnership• Creditor of lim partner may obtain charge against interest in partnership
Chapter 48 Partnerships
Limited Partnerships (cont’d):• Created strictly by compliance with statute – only in
enabling jurisdictions• Some states use ULPA (Uniform Limited Partnership
Act); some use RULPA (Revised Uniform Limited Partnership Act, 1985)
• Formation requires certificate and filing by partners with name of partnership, character/location of business, term, description of capital, name/residence of general and lim partners incl. status and rights of each
• RULPA requires office and agent for service for partnership; provides for procedure on dissolution; allows even lim partners to contribute certain services; certificate does not require names of lim partners
Chapter 48 Partnerships
Limited Liability Companies:• hybrid of corporate and partnership law• Company formed by 1 or more members (owners);
are equivalent to partners in general partnership (manage business)
• Members may elect manager to operate day-to-day operations of business – does not have to be a member of LLC
• Liability shield is open to all members – no restrictions like limited partners
• Formed by state law procedure:• Articles of Organization: details of company,
names/addresses of members; filed with state• Common to have an Operating Agreement between
members; private contract• No automatic dissolution – holders of financial rights in LLC
may elect members and continue business of LLC
Chapter 49 Corporations
Overview• Is an artificial person (single, separate legal entity)
created by or under authority of state or statute• May be owned by 1 or more persons (shareholders)• Shareholders generally not personally liable for
debts/obligations of corporation; risk of loss extends only to actual investment
• Generally, shares are transferable• Corp vested with capacity of continuous succession• Is limited by provisions of its charter (incorporation
documents) or operating management• RMBCA (Revised Model Business Corporations Act)
applies in many, but not all states – covers formation, activities, termination of corporations
• Generally, taxation occurs at corporate level, and again at shareholder level
Chapter 49 Corporations
Definitions• Domestic CorporationDomestic Corporation: does business in state where
incorporated• Foreign CorporationForeign Corporation: doing business in any state except one
in which incorporated; subject to controls/admin requirements of state in which doing business
• Professional CorporationProfessional Corporation: most state legislation allows professionals (e.g. doctors, attorneys, accountants) to incorporate; shares usually only owned by professionals who retain persona liability for professional acts
• Shareholder/StockholderShareholder/Stockholder: owner of equity interest in corporation
• InsidersInsiders: traders of stock subject to federal securities legislation; unlawful to defraud or make untrue statements calculated to deceive re: purchase/sale of any security in interstate commerce; officers, directors, holders of more than 10% of corporation stock may not buy/sell stock for profit within any 6 month period
Chapter 49 Corporations
Corporate Powers• Implied:Implied:
• to sue/be sued in corp name• make/amend corporate bylaws• acquire, mortgage, transfer real property and
chattels for corporate purposes• issue corporate bonds
• Express (only):Express (only):• grant gifts• enter into partnerships• lend monies or act as surety• acquire/reacquire own shares
Chapter 49 Corporations
Directors• Are elected by shareholders, however have statutory right to manage affairs
of corporation independent of direct shareholder influence• Can be inside (employee, officer or stockholder of corp) or outside directors• Audit Committee: operating committee of bd of directors (independent of
corp); oversee financial reporting and internal control processes, accounting policies, and external auditors
• Usually only removed before end of term for cause (fraud or incompetency)• Meetings dictated by charter or by statute, including notice provisions for
shareholders; quorum specified; meetings can be waived with written consent of directors
• Some day-to-day activities can be delegated to sub-committee of bd of directors
• Power to initiate fundamental changes, manage the business of the corporation, declare dividends – all subject to ultimate approval of shareholders
• Personally liable for improperly or unlawfully paid dividends• Are fiduciaries of corporation; duty to act with reasonable care and loyalty;
courts have held they are not accountable for mere errors of judgment if acting in good faith and not clear and gross negligence
• Can personally deal with the corporation, as long as fully disclose interest to other board members and approved; may not divert business opportunity from corporation to self without disclosure and 1st opportunity given to corp
Chapter 49 Corporations
Officers
• Usually appointed by corp directors – serve at board’s pleasure
