Outline of Final Paper - Legal and Ethical Issue

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Law and the Business Person

Chapter 1

The Civil Law and Common Law Traditions Why should a business student study law? After all, you are not going to law school, and if you ever have a legal problem, you can always consult an attorney. Perhaps you have never sued anyone, been sued yourself, been arrested, or written a contract. If all this is true, the law probably seems like some foreign country that you have never been to and have no desire to visit. The truth is, as a businessperson, you can no longer view the law from a distance. Your life and the law, whether you like it or not, will be intertwined, and having a basic understanding of the law’s scope, application, and in�luence will serve you well, both in business and in your personal life.

If you are a manager, business owner, employee, or entrepreneur, the law will impact your daily decision making and have far-reaching consequences in all your business activities. Believe it or not, a law course is an integral part of your education. This will become clearer to you as you read cases and witness for yourself the unfortunate situations that people have gotten themselves into.

Whereas larger companies have in-house legal departments or have access to the expertise of large law �irms, small businesses often operate with little knowledge of the law and minimal access to legal counsel, making a legal background even more valuable in the marketplace. Regardless of size, any business can bene�it greatly from employing people at all levels who have at least a basic understanding of the law and a solid grasp of essential legal principles so that they can recognize potential legal problems and refer them to legal counsel before they become costly matters that threaten the health of a business. This is especially true in the United States, which has no uni�ied legal system but rather an overlay of federal, state, and local laws. Further, the trend toward more global commerce and trade, governed by international treaties such as the North American Free Trade Agreement, has implications for businesses of all sizes and types. Today, many business transactions involve two or more states and may even include parties separated by the full continent, so a much greater amount of business is conducted by various means across state lines.

While no textbook can become a comprehensive hands-on guide to American law (the legal encyclopedias that attempt to do so run tens of thousands of pages and still do not cover all aspects of the law), it is the purpose of this text to provide an accurate, easy-to-understand, useful guide to some areas of the law that have the greatest impact on business. Business law, as well as the legal environment of business and legal studies courses, will provide students with the skills to recognize and apply the proverbial ounce of prevention to their business careers and personal lives. This can prove more useful to employers and to themselves than pounds of competent, costly legal advice obtained too late to remedy a problem that could have been avoided.

Although this course will not "make you a lawyer," it will provide you with a number of advantages. First, you will better be able to recognize legal problems before they happen, a topic often referred to as preventive law. If you can prevent a situation or con�lict from developing into a lawsuit, you may save your business money and the embarrassment of a lawsuit, as well as maintain a lawful and ethical work environment. Second, in the event that you are involved in a controversy, you may be able to resolve the dispute outside of court through "alternative dispute resolution" techniques such as negotiations, mediation, or arbitration. You will learn about each of these and their advantages and disadvantages. If you do have to deal with a lawyer, this course will teach you many legal concepts and the vocabulary to effectively communicate with legal counsel. You will also learn how to hire an attorney, manage legal counsel, and deal with the legal profession.

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The United States Capitol in Washington, D.C., is the meeting place of Congress, the nation's federal legislative body.

1.1 Law: Its Scope and Origins No single course or textbook can address all of the complexities of law. If you stop to think about it, law—and legal systems—have been in effect since early civilization began. Thus, there have been many forms of law and legal systems, too many to enumerate. Suf�ice it to say that people need rules to maintain order; otherwise, society would revert to barbarism. Throughout the ages, philosophers, jurists, political scientists, political leaders, and common people from all walks of life have de�ined law in a number of ways. Cicero viewed law as "nothing but a correct principle drawn from the inspiration of the gods, commanding what is honest, and forbidding the contrary." For the eminent British jurist William Blackstone, law could be de�ined as "a rule of civil conduct, prescribed by the supreme power in a state, commanding what is right and prohibiting what is wrong." Saint Thomas Aquinas, on the other hand, de�ined law as "an ordinance of reason for the common good, made by him who has care of the community." Whatever our working de�inition, law is often what Justice Felix Frankfurter described as "all we have standing between us and the tyranny of mere will." We will see that this is true and, even more so, come to appreciate that law also allows us to conduct business, enter into formal relationships, depend on some predictability in our affairs, and create order in our lives.

At its simplest, law comprises rules of behavior that a government imposes on its people for the bene�it of society as a whole. As such, it represents the governing body’s subjective views of what is best for that society, combined with precedent and tradition. And even though most legal systems attempt to protect society and promote the common good, there can be radical differences in the law from one country to another, and even in different regions within countries, the 50 United States being a prime example. Although federal and constitutional law serve to balance and put a check on state and local law, for example, and in turn, the federal government is limited in its powers to legislate and must give states the power to regulate certain matters, there is no "one" law, as in a country whose legal system is based on civil law (codi�ied statutes alone). Unlike the U.S. common law system, a civil law system, such as prevails in Europe and South America, is more ef�icient and stable, leaving little room for judicial interpretation and lawyers. Trial by jury is not an option, so judges apply the law in a highly predictable, relatively swift proceeding, and the law itself is slow to change. In common law jurisdictions like the United Kingdom and the United States, however, there is much more litigation, so you need to be prepared.

One of the reasons that studying law is dif�icult is that the numerous "factions" that constitute our legal system are all operating at the same time. There is state and federal law, statutory law, administrative law, local law, and so on. For example, each of the 50 states has a legislative body that passes state statutes. Each of the states also has a state court system ruling on cases and making state "case or judicial law." Operating at the same time is the federal legislative body—Congress, which makes federal statutes—and the federal courts, which make federal case law. These are just a few of the "places" making law. As you can imagine, there are thousands of volumes and treatises dealing with questions about what is the law and legal history, as well as reporting on all of the new law being made every day. The law is vast and complicated, no doubt, but understanding how it works and how the layers of lawmaking bodies �it together into the larger scheme is an essential part of your education.

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1.2 Sources of Law Table 1.1 lists the four major sources of law in the United States: judicial, statutory, constitutional, and administrative. Note that each source of law has both a federal and state component.

Table 1.1: The foundations of the American legal system

Judicial Law

Federal case law State case law

Statutory Law

Federal statutes State statutes

Constitutional Law

U.S. Constitution State constitutions

Administrative Law

Federal administrative agencies State administrative agencies

Judicial (Case) Law

The phrase judicial law is used interchangeably with case law. Judicial law is law made in courts, by judges, when they rule on a case and write an opinion; it had its origins in what is called the common law. When the early pilgrims immigrated to America, they brought with them their legal system, along with customs, traditions, and values that helped to shape our legal system. It is in the nature of common law, however, that it adapts to the local customs, traditions, and needs of a people. Thus, despite its English roots, American law has evolved to �it the needs of our federalist system and re�lects regional differences and values. As a result, law in the United States today resembles more the early English common law system, with its regional differences based on local customs and traditions, than it does the relatively uni�ied law of the modern-day United Kingdom.

Before a judge can "make law," there �irst must be a controversy brought to the courtroom for a decision. Such a controversy involves two parties: the plaintiff, or the person bringing the lawsuit, and the defendant, or the person being sued. A civil lawsuit is one in which the plaintiff is seeking money, or restitution. (This should be contrasted with a criminal action, which is being brought to punish and possibly incarcerate the defendant.) As more and more cases are decided, they form a body of law. These cases become precedent for cases that follow, building one upon the other. Judges rely on previous cases to form their opinions and so on down the line.

When a judge decides a case in court, the judge will often write an opinion that is published in case books, or compendiums of court opinions. In that way, others can look up and read the decisions to determine what the law is and how a judge ruled on a speci�ic topic. Figure 1.1 provides an example of a case as it appears in a case book.

Figure 1.1: Example of a case

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Judicial Law

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Stare Decisis and Precedent

SLIDE 1 OF 5

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Yet another name for a case or an opinion is precedent. Precedent also means a previous case. If you look at the case in Figure 1.1, you will see in the last paragraph a series of citations that begin like this:

Ciofalo v. Vic Tanney Gyms, supra, 10 N.Y.2d 297, 220 N.Y.S.2d 962, 177 N.E.2d 925;

The judge is using each of these cases to decide in the current case. Each one of these cases is precedent. The actual use of the case to form a decision in the current controversy is called stare decisis, which is Latin for "standing on previous decisions." Stare decisis is a fundamental principle of both English and American legal systems. The stability of common law depends on judges following legal precedent guided by the doctrine of stare decisis. This stability allows legal practitioners to predict how a given case will be decided by examining how similar cases were decided in the past. Judges don’t "invent" or "make up" the law, depending on whim; for the most part, they rely heavily on previous cases to write their opinions. Under the principle of stare decisis, a court should follow established legal precedent unless there is a compelling reason not to do so. This principle is crucial to common law; if judges did not follow established precedent, there would be little predictability to the legal system. Attorneys would have no solid guidelines upon which to base their advice to clients and no stable guideposts on which to base legal arguments and chart legal strategies for arguing cases in court.

Changing Precedent

Sometimes, however, the judge will reject a previous decision and refuse to follow it. Recall, for example, the U.S. Supreme Court decision of Roe v. Wade, which struck down state laws limiting abortion and held that abortion is legal. In doing so, the Court rejected previous cases that stated abortion was illegal. When do courts reject stare decisis? The decisions of a state’s highest court are binding on that state’s lower courts, which must follow it, but are only persuasive precedent on the courts of other states, which are free to follow or ignore such precedent. This means that if a case is being heard in New York and the attorney attempts to use a Pennsylvania case as precedent, the judge can refuse to recognize the Pennsylvania case. Thus, managers should be aware that state law is binding only within that state, and the law varies greatly from one state to another. This is important to you as a business manager because there may be instances in which "law" from another state is brought to your attention but does not apply to you at all. Thus, the doctrine of stare decisis is limited to decisions within the same jurisdiction, state, or region.

Another reason that stare decisis is not always followed is the result of a change in the political climate of the country. Sometimes opinion around an issue changes so much that the courts re�lect a change in attitude and reject well-established doctrine. Consider racial discrimination in the United States, which at one time was legal and upheld as constitutional by the U.S. Supreme Court. Over time, both the law and cases have changed to re�lect a different philosophy. This was true in 1954, when the Supreme Court found racial discrimination illegal in the case of Brown v. Board of Education. Until that time, the doctrine of "separate but equal" accommodations for blacks and whites had been applied by the courts. The Brown decision eradicated the doctrine and replaced it with a new "law." Here was an example of social mores changing to such a degree that the Court refused to follow previous cases.

In summary, case or judicial law is made in courts by judges rendering an opinion. Each state has at least one state court that is hearing controversies and rendering opinions. Thousands of opinions are being written each day from all of these states. All of these state court opinions form a body of law called case or judicial law because they are based on cases, or controversies between people. Thus, when you wonder, "What is the law?" remember that only one aspect of law includes state court opinions.

Statutory Law

Another key site for lawmaking is in both state and federal legislatures, which are governing bodies whose job is to make new laws. Law made by a legislature is called a statute. Legislatures gain consensus from their members to pass the bills making new laws, after which the bills are signed by the governor (for the state) or the president (for Congress). At any time in the United States, there are 50 state legislatures passing state statutes and a federal legislature (Congress) passing federal laws.

Federal

At the federal level, Congress can legislate over a broad range of areas through the exercise of its constitutionally granted powers. These powers are set out in the federal (U.S.) Constitution in Article I, Section 8. Whenever Congress legislates within its area of constitutionally granted power, the resulting legislation has the force of law, although its legality can be challenged in federal court, as will be discussed later on. Federal law is not some remote or arcane academic exercise; it affects each of us on a daily basis. This is especially true for people involved in business. As a manager, you will deal with many important federal laws. For example, the Americans with Disabilities Act of 1990 spells out how employers must accommodate disabled workers. This is a federal law that applies to all businesses, as opposed to a state law that applies only to businesses within that particular state. Other examples of federal statutory law include the Civil Rights Acts of 1964, which prohibits discrimination on the basis of race, and the Age Discrimination in Employment Act of 1967, which describes the rules for hiring and �iring employees above the age of 40. The Senate also plays a role in international agreements, or treaties, as it is empowered to ratify treaties negotiated by the president. These treaties (e.g., the North American Free Trade Agreement, or NAFTA, approved in 1994) impact businesses in all 50 states if they engage in international commerce. See also Timeline of Major Legal Developments That Affect Modern Businesses.

Figure 1.2 provides an example of a federal statute. Notice that a federal statute looks completely different than a case. Federal statutes do not have parties, nor do they involve a controversy between people. Instead, they are a pronouncement of the law and therefore are sometimes much shorter and terse than a case, which involves people, a speci�ic controversy, and an explanation of events. Note the citation for where to �ind the statute in the U.S. Code books.

Figure 1.2: Example of a federal statute

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A Closer Look: Finding the Law on the Internet

During the course of your work, you may have occasion to research laws. Since you will most likely be accessing legal materials via the Internet, an excellent site that is free to all users is the Cornell University Law School Legal Information Institute (LII), which can be found at Cornell Law (http://www.law.cornell.edu/) . One advantage of online research is that you do not need an actual citation. For example, if you go to this website and type in "age discrimination law," the appropriate statute will appear. Please note the extensive legal materials that are available online for free.

Many times, �inding federal statutes is not useful because their language is overly complex and dif�icult to understand. In that case, be aware that there are many resources that will explain or interpret what a statute actually means in down-to-earth language along with the underlying reasons for passage of the law. For example, the Congressional Research Service located at Federation of American Scientists (http://www.fas.org/sgp/crs/misc/97-589.pdf) explains many complicated federal statutes.

Suppose, for example, that your supervisor asked you to rewrite part of the employee handbook pertaining to discrimination. Many reliable websites exist that can explain the law, from the more basic aspects to detailed and legally sophisticated information. While these do not take the place of utilizing an attorney, there are many daily tasks that you will perform as a manager for which access to law sites will be informative and helpful to your work.

State

Every state has its own legislature, which is usually patterned after Congress, with two chambers (often, house and senate) comprising elected members from the two main political parties, one of which forms a majority. These legislatures enact state laws in a wide range of areas, including civil and criminal law and procedure, business regulation, and, of course, taxation. The power of state legislatures to regulate both business and private conduct is far greater than that of the federal government, since most states reserve to themselves in their state constitutions broad powers to legislate in all areas touching on the welfare of their citizens. In addition, the Founding Fathers explicitly limited the powers of the federal government to regulate state matters. In general, states have the right to regulate all areas of private or public life as long as they do not infringe on any right protected by the U.S. Constitution (see Table 1.2).

State and local legislation that does not infringe on a constitutionally protected right is valid as long as it can pass a relatively �lexible rational relationship test, which simply means that any state law that is rationally related to the preservation of a valid societal interest is valid. This litmus test of constitutionality is a simple one to pass, since nearly any law can be rationally justi�ied as serving some valid purpose. The test is somewhat more stringent, however, when a vital interest or suspect classi�ication is involved; in such instances, the state must pass a strict scrutiny test of constitutionality, wherein the courts weigh the state’s interest against the infringement of protected rights in determining the validity of a statute. For purposes of the strict scrutiny test, a vital interest can be de�ined as any constitutionally protected right, such as the rights enumerated under the Bill of Rights. A suspect classi�ication would include a law that makes distinctions based on race, sex, color, religion, or national origin.

