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Business Law FAQ

In what ways are joint ventures and partnerships alike?

Joint ventures and partnerships share many characteristics. A partnership where two or more individuals or entities join together for a particular "short term" purpose is sometimes called a joint venture. In a partnership or joint venture, each partner has equal ability to legally bind the entire entity. A partner can represent the whole organization in the normal course of business, and his or her legal actions on behalf of the partnership (in this case, the joint venture) create legal obligations.

Example: Ed Smith and his friend Bob Clark create a limited joint venture to sell freshly caught crab on a California pier. Ed obtains a credit line on behalf of the partnership, and buys a $500,000 boat for this purpose, without getting Bob’s approval. Ed’s status as a partner gives him the ability to bind the entire venture even without Bob’s consent. The bank can enforce payment of the credit line against either Bob or Ed in this instance.

While it is legal to limit the powers of individual partners through a partnership or joint venture agreement, those agreements do not bind the rest of the world. Since businesspeople outside of the partnership have no knowledge of the limitations, they are entitled to rely on the apparent authority of an individual partner as determined by the usual course of dealing or customs in the trade.

Individual members of a partnership or joint venture may face liability for the actions of the partnership or the joint venture. However, new limited liability partnership laws and corporate form options for joint ventures may reduce this risk.

Call one of our attorneys and we can discuss the appropriate form of entity with you to provide you with the greatest liability protection.

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Do shareholders of closely held corporations have any legal responsibilities to each other?

Corporate law imposes a fiduciary duty on business directors that requires them to act in the best interests of the company's shareholders. For closely held corporations where shareholders work together and may act as directors, there may be a fiduciary responsibility between shareholders in some instances.

The traditional legal view holds that shareholders have no special responsibilities to one another. In closely held businesses, however, majority shareholders can potentially greatly damage the interests of small shareholders. Since most investors do not want to buy closely held shares, minority shareholders have few options when their interests are compromised. In response, some states and courts have recognized fiduciary duties among shareholders of closely held businesses.

These duties depend on the state and the particular circumstances of the case. Some state court holdings require that majority shareholders exercise the utmost good faith and loyalty to minority shareholders of close corporations.

Example: Helen is a minority shareholder in her uncle’s product packaging company. Her uncle refuses to provide her the business records upon her request, claiming that he has no duty to do so. Helen’s uncle has violated his fiduciary duty to her.

Some states do not establish a fiduciary duty, but offer special rights to minority shareholders. In some cases, minority shareholders of close corporations can compel the company to dissolve. Other laws authorize special voting trust rules or other options to boost the power of the minority shareholder.

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What is a shareholder voting agreement?

Shareholders may choose to pool their votes for a particular goal. Voting agreements may specify that the involved shareholders will vote their shares together or cooperatively. Courts usually uphold shareholder voting agreements as long as they relate to issues upon which shareholders can vote.

Voting pools may specify exactly how the participating shares should be voted, or they may allow for negotiation and agreement for each individual issue. Many voting pools include an alternative dispute resolution procedure for reaching agreement on such issues.

Some states require that voting pools follow specific guidelines to be valid. These laws may limit the length of a shareholder agreement, or may require that the shareholders deposit a copy of the agreement with the corporation. If a party to a valid voting agreement violates the agreement, the other parties may sue the uncooperative party. Courts may require that the dissenting shareholder vote according to the agreement, or they may disqualify violating votes.

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Why do corporate laws require that directors explicitly dissent from objectionable board decisions?

When a director faces a board decision regarding an objectionable or even illegal matter, he or she cannot escape personal liability for the corporate action unless the director records his or her dissent, either at the time of the vote or within a short period thereafter. The director's pursuit of legal protection through this procedure serves multiple purposes:

  • The dissenting director will not be liable for any legal problems arising from the vote;
  • Other directors may rethink a questionable position or action; and
  • Shareholders who examine the voting record receive notice of potential problems.

