Articles Posted in Organization: Inc./LLC/Sole Proprietor

bookThe structure of a corporation establishes a division of rights and responsibilities among at least three groups. Ownership of the corporation is vested in the shareholders, while directors are charged with its overall management. Officers are responsible for the corporation’s day-to-day operations. A shareholder who is not also a director or officer may not have much of a role in the operation or management of a corporation, but they have rights to information about the corporation’s financial status. The Delaware Court of Chancery recently ruled in favor of a shareholder seeking access to a corporation’s books. Rodgers v. Cypress Semiconductor Corporation, No. 2017-0070-AGB, order (Del. Chanc. Ct., Apr. 17, 2017). The court’s order offers useful guidelines for shareholders seeking access to corporate information.

New Jersey law defines “shares” as “the units into which the proprietary interests in a corporation are divided,” and a “shareholder” as “a holder of record of shares in a corporation.” N.J. Rev. Stat. §§ 14A:1-2.1(l), (m). Any shareholder has the right to request financial documents, including balance sheets and profit and loss statements, from the corporation. Certain shareholders “have the right for any proper purpose to examine…[the corporation’s] minutes of the proceedings of its shareholders and record of shareholders.” Id. at § 14A:5-28(3).

Delaware law goes further, giving shareholders the right to inspect a wide range of corporate documents upon a “written demand under oath stating the purpose” of the shareholder’s request. 8 Del. Code § 220(b). If the corporation denies the shareholder’s demand, the shareholder can petition the Court of Chancery to compel production. A plaintiff in such a case must establish standing as a shareholder, compliance with the “form and manner of making a demand for inspection,” and a “proper purpose” for the inspection.” Id. at § 220(c).

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meetingThe owners of a corporation, typically known as shareholders or stockholders, are shielded from individual liability for corporate debts. This is one of the main purposes of organizing a business venture as a corporation. Protection from liability is not absolute, however, and courts can “pierce the corporate veil” to hold shareholders individually liable for a variety of reasons under both statutes and common law. New York’s Business Corporations Law includes a provision that allows courts to hold the “10 largest shareholders” of a corporation liable for unpaid wages owed to the corporation’s employees. N.Y. Bus. Corp. L. § 630. The New York Legislature amended the law in 2016 to ensure that it applies equally to domestic and foreign corporations.

Shareholders, as a matter of general legal principle, may not be held individually liable for the corporation’s debts as long as any actions by the shareholders are reasonable and directed toward the benefit of the corporation. Self-dealing by a shareholder, the use of a corporation by a shareholder as an “alter ego,” or acts that are illegal or grossly negligent may result in individual liability. A wide array of court decisions have identified circumstances in which courts may pierce the corporate veil. Certain situations also allow courts to hold all shareholders or a distinct group of shareholders strictly liable for corporate debts.

Section 630 effectively imposes a strict liability standard on a group of corporate shareholders. An employer with a claim for unpaid wages must serve written notice on a shareholder, either within 180 days of being terminated or 60 days after reviewing the corporation’s shareholder records. The statute identifies the 10 largest shareholders based on “the fair value of their beneficial interest as of the beginning of the period during which the unpaid services…are performed.” N.Y. Bus. Corp. L. § 630(a). These shareholders are jointly and severally liable for the amount of unpaid wages.

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Brooklyn BridgeOne of the greatest advantages of organizing a business as a corporation, along with certain other types of business entities, is that it shields the business’ owners from liability for business debts and other obligations. Corporations and other business entities exist separately from their owners as distinct legal entities. Creditors and other claimants can only recover from the business entity, except in certain rather extreme situations. A court rarely may “pierce the corporate veil” by allowing someone to assert a claim against, or collect a business debt from, the owners of a business. New York and New Jersey have similar rules regarding when a court may do this.

Types of Business Entities

Not all business entities protect owners from liability. An individual who operates a business with no formal legal structure is known as a sole proprietor. Two or more people operating a business in this manner are considered to be in a general partnership with each other. In both cases, the owners of the business may be held personally liable for business debts.

Organizing a business as a corporation requires filing paperwork with the state. Owners of a corporation are known as shareholders. Provided that they abide by the requirements set out by state law and by the business’ own bylaws, shareholders are shielded from liability.

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Fox NewsCorporate directors and officers owe a fiduciary duty to the corporation and its shareholders to act in the corporation’s best interest. This is commonly known as the “duty of loyalty.” A breach of this duty may expose both the individual officer or director and the corporation itself to liability to the shareholders. Allegations against the former chairman and chief executive officer of a large New York City media company have led to a discussion of whether this individual might have breached the duty of loyalty in connection with an ongoing scandal. While it is important to note that these are only allegations, the ongoing story provides a useful demonstration of the duty of loyalty, as well as a possible defense to a claim of breach.