Figure 1.3 provides an example of what a state statute "looks like." Notice that it begins with a number, in this case 28-1381, which is a typical way to recognize that this is statutory law. Next, note that it has a title, in this case the sentence beginning with "Driving . . ." Notice that there are differences between the format of a case and a statute. Remember that cases begin with the name of the parties and are the result of a controversy between two people, whereas a statute is passed by a legislative body.

Figure 1.3: Example of a state statute

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Local

In addition to state and federal legislatures, "local" legislative bodies (e.g., city councils and various town boards and planning commissions) have the power to legislate in areas allowed them by their local charters. These local ordinances also carry the weight of law and form a part of the state’s statutory law. Often when doing business, these local laws are the �irst place to check when a question about the legality of a certain action arises, such as zoning. Local laws are frequently restrictive and much more narrow in scope and intent than either state or federal laws.

Constitutional Law

In addition to judicial and statutory law, 51 constitutions play a signi�icant role in formulating "the law." There are 51 constitutions because each state has a constitution (50) and there is one federal constitution, the U.S. Constitution. A country or state’s constitution is the most fundamental source of law. It delineates in general terms the sovereign state’s form of government and provides the basic framework for its laws. Article VI, Section 2, of the U.S. Constitution speci�ically sets the U.S. Constitution as the "supreme law of the land" (see Appendix A: The Constitution of the United States of America (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/appa#appA) ). As such, no other law passed by a state or the federal government can con�lict with it; any law that does can be found by the courts to be unconstitutional and void.

Constitutions are necessarily broad documents. In the United States, the job of interpreting the federal constitution and that of every state is left to the courts. Both state and federal courts have the power to interpret the U.S. Constitution, but the �inal word on the analysis of the federal constitution is reserved to the U.S. Supreme Court, whose interpretation of the Constitution is �inal and represents binding precedent on all lower courts, state and federal.

The U.S. Constitution serves as an important source of law in the areas of governmental power. It empowers states and the federal government to pass and enforce laws that regulate people’s interactions with one another and with their government while limiting the government’s ability to legislate in certain areas.

Under our Constitution, the federal government is one of limited powers. Congress has the power to legislate only in areas that it has been speci�ically granted the power to regulate by the U.S. Constitution. The powers of Congress are enumerated in Article I, Section 8 (see Table 1.2).

Table 1.2: Powers of Congress listed in Article I, Section 8, of the U.S. Constitution

Collect taxes and import duties, pay debts, and provide for the common defense and general welfare of the United States

Borrow money

Regulate commerce with foreign nations, among the states, and with the Indian tribes

Establish rules for naturalization and bankruptcy

Coin money, regulate its value, and �ix a standard of weights and measures

Punish counterfeiting

Establish post of�ices and post roads

Issue patents and copyrights

Set up federal courts inferior to the U.S. Supreme Court

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De�ine and punish crimes on the high seas and crimes against the United States

Declare war, grant letters of marque and reprisal, and make rules regarding the seizure of property under letters of marque and reprisal

Raise and support armies

Create a navy

Regulate the armed forces

Exercise control over the territory encompassing the seat of government

Under the U.S. Constitution, states are free to create legislation to regulate any area not speci�ically reserved to the federal government. Thus, states can adopt any laws they wish within their borders as long as they do not con�lict with a duly enacted federal law or transgress upon any right guaranteed by the U.S. Constitution, as interpreted in the courts.

While the Constitution gives broad regulatory powers to states and the federal government, it also preserves the rights of the individual in the Bill of Rights. The most signi�icant body of constitutional law concerns itself with the prohibitions on governmental powers enumerated in the Constitution—in particular, the guarantees provided to individuals by the Bill of Rights (the �irst 10 amendments to the U.S. Constitution), the Fourteenth Amendment, and the U.S. Supreme Court’s interpretation of the broad language in which they are framed.

But even the U.S. Constitution is not static. Under Article V of the Constitution, Congress may propose a constitutional amendment by a two-thirds vote by the House of Representatives and the Senate. If a proposed amendment is approved by Congress, it then goes to all the states’ legislatures. If three-quarters of the states’ legislatures approve the amendment, it becomes part of the Constitution and the preeminent law of the land. States may also propose amendments to the Constitution to Congress on their own initiative by votes for such a proposal in two-thirds of the states’ legislatures. If the states make the initiative, Congress must decide whether to allow rati�ication by constitutional conventions in three-quarters of the states; the change is then rati�ied upon its approval by three-quarters of the states’ legislatures, by a constitutional convention in three-quarters of the states, or by a vote for rati�ication by three-quarters of the states’ legislatures.

Other than the right to each state’s equal representation in the Senate, there is no limit to what changes can be written into the Constitution. To date, the Constitution has been amended 27 times. In the case of the Eighteenth Amendment (1919) (better known as Prohibition), which outlawed the manufacturing, sale, or transportation of intoxicating liquors in the United States, Congress changed its mind and repealed Prohibition in the Twenty-First Amendment (1933), leaving it up to the individual states to prohibit the sale of alcoholic beverages as they saw �it.

Administrative Law

One of the least visible entities that "makes law" is the state or federal administrative agency, whose members are appointed by government leaders but who operate quasi-independently, reporting to Congress and the public. When Congress decided to regulate nuclear energy, for example, it created the Nuclear Regulatory Commission and empowered it with the ability to both create and enforce rules for the safe civil use of nuclear energy. Although Congress could have created and enforced these rules itself, individual members of Congress have neither the necessary expertise nor time to engage in such micromanagement of the regulatory environment. The same holds true for other agencies whose primary purpose is the regulation of business and industry, including the Federal Aviation Administration, the Securities and Exchange Commission, the National Labor Relations Board, the Federal Trade Commission, and the Federal Communications Commission, among many others.

At the state level, state legislatures and governors also set up administrative agencies to help them regulate business and carry out other important governmental functions. Taken together, the rules that all federal and state agencies promulgate are quasi-judicial and quasi-legislative. That is, they have the force of law and form the most important component of administrative law. Like statutes, however, most administrative rules and many administrative agency decisions are subject to judicial review, the process whereby statutes, administrative rules, and administrative agency decisions are reviewed by courts when challenged. (See Chapter 5, Administrative Law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec5.1#sec5.1) , for a fuller discussion.)

All agencies have this in common: a need to regulate a highly technical industry or business environment in order to ensure safety and fair practices. Administrative agencies are empowered by either the executive or legislative branches of the state or federal government to assist them in carrying out necessary governmental functions that they lack either the time or expertise to carry out themselves.

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John Marshall was the �irst chief justice to enact the power of judicial review.

1.3 The Three Branches of Government and the Balance of Power The U.S. government comprises three branches: judicial, executive, and legislative. These branches were designed to balance each other so that one cannot become too powerful. For example, the courts can review the actions by the legislative and executive branches.

No matter how clear the language of a statute or how plain its import, it is generally impossible in a common law jurisdiction to interpret a statute, or the federal or state constitutions, at face value. Ultimately, the validity of any statute is determined by the courts, as is its meaning. A case in point is the Second Amendment to the U.S. Constitution, which reads: "A well-regulated militia being necessary to the security of a free state, the right of the people to keep and bear arms shall not be infringed." Any reasonable interpretation of that amendment that looks at the plain meaning of the language used, particularly when viewed with its revolutionary framers’ inherent distrust of government, leads one to believe that the U.S. Constitution guarantees the right of citizens to own and bear guns. Nevertheless, the amendment has been interpreted to mean only that individual states can raise their own militias (e.g., national guards) if they so choose.

Regardless of the wisdom of such an interpretation, one message is clear: any statute, including the U.S. Constitution, means only what the courts ultimately decide it means. This has been the case ever since Marbury v. Madison (5 U.S. 137 [1803]), when Chief Justice John Marshall �irst announced the power of judicial review (the power of courts to declare the acts of legislative bodies, including the U.S. Congress, void if they violate the courts’ interpretation of the Constitution). In what is arguably the greatest act of judicial activism in the history of U.S. jurisprudence, Chief Justice Marshall argued, "It is a proposition too plain to be contested that the Constitution controls any legislative act repugnant to it, or that the legislature may not alter the Constitution by an ordinary act. . . ." This novel proposition was not challenged. The power of the courts generally, and ultimately of the U.S. Supreme Court, to declare any act of the U.S. Congress or any federal or state law unconstitutional has now been well established by more than 200 years of legal precedent. Nothing in the U.S. Constitution itself explicitly reserves this right to the courts, and British courts did not historically enjoy a similar privilege (only the king, queen, or Parliament itself could invalidate a royal edict or Act of Parliament). Arguably, the chief justice could have been successfully impeached for overstepping his bounds and infringing on congressional legislative privilege. By not challenging the decision, Congress left the courts as the ultimate authority on the Constitution, empowering the judicial branch of government to curb the actions of legislative and executive branches when these, in its view, transgressed the U.S. Constitution.

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Key Terms

Click on each key term to see the de�inition.

administrative agency (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A governmental entity established to regulate a particularly complex, technical area of business or industry (e.g., nuclear power, communications, securities exchanges) that relies on special expertise.

administrative law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Law made by a state or federal administrative agency.

Bill of Rights (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The �irst 10 amendments to the U.S. Constitution, enumerating the individual rights and powers of citizens.

case law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Law made by a judge (or panel of judges) as the result of a controversy between two parties. Also called judicial law.

citation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The abbreviations following legal sources that tell the reader where to �ind the original text of the law.

common law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The name given to the body of law established by the English and brought to the United States as the �irst law established in the colonies. Can also mean case law or the aggregate body of case law.

Congress (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The federal legislative body that enacts federal statutes.

controversy (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A dispute between two or more parties that may be decided in court.

federal (U.S.) Constitution (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The "supreme law of the land" to whose standards all laws must be submitted.

federal statute (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A law passed by Congress and signed into law by the president.

judicial law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

See case law.

judicial review (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The power of courts to declare the acts of legislative bodies, including the U.S. Congress, void if they violate the courts’ interpretation of the U.S. Constitution.

lawsuit (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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A controversy brought to court by litigants: the plaintiff and defendant.

litigation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The act of suing someone in court; a plaintiff bringing a lawsuit against a defendant.

precedent (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A previous case or body of cases that holds sway over current legal decisions in a common law system.

quasi-judicial (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In the context of administrative agencies, describes the process of adjudicating disputes over agency rules or their application in hearings similar to trials, presided over by administrative law judges—that is, when an agency acts "like a court."

quasi-legislative (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Describes the process of creating one’s own rules (such as when an administrative agency exercises a legislative power).

stare decisis (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The use by a judge of previous decisions (precedent) to make a legal decision or ruling.

state constitution (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Each state’s governing document that sets the standard for all laws within its borders. State constitutions are established, written, and amended by the state legislature.

state statute (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A law passed by a state legislature and signed into law by the governor.

statute (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A law passed by either a state or federal legislature.

U.S. Code (U.S.C.) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The set of books that contains all the federal statutes passed by Congress.

Chapter 1 Flashcards

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Critical Thinking and Discussion Questions

1. Why do business managers and others need to understand the foundations, origins, and scope of the law?

2. What is the advantage to the American legal system of using stare decisis?

3. How does the concept of judicial review empower the court system?

4. Locate the website for your state’s legislature. Find a recent law passed by your state legislature and give the citation for the statute as well as a brief summary of the legislation.

5. Locate a case on the Internet. What is the citation for the case? What happened in the case? How did you go about �inding the case? Does the case use stare decisis in its decision, and if so, how?

6. Why were administrative agencies created? Find the website for an administrative agency and explain what types of issues the agency deals with and whether it holds hearings. If the agency does hold hearings, describe the types of opinions it issues.

7. Suppose that Judge Harrison is hearing a case in her court and that the attorneys present her with two disparate cases to use in her decision. Based on the concept of stare decisis, how would the judge go about making her decision? Does Judge Harrison have to use previous cases to make a ruling in the current case?

A governmental entity established to regulate a particularly complex, technical area of business or industry (e.g., nuclear power, communications, securities exchanges) that relies on special expertise

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Chapter 28

Sole Proprietorships and Partnerships Beginning with this chapter, we will explore the most common forms of business organization in order to understand their fundamental makeup and examine the bene�its and liabilities of structuring a business under each distinct form of business organization. One of the �irst decisions that must be made by anyone seeking to establish a new business is what organizational form to choose. The most common types of business organizations are:

1. Sole proprietorships;

2. Partnerships;

3. Limited partnerships;

4. Corporations; and

5. Limited liability companies (LLCs).

As we will see, each type of business organization offers certain bene�its as well as drawbacks that should be carefully weighed before deciding which form is best suited to the new venture. Table 28.1 provides a comparison of the different types of business entities. The requirements for starting a business under each of the available forms of business organization vary widely. For example, individuals who start a business under their own name alone or in traditional partnerships will have very few organizational formalities, whereas those who wish to organize a new business as a limited partnership, corporation, or limited liability company (LLC) will need to strictly follow the requirements of their state's limited partnership, corporation, or LLC acts. Consult the of�ice of the secretary of state in your location for registration requirements.

Table 28.1: Business entity comparison

Sole Proprietorship General Partnership Limited Partnership

TYPE OF ENTITY

SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION

DEFINED A business owned and run by one person.

An association of two or more people for a pro�it.

An entity that is created by permission of the state whose ownership is represented by shares of stock.

ADVANTAGES No meetings; run the business by yourself; no disagreements with others about how to run the business; liable only for own mistakes.

Have two or more people to help in running the business and share the liability. Have others to discuss the business plan with and share ideas for the business.

Limited liability of the owners and tax advantages.

DISADVANTAGES Taxed on income like regular income; have all of the liability; have no one else to contribute ideas.

Taxes. The pro�its of the partnership are taxed as personal income on each partner's individual tax return, but the entity must �ile Form 1065 with the IRS.

Expensive and complicated to create; must follow state rules and comply with state and federal �iling laws.

WHO OWNS The sole proprietor. The partners. The shareholders.

HOW FORMED Many states require a business certi�icate to be �iled at the county clerk's of�ice; some also require an EIN (federal) number.

Many states require a business certi�icate to be �iled at the county clerk's of�ice; as between the partners, the agreement can be informal and oral.

Preincorporators must �ile Articles of Incorporation with the secretary of state; state must issue charter. Other forms required. If public, must comply with federal and state law regarding the initial issuance of shares of stock.

WHO OPERATES The sole proprietor. The general partners, but they can turn over day-to-day management to a managing partner.

The corporate of�icers.

LIABILITY OF OWNERS

The sole proprietor's assets, personal and business-related, are all subject to a lawsuit.

All the partner's assets (personal and business) are subject to a lawsuit.

Liability is limited to one's investment (i.e., in shares of stock).