The law uses this requirement to push directors to state their misgivings, with the hope that their dissent will guide their corporations toward better business practices, avoid damaging third parties, and reduce the number of lawsuits. Directors must stay abreast of the board's activities, and should be prepared to dissent to actions that may implicate them personally, if not from a legal perspective, at least from a moral one.

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Do limited liability companies follow the partnership or corporation model for dissolution?

Limited liability companies can be forced to dissolve under more circumstances than corporate business organizations. As with partnerships, an outside occurrence can signal the end of a limited liability company's existence. Depending on the state statute, a limited liability company may formally terminate if an owner experiences:

  • Death;
  • Retirement from the company;
  • Resignation from the company;
  • Personal bankruptcy; or
  • Expulsion from the company by the other owners.

Once dissolution is brought on by one of these events, the remaining members typically must wrap up the company's remaining obligations and terminate the organization. However, if two or more members remain, they can avoid termination by agreeing to continue the business. In this case, members should review state limited liability company laws for formal requirements to remain a legal business entity.

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Can closely held businesses be bought and sold?

Individuals and other businesses can acquire closely held businesses as long as the current shareholders are willing to sell. Since many closely held businesses involve family relationships, emotional events including divorce, estrangement, or death may precipitate the business sale. Needless to say, these circumstances may complicate any business transaction.

One difficulty in purchasing or selling a closely held business involves valuation. Since shares in closely held businesses are not commonly traded, parties may find it nearly impossible to agree on a fair price for the business. Financial professionals, business brokers, and attorneys can assist the parties in valuing the business and reaching an amicable agreement for its transfer.

Another common issue involves the transferability of the business interest, which depends on the underlying business form. Some transfers cause no complications whatsoever. For sole proprietorships, the buyer purchases the company's assets and takes over operations. Partnerships and limited liability companies do not transfer as easily. If a partner or limited liability company owner sells his or her interest, the buyer cannot participate in the business without the remaining owners' consent. Essentially, the buyer succeeds to the seller's profits and losses in the business unless the other parties agree to allow him or her to participate in management of the business. Corporate ownership interests cause the fewest problems because corporate shareholders may sell their entire interests, without the consent of the remaining shareholders.

Experienced competition may destroy the value of the purchased business. Purchasers of closely held businesses should consider having the sellers sign non-compete agreements. These agreements prevent sellers from using their expertise and market knowledge to compete against the purchaser in his or her new venture. Courts generally uphold these agreements so long as they are reasonable in scope and duration.

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What are the possible consequences of personal liability for business debts and obligations?

Personal liability can devastate the accumulated wealth of a lifetime of work. This form of liability opens the individual to claims for a wide range of business obligations. Most people realize that personal liability may extend to business losses, but other obligations may also reach individuals, including:

  • Damage awards in lawsuits;
  • Tax deficiencies and penalties; and
  • Back wages and benefit payments.

Example: Chuck has a mobile window washing business that he operates as a sole proprietorship. During work one day, he causes an automobile accident. Due to expenses, he had previously reduced his vehicle coverage to the state minimum. Judgments and settlements in this case will be assessed against the business assets, as well as Chuck’s personal assets.

Limited liability offered by incorporation shelters business owners from personal liability. Certain types of insurance can also help cover business owners, directors, and officers. However, if an owner or director performs certain personal acts, behaves illegally, or fails to uphold statutory requirements for corporate status, he or she may face personal liability despite the corporate shelter.

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What are the differences between C and S corporations?

The Internal Revenue Code allows for two different levels of corporate tax treatment. Subchapters C and S of the code define the rules for applying corporate taxes. Subchapter C corporations include most large, publicly-held businesses. These corporations face double taxation on their profits if they pay dividends: C corporations file their own tax returns and pay taxes on profits before paying dividends to shareholders, which are subsequently taxed on the shareholders' individual returns as regular income.