Under New York law, corporate officers, directors, and majority shareholders are considered “guardians of the corporate welfare.” Alpert v. 28 Williams Street Corp., 63 N.Y.2d 557, 568 (1984), quoting Leibert v. Clapp, 13 N.Y.2d 313, 317 (1963). Even if a particular action does not violate any specific law, it might violate the duty of loyalty if its purpose is “the aggrandizement or undue advantage of the fiduciary to the exclusion or detriment of the stockholders.” Alpert, 63 N.Y.2d at 569.

“Self-dealing” is a common example of a breach, such as when an officer or director has a significant financial interest in a corporate transaction and prioritizes their own interests over those of the corporation. An officer or director can avoid legal liability if they disclose the conflict of interest to the corporation ahead of time and receive approval from a majority of disinterested directors or shareholders. See N.Y. Bus. Corp. L. § 713.

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Boris Dzhingarov [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrTax treatment is one of the key factors a business owner must consider when choosing a business form. Business partnerships can exist in several multiple forms, differing mainly in the extent of liability protection offered to the owners. As a general rule, partnerships are not directly subject to federal income tax. Individual partners are instead liable for tax on a pro rata share of partnership income, commonly known as “pass-through taxation.” 26 U.S.C. § 701. Congress passed the Bipartisan Budget Act (BBA) of 2015, Pub. L. 114-74 (Nov. 2, 2015), 129 Stat. 584, which amends the rules for partnership tax audits and could make partnerships themselves subject to income tax. The new rules do not go into effect until 2018.

A general partnership consists of any two or more people engaged in business together. It does not offer its owners, known as partners, any protection against personal liability for business debts. State laws allow the formation of partnerships that offer liability protection, including limited liability partnerships and limited partnerships. See, e.g. N.J. Rev. Stat. §§ 42:1A-47, 42:2A-1 et seq. The business form known as the limited liability company, see N.J. Rev. Stat. § 42:2C-1 et seq., is normally subject to pass-through taxation like a partnership, but it gives owners the option to elect taxation as a corporation. 26 C.F.R. § 301.7701-3(a).

The current rules regarding partnership tax audits originated with the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, Pub. L. 97-248 (Sep. 3, 1982), 96 Stat. 324. TEFRA created a process for partnership-level audits, instead of audits of each individual partner. Partnerships that are subject to these audit rules are known as TEFRA partnerships. A “small partnership exception” applies to many partnerships with 10 or fewer partners. 26 U.S.C. § 6231(a)(1)(B). Partnerships with 100 or more partners may make a “large partnership election,” which allows for different procedures. 26 U.S.C. §§ 771 et seq., 6240 et seq.

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Dr_Martens,_black,_old.jpgNew York and New Jersey laws provide a wide range of options regarding the organization and structure of businesses, with recognition that the needs of a small, one- or two-person operation are likely to be substantially different from those of a much larger business. Businesses with no formalized legal structure are known as sole proprietorships if they have only one owner, and general partnerships if they have two or more. An informal business structure works for many business owners, but the business entities defined by state law have certain benefits that everyone should consider. Converting a business from a sole proprietorship to a limited liability company (LLC) can be an effective way for a business owner to protect both the business and themselves.

Sole Proprietorship vs. LLC

Operating a business as a sole proprietorship may offer some advantages:

– Simplicity: There is no need to file any specific paperwork with the state to maintain the business, aside from an assumed business name, also known as a “DBA.”

– Only one tax return: A sole proprietorship, unlike a corporation, does not file its own tax return. The business owner includes business income and expenses in a schedule attached to his or her personal return.

These possible advantages, however, come with some distinct disadvantages:

– The owner of a sole proprietorship is personally liable for any and all business debts.

– Similarly, business assets are susceptible to claims against the owner as an individual.

– A sole proprietor must keep meticulous records distinguishing personal and business assets, debts, and expenses.
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Fondos_archivo.jpgA business entity created under the laws of New Jersey or another U.S. state is, at the most basic level, a collection of legal rights and obligations aimed at specific business activities, usually with the goal of making a profit. Those rights and obligations depend on a substantial number of agreements that should be reduced to writing and stored where a business owner can easily find them.

The following list includes 15 types of documents you should keep with your business records. You might need any of them if you have a disagreement with a business partner, co-owner, contractor, or employee, if you want to do business with a government agency, if you are looking for venture capital or other new investors, if you are trying to wind the business down, or simply in preparation for the unexpected. A few ounces of paper might be worth many pounds of future regret.