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HOW TAXED As personal income on Form 1040. Income is reported on Form 1040 as personal income and paid at the personal rate, but the partnership also has to �ile Form 1065.

At the state's corporate rate.

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28.1 Sole Proprietorships The oldest and simplest form of business organization is the sole proprietorship. Under this form of business organization, the owner of a business personally operates and is solely responsible for all aspects of the enterprise. A sole proprietor who is hired by another to perform services may also be an independent contractor. An independent contractor usually performs one job and works at his or her own discretion. Thus, if ABC Corporation hired Fisher Painting, a sole proprietorship owned by Martha Fisher, Martha would be both a sole proprietor and an independent contractor. (For other employment issues relating to sole proprietorships, see Chapter 21 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch21#ch21) , Establishing the Employment Relationship, and Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) , Principal–Agency Law.)

Formation of a Sole Proprietorship

The greatest bene�it of the sole proprietorship form of business organization is that few formalities are required for its formation. To a certain extent, people wishing to go into business for themselves in a business that carries their own name can start the enterprise at any time without the need to seek state or local approval.

Creating a Tax Entity

The �irst step in starting a sole proprietorship is to open a bank account so that the business can receive money and pay debts, either with checks or electronically. To open a business account, the bank will require a federal tax identi�ication number (TIN). This nine-digit number could be the proprietor's Social Security number or an employer identi�ication number (EIN) that the IRS assigns the business (in the format 12-3456789) and is used for �iling tax returns. (All the information to obtain the federal tax number can be found at GovServices (http://www.taxid-gov.us) .)

All sole proprietors do not need to set up an EIN. If a sole proprietorship does not have employees, it is not required to have an EIN. In fact, the IRS generally prefers that sole proprietors use their Social Security number. However, employers with one or more part-time or full-time employees, no matter how small their business, must have one. Also, if they plan to use an EIN to differentiate between personal and business �inances, they should have an EIN before applying for business permits. In addition, if they pay subcontractors or others for services valued at more than $600 in a calendar year, they may need to get an EIN. Anyone who registers as a limited liability company, corporation, partnership, or joint venture must have an EIN.

Before a sole proprietor can collect any money from sales, the state tax division will require that the business register for permission to collect sales tax. This process may take months, so planning ahead is essential. Once the federal TIN and state tax collection permission have been acquired, there are no other formalities to go through before business can begin.

Licensing

Some types of businesses require licenses to do business, such as bars (liquor license) or real estate �irms. So a sole proprietorship must comply with all state and federal regulations applicable to business concerns. While there may be few formalities for actually forming the business, it is not as simple as simply setting up a lemonade stand.

Doing Business As

Persons who wish to do business under an assumed name must apply for a permit from the appropriate state of�ice in their state (typically the secretary of state's of�ice) and pay a nominal fee for the privilege of doing business under a trade name. The primary purpose of this requirement is to prevent different persons from doing business under the same name in the same area, which might cause consumers confusion, and to have on record the names and addresses of the owners of these businesses so that they may be readily found and held accountable for any civil or criminal transgressions. Thus, Rick Carpenter generally needs no special permission to start a carpentry business under the name Rick Carpenter or Rick Carpenter's Carpentry Service, but he would need to get what is commonly termed a Doing Business As (DBA) certi�icate from the appropriate of�ice in his state if he wanted to call his business Good Homes Carpentry, Expert Carpentry Works, or any other assumed name.

Benefits of Sole Proprietorships

As already discussed, there are few formalities to launch a sole proprietorship, and as a result, persons starting a business often choose this form to begin with. Other types of businesses, such as limited partnerships, corporations, and LLCs, require the drafting and �iling of speci�ic forms and approval from government of�icials before the business can get off the ground—a process that requires an investment of time and money to complete.

Autonomy

If you ask a sole proprietor what the other greatest advantage is to this form of business, he or she will most likely reply that it is not having to share the management with anyone else. The sole proprietor does not have to ask for anyone's permission, wait for votes or meetings, or seek others' approval. Business decisions can occur quickly. Partnerships and corporations, on the other hand, require the members to reach a consensus and, in the case of corporations, sometimes onerous formalities before major business decisions (e.g., the sale of substantial portions of the assets of the business or the acquisition of business property) can be made. These processes can interfere with the smooth operation of some businesses and make instituting major changes slow and often tedious.

Freedom From Vicarious Liability of Co-Owners

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Just as important as the autonomy that the sole proprietorship permits the business owner is the freedom from liability for the negligent acts or bad business decisions of others. General partners in a partnership are deemed to be agents of the partnership and of one another under the common law of partnership (see Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for a full treatment of principal–agency law). Thus, if there are partners A, B, and C, and only C is negligent, A and B will also be liable. In a corporation (discussed in Chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) ), directors and of�icers of a corporation are deemed to be agents of the corporation they serve.

Under the law of agency, principals can be bound by the authorized acts of their agents and are liable for the negligent acts of their agents committed during the course of the agency. Thus, partners in a partnership can be held liable for contracts entered into on behalf of the partnership by any other partner as well as for the negligent acts of any partner that injures a third party. Likewise, a corporation can be held liable for the authorized acts of its of�icers and directors, as well as their negligence. Sole proprietors, however, need never worry about being responsible for the bad judgment, negligence, or bad faith of a co-owner, since they are the only owners; they are responsible only for their own acts and for the acts of their agents.

Cost Savings

There are signi�icant �inancial advantages for the sole proprietorship in terms of tax savings and lower administrative costs. Unlike most corporations, the sole proprietorship does not pay federal, state, or local income taxes as a business entity; instead, all income earned by the business is taxed as simple income to the owner. This means that if the business makes $250,000, then that �igure is reported on the sole proprietor's tax return as income (on a Schedule C form). Because bookkeeping and legal formalities for the business are simpli�ied, the administrative costs are usually lower than for other forms of business organization. For example, the sole proprietorship often has less need for legal and accounting services compared with other business organizations.

Drawbacks of Sole Proprietorships

While there are many bene�its rooted in the simplicity of the sole proprietorship, a number of tangible drawbacks stem from this form of business organization. Chief among these is the unlimited personal liability of the sole proprietor for all debts incurred by the business. The sole proprietorship is not recognized as a separate entity from its owner; as a consequence, the debts of the business are deemed to be the personal debts of the owner, and the sole proprietor has unlimited personal liability for all the debts, contractual obligations, and legal judgments the business incurs. If the business fails, its owner not only can lose the capital invested in the business but can also face the prospect of having his or her personal assets raided to satisfy business debts if the business assets are insuf�icient to cover business debts. Consequently, the business failure of a sole proprietorship often means personal bankruptcy.

Another downside of the sole proprietorship is that the owner must rely solely on his or her own assets and expertise in running the business, including dealing with pro�its and losses. While the business owner need not share pro�its or consult with others on business decisions, neither can the sole proprietor count on others to lend their expertise, share business losses, or shoulder part of the responsibilities for the business's daily operation. Such assistance can be obtained in the form of hiring employees, but individuals who draw a salary are seldom as committed to the enterprise or as motivated to ensure its success as those whose fortunes are tied directly to the success or failure of the business. Further, the lack of co-owners of a business enterprise can be a particularly important drawback when the business owner needs to raise capital to expand or to cover extraordinary expenses.

Property Status and Transferability of Sole Proprietorships

A sole proprietorship is considered personal property (see also Chapter 19 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch19#ch19) ). As such, it can be transferred in whole or in part at any time by its owner through sale or testamentary gift (through a will). If a business concern that is organized as a sole proprietorship is sold or otherwise transferred by its owner, its nature can change, depending on both the terms of its transfer and the wishes of the new owners. A sole proprietorship transferred to a single person who continues to run the business as a sole proprietor, for example, retains its previous status, whereas one transferred to two or more persons as joint owners becomes a partnership. A sole proprietorship can also be reorganized as a corporation if its new owner so desires. The type of business organization can also be changed by a present owner by reorganizing the business from a sole proprietorship to a partnership, corporation, or any other business organization recognized by the state.

Termination of the Sole Proprietorship

If there are few formalities for starting a sole proprietorship, there are none for ending one. The sole proprietorship can terminate as a business concern at any time at the will of its owner. Alternatively, it can end by operation of law—upon the death, incapacity, or bankruptcy of the owner. Consistent with this business form, when the business ends, its owner will remain personally liable for the completion of any outstanding contracts and for meeting any other outstanding business obligations. If the business ends owing to the death or incapacity of its owner, the owner's estate or guardian will be responsible for paying creditors out of estate funds.

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28.2 Partnerships When two or more people wish to start a business together, the sole proprietorship is not a viable entity, and they must consider another form. One of the more popular (and less expensive) businesses to begin is a partnership. There are two types of partnerships: general partnerships (discussed here) and limited partnerships (discussed in Chapter 29 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch29#ch29) ).

Partnership law differs from state to state, but all states have adopted (in one form or another) the Uniform Partnership Act (UPA). Because there are 50 different states, you need to consult individual state law to ascertain the most current version. If you wish to see samples of the act, the following websites will give you the �lavor of the rules: Click here (http://www.law.fsu.edu/journals/lawreview/issues/232/larson.html) (Florida) and here (http://codes.lp.�indlaw.com/cacode/CORP/1/2/5.5) (California). Other states' laws can be accessed on the Internet. All states de�ine partnership as "an association of two or more persons to carry on as co-owners a business for pro�it. . . ." (§ 101(6) Uniform Partnership Act (1997)). Any time that two or more individuals are engaged in a business as co-owners with the intent to make a pro�it, a partnership arises automatically (de jure, or by law), and the rights and responsibilities of each partner will be dictated by the law of partnership in the state where the partnership was formed.

The contractual provisions contained in the agreement de�ine the relationship as well as the rights and responsibilities the partners owe to one another. In the absence of a partnership agreement, or in cases in which the partnership agreement fails to de�ine key rights and responsibilities, the state's common law of partnership (and, where applicable, the state's partnership act) will de�ine these rights and obligations.

Formation of a Partnership

Like the sole proprietorship, the partnership form of business organization does not require speci�ic formalities for its creation. Oral and written agreements to enter into a partnership are generally equally binding. A partnership can also arise by operation of law even absent a speci�ic agreement: Any voluntary association by two or more persons to conduct a business for pro�it as joint owners automatically results in the creation of a partnership by operation of law, whether or not the joint owners speci�ically intended it. This holds true if two people start to sell a product but decide between themselves that they are not partners or they don't consider themselves a partnership.

One would think that people contemplating going into business together would want to put their understanding in writing. That way, if any disputes or misunderstandings arose, the agreement could serve as a guide. In far too many cases, however, partners do not execute a written partnership agreement. This may be because of the cost of hiring an attorney, or mere laziness or aversion to discussing the minutiae of the agreement. It may also result from the partnership being a close family relation or friend with whom they don't foresee con�lict. Whatever the reason, it is a poor excuse, because forming an agreement is easy and the forms are available online. For an example, click here (http://lergp.cce.cornell.edu/Business_Management/Sample%20Partnership%20Agreement_110410.pdf) . The consequences of not setting forth the terms of the partnership can be dire—the loss of the business, personal debt, and damaged personal relationships. It pays to be ready for the worst (dissolution, divorce, creditors, and personal problems of a partner) in order to protect the interests of all parties involved. See Figure 28.1 for a sample partnership agreement.

Figure 28.1: Sample partnership agreement

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Agency Rights and Duties of Partners

When partners act within the scope of their authority, they are agents of the partnership and of each other. As such, they bind the partnership to any contracts they enter into on the partnership's behalf within the regular course of business. As is true of all agents, partners have �iduciary duties to the partnership and to each other. As co-owners of the business, partners also have the interests of principals in the enterprise; since each partner is both an agent and a principal of the partnership, each partner also owes every other partner the duties of a �iduciary. As such, partners must place partnership interests above their own personal gain and must execute their duties as partners with the utmost good faith. (See Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for a list of �iduciary duties of agents and principals.) Table 28.2 illustrates these relationships.

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Table 28.2: Partnership relationships

PARTNER 1 PARTNER 2 PARTNER 3

Principal of 2 and 3 Principal of 1 and 3 Principal of 1 and 2

Agent of 2 and 3 Agent of 1 and 3 Agent of 1 and 2

The general duties owed by agents to their principals, discussed in Chapter 27, apply to each partner in the partnership. Thus, partners owe the partnership and one another:

The duty of loyalty;

The duty of obedience (they must carry out the rightful requests of the majority of the partners);

The duty to exercise reasonable care and diligence in the exercise of their partnership duties;

The duty to notify the partnership of any facts learned that are relevant to the partnership; and

The duty to make an accounting to the partnership of any bene�its derived from conducting partnership business as well as any expenses incurred on the partnership's behalf.

By the same token, the partnership owes each individual partner:

The duty of reimbursement and indemni�ication; and

The duty of cooperation.

Contractual Rights and Duties of Partners

Although all partners are duty bound as agent and principal, they are generally free to control the nature of their relationship to one another and the duties they owe one another and the partnership by drafting the partnership agreement. This is true as long as they do not violate the law or the public policy of the states in which they do business. Unless there are provisions to the contrary in the partnership agreement, partners have an equal right to manage the business and to share in its pro�its. The mere fact that one partner makes a greater capital contribution to the partnership will not give that partner a greater voice in the management of the business or a greater share in its pro�its unless it is provided in the partnership agreement. Similarly, partners must share in the losses of the business in accordance with the share of pro�its they receive from it. Thus, if partners share pro�its equally, they will also share losses equally. If, however, the partners adopt a formula for the unequal allocation of pro�its among themselves, the same formula will apply to the (unequal) sharing of losses between the partners unless they agree otherwise.

Limitations on Partners' Ability to Define Their Rights and Obligations

Although partners are generally free to de�ine their obligations to each other and to the partnership in the partnership agreement, some acts are speci�ically forbidden by law. The Uniform Partnership Act (UPA) prohibits several activities by partners:

Engaging in certain activities that include unreasonably restricting the right of partners to access partnership books and records;

Eliminating the duty of loyalty (though partners may de�ine what types of activities are not considered a violation of the duty of loyalty, as long as these are reasonable);

Eliminating the duty of care or the obligation of good faith owed by each partner to the partnership;

Restricting the rights of third parties under the act; and

Unilaterally binding the partnership to a contract that assigns the partnership property for the bene�it of creditors, disposes of the partnership's goodwill, or confesses a judgment.

Each of these is discussed in more detail below.

Limitations of Partners' Ability to Bind the Partnership

Because they are agents, partners can individually bind the partnership to contracts entered into on its behalf during the regular course of business. The same rules of agency apply: there must be express, implied, or apparent authority. Therefore, if the partner is authorized, and he or she orders of�ice equipment from a store in the name of the partnership, the partnership is legally obligated to pay the bill. There are certain acts, however, for which the unanimous consent of all partners is required. The reason for this is that these acts are so dangerous for the partnership that every single partner's consent is needed. These acts include assigning partnership property for the bene�it of creditors, disposing of the partnership's goodwill, and confessing a judgment (Uniform Partnership Act § 9(3)(a–e)).