• Express power to contract for corp and implied authority to act as position reasonably requires
• Corporation liable for actions of officers if committed within scope of duties
• Same fiduciary obligations to corp as directors
• Principal exec officer/financial officer must certify annual/quarterly SEC reports (publicly traded stock corps)
Chapter 49 Corporations
Corporate Liability
• Corp is liable on contracts of and torts committed by its employees
• Respondeat SuperiorRespondeat Superior: doctrine holds corp liable for tortious acts of employees if committed within scope of employment
• Ultra ViresUltra Vires: acts beyond scope of corporate authority granted by charter/statute; not illegal, but are void or unenforceable at common law; today most jurisdictions do not recognize this doctrine to nullify contract or legal action, but can be asserted by shareholders of the corp
Chapter 49 Corporations
Corporate Veil
• Shareholder’s “shield” against personal liability for corporation’s actions is referred to as a “veil”
• Veil may be “pierced” by courts in certain circumstances: Corporate fraudCorporate fraud; shareholders held liable instead
of victims left “holding the bag”, especially if found corporation was set up with intent to defraud
Initial under-capitalizationInitial under-capitalization, or under-capitalization of a subsidiary corporation
Shareholder loansShareholder loans, especially where there is under-capitalization
Chapter 49 Corporations
Formation• “Promoter” forms, arranges capitalization, initiates general
business of corp; draws up charter and promotes stock subscriptions
• Fiduciary obligation to corp (act in good faith and in corp’s best interest); may not self-deal in secret
• Corporation not liable for promoter’s contracts – theory is that corp entity does not yet exist, but actions may be adopted by statute, agreement or by implication (e.g. accepting benefits)
• Incorporation: regulated by state laws; usually require “lawful” activity; dictate Articles of Incorporation: signed by incorporators (often also promoters) Name of corp, purpose, capital stock authorized, location of principal
office, no of directors, name/address of reg’d agent for service, capital structure
After signature, filed at state office; corporate entity exists from time of filing – often, certificate follows later
Defects in formation usually curable if substantial compliance Shareholders are personally liable if “non-corporation”
Chapter 49 CorporationsFinancing• Subscription agreements: subscriber agrees to purchase specified
no and type(s) of shares of corporate stock at specified price• Can be pre-incorporation or post; can also be conditionalconditional (issued
only on occurrence of specified event; should be in writing)• Unlawful to issue (issued stockissued stock) more shares than authorized in
articles (authorized stockauthorized stock); remaining un-issued stock is outstanding stockoutstanding stock;
• Common stockCommon stock: owner share in dividends/liquidation; may be voting or non-voting
• Preferred stockPreferred stock has special rights/preferences; often receive par value at liquidation before common stockholders; can be voting or non-voting
• Issuance of Stock: UCC dictates liability of corp for issuance; will be liable to good faith
subscribers for damages if issued without corporate authority (e.g. forged);
Consideration for stock must be cash or property, incl. promissory notes, past services or contract for future services
Bd of directors may determine price of no-par value stock; par value stock must be issued at price stipulated
Chapter 49 CorporationsStockholders• May not exercise direct control over corporate
management, but certain powers/rights: Derivative actionDerivative action: can sue for benefit of corporation if corp
suffered harm (e.g. theft by director) Direct actionDirect action: only for individual stockholder rights Asset share on dissolution Voting rights (if provided by stock) Right to inspect books/records of corp Right of 1st refusal on issue of newly authorized stock Dividends when declared by directors Notice of meetings Fundamental changes (e.g. amend articles, merger) Share voting trustsvoting trusts, poolingpooling, proxyproxy Shareholders have no fiduciary duty, except majority
shareholders to minority shareholders as a group (may not use majority to injure, oppress or defraud minority)
Chapter 49 Corporations
Fundamental Corporate Changes• ReorganizationReorganization:
MergerMerger: 2 or more corps join together (one loses, other retains identity)
ConsolidationConsolidation: 2 or more corps join together; both old corps cease to exist and absorbed by new corp
procedure different in each state, but usually requires bd of directors and shareholder approval, state filing, appraisal rights for shareholders
• DissolutionDissolution: can be voluntaryvoluntary: by directors vote and shareholder
majority approval or involuntaryinvoluntary: corp has exceeded authority of
statute; shareholder action if directors have committed fraud, oppression etc.