Subchapter S corporations meet certain requirements that allow the business to insulate shareholders from corporate debts but avoid the double taxation imposed by subchapter C. To receive subchapter S treatment, corporations:

  • Must be domestic;
  • Must not be affiliated with a larger corporate group;
  • Must have no more than one hundred shareholders;
  • Must have only one class of stock;
  • Must not have any corporate or partnership shareholders; and
  • Must not have any nonresident alien shareholders.

Additionally, after a business is incorporated, all shareholders must agree to subchapter S treatment prior to electing that option with the Internal Revenue Service. The limitations imposed by the subchapter may affect the transferability and marketability of corporate shares.

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What are the benefits and drawbacks of nonprofit, tax-exempt status?

Many organizations see only the financial benefits of nonprofit and tax-exempt status. Qualifying groups pay no tax on federal, state, and local taxes, and therefore can devote a larger proportion of their resources to achieving their particular goals. The status can also qualify groups for special grants or government funding, as well as special rates for services or even postage. Donors prefer contributions to these groups because they can deduct the payments from their own taxes.

The form of the organization offers advantages in itself. Since nonprofits exist as corporations, they possess all the benefits of corporate status. The corporate form shields owners and managers of the organization from personal liability for the group's actions, subject to certain legal exceptions. Nonprofit incorporation formalizes the group's goals and helps maintain organizational focus as the effort grows.

Despite these advantages, nonprofit and tax-exempt status should not be an automatic goal. Drawbacks to the status include:

  • The inability to divide profits among members beyond payment of reasonable salaries;
  • Limitations on the sources of the group's incomes, including from solicitation efforts; and
  • Restrictions on the use of assets to purposes justifying tax exemption.

Some organizations prefer the flexibility and potential for personal gain implicated by for-profit status. Other organizations eschew incorporation entirely. Many smaller organizations will not realize substantial advantages from nonprofit tax-exempt status after going through the intensive application process. Each individual group must weigh the pros and cons of the status carefully in light of their organizational goals and values.

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What types of legal procedures should corporations maintain?

Once incorporators establish a new business, the directors must ensure that it retains its legal status. Depending on the business form, certain legal formalities must be followed for this purpose. Once incorporated, an ongoing business's obligations include:

  • Obtaining federal and state tax identification numbers for the business and filing needed tax returns annually;
  • Issuing shares of stock as mandated by the articles of incorporation and federal securities law;
  • Establishing and maintaining corporate books and records, including accounting ledgers, shareholder records, and corporate minutes;
  • Calling and conducting an initial meeting of the board of directors or shareholders, as required in the articles of incorporation;
  • Holding future meetings at least as often as required by applicable business laws;
  • Conforming all decisions and internal procedures set forth by the articles of incorporation;
  • Recording all actions and decisions of the board of directors in the corporate minutes; and
  • Maintaining annual registration with the state government as required by law.

These items and more are provided in your Corporate kit to ensure your continued compliance with legal requirements.

Additionally, some businesses must comply with licensing requirements or professional standards to preserve their status. These businesses may need to maintain further records or use special procedures or equipment based on rules for their specific industries.

In many situations, a failure to abide by corporate obligations can result in personal liability for directors, officers, or shareholders for business obligations and debts. Because of these harsh consequences and because the specific legal requirements vary depending on the business's location and form, businesses should seek professional legal advice.

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What is "piercing the corporate veil?"

Sometimes, courts will allow plaintiffs to receive compensation from corporate officers, directors, or shareholders for damages rather than limiting recovery to corporate resources and corporate assets. This procedure avoids the usual corporate immunity for organizational wrongdoing, and may be imposed in a variety of situations. The specific criteria for piercing the corporate veil vary somewhat from state to state and may include the following:

  • If a business is indistinguishable from its owners in practical terms, courts will not allow owners to benefit from limited liability.