Assigning Partnership Property for the Bene�it of Creditors

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Generally, assigning partnership property means that to resolve a debt with a creditor, the partnership transfers its interest in speci�ic partnership property. In such a secured transaction, if the partnership does not pay the debt, the creditor may keep the property. The UPA prohibits one partner from assigning partnership property to a third party without the permission of all the other partners. This rule makes sense because, as a partner, you would not want one of the other partners assigning property interests without your permission; otherwise, the property of the partnership could be pledged to another without your knowledge.

Disposing of the Partnership's Goodwill

Goodwill is the intangible "name recognition" of a business that has meaning to customers, and in some cases, may be worth a great deal of money. In this case, the partnership would be selling its name or goodwill to a third party. The UPA prohibits one partner from selling the goodwill of the business without the permission of the other partners. Again, this is an essential asset of the business: that all partners should have a say in assigning property to someone outside of the business.

Confessing a Judgment

A judgment occurs at the conclusion of a civil trial, when the jury or judge pronounces a "winner." In the case of confessing a judgment, however, the debtor is agreeing that he or she owes the creditor money without going to court. For a partnership to confess a debt, all the partners must be in agreement; one partner cannot sign a "confession" that binds the other partners.

Acts That Interfere With the Partnership's Business

Submitting a partnership claim to arbitration or doing any other act that would make it impossible to carry out the ordinary business of the partnership is likewise prohibited by the UPA.

Limitation on Partners' Right of Compensation

Students are often surprised to learn that partners do not automatically, or even customarily, receive a salary. In fact, partners serve without compensation for their services unless the partnership agreement provides otherwise. Instead, partners are paid their respective share of the pro�its by taking a draw, meaning that they take from the partnership's account their share of the pro�its. According to the Revised Uniform Partnership Act (RUPA), a partner is also entitled to reasonable compensation for winding up the business after the dissolution of the partnership (RUPA (1997) § 401(h)).

Partners' Capital Contributions

In the event that a partner dies or withdraws from the partnership, that person is entitled to the repayment of his or her capital contribution. Recall that this was the seed money each partner contributed to fund the start of the partnership. Additionally, suppose that a partner made a loan to the partnership or paid a partnership bill out of personal funds. If so, payments or advances to the partnership by any partner above and beyond the agreed-upon initial capital contribution will earn interest for the partner as of the date it is made.

Admission of New Partners

Admission of new partners into an existing partnership agreement can be made only with the unanimous consent of all partners (RUPA (1997) § 401(i)).

Partners' Right to Inspect Partnership's Books

Every partner has the right to inspect the partnership books at any time. The books must be kept at the principal of�ice of the partnership and made available to every partner, at all times, for inspection and copying. RUPA also gives the right to inspect to other interested parties: a partner's agents and attorneys as well as former partners, their agents, and attorneys, pertaining to the period during which they were partners (RUPA (1997) § 403(b)). While this might not seem like an important right, being able to send an assistant (agent) to photocopy hundreds of pages of information can be a signi�icant time- saver for an attorney or partner facing litigation.

Partners' Liability for Partnership Debt

Partners are jointly and severally liable for all partnership debts. This means that partners can be sued individually or together by any person to whom the partnership owes a debt. These include debts that arise from contracts, tort liability, or liability to the state and federal governments for taxes or fees connected with running the business. Thus, each partner is subject to unlimited personal liability for partnership debts. If a single partner is sued by a creditor, the partner must fully discharge the debt out of his or her personal assets and would then be able to seek reimbursement from the other partners for their individual share of the liability. If the other partners are insolvent, however, the solvent partner could be left with no recourse.

New partners admitted to an existing partnership are liable only for partnership debts incurred after they join the partnership, and partners who dissociate themselves from the partnership are liable only for debts incurred up to the time of their dissociation, but not after.

Partners' Property Rights

Because a partnership is an entity distinct from its partners, the partnership holds title to the partnership property. Property that is acquired by or in the name of the partnership is the property of the partnership and does not belong to any individual partner (RUPA § 203). The partnership can hold and dispose of property in the same way in which a corporation or an LLC can hold and dispose of property—in the "name of the partnership," not in the name

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of individual partners. This brings the partnership form of business organization in line with other forms of business organization that are creatures of statute, such as the limited partnership, corporation, and LLC.

Purported Partners

In our discussion of agency by estoppel in Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) , we saw that if a principal misleads a third party into believing that a person who is not an agent is in fact the principal's agent, the principal will be unable to disavow acts of the purported agent. After all, the third party relied on the purported agent's misrepresentations and may have suffered some tangible loss as a consequence. The principal is thereby prevented from denying the existence of the agency or the lack of authority of the purported agent when he or she is sued by an innocent third party, who justi�iably relied on the existence of the agency because of the misrepresentation.

The same common law tenet applies to partnerships. Partners can be prevented from denying a purported partner's partnership status if the partners allow an innocent third party to mistakenly and justi�iably believe that a nonpartner is a partner. In such cases, a partnership by estoppel exists. This means that the partners are prevented (estopped) from denying the nonpartner's partnership status with regard to any innocent third person:

If a person, by words or conduct, purports to be a partner, or consents to being represented by another as a partner . . . the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership. (RUPA § 308(a) (1997))

Partners are also liable for the purported agent's actions as though the person were in fact a partner. Under the common law, UPA, and RUPA, if all partners in the partnership consent to the misrepresentation, all partners are bound by it. However, if fewer than all the partners consent to the misrepresentation, only those partners who consented to the misrepresentation are jointly and severally liable to any innocent third parties who relied on the misrepresentation in dealing with the purported partner (RUPA § 308(b) (1997)). The following examples will illustrate:

Adam tells Betty that he is a partner of Charlene and David. Betty believes him and enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will not bind Charlene or David, as the statements by Adam were not made in their presence or with their acquiescence. Only Adam is liable under this contract.

Adam tells Betty that he is a partner of Charlene and David in Charlene's presence, and Charlene does not dispute the statement. Betty later enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will bind Charlene but not David, as the statements by Adam were not made in David's presence or with his acquiescence. Only Adam and Charlene are liable under this contract.

Adam tells Betty that he is a partner of Charlene and David in the presence of both Charlene and David, who do not dispute the statement. Betty later enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will bind Charlene and David (as well as Adam) because the misrepresentation was made in their presence and was not objected to by either of them.

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28.3 Partnership Dissociation Even if the partners formed their business with the idea that they would continue for many years, it is not uncommon for people to have a falling out. At that juncture, the partners then wonder how to end the partnership that they formed. The name given to ending a partnership is dissociation. There are a number of voluntary and involuntary ways in which a partner may be dissociated from the partnership.

If the partnership is one "at will," then by de�inition, it has no ending date. Any partner can leave the partnership at any time without incurring further liability. Sometimes the partnership agreement states that it will end upon the happening of an event. For example, the partnership agreement might say:

TERM OF THE PARTNERSHIP

This partnership will end when the house at 124 Elm Street is purchased, the renovations complete, and the house is sold to a third-party purchaser.

In such a case, the partnership ends upon the happening of an event that all the partners agreed to upon partnership formation.

Sometimes the actions of a partner are so egregious that the other partners do not want that person associated with the partnership anymore. When this occurs, the partners may expel the partner from the partnership if they have a partnership agreement that provides for such a scenario. Without an agreement, a partner can still be expelled from a partnership, but it must be by unanimous vote of the partners and only for reasons such as "It is unlawful to carry on the partnership business with that partner." If the partnership cannot agree to expel a partner, then the partnership can go to court and seek a judicial determination for a reason such as the partner engaging in wrongful conduct that "adversely and materially affected the partnership business." Both UPA and RUPA have lists of reasons to terminate a partnership. Examples of reasons to terminate a partnership vary from state to state, depending on how that state adopted the UPA. For examples of what two states have adopted as reasons for termination, click here (http://delcode.delaware.gov/title6/c015/index.shtml) (Delaware) and here (http://www.leg.state.nv.us/NRS/NRS-087.html#NRS087Sec4343) (Nevada).

Winding Up

After dissociation, a partnership enters the winding-up period. During this time, the partners may continue to carry out business that is reasonably necessary to complete contracts in progress and to otherwise bring the business affairs to an orderly close. Upon dissociation, partners lose the authority to bind the partnership to new contracts. If a partner enters into new contracts on behalf of the partnership during the winding-up period, the partnership and other partners will not be bound by such contracts; rather, the partner acting without express authority will be personally liable on these contracts in the same way as any agent who exceeds his or her actual authority (see Chapter 27, Section 27.2 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec27.2#sec27.2) ).

Even after dissociation and winding up, partners retain unlimited personal liability for partnership debts. If the assets of a dissolved partnership are insuf�icient to cover partnership debts, creditors of the partnership can sue partners individually or jointly for any shortfall.

Notice to Third Parties Upon Dissolution

Because partners are agents of the partnership, when a partnership is dissolved other than by operation of law (such as by the death or bankruptcy of a partner), partners still have apparent authority to bind the partnership with respect to persons who had previously extended credit to the partnership or known of its existence. For this reason, it is essential that notice be given to such persons that the partnership has been dissolved. Until such notice is received, persons who knew of the partnership's existence or who had extended credit to the partnership in the past may still enter into binding contracts with the partnership through any of its partners. Several methods are available for effectively revoking partners' apparent authority to bind the partnership to new contracts:

Persons who have previously extended credit to the partnership must be personally noti�ied of the partnership's dissolution by any reasonable means (e.g., by letter, telephone, telegraph, or in person). If such noti�ication is mailed, it is effective when it is received, even if it is never read.

Noti�ication to persons who might have known of the existence of the partnership but had not extended credit to it previously is suf�icient if it is published in a newspaper of general circulation in the area or areas where the partnership did business.

Partnerships

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Key Terms

Click on each key term to see the de�inition.

assigning partnership property for the bene�it of creditors (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

To resolve a debt with a creditor, the partnership transfers its interest in speci�ic partnership property to a creditor.

assumed name (D.B.A.) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A name for a business, other than the owner's real name. Also known as doing business as, or D.B.A.

capital contribution (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The initial amount of money each partner contributes to begin the business; "seed money."

confessing a judgment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A legally binding agreement in which a party admits that he or she owes another money; thus, the creditor does not have to sue the debtor in court but can use the confession to collect the money from the debtor.

corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business entity that is formed by permission of the secretary of state's of�ice and has shareholders. The law grants a corporation status as an arti�icial being, much like a person, in that it has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.

dissociation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When a partner leaves a partnership either voluntarily, because of the partnership agreement terms, or owing to egregious conduct. Upon dissociation, partners lose the authority to bind the partnership to new contracts.

draw (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A partner's share of the pro�its, withdrawn on a regular basis from the partnership's account.

federal tax identi�ication number (TIN) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The number the government assigns to a business entity (e.g., a sole proprietorship) in the form of a nine-digit number; used for �iling tax returns.

general partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by two or more persons for the purpose of engaging in a business for a pro�it. Also can exist de jure (by law).

goodwill (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The intangible "name recognition" of a business that has meaning to customers and, in some cases, may be worth a great deal of money.

joint and several liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The concept that partners can be sued individually or collectively for debts the partnership owes or to pay damages in tort lawsuits.

limited liability company (LLC) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by permission of the secretary of state's of�ice; usually applies to professionals such as doctors or lawyers.

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limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of partnership in which there are general partners and limited partners who are investors in the general partnership.

partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by two or more people in which they are engaged in a business as co-owners with the intent to make a pro�it.

partnership agreement (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The contract entered into by the partners setting forth their respective rights and duties.

partnership books (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The records showing the �inancial transactions of the partnership. The books must be kept at the principal of�ice of the partnership and made available to every partner, at all times, for inspection and copying.

partnership by estoppel (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When partners are prevented (estopped) from denying the nonpartner's partnership status with regard to any innocent third person who justi�iably relied on the misrepresentation by an apparent partner.

pro�its and losses (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Pro�its refers to the money accrued after paying any debts owed; losses refers to not having any money accrue or having less money after paying debts.

Revised Uniform Partnership Act (RUPA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Approved by the National Conference of Commissioner Uniform State Laws (NCCUSL) in 1994 and amended in 1996 to add the Limited Liability Partnership (LLP) provisions. Each state adopted the RUPA on a different date.

sole proprietorship (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business in which the owner personally operates the business and is solely responsible for all aspects of the enterprise.

secretary of state (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The state of�icial responsible for registering business entities.

testamentary gift (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A gift given through a will.

Uniform Partnership Act (UPA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A set of laws articulating how to create, dissolve, and run a partnership, originally written by the National Conference of Commissioner Uniform State Laws (NCCUSL) and adopted by every state except Louisiana. Each state's adoption of the UPA varies; all states follow the gist of the law, but states may have changed parts of the law in their adoption of it.

unlimited personal liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In a partnership, once the partnership assets are exhausted, the personal assets of the partners are subject to collection by a creditor. For a sole proprietor, all debts incurred by the business are the personal responsibility of the owner.

winding up (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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The period after dissociation, when partners may continue to carry out business that is reasonably necessary to complete contracts in progress and to otherwise bring the partnership's business affairs to an orderly close.

Chapter 28 Flashcards

Critical Thinking and Discussion Questions

1. What formalities are necessary for the formation of a sole proprietorship?

2. What are the basic bene�its of doing business as a sole proprietorship? What are the drawbacks?

3. What duties do partners owe the partnership? What duties are owed all the partners by the partnership?

4. In the absence of an agreement to the contrary, how are pro�its in a partnership shared? What about expenses?

5. Partners may generally unilaterally bind the partnership to contracts they enter into with third parties on the partnership's behalf in the regular course of business. But some types of acts require unanimous assent by all partners in a partnership. What are they?

6. What types of activities can a partnership engage in during the winding-up period?

7. Robert Nussbaum, a talented college student with a wonderful voice, would like to start his own business selling self-published audiobooks that he will produce himself by reading from works of �iction in the public domain, digitally recording these on his computer and burning them on CDs. He intends to sell his custom collections on eBay and will advertise his collections as Robert Nussbaum's Classic Audiobooks.

a. Will Robert be in violation of the law if he starts doing business without �irst seeking a permit from the state?

b. Can Robert name his business Classic Audiobook Productions without getting a state permit?

c. If Robert's state has a sales tax that applies to the sale of audio and music compact discs, can he go into business without informing the state if he believes that most of the sales will come from out of state?