Chapter 49 Corporations
Federal Income Tax Implications• Corps formed under state law are generally taxed as
corporations (separate taxable entity)• Cash and ordinary dividends are income to
shareholders• Stock dividends (additional shares issued in proportion
to existing holdings); are tax free to common shareholders
• ““S” corporationsS” corporations: usually small, closely held or family controlled corporations; taxed only at the shareholder level; certain limitations:
• Max 100 shareholders• Only one class of stock permitted• Affiliated groups, corporations, financial institutions, insurance co’s
etc. often prohibited
Chapter 49 Corporations
Agency• Consensual, fiduciary relationship• One person (agent) agrees to act on behalf and under control
of another (principal)• Partners are agents of partnership and other partners• Corporations must act through agents• Unincorporated associations are not separate legal entities, so
cannot appoint agents, but their individual members as principals may
• Notice by 3rd party to agent is notice to principal if agent has actual or apparent authority to receive, unless adverse interest known to 3rd party
• Agent’s knowledge imputed to principal if agent has authority to represent principal, unless interest adverse
• Admission of agent to 3rd party in scope of employment/agency are binding on principal; may be introduced as evidence
Chapter 49 Corporations
Agency (cont’d)• Principal’s duties to agent:
Compensation for services Reimbursement of expenses Indemnification Compensation for injury
• Agent’s duties to principal: Loyalty (fiduciary duty – can’t act against interest of principal,
must disclose any self-interest and can’t compete without permission; confidentiality of principal’s info
Follow lawful instructions of principal Communicate material facts Account for property
• Agents have actual, implied and/or ostensible authority to contract for principal
Chapter 49 Corporations
Agency (cont’d)• Creation:
Appointment: need not be in writing; consideration not necessary
Can be express or implied Can use power of attorney Cannot appoint agent to perform duties that principal is
bound to perform personally, or if precluded by statute (e.g. execution of will), or that principal cannot legally perform
Acts of an agent can be ratified after the fact by principal by operation of law: estoppel (actions cause 3rd party to
believe agency exists); by necessity (e.g. emergency)• Termination:
By notice: by principal or agent to each other, or to 3rd party; either actual or constructive (e.g. publication)
By agreement; By renunciation by agent or principal; breach could arise
Chapter 49 Corporations
Agency (cont’d)• Respondeat SuperiorRespondeat Superior:
Master liable for wrongful acts of servant; principal liable for wrongs of agent
Provided within scope of employment/agency Referred to as vicarious liability Scope of agency:
• type of act agent authorized to perform;• substantially within time/place authorized;• intended to serve principal (even if agent violated
principal’s instructions);• principal not liable if agent acts outside scope of duties;• principal not usually liable in criminal law for agent’s
actions, unless crime anticipated or acquiesced in; some statutes attract criminal liability (e.g. environmental protection legislation)
Chapter 49 Corporations
Agency (cont’d)• Contracts:
Material misrepresentation of facts inducing 3rd party to enter into K may be grounds for rescission
If 3rd party knew dealing with agent and identity of principal, K only binding on principal; if knew of principal, but not identity, K binds both agent and principal; if entirely undisclosed agency, K binds agent only, but undisclosed principal generally has right to enforce K against 3rd party
• agents liable for own torts against 3rd parties, even if principal vicariously liable, but 3rd party entitled to only one recovery
COMPARISON OF VARIOUS BUSINESS ENTITIES
General Partnership
Limited Liability Partnership
Limited PartnershipLimited Liability
CompanyCorporation
State Filing Required No Yes Yes Yes Yes
Designation of Owners Partners Partners
General Partners and Limited Partners
Members Shareholders
Persons with Authority to
BindPartners Partners General Partners
Members or Managers
Officers
Governing Documents
Partnership Agreement
Partnership Agreement & Application for LLP
Certificate & Partnership Agreement
Articles of Organization &
Operating Agreement
Articles of Incorporation &
Bylaws; Shareholder Agreements
Limited Liability No Yes, if election made
No for General Partners; Yes for Limited Partners
(not participating in managing
Yes Yes
Ownership Interest Treated
as SecurityGenerally, NO Generally NO
Generally NO for General Partner; Generally YES for
Limited Partner
Depends on management
form;Generally, YES