Example: Tina has a cookie corporation called Tina’s Fancy Cookies, Inc. In an effort to reduce costs, she opted to funnel all expenses and income from the corporation through her personal bank account. In addition, Tina signs business and distribution agreements in her own name and not as an officer of Tina’s Fancy Cookies, Inc. Tina may be liable for breaching a business agreement because she and her company are legally indistinct.

  • If a corporation is formed for fraudulent purposes, courts will allow recourse to the owners.
  • If a business fails to follow corporate formalities in areas such as record-keeping and decision-making procedures, a court may impose liability on the individuals controlling the business.

Example: Tim and Sharon create a corporation for a funeral business. In over 10 years, they never held Board of Director or Shareholder meetings and rarely kept business records of the business decisions that were made. Tim subsequently gets sued by the casket company for unpaid invoices. Tim claims personal immunity as a corporate officer. The casket company successfully sues Tim personally with the piercing the corporate veil theory.

The potential for personal liability encourages businesses to observe legal requirements and to avoid damage to third parties.

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Learn More: Business Organizations

The form you choose for your business organization creates specific legal consequences for matters as diverse as taxes, insurance, and management. Once formed, a business faces challenges in its relationships with its shareholders, creditors, employees, and other businesses. Every business concern has important legal issues that can dramatically affect the likelihood of future success. Experienced lawyers can help create a business strategy that manages these legal risks.

Business successions take place upon the death or withdrawal of a business owner. Depending on the form of the business, transfers of ownership interests may not achieve a complete change of control. Careful estate planning can minimize problems and facilitate business owners' goals.

Closely held businesses involve a small number of shareholders, and are common forms for family-owned corporations. Due to their low number, shareholders often assume management and direction of the company. This consolidation of responsibilities can lead to specialized legal issues.

Directors' and officers' liability occurs when corporate representatives undertake actions that are illegal, unauthorized, or damaging to the business. While the corporate structure offers protection from liability in most instances, some actions or decisions can expose directors and officers to legal risks even if made in the course of business.

Dissolution of a business may happen for a variety of reasons including management deadlock and lack of profitability. Since most business organizations exist in legally-mandated forms, they must use statutory procedures to close their doors. State laws help protect shareholders and creditors of dissolving companies.

Formation and business planning continues long after the articles of incorporation are first written. Businesses must plan for profitability, tax consequences, employment issues, and other concerns. Business forms can change with commercial needs and realities, and experienced businesspeople will keep an open eye for changing risks and opportunities.

Joint ventures involve two or more companies or individuals in a partnership for a particular purpose. Each contributing member provides capital, expertise, technology, or other special resources to the venture. Special legal liabilities apply to the members of the venture.

Limited liability companies allow their owners to enjoy the tax status of a partnership and the limited liability of a corporation. This business form is gaining in popularity nationwide, with special state laws addressing formation and operational issues.

Nonprofit and tax-exempt organizations incorporate in order to pursue an organizational goal in the public interest. Nonprofit corporations exist under state law, but must apply to the Internal Revenue Service and their state franchise board for tax-exempt status. Although the application process is lengthy, qualifying organizations realize substantial financial benefits.

Partnerships can arise in some instances even when the partners do not intend to form a distinct organization. While some types of partnerships do not impart the liability limitations of other business forms, they do have favorable tax implications. Increasingly, state laws provide for new partnership forms that grant more liability protection.

Reorganizations allow bankrupt businesses to regroup in order to stay open and satisfy creditors as much as possible. The commercial bankruptcy option has many advantages over liquidation, which requires selling off many assets and after which the business ceases to exist.

Shareholders' rights include certain powers of control over the corporation. The corporation must protect shareholder interests, and perform certain legal duties in order to preserve shareholders' prerogatives and options.

Trade associations connect individual businesses and business groups to work together for common goals. Trade associations provide a forum for brainstorming, political action, and industry standardization.

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Law Offices of Daniela Lungu
4695 Chabot Drive, Suite 200
Pleasanton, CA 94588

Phone: (925) 558-2710
Fax: (925) 558-2701

 

 


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