8. Harry and Harriet enter into an agreement to start an antique dealership business as equal partners. Harry agrees to make a $50,000 capital contribution to the business, and Harriet agrees to provide a commercial building that she has inherited worth $150,000 as her capital contribution. The agreement between the partners speci�ically states that business pro�its and losses will be shared equally. After successfully running the business for a number of years, the partners decide they would like to hire someone to manage the daily operation of the business for them. They hire Helen as the general manager of the business. Although Helen is not a part owner of the business, her salary will be based on a share of the business pro�its. And, although all fundamental business decisions are made by Harry and Harriet, they often ask her advice before implementing new policies.

a. Is Helen a partner? Explain fully.

b. If the business goes bankrupt and after dissolution its debts exceed its assets by $200,000, what will the responsibility of Harry, Harriet, and Helen be with regard to the debts?

c. Assume that after dissolution, the debts of the business exceed its assets by 100,000 and that Harry is insolvent, but Harriet has personal assets (including her family home) in excess of $100,000. How much of the debt could creditors ask Harriet to bear? Explain.

To resolve a debt with a creditor, the partnership transfers itsClick card to see term 👆

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Chapter 29

Limited Partnerships The limited partnership form of business organization was primarily created to address one of the worst shortcomings of the traditional partnership form: unlimited personal liability for �inancial obligations incurred by the partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) , Sole Proprietorships and Partnerships). Although such liability of partners protects the general public against losses when dealing with a partnership, unlimited personal liability can make individuals less willing to become partners. What the limited partnership form of business organization accomplishes is to create a special class of partner who is merely an investor but does not become involved in the actual running of the business. As an investor, the limited partner is in a position similar to that of a shareholder in a corporation: The only money the partner can lose is his or her investment or capital contribution if the enterprise should fail or be sued.

Unlike the sole proprietorship and partnership forms of business organization, which were recognized at common law, the limited partnership is a creature of statute. This means that a limited partnership can be formed only in accordance with the speci�ic requirements of each state’s limited partnership act. With the exception of Louisiana, all states, Washington, D.C., and the U.S. Virgin Islands have adopted the 1916 and 1976 versions of the Uniform Limited Partnership Act (ULPA). This chapter will concentrate on the 1976 version of the ULPA (as amended in 1985) as it represents the law in the majority of jurisdictions. For the sake of simplicity, the act will be referred to simply as the ULPA from this point on. As always, keep in mind that the law in the individual states may vary and is always subject to change.

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29.1 Formation of a Limited Partnership A limited partnership is a special type of partnership made up of both general and limited partners. There must be at least one or more general partners who manage the business and have unlimited personal liability for partnership debts. In addition, limited partners contribute capital to the business and share in its pro�its, but their liability is limited to their investment in the business. Being a limited partner is desirable because the limited partnership is an investment device. The limited partner is loaning money to the business and is not interested in helping to run or manage it; instead, he or she is doing something more like buying shares of stock with the expectation of a return, as in an oil and gas venture.

Filing a Certificate of Limited Partnership

In order to form a limited partnership, a certi�icate of limited partnership needs to be executed and �iled with the appropriate state of�ice, usually the of�ice of the secretary of state. Once it is �iled, the limited partnership comes into existence. The certi�icate usually includes the following information:

1. The name of the limited partnership;

2. The address of the of�ice;

3. The name and the business address of each general partner; and

4. The latest date upon which the limited partnership is to dissolve

As should be apparent from these requirements, the main purpose of requiring the limited partnership certi�icate to be executed and �iled is to give notice to the general public of the existence of the partnership and the identity of its general partners, who will ultimately retain unlimited personal liability. Once a certi�icate of limited partnership is �iled, it can be amended by duly notifying the secretary of state of any desired changes. Amendments to the certi�icate are mandatory and must be made within 30 days after the admission or withdrawal of a general partner or the continuation of the business after the happening of an event that requires its dissolution, such as the withdrawal of a general partner.

Admission of New Partners

A person may become a limited partner at the time of the original formation of the limited partnership or "at any later time speci�ied in the records of the limited partnership for becoming a limited partner" (ULPA § 301(a)(2)). After originally �iling the certi�icate with the secretary of state, a limited partner may be admitted as provided for in the partnership agreement. Or, if no provision is made in the agreement, that person can be brought in by the unanimous consent of all partners.

General partners may also be admitted after �iling the original certi�icate of limited partnership, either as provided in writing in the partnership agreement or with the written consent of all partners. In most states, corporations are allowed to be general or limited partners in limited partnerships.

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29.2 Rights and Obligations of General and Limited Partners The rights and obligations of general partners in a limited partnership are similar to those of partners in a traditional partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) ). General partners are co-owners of the business who owe the business the �iduciary duties of agents and who share in the management and the pro�its of the business, as well as in its debts. Limited partners, on the other hand, share only in the pro�its of the business and are liable for its debts only up to the limit of their capital investment. They are prohibited from participating in the control of the business.

Purported Limited Partners

If a limited partner participates in the control of the business, he or she will be "liable to persons who transact business with the limited partnership reasonably believing, based upon the limited partner’s conduct, that the limited partner is a general partner" (ULPA § 303). In addition, he or she can lose his or her special status and be subject to unlimited liability for the debts of the business to persons who, in the course of good-faith business dealings, believe the limited partner to be a general partner. In other words, a limited partner who becomes involved in the management of the business is estopped from denying he or she is a general partner with regard to persons who might have reasonably believed him or her to be a general partner because of his or her involvement in managing the business. A limited partner who allows his or her name to be used in the name of the partnership (a privilege reserved to general partners) will be liable as a general partner to any person who extends credit to the partnership without actual knowledge that the partner so named is only a limited partner (see also the subsection titled "Purported Partners" in Chapter 28).

Voting Rights

Despite the prohibition on limited partners managing the partnership, limited partners can be granted the right to vote along with general partners on some partnership matters by express provision in the limited partnership agreement. Note, however, that even if they vote on any of the following matters, that does not constitute participating in management of the business:

1. The dissolution and winding up of the limited partnership;

2. The sale, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the limited partnership;

3. The incurrence of indebtedness by the limited partnership other than in the ordinary course of its business;

4. A change in the nature of the business;

5. The admission or removal of a general partner;

6. The admission or removal of a limited partner;

7. A transaction involving an actual or potential con�lict of interest between a general partner and the limited partnership or the limited partners;

8. An amendment to the partnership agreement or certi�icate of limited partnership; or

9. Matters related to the business of the limited partnership not otherwise enumerated in this subsection that the partnership agreement states in writing may be subject to the approval or disapproval of limited partners. (ULPA § 303(b)(6))

When corporations are involved as partners, the liability of the corporation for partnership debts will encompass either all assets of the corporation (if the corporation is a general partner) or the capital invested in the partnership (if the corporation is a limited partner). As you will see in chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) , in either case, the corporate shareholders (the owners of the corporation) will be insulated from personal liability beyond their investment in the corporation.

Sharing Profits and Losses

Recall that, in a general partnership, the partners shared the pro�its and losses equally unless the partnership agreement stated otherwise. In a limited partnership, by contrast, the pro�its and losses of the limited partners are distributed in proportion to their respective contributions. ULPA states that unless the partnership agreement states otherwise, "pro�its and losses shall be allocated on the basis of the value . . . of the contributions made by each partner."

Withdrawal by General and Limited Partners

A general partner may withdraw from a limited partnership at any time by giving written notice to the other partners. If the partnership agreement prohibits withdrawal, a general partner may still withdraw but in doing so will be in breach of the partnership contract and can be sued for damages by the other partners. Upon the withdrawal of a general partner, the partnership will be dissolved unless the partnership agreement provides for continuation by the remaining partners in such a situation.

Limited partners may also withdraw at any time upon the happening of events noted in the partnership agreement, or at any time by giving not less than six months’ prior written notice of their intention to all partners. If the limited partner’s right to withdraw is limited in the partnership contract, and the limited partner withdraws in violation of such a contract, then he or she may be liable for breach of contract. The withdrawal of a limited partner will not automatically dissolve the partnership unless the limited partnership agreement so provides.

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Assignment of Partnership Interest

General and limited partnership interests are personal property that may be freely assigned in whole or in part in the absence of an agreement to the contrary. Assignment of a partnership interest will not cause dissolution of the partnership. If a limited partnership interest is assigned, the assignee can become a limited partner of the business with all the rights and responsibilities of the assignor (limited partner).

Dissolution of a Limited Partnership

This section will explore the actions and events that may result in the end of a limited partnership, keeping in mind again that the entity is a creature of state statute. Dissolution of a limited partnership may be divided into two types: judicial and nonjudicial.

Nonjudicial dissolution refers to the termination of a limited partnership as the result of the occurrence of an event under ULPA § 801 as follows:

At the time speci�ied in the certi�icate of limited partnership;

Upon the happening of events speci�ied in writing in the partnership agreement;

With the written consent of all partners; or

By an event of withdrawal of a general partner, unless at the time there is at least one other general partner and the written provisions of the partnership agreement permit the business of the limited partnership to be carried on by the remaining general partner, and that partner does so. (The ULPA continues on to state that the limited partnership is not dissolved and is not required to be wound up by reason of any event of withdrawal if, within 90 days after the withdrawal, all partners agree in writing to continue the business of the limited partnership and to the appointment of one or more additional general partners if necessary or desired.)

The second way to terminate a limited partnership is by going to court and requesting that the court intercede and terminate the partnership. In such a case, the court must �ind that "it is reasonably impractical to carry out the business in conformity with the terms of the limited partnership agreement."

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29.3 Foreign Limited Partnerships A foreign limited partnership, despite its name, is merely a domestic limited partnership that is doing business in a state or states other than the one in which it was organized. Foreign limited partnerships must register and submit a form in duplicate to the appropriate of�ice (generally the secretary of state’s of�ice) in every state where they wish to do business and pay the requisite fees. The ULPA requires that the following information be provided in the application for registration to the secretary of state:

1. The name of the foreign limited partnership and, if different, the name under which it proposes to register and transact business in this state;

2. The state and date of its formation;

3. The name and address of any agent for service of process on the foreign limited partnership whom the foreign limited partnership elects to appoint;

4. A statement that the secretary of state is appointed the agent of the foreign limited partnership for service of process if no agent has been appointed;

5. The address of the of�ice required to be maintained in the state of its organization by the laws of that state or, if not so required, of the principal of�ice of the foreign limited partnership;

6. The name and business address of each general partner; and

7. The address of the of�ice at which is kept a list of the names and addresses of the limited partners and their capital contributions, together with an undertaking by the foreign limited partnership to keep those records until the foreign limited partnership’s registration in this state is canceled or withdrawn.

The registration requirements above are meant to protect the citizens of the state in the event that they have claims against a foreign limited partnership by making it easy to sue both the partnership and its individual members. In addition, the registration fee (which varies by state) is a source of income for state governments. If an application to register as a foreign limited partnership is properly completed and accompanied by the appropriate fee (which varies from state to state), the secretary of state issues a certi�icate of registration to transact business to the applicant, returning a copy of the application to the applicant and keeping one on �ile.

When a foreign limited partnership does business in a state without �iling the required certi�icate, ULPA provides that, until it completes the registration process, the partnership will not be allowed to bring any lawsuit in the state seeking civil relief for alleged breaches in contract or torts committed against it. It can, however, enter into valid contracts notwithstanding the failure to register and can be sued by third parties in the state’s courts.

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29.4 Right of Limited Partners to Bring Derivative Actions Like shareholders of a corporation (see chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) ), limited partners in a partnership have the right to bring derivative actions on behalf of the limited partnership if the general partners refuse to do so. A derivative action is an action by a limited partner to enforce a partnership cause of action against third parties that the general partners are unwilling to enforce themselves. ULPA provides that if a derivative action by a limited partner on behalf of the partnership succeeds, a court has the power to award reasonable costs, including attorney’s fees, to the limited partner bringing the lawsuit on the partnership’s behalf. Any recovered amount beyond the costs of litigating the case is then turned over to the partnership. A derivative action can be brought only by a limited partner (while still a partner) for any action that accrued after he or she was admitted as a partner to the limited partnership. In order to bring a derivative action, the limited partner must show that the general partners have been unwilling to bring the action themselves on behalf of the limited partnership and that they are unlikely to do so on their own.

The following case excerpts exemplify the circumstances under which a derivative lawsuit might arise.

Cases to Consider: Day et al. v. Stascavage et al.

Day et al. v. Stascavage et al., Colorado Court of Appeals

The entity at issue is HMC, Ltd., a Colorado limited partnership formed to invest in real property in the Gar�ield County Town of Parachute. Investors hoped a referendum would allow gambling in the nearby City of Ri�le. But the referendum failed. Some of the partnership’s properties were sold in prior transactions that are not challenged. Two limited partners, Judith Day and Bryan Barnes, brought the derivative claims against general partners Hayden C. W. Rader, Michael P. Stascavage, and Chalmers I. Morse. The claims involve the sale of the remaining partnership lots (the property) to general partner Rader. The contract was signed in November 2005, and the sale closed in September 2007. Rader paid $258,000 and also assumed obligations of $66,000.

The limited partners alleged that the sale price was far below the property’s fair market value. Though Gar�ield County had assessed the property at $258,000, the limited partners alleged this tax assessment was formulaically discounted and based on outdated information. They alleged the property was worth well in excess of $1 million and perhaps as much as $4 million. The limited partners asserted several derivative claims, including breaches of �iduciary duty and civil theft. Each veri�ied claim alleged that the property had been sold to Rader for less than its fair market value. The limited partners alleged it would be "futile" to demand that the general partners pursue the claims, as "it is the wrongdoing of the general partners which is at issue."

The general partners responded by agreeing to a court order appointing an SLC (Special Litigation Committee). Ultimately, a Vail, Colorado, lawyer served as the SLC to decide whether the partnership should pursue the claims asserted in the derivative lawsuit. The lawyer’s investigation spanned ten weeks, totaling some thirty hours, and yielded a fourteen-page report recommending that the claims be dismissed. Relying on the SLC report, defendants moved to dismiss the derivative claims. To respond to that motion, the limited partners were allowed to depose the SLC. The court concluded the attorney SLC (1) was "independent and disinterested" and (2) followed "appropriate" investigative procedures. Accordingly, as the SLC had recommended, the court dismissed the limited partners’ derivative claims. The court issued a C.R.C.P. 54(b) certi�ication allowing immediate appeal.

***

Derivative actions provide shareholders an equitable remedy "to protect the interests of the corporation from the misfeasance and malfeasance of ‘faithless directors and managers.’" [citations omitted]. Derivative suits raise two distinct issues: "�irst, the plaintiff ’s right to sue on behalf of the [entity] and, second, the merits of the [entity] claim itself." The �irst is for the court to decide, while the second is for a jury if the claims are otherwise jury-triable. There are prerequisites—including making a demand (or showing futility of a demand) on directors or general partners—to such actions. The limited partners here indisputably complied with these procedures, and no one challenged their allegation regarding the futility of a demand. The question in this case is whether the SLC’s report required dismissal of the derivative claims. Under Colorado law, which follows the New York rather than Delaware approach, a "court may not second-guess [the SLC’s] business judgment in deciding not to pursue the derivative litigation." But before deferring to the SLC, a court must determine that the SLC "was independent, and did employ reasonable procedures in his or her analysis." As our supreme court has explained, "[u]nlike evaluation of a business judgment, trial courts are well equipped to evaluate the methodology and procedures best suited to conduct such an investigation." [citation omitted]

***

The issue thus is whether the SLC’s investigation was suf�iciently thorough to support his or her conclusion. The undisputed facts of this case show the investigation was legally inadequate. The "cornerstone of a court’s review of the SLC’s procedures" is "the thoroughness of that committee’s investigation." Relevant factors include "the length and scope of the investigation, the use of experts, the corporation or defendant’s involvement, and the adequacy and reliability of information supplied to the committee." Courts will not defer to an SLC whose "‘investigation lacked the thoroughness which is necessary for a truly objective and meaningful recommendation.’" Here, the SLC was charged with evaluating the essential fairness of a self-dealing transaction between the partnership and a general partner. Under Colorado

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law, such a transaction is not categorically precluded, but it must be "demonstrate[d] that the transaction took place in good faith, was fair to the [entity], and was accompanied by full disclosure."