1. Formation Documents

Forming a business entity requires filing documents with the state and paying a fee. In New Jersey, the Department of the Treasury’s Division of Revenue and Enterprise Services handles business formation. A document forming a corporation is often known as a Certificate of Incorporation, while one creating a limited liability company (LLC) is known as a Certificate of Organization.
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Ford_1921.jpgAccording to most U.S. corporate laws, a for-profit corporation may be established for nearly any lawful purpose, subject to restrictions in particular industries or professions. One of the primary purposes of a for-profit business has long been held to be making profits for the company’s shareholders, and this causes many people to perceive the interests of American businesses as being at odds with the interests of society. New York, New Jersey, and more than 20 other states now allow the creation of “benefit corporations,” or “B corporations,” which allow business owners to direct for-profit enterprises towards one or more specified public benefits. See N.Y. Bus. Corp. L. § 1701 et seq., N.J. Rev. Stat. § 14A:18-1 et seq. B Labs, the nonprofit organization that developed the model legislation for most B corporation statutes, offers private certification for B corporations that meet certain standards.

The Michigan Supreme Court once held that “[a] business corporation is organized and carried on primarily for the profit of the stockholders.” Dodge v. Ford Motor Company, 170 N.W. 668 (Mich. 1919). While this is no longer held by law to be a corporation’s sole purpose, that perception of the business world endures for many people. In situations where a corporation’s shareholders want to direct resources towards a particular cause, minority shareholders might be able to stop them if it would have a negative impact on their shares.

B corporations must identify one or more “general public benefits” that they intend to support through their activities. “General public benefit” is defined as something that makes a “material positive impact on society and the environment” as determined in comparison to “a third-party standard.” N.Y. Bus. Corp. L. § 1702(b), N.J. Rev. Stat. § 14A:18-1. Existing corporations may amend their formation documents to become B corporations, or new entities may incorporate as B corporations. Many well-known businesses, such as the New York-based e-commerce company Etsy, are organized as B corporations.
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teamwork-382673_640.jpgThe New York City Council approved its fiscal year 2015 budget (PDF file) in late June. The new budget includes $1.2 million for the support and development of worker-owned cooperative businesses, commonly known as “worker cooperatives.” The defining feature of a worker cooperative is that the employees own all, or at least a substantial majority, of the company. Advocates for worker cooperatives state that they can benefit local communities by keeping ownership close to home and promoting good employment practices. The allotment of funds by the City Council is reportedly the largest investment ever by a city government in this type of business.

The U.S. Federation of Worker Cooperatives (USFWC), the only nationwide organization for worker cooperatives, defines the business form as an entity that is “owned and controlled by [its] members, the people who work in [it.]” Worker cooperatives have two “central characteristics,” according to the USFWC: (1) investment in and ownership by “worker-members,” who receive distributions of profits; and (2) a democratic decision-making process involving one member, one vote. Profits are often known as “surplus,” which is one of many ways that worker cooperatives seek to distinguish themselves from other models of business ownership.

Article 5-A of New York’s Cooperative Corporation Law allows businesses incorporated in the state to elect to be governed as a worker cooperative. Businesses that make this election are subject to parts of both the business corporation law and the cooperative corporation law. New Jersey does not have a specific business form for worker cooperatives, but businesses can choose to form as a corporation under subchapter C or S, as a limited liability company (LLC), or as other business forms.
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Franklin-auto_1920-0419.jpgA family businesses is generally defined as any business in which members of a family own a majority of the shares or control the company. In some family businesses, some family members keep on running the business, while others pursue other career paths. Fairly dividing the interest in a family business between actively-involved shareholders and those non-participating family members can be tricky. Corporate law, fortunately, provides a near-infinite range of possibilities for ensuring that active family members can continue to run the business while inactive members can continue to receive income. Creating classes of preferred stock is one option, although it carries certain risks.

Ownership of a corporation is represented as shares of stock. A corporation’s board of directors can issue shares in accordance with the corporation’s governing documents and state and federal law. The default form of stock is known as “common stock,” but corporations can authorize and issue other types of stock. “Preferred stock,” or “preferred shares,” give shareholders priority over holders of common stock regarding the corporation’s earnings and assets. Preferred shareholders might be entitled to fixed dividend payments, but in exchange, preferred shareholders often give up voting rights in the corporation.

Corporate law places several important limits on classes of preferred stock. A corporation cannot elect subchapter S status, for example, if it has more than one class of shares. Courts might treat issuance of preferred shares as a form of compensation that raises questions regarding directors’ fiduciary duties, as happened in New York in Lippman v. Shaffer, 15 Misc.3d 705 (N.Y. Sup. Ct., Monroe Co. 2006). The case involved a dispute between shareholders in a family-owned business over cash payments and issuance of preferred stock. The court granted summary judgment to the plaintiff on several counts and ordered the defendants to return various payments to the corporation.
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