There is no dispute that the critical issue in evaluating whether pursuing the derivative claims was in the partnership’s best interests was the value of the partnership property sold in the insider transaction. The derivative claims alleged that the general partners had sold the property to one of their own for much less than the property’s fair market value. The SLC’s report recognized that the focus should be on the transaction’s "fairness" and "whether full value was received in the transaction." And the district court recognized "[t]he key factor" in evaluating fairness was "the price" at which the property was sold.

Despite spending some thirty hours (including general legal research) and writing a fourteen-page report (including general legal discussion), the SLC conducted no independent investigation into this critical point. In a case that cried out for an expert appraisal of the property’s value, the SLC never sought an appraisal.

The district court wrote that the SLC "did not have the Property appraised because such an appraisal would re�lect today’s value, and not the value . . . in November 2005" when two general partners agreed to sell it to the other. That reasoning ignores the availability of "retrospective appraisals," which are necessary and appropriate in a variety of legal contexts. ("Retrospective appraisals [effective date of the appraisal prior to the date of the report] may be required for property tax matters, estate or inheritance tax matters, condemnation proceedings, suits to recover damages, and similar situations."); see generally Hice v. Lott, 223 P.3d 139, 144 (Colo. App. 2009) (noting that Colorado’s "Division of Real Estate adopted USPAP [Uniform Standards of Professional Appraisal Practice] as ‘the generally accepted standards of professional appraisal practice’") (quoting regulation). Here, for example, the limited partners presented the SLC with a historical market analysis of allegedly comparable land. While the SLC was not required to accept that analysis, he could not decline to investigate the property’s fair market value at the time of the insider sale.

The SLC simply accepted, without any independent scrutiny or any expert opinion, the general partners’ reliance on the tax assessment. The limited partners, however, presented the SLC with information that this assessed value was signi�icantly lower than the property’s actual fair market value because it was outdated and based on a statutory formula arti�icially discounting the value of vacant land. Again, the SLC was not required to credit those contentions. But neither could he blithely accept the tax assessment as a fair appraisal of then-current market value.

The SLC admittedly made no effort to investigate whether the county’s tax assessment accurately depicted the property’s fair market value at the time of sale. He was unfamiliar with a possible statutory discounting formula, and he never contacted the Gar�ield County Assessor’s Of�ice to investigate this issue.

It is not our role to consider whether in fact the property was worth more than general partner Rader paid for it. But "courts are well equipped to evaluate the methodology and procedures best suited" to an SLC investigation. Plainly, the SLC’s investigation was procedurally inadequate to support any independent determination of the critical issue whether a general partner bought the property at a price that was fair to the partnership as a whole.

***

Because the SLC did not employ reasonable investigative procedures, the SLC’s conclusion that the partnership should not pursue the derivative claims is not entitled to deference. Accordingly, the limited partners’ derivative suit may now proceed. 13 Fletcher, supra, §  6019.50, at 250 (result of de�icient SLC investigation is that "[t]he shareholder-plaintiff may then resume immediate control of the litigation with a view toward prosecuting it to a conclusion regardless of the position taken by the committee appointed by the board"); see also Janssen v. Best & Flanagan, 662 N.W.2d 876, 889 (Minn. 2003) ("the derivative suit proceeds on its merits" after a court concludes that an SLC investigation was inadequate) (citing cases). The order dismissing the derivative claims is reversed, and the case is remanded for further proceedings consistent with this opinion.

Read the full text of the case here (http://www.courts.state.co.us/Courts/Court_of_Appeals/opinion/2010/09CA2488.pdf) .

Questions to Consider

1. Why did the limited partners have to resort to a derivative action in this case?

2. What are the objectives of a Special Litigation Committee (SLC)?

3. Who won the case? What happens next?

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Key Terms

Click on each key term to see the de�inition.

assignment of a partnership interest (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Transfer of the right to receive pro�its from a partnership to an outside third party. 

certi�icate of limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The initial paperwork �iled with the secretary of state to form a limited partnership.

certi�icate of registration (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The form that a foreign limited partnership must �ile in order to legally do business in the United States. In some states, this is also the name given to the form that must be �iled by a domestic limited liability partnership.

derivative action (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A legal action brought by a limited partner to enforce a partnership cause against third parties that the general partners are unwilling to enforce themselves.

domestic limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A partnership is domesticated in the state where it �iled its original certi�icate of limited partnership.

foreign limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A domesticated limited partnership that is doing business in a state or state other than the one it was organized in.

general partners (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Co-owners of the partnership who owe the business the �iduciary duties of agents and who share in the management and the pro�its of the business, as well as in its debts.

limited partners (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Co-owners of a partnership who share only in the pro�its of the business and are liable for its debts only up to the limit of their capital investment. They are prohibited from participating in the control of the business.

limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A special type of partnership that comprises both general and limited partners.

Special Litigation Committee (SLC) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Legal experts that help decide whether a partnership should pursue the claims asserted in a derivative lawsuit.

Uniform Limited Partnership Act (original act, 1916; amended in 1976, 1985, and 2001) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The law governing limited partnerships promulgated by the National Conference of Commissioners of Uniform State Laws. The 2001 enactment, which combined the ULPA and its revised version (RULPA), has been adopted by 18 states and the District of Columbia.

Chapter 29 Flashcards

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Critical Thinking and Discussion Questions

1. How is a limited partnership formed? What information must be contained in the certi�icate of limited partnership?

2. What is the basic difference between a limited partner and a general partner in a partnership?

3. In most states, may a corporation be a limited or general partner?

4. If the partnership agreement is silent as to the withdrawal of members, what is the effect of a general partner withdrawing from the partnership? What is the effect of a limited partner withdrawing?

5. De�ine foreign and domestic limited partnerships.

6. May foreign limited partnerships do business in states other than the one they were organized in? If so, do they need to follow any speci�ic procedures before they can do business?

7. Tom, Dick, and Harriet start a new tax preparation and �inancial planning business together. Their state does not require any special licensing for such businesses, and, since the three partners are good friends, they do not draw up any speci�ic agreement relating to the business. They do, however, verbally agree that all pro�its of the business are to be shared equally, and so are all losses, except that Harriet will be responsible only up to the extent of her capital contribution in the business. They further agree that Harriet will not have any direct role in managing the business but rather will be an investor. a. What form of business organization do the friends have? Explain. b. Is Harriet a limited partner, since that is obviously the role that the parties intended for her to play in the business? c. Assume that Harriet had invested $50,000 in the business, while Tom and Dick had invested $5,000 each in the venture. What is each party’s potential liability should the business fail?

8. Dominick, Jerry, and Joan are partners in a general partnership involving a lucrative used automobile dealership in northern Pennsylvania. Because of the success of their business, they want to expand their operations to New York and New Jersey, opening two new dealerships in those states. a. Can they reorganize the general partnership into a limited partnership to attract new investors? b. What requirements would have to be met by the limited partnership before it could start doing business in New York or New Jersey?

Transfer of the right to receive profits from a partnership to

t d th d t

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Chapter 30

Corporations Like the limited partnership, the corporate form of business organization owes its existence to statutory law. New York was the �irst state to enact a corporate statute, in 1811, with other states following soon thereafter. Today, every state has enacted a business corporation statute, with about two-thirds of the states basing their business corporation law on the Model Business Corporation Act (MBCA) of 1950. This chapter will discuss the unique character of the corporation, types of corporations, how to form and dissolve a corporation, and how to manage this type of business.

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30.1 The Corporation as an Entity Unlike sole proprietorships and traditional common law general partnerships (both discussed in Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) ), a corporation is viewed as a separate entity from its owners. The law grants a corporation status as an arti�icial being much like a person for most purposes. This means that the corporation has certain rights and responsibilities not traditionally enjoyed by other business organizations. As an arti�icial being, a corporation has the right to own property in its own name, borrow or lend money, and sue and be sued, and it is entitled to the protection of most laws, the same as natural persons. On the other hand, like a natural person, a corporation must pay taxes (although at a lesser rate than individuals) and can be found guilty of crimes for which the punishment is a �ine. In addition, a corporation can be set up to enjoy perpetual existence, unlike sole proprietorships and partnerships, which may be dissolved upon the death or incapacity of the sole proprietor or of a general partner.

The limited liability offered by a corporation to its owners is its greatest appeal. Because a corporation is deemed to be an entity separate from its owners, the owners of a corporation (its stockholders) are not personally liable for corporate debts beyond their investment in the company. All that a shareholder risks in purchasing a share of stock is the money paid for its purchase. On the other hand, stockholders pay a premium for this protection. Corporations pay taxes in their own right, including federal income taxes as well as state income taxes, where applicable. This means that the pro�its of the corporation are subject to double taxation: The corporation pays income taxes on corporate pro�its, and then the shareholders pay personal income taxes on corporate pro�its distributed to them as dividends. Some maintain that the taxation is in fact "triple" because shareholders also pay taxes on capital gains realized from the sale of their stock.

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30.2 Classi�ication of Corporations Corporations are commonly classi�ied in accordance with their purpose, the nature of their activities, and their ownership.

Public and Private Corporations

The corporate form serves both private and public interests equally well. Public corporations are organized by federal, state, or local governments in order to carry out necessary public services. Municipalities, such as cities and towns, are often organized as public corporations, as are companies entrusted with the administration of public services. Private corporations, on the other hand, are organized by private individuals to carry out private business.

For-Profit and Nonprofit Corporations

Corporations can be created for pro�it and nonpro�it purposes. Public corporations are by nature nonpro�it entities, since their purpose is not to make money but rather to advance the public good in some way. Private corporations, on the other hand, can be either for-pro�it or nonpro�it, depending on their purpose. A nonpro�it corporation is one that is organized for the purpose of achieving some artistic, humanitarian, or philanthropic purpose or rendering a public service, as opposed to a for-pro�it corporation, or a traditional business, which is organized to make a pro�it. Like Chapter S corporations (discussed below), nonpro�it corporations are exempt from having to pay federal income taxes (as well as state and local income taxes in states that assess these).

Domestic, Foreign, and Alien Corporations

Corporations are classi�ied as domestic, foreign, or alien depending on where they were organized and where they do business. Like limited partnerships, corporations are deemed to be domestic corporations in one state only: where they originally �iled their Articles of Incorporation. In all other states, they are foreign corporations—once they �ile the correct paperwork, that is. Corporations organized under the laws of another country are considered alien corporations when they do business anywhere in the United States. As is true of limited partnerships, corporations wishing to transact business in a state other than that of their incorporation must register with the secretary of state in each such state. The address of a registered of�ice in the state and the name and address of a registered agent of the corporation for the state must be provided to the secretary of state as part of the registration process and accompanied by the appropriate fee.

Closely Held and Publicly Traded Corporations

A closely held corporation is one whose shares are not traded to the general public in any stock exchange. Rather, the stock is usually only available to the owners, who may be a small group of people or a family. Such corporations are usually (but not always) small companies owned by a few investors. A publicly traded company, on the other hand, is one whose shares are traded in any stock exchange.

Professional Corporations

Professional corporations (PCs) are for-pro�it corporations organized to provide a professional service. Physicians, lawyers, architects, accountants, and engineers are but a few of the professions whose members commonly form PCs. A PC must have the words Professional Corporation (or the letters PC) following the corporate name instead of the normal words or abbreviations appended to corporate names (e.g., Corp., Inc., Co., or Ltd.).

Chapter S (Subchapter S) Corporations

The greatest disadvantage of organizing a business as a corporation is the double taxation to which corporate pro�its are subject. The Internal Revenue Code (IRC), however, grants a tax exemption to small business corporations, which can qualify as S corporations, also called subchapter S corporations. This is because the S corporation rules are contained in Subchapter S of Chapter 1 of the Internal Revenue Code (IRC).

To qualify, the business must be "a small business corporation for which an election under section 1362(a) is in effect for such year." Under IRC § 1361(b) (1), in order to qualify as an S corporation and enjoy the bene�it of tax exemption, a small business may not:

Have more than 100 shareholders;

Have as a shareholder a person (other than an estate, a trust described in subsection (c)(2), or an organization described in subsection (c)(6)) who is not an individual;

Have a nonresident alien as a shareholder; and

Have more than one class of stock (however, voting and nonvoting classi�ications within a class of stock are permitted).

Financial institutions and insurance companies are generally ineligible for S corporation status. S corporations are permitted to have wholly owned subsidiaries as long as the corporation owns 100% of the subsidiary S corporation’s stock.

Undistributed corporate income must be treated as taxable income to the shareholders. (Such income is not treated as taxable income in a regular C corporation until it is actually distributed to shareholders, such as by cash dividends.) Shareholders are allowed to deduct net operating losses from their gross income, whereas shareholders in a standard corporation may not take such deductions.

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The purpose of Chapter S incorporation is to allow relatively small, closely held businesses that would otherwise be organized as partnerships or limited partnerships to take advantage of the corporate form of business organization without being subjected to double taxation or to the formalities of corporate governance, such as annual meetings and boards of directors. Since S corporations were �irst recognized in 1958, the trend has been to expand the eligibility requirements, at least as related to the maximum number of allowed shareholders, which has been incrementally increased during the past two decades from 15 to 100.

Some states require corporations to �ile for Chapter S treatment with the state as well as with the federal government. After all, federal tax-exempt status does not automatically guarantee that a given state or city may not tax the corporation or apply different standards for income tax exemption under state and local law.

Chapter C Corporations

Corporations subject to taxation that do not elect S corporation status are referred to as Chapter C corporations under IRC § 1361(a)(2). A Chapter C corporation (or C corporation) is, broadly speaking, a large, publicly traded corporation that may have an unlimited number of shareholders, both domestic and foreign.

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30.3 Corporate Formation Corporations are formed in accordance with their state’s business corporation act. Therefore, corporations can be formed only by complying with the relevant state statute that makes the corporate form of business organization possible. To begin a corporation, someone must �irst have an idea for a service or product. The people who form the initial group who aim to create a new corporation are called the incorporators (or sometimes the promoters) because they are usually the founders of the company and put up or help raise the money to begin the venture.

Preincorporation Activities

One way in which promoters raise money is through stock subscriptions. These are promises from third parties to purchase stock when the corporation comes into existence and, as such, are contracts (see Unit III (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/unit03#unit03) , Contracts). Because promoters are acting on behalf of a nonexistent entity when they sell subscriptions, they are not held to be agents of the corporation; a corporation that is not yet in existence cannot be a principal and, thus, cannot consent to the agency (see Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for concepts of principal–agency law). What this means is that promoters are personally liable for any contracts they enter into on the future corporation’s behalf before the corporation comes into existence. In most instances, this does not present a problem for promoters because the new corporation will ratify the contracts, thereby taking the promoters off the hook with regard to liability.

Nevertheless, there is an element of risk for promoters when they carry out their preincorporation duties because there is no guarantee that the board of directors of the company will ratify the promoters’ contracts on the corporation’s behalf. In fact, the corporation may never even be formed. In such cases, promoters can �ind themselves in the very uncomfortable position of retaining personal liability for contracts entered into on the corporation’s behalf and monies extended on behalf of the corporation. They put themselves at risk as they fronted money for such necessary preincorporation activities as hiring lawyers, accountants, and other professionals to assist in getting the corporation off the ground; paying �iling fees; and arranging commercial leases or employment contracts.

Once the promoters’ initial groundwork for the corporation is completed, the promoters must select one or more persons to act as incorporators (alternatively, the promoters can act as incorporators themselves).

Articles of Incorporation

The incorporators are responsible for writing the Articles of Incorporation. This document forms the skeleton of the corporation by clearly outlining the following:

The name for the corporation. Incorporators must meet two requirements in selecting a corporate name: 1. With few exceptions, the name may not currently be in use by another corporation in the same state. 2. The corporate name must include one of the following words in its title: corporation, incorporated, company, limited, or one of the following abbreviations for such words: Corp., Inc., Co., or Ltd.) (The abbreviation Ltd. is more commonly used in Great Britain and Canada; in those U.S. states that allow such an abbreviation, it means Inc.)

The number of shares of stock that the corporation is authorized to issue;

The address of the corporation’s initial registered of�ice and its initial registered agent at that of�ice; and

The name and address of each incorporator.

In addition to the above mandatory minimum information, Articles of Incorporation may contain some or all of the following types of information:

The names and addresses of the individuals who are to serve as the initial directors;

Provisions regarding the purpose of the corporation, its management, and its regulation;

Limits on powers of the corporation or its board of directors and its shareholders;

The par value of its authorized shares or classes of shares; and

The imposition of personal liability on shareholders for the debts of the corporation.

Classes of shares refers to the types of shares of stocks that a corporation issues. For example, most corporations issue both common and preferred stock. Preferred stock gives its owners priority with regard to the distribution of dividends and a more elevated status if the corporation goes through bankruptcy. As you can see, the Articles of Incorporation have similar requirements to the certi�icate of limited partnership (see Chapter 29 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch29#ch29) ). The required information serves a similar purpose: to give notice to the public at large of the existence of the corporation and to provide an agent on whom process can be served by anyone seeking to initiate legal action against the corporation.

The incorporators next send the Articles of Incorporation to the secretary of state’s of�ice in the state in which they wish to form their corporation. This is the state where the corporation is domesticated, or initially formed. The secretary of state examines the Articles and, if all is in order and accompanied by the appropriate �iling fee, stamps and �iles them. At that moment, the corporation "comes into existence." A stamped copy of the Articles of Incorporation is

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then returned to the corporate of�ice, along with a stamped receipt for the paid �iling fee. The exact time of the corporation coming into existence is signi�icant because it is only after it is in existence that it can have liability for corporate acts.

If the corporation’s directors are named in the Articles of Incorporation, an organizational meeting is called by a majority of the directors. The primary purpose of this meeting is the appointment of corporate of�icers and adoption of the corporate bylaws—the internal rules governing the operation of the corporation. During this �irst meeting, the directors also typically ratify any contracts entered into on the corporation’s behalf by the promoters, thereby relieving them of personal liability. In the event that the directors are not listed in the articles of incorporation, the majority of the incorporators call the organizational meeting. At this meeting, the �irst order of business is the appointment of directors by the incorporators. Once appointed, the directors appoint the corporate of�icers, adopt the corporate bylaws, and ratify the incorporators’ preincorporation contracts on the corporation’s behalf.

Defective Incorporation

Given all the rules and paperwork surrounding the formation of a corporation, it is not unusual that mistakes are made. Sometimes, there is a defect in the Articles of Incorporation submitted for �iling, for example. The problem could be something as simple as a typographical error or something as serious as fraud. If the corporation is correctly formed with no mistakes in the paperwork, then we say it is a de jure corporation, or a corporation by virtue of law. Sometimes a good-faith effort is made to comply with the law, but necessary information is negligently omitted from the Articles of Incorporation, such as an incorporator’s address. The business enterprise will be considered a de facto corporation, or a corporation in fact, and treated as a valid corporation until such errors or omissions are legally corrected.

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30.4 Management of the Corporation The day-to-day operation of a corporation is carried out by corporate of�icers. The of�icers are elected by the board of directors, which is elected by the shareholders. Thus, one may argue that the shareholders hold the power, since ultimately they decide who is elected to the board. Figure 30.1 illustrates the management structure of the corporation.

Figure 30.1: Corporate management structure

The management structure of a corporation involves three groups, the shareholders, the corporate of�icers, and the board of directors. Shareholders are those who have purchased shares of stock. This group elects the board of directors, who oversee the corporation and set policy. The board of directors appoint corporate of�icers, who are responsible for running the day-to- day operations of the business.

Corporate Directors

Corporate of�icers carry out the day-to-day decisions of the corporation, but corporate directors are in charge of policy decisions. Should the corporation expand? Who should be the next president? Does the current plant in Indiana need to be re�itted, or should a new one be built? Additionally, the board appoints the corporate of�icers, who run the business and who determine the fate of the business. Depending on how they tackle these questions, the corporation will be pro�itable or not. If it is pro�itable, the shareholders will most likely be pleased and retain the members by voting them on to successive terms; if not, they will be voted out.

By law, corporate directors have a highly re�ined legal duty called a �iduciary responsibility (see Chapters 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch09#ch09) and 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for more on this topic) to the corporation they serve. As such, they must exercise their responsibilities in good faith and use reasonable care in their efforts to further the best interest of the corporation. Directors are personally liable to the corporation if they breach these duties.

In addition to having the right to vote for directors at the annual shareholders’ meetings, shareholders can remove directors by calling a special meeting for that purpose at any time and then voting them out of of�ice. The Articles of Incorporation can stipulate that removal be only for cause; however, if the Articles of Incorporation are silent as to removal of directors, then they can be removed with or without cause (e.g., with or without a valid reason).

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The term of the �irst board of directors named in the Articles of Incorporation or by the incorporators expires at the �irst shareholders’ meeting. After this initial term, the Articles of Incorporation can provide for staggered terms for board of directors members, such as two or three staggered groups that are as nearly equal in size as possible. If such a scheme is selected, the board members in the �irst group serve for one year, the members in the second serve for two years, and the third group serves for three years.

The board of directors of a corporation meets a few times a year to consider and vote on important policy decisions. The meetings may involve experts and corporate of�icers who meet with the directors and provide information on a speci�ic topic. In this way, members of the board can be informed on matters. The board then votes, and an af�irmative vote becomes an of�icial action recorded in the corporate minutes. One question that arises is how informed board members have to be before they vote. The law holds them to a standard known as the "business judgment rule," which states that boards must make their decisions on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company. Failure to come up to this standard may result in individual liability for the directors.

Corporate Officers

Corporate of�icers are appointed by the board of directors and serve at the pleasure of the board. The speci�ic duties of corporate of�icers can be set out in the corporate bylaws or prescribed by the board of directors. The board of directors, acting in a manner consistent with the corporate bylaws, can also appoint an of�icer to prescribe the duties of other of�icers. Like directors, of�icers serve in a �iduciary capacity: They must exercise their responsibilities in good faith, using reasonable care, and make a good-faith effort to further the best interests of the corporation.

The precise number and titles of corporate of�icers can be spelled out in the corporate bylaws, but every corporation must have a secretary or the equivalent: an of�icer whose duty it is to keep records of directors’ and shareholders’ meetings and to authenticate records of the corporation. A single person can act in various capacities as an of�icer, so it is possible to have one of�icer who acts as both president and secretary of the corporation. Some states, though, require there to be at least two corporate of�icers in every corporation (e.g., a president and a secretary) even if a single shareholder owns all the corporation’s stock, as in some closely held corporations.

Shareholders

The owners of a corporation are its shareholders. Each shareholder owns a part of the corporation equal to the number of shares owned divided by the total number of shares issued and outstanding. As an example, if a corporation has 1,000 shares issued and outstanding and a shareholder owns 100 of those shares, he or she would own a one-tenth interest in the corporation.

Even though they are the corporation’s owners, shareholders do not have the right to directly participate in the management of the company. Instead, they participate indirectly by voting for the board of directors at the annual shareholders’ meetings. The responsibility for managing the corporation falls to the directors, who in turn hire corporate of�icers to implement their policies and manage the day-to-day operations of the corporate enterprise.

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30.5 Special Types of Corporate Lawsuits This section will discuss two unique situations involving corporate lawsuits, derivative actions and piercing the corporate veil.

Derivative Actions

Directors and of�icers of a corporation have the responsibility to manage and further the interests of the corporations they serve. When shareholders believe that corporate actions have damaged the corporation, or when management refuses to enforce the rights of the corporation in civil proceedings against third parties, one or more shareholders can seek to bring a derivative action on behalf of the corporation to recover civil damages.

Before a shareholder can begin a derivative action on behalf of the corporation, the corporation must be given notice and the opportunity to entertain the shareholder’s demand. Under corporation law, 90 days are required to pass from the date that notice is given by the shareholder, or rejection of the demand by the corporation, before the derivative action can commence. If a corporation begins an inquiry into the allegations of the complaint, a court can stay the action for a time period it deems appropriate to allow the corporation to investigate and possibly address the substance of the complaint. If the derivative action continues and is successful, any proceeds obtained in the proceedings go to the corporation on whose behalf the suit was brought by the shareholder(s). For an example of how complex a derivative lawsuit involving a large multinational conglomerate is, see In re the Dow Chemical Company Derivative Litigation (http://courts.delaware.gov/opinions/download.aspx?ID=132000) (January 11, 2010).

After a derivative action �inishes, a court can order the corporation to reimburse the reasonable costs of the suit, including attorney’s fees, to the shareholder(s) who brought the derivative action if the proceedings result in a substantial bene�it to the corporation.

Corporate Organization & Operation

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for a pdf of this slideshow.

Piercing the Corporate Veil

If shareholders are to enjoy the limited liability offered by the corporate form of business organization, it is crucial that the separate entity status of the corporation be maintained. This means, for example, that shareholders are protected if there is a lawsuit against the corporation. There is, in effect, a shield protecting their personal assets; shareholders are liable up to the amount of their investment only.

Failure to comply with the formalities required of a corporation, however, can result in a court ignoring the corporate entity and holding its owners subject to unlimited personal liability for all corporate debt. A court will pierce the corporate veil in instances where it �inds that a corporation has been created to defraud creditors, where corporate funds or property are not kept separate from those of its shareholders, or when required formalities (such as keeping minutes of directors’ and shareholders’ meetings) have been ignored.

The following are excerpts from one of the most famous cases involving a request to pierce the corporate veil.

Cases to Consider: Walkovszky v. Carlton

Walkovszky v. Carlton, 18 N.Y.2d. 414 (N.Y. Ct. App. 1966)

This case involves what appears to be a rather common practice in the taxicab industry of vesting the ownership of a taxi �leet in many corporations, each owning only one or two cabs.

SLIDE 1 OF 10

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The complaint alleges that the plaintiff was severely injured four years ago in New York City when he was run down by a taxicab owned by the defendant Seon Cab Corporation and negligently operated at the time by the defendant Marchese. The individual defendant, Carlton, is claimed to be a stockholder of 10 corporations, including Seon, each of which has but two cabs registered in its name, and it is implied that only the minimum automobile liability insurance required by law (in the amount of $10,000) is carried on any one cab. Although seemingly independent of one another, these corporations are alleged to be "operated as a single entity, unit and enterprise" with regard to �inancing, supplies, repairs, employees and garaging, and all are named as defendants. The plaintiff asserts that he is also entitled to hold their stockholders personally liable for the damages sought because the multiple corporate structure constitutes an unlawful attempt "to defraud members of the general public" who might be injured by the cabs.

***

The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability but, manifestly, the privilege is not without its limits. Broadly speaking, the courts will disregard the corporate form, or, to use accepted terminology, "pierce the corporate veil," whenever necessary "to prevent fraud or to achieve equity." In determining whether liability should be extended to reach assets beyond those belonging to the corporation, we are guided, as Judge Cardozo noted, by "general rules of agency." In other words, whenever anyone uses control of the corporation to further his own rather than the corporation’s business, he will be liable for the corporation’s acts "upon the principle of respondeat superior applicable even where the agent is a natural person." Such liability, moreover, extends not only to the corporation’s commercial dealings but to its negligent acts as well.

In the Mangan case (247 App. Div. 853, mot. for lv. to app. den. 272 N.Y. 676, supra), the plaintiff was injured as a result of the negligent operation of a cab owned and operated by one of four corporations af�iliated with the defendant Terminal. Although the defendant was not a stockholder of any of the operating companies, both the defendant and the operating companies were owned, for the most part, by the same parties. The defendant’s name (Terminal) was conspicuously displayed on the sides of all of the taxis used in the enterprise and, in point of fact, the defendant actually serviced, inspected, repaired and dispatched them. These facts were deemed to provide suf�icient cause for piercing the corporate veil of the operating company—the nominal owner of the cab which injured the plaintiff—and holding the defendant liable. The operating companies were simply instrumentalities for carrying on the business of the defendant without imposing upon it �inancial and other liabilities incident to the actual ownership and operation of the cabs.

In the case before us, the plaintiff has explicitly alleged that none of the corporations "had a separate existence of their own" and, as indicated above, all are named as defendants. However, it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business. It is quite another to claim that the corporation is a "dummy" for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. Either circumstance would justify treating the corporation as an agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the �irst, only a larger corporate entity would be held �inancially responsible while, in the other, the stockholder would be personally liable. Either the stockholder is conducting the business in his individual capacity or he is not. If he is, he will be liable; if he is not, then, it does not matter—insofar as his personal liability is concerned—that the enterprise is actually being carried on by a larger "enterprise entity."

***

The individual defendant is charged with having "organized, managed, dominated and controlled" a fragmented corporate entity but there are no allegations that he was conducting business in his individual capacity. Had the taxicab �leet been owned by a single corporation, it would be readily apparent that the plaintiff would face formidable barriers in attempting to establish personal liability on the part of the corporation’s stockholders. The fact that the �leet ownership has been deliberately split up among many corporations does not ease the plaintiff ’s burden in that respect. The corporate form may not be disregarded merely because the assets of the corporation, together with the mandatory insurance coverage of the vehicle which struck the plaintiff, are insuf�icient to assure him the recovery sought. If Carlton were to be held individually liable on those facts alone, the decision would apply equally to the thousands of cabs which are owned by their individual drivers who conduct their businesses through corporations organized pursuant to section 401 of the Business Corporation Law and carry the minimum insurance required by subdivision 1 (par. [a]) of section 370 of the Vehicle and Traf�ic Law. These taxi owner- operators are entitled to form such corporations and we agree with the court at Special Term that, if the insurance coverage required by statute "is inadequate for the protection of the public, the remedy lies not with the courts but with the Legislature." It may very well be sound policy to require that certain corporations must take out liability insurance which will afford adequate compensation to their potential tort victims. However, the responsibility for imposing conditions on the privilege of incorporation has been committed by the Constitution to the Legislature (N.Y. Const., art. X, § 1) and it may not be fairly implied, from any statute, that the Legislature intended, without the slightest discussion or debate, to require of taxi corporations that they carry automobile liability insurance over and above that mandated by the Vehicle and Traf�ic Law.

While the complaint alleges that the separate corporations were undercapitalized and that their assets have been intermingled, it is barren of any "suf�iciently particular[ized] statements" that the defendant Carlton and his associates are actually doing business in their individual capacities, shuttling their personal funds in and out of the corporations "without regard to formality and to suit their immediate convenience." Such a "perversion of the privilege to do business in a corporate form" would justify imposing personal liability on the individual stockholders. Nothing of the sort has in fact been charged, and it cannot reasonably or logically be inferred from the happenstance that the business of Seon Cab Corporation may actually be carried on by a larger corporate entity composed of many corporations which, under general principles of agency, would be liable to each other’s creditors in contract and in tort.

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In point of fact, the principle relied upon in the complaint to sustain the imposition of personal liability is not agency but fraud. Such a cause of action cannot withstand analysis. If it is not fraudulent for the owner-operator of a single cab corporation to take out only the minimum required liability insurance, the enterprise does not become either illicit or fraudulent merely because it consists of many such corporations. The plaintiff ’s injuries are the same regardless of whether the cab which strikes him is owned by a single corporation or part of a �leet with ownership fragmented among many corporations. Whatever rights he may be able to assert against parties other than the registered owner of the vehicle come into being not because he has been defrauded but because, under the principle of respondeat superior, he is entitled to hold the whole enterprise responsible for the acts of its agents.

In sum, then, the complaint falls short of adequately stating a cause of action against the defendant Carlton in his individual capacity.

The order of the Appellate Division should be reversed, with costs in this court and in the Appellate Division, the certi�ied question answered in the negative and the order of the Supreme Court, Richmond County, reinstated, with leave to serve an amended complaint.

Read the full text of the case here (http://www.courts.state.ny.us/reporter/archives/walkovszky_carlton.htm) .

Questions to Consider

1. Did the court decide to pierce the corporate veil?

2. What factors did the court say were necessary before the corporation lost its shield against personal liability?

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Key Terms

Click on each key term to see the de�inition.

alien corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation organized under the laws of another country that does business anywhere in the United States.

Articles of Incorporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The initial paperwork �iled by the incorporators with the secretary of state that, if approved, begins the corporation.

arti�icial being (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The concept that a corporation is a separate entity (separate from its owners) and can sue and be sued, borrow or lend money, etc., in the corporate name, much like a natural person.

board of directors (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The group of people that oversee a corporation and set policy. They are elected by the shareholders at the annual meeting.

business judgment rule (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A standard known for of�icers of a corporation, stating that boards of directors must make their decisions on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Failure to come up to this standard may result in individual liability for the directors.

bylaws (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The internal rules governing the operation of the corporation.

Chapter C corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation that can have unlimited shareholders, foreign or domestic.

Chapter S corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation with no more than 100 shareholders, all of whom are individuals, which the IRS exempts from paying federal corporate taxes but is treated as a partnership for federal tax purposes.

classes of shares (stock) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Corporate stock comprises several types, including common stock and preferred stock. Different classes of stock confer different voting rights on their owners.

closely held corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Also known as a close corporation, a business entity whose shares are not traded to the general public in any stock exchange but that has a close-knit group of shareholders (or in some cases, only a single shareholder).

corporate of�icers (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The persons responsible for the day-to-day operation of a corporation who are appointed by the board of directors.

corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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A business entity that is separate and distinct from its owners, the shareholders. The law grants a corporation status as an arti�icial being, much like a person, in that it has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.

de facto corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation in fact, and treated as a valid corporation.

de jure corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation properly formed by virtue of law.

derivative action (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A lawsuit brought by the shareholders of a corporation instead of the board of directors, whom the shareholders believe did not take proper and timely action.

distributions (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In a Chapter C corporation, a distribution occurs when pro�its of the corporation are sent to the shareholders in the form of dividends.

dividends (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Pro�its divided equitably among stockholders.

domestic corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation operating only in the state in which it �iled its Articles of Incorporation.

double taxation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The concept that corporations are taxed twice: �irst, when the corporation pays income taxes on corporate pro�its, and second, when the shareholders pay personal income taxes on corporate pro�its distributed to them as dividends.

for-pro�it corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A traditional business that is organized for the purpose of returning a pro�it to the owners.

foreign corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation operating in states in which it did not �ile its original Articles of Incorporation. To become a foreign corporation, the business must �ile with the secretary of each state where it seeks to operate.

incorporators (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

People who form the initial group who aim to create a new business by making investments, selling stock subscriptions, and performing preincorporation activities at their own risk. Also known as promoters.

Model Business Corporation Act (MBCA) of 1950 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The basis of corporate law in most states, a model statute created by the American Bar Association.

nonpro�it corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporation organized for the purpose of achieving some artistic, humanitarian, or philanthropic purpose or the rendering of some public service. By de�inition, all public corporations are nonpro�it.

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piercing the corporate veil (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When a court allows a plaintiff to reach beyond the corporate assets and corporate immunity and allows the personal assets of the company owners or directors to be subject to a lawsuit, usually when there has been fraud in the formation of the corporation or other serious misconduct.

preferred stock (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A class of stock shares that gives its owners priority with regard to the distribution of dividends and a more elevated status if the corporation goes through bankruptcy.

private corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of corporation organized by private individuals to carry out private business, either pro�it or nonpro�it, depending on its purpose.

professional corporation (PC) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of corporation that is for pro�it and organized to provide a professional service such as for physicians, lawyers, architects, accountants, and engineers.

promoters (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

See incorporators.

public corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of corporation organized by the federal, state, or local government to carry out a necessary public service that is by nature nonpro�it.

publicly traded company (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of corporation whose shares are traded in any stock exchange.

registered agent (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The person designated by a corporation to receive service of process on behalf of the corporation.

secretary (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A corporate of�icer whose duty it is to keep records of directors’ and shareholders’ meetings and to authenticate records of the corporation.

shareholders (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The owners of a corporation whose interest in the corporation is represented by shares of stock. Shareholders exercise decision-making authority over the corporation at the annual meeting by electing members of the board of directors, rather than in the daily operations of the company.

stock subscription (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A contract in which the person agrees to buy shares of stock when the corporation comes into existence.

stockholder (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Person owning shares of stock in a corporation.

wholly owned subsidiary (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A company whose common stock is 100% owned by another company, commonly called the parent company.

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Chapter 30 Flashcards

Critical Thinking and Discussion Questions

1. What information must be contained in a corporation’s Articles of Incorporation?

2. Under the Model Business Corporation Act, when does a corporation’s existence begin?

3. De�ine the terms de jure corporation and de facto corporation.

4. Is a corporation responsible for the preincorporation contracts of its promoters once it comes into existence? Explain. Are promoters agents of the corporation? Explain.

5. What is the difference between a domestic, a foreign, and an alien corporation?

6. Under what circumstance might a court "pierce the corporate veil"?

7. Marlene, Charlene, and Phillip wish to start a band. They call their group MCP (Musically Challenged Persons) and begin booking gigs at local parties. Worried about the potential liability to which they may be subjected as a partnership, the three friends agree to incorporate their business. They sign an agreement that states, "We, the undersigned, hereby establish the MCP Corporation, an entertainment company devoted to �illing the needs of musically challenged audiences everywhere." Each person then signs the agreement. a. Is a corporation formed by the agreement? Explain. b. Under these facts, what type of business organization is involved? c. Assume for the moment that a de jure corporation is not formed under the facts given. Is a de facto corporation formed? Explain. d. What procedure should the three artistic entrepreneurs follow to incorporate their business?

8. José, Karen, and Lenny are partners in a very successful restaurant business in New Jersey. José is a citizen of Mexico who is a legal resident alien in the United States. Karen is a Canadian national who lives in Toronto but travels frequently to the United States on business. Lenny is an American citizen who lives in Elizabeth, New Jersey. The partners have recently decided that they would like to expand their business to numerous other sites in the state and would like to incorporate to lessen their personal liability risks. a. May the partners opt to �ile as a Chapter S corporation? Explain fully. b. What is the downside of creating a standard Chapter C corporation for the partners?

A corporation organized under the laws of another countryClick card to see term 👆

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The Constitution of the United States of America Preamble

We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.

Article I

Section 1

All legislative Powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives.

Section 2

The House of Representatives shall be composed of Members chosen every second Year by the People of the several States, and the Electors in each State shall have the Quali�ications requisite for Electors of the most numerous Branch of the State Legislature.

No Person shall be a Representative who shall not have attained to the Age of twenty �ive Years, and been seven Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State in which he shall be chosen.

Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three �ifths of all other Persons. The actual Enumeration shall be made within three Years after the �irst Meeting of the Congress of the United States, and within every subsequent Term of ten Years, in such Manner as they shall by Law direct. The Number of Representatives shall not exceed one for every thirty Thousand, but each State shall have at Least one Representative; and until such enumeration shall be made, the State of New Hampshire shall be entitled to chuse three, Massachusetts eight, Rhode-Island and Providence Plantations one, Connecticut �ive, New-York six, New Jersey four, Pennsylvania eight, Delaware one, Maryland six, Virginia ten, North Carolina �ive, South Carolina �ive, and Georgia three.

When vacancies happen in the Representation from any State, the Executive Authority thereof shall issue Writs of Election to �ill such Vacancies.

The House of Representatives shall chuse their Speaker and other Of�icers; and shall have the sole Power of Impeachment.

Section 3

The Senate of the United States shall be composed of two Senators from each State, chosen by the Legislature thereof for six Years; and each Senator shall have one Vote.

Immediately after they shall be assembled in Consequence of the �irst Election, they shall be divided as equally as may be into three Classes. The Seats of the Senators of the �irst Class shall be vacated at the Expiration of the second Year, of the second Class at the Expiration of the fourth Year, and of the third Class at the Expiration of the sixth Year, so that one third may be chosen every second Year; and if Vacancies happen by Resignation, or otherwise, during the Recess of the Legislature of any State, the Executive thereof may make temporary Appointments until the next Meeting of the Legislature, which shall then �ill such Vacancies.

No Person shall be a Senator who shall not have attained to the Age of thirty Years, and been nine Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State for which he shall be chosen.

The Vice President of the United States shall be President of the Senate, but shall have no Vote, unless they be equally divided.

The Senate shall chuse their other Of�icers, and also a President pro tempore, in the Absence of the Vice President, or when he shall exercise the Of�ice of President of the United States.

The Senate shall have the sole Power to try all Impeachments. When sitting for that Purpose, they shall be on Oath or Af�irmation. When the President of the United States is tried, the Chief Justice shall preside: And no Person shall be convicted without the Concurrence of two thirds of the Members present.

Judgment in Cases of Impeachment shall not extend further than to removal from Of�ice, and disquali�ication to hold and enjoy any Of�ice of honor, Trust or Pro�it under the United States: but the Party convicted shall nevertheless be liable and subject to Indictment, Trial, Judgment and Punishment, according to Law.

Section 4

The Times, Places and Manner of holding Elections for Senators and Representatives, shall be prescribed in each State by the Legislature thereof; but the Congress may at any time by Law make or alter such Regulations, except as to the Places of chusing Senators.

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The Congress shall assemble at least once in every Year, and such Meeting shall be on the �irst Monday in December, unless they shall by Law appoint a different Day.

Section 5

Each House shall be the Judge of the Elections, Returns and Quali�ications of its own Members, and a Majority of each shall constitute a Quorum to do Business; but a smaller Number may adjourn from day to day, and may be authorized to compel the Attendance of absent Members, in such Manner, and under such Penalties as each House may provide.

Each House may determine the Rules of its Proceedings, punish its Members for disorderly Behaviour, and, with the Concurrence of two thirds, expel a Member.

Each House shall keep a Journal of its Proceedings, and from time to time publish the same, excepting such Parts as may in their Judgment require Secrecy; and the Yeas and Nays of the Members of either House on any question shall, at the Desire of one �ifth of those Present, be entered on the Journal.

Neither House, during the Session of Congress, shall, without the Consent of the other, adjourn for more than three days, nor to any other Place than that in which the two Houses shall be sitting.

Section 6

The Senators and Representatives shall receive a Compensation for their Services, to be ascertained by Law, and paid out of the Treasury of the United States. They shall in all Cases, except Treason, Felony and Breach of the Peace, be privileged from Arrest during their Attendance at the Session of their respective Houses, and in going to and returning from the same; and for any Speech or Debate in either House, they shall not be questioned in any other Place.

No Senator or Representative shall, during the Time for which he was elected, be appointed to any civil Of�ice under the Authority of the United States, which shall have been created, or the Emoluments whereof shall have been encreased during such time; and no Person holding any Of�ice under the United States, shall be a Member of either House during his Continuance in Of�ice.

Section 7

All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills.

Every Bill which shall have passed the House of Representatives and the Senate, shall, before it become a Law, be presented to the President of the United States: If he approve he shall sign it, but if not he shall return it, with his Objections to that House in which it shall have originated, who shall enter the Objections at large on their Journal, and proceed to reconsider it. If after such Reconsideration two thirds of that House shall agree to pass the Bill, it shall be sent, together with the Objections, to the other House, by which it shall likewise be reconsidered, and if approved by two thirds of that House, it shall become a Law. But in all such Cases the Votes of both Houses shall be determined by yeas and Nays, and the Names of the Persons voting for and against the Bill shall be entered on the Journal of each House respectively. If any Bill shall not be returned by the President within ten Days (Sundays excepted) after it shall have been presented to him, the Same shall be a Law, in like Manner as if he had signed it, unless the Congress by their Adjournment prevent its Return, in which Case it shall not be a Law.

Every Order, Resolution, or Vote to which the Concurrence of the Senate and House of Representatives may be necessary (except on a question of Adjournment) shall be presented to the President of the United States; and before the Same shall take Effect, shall be approved by him, or being disapproved by him, shall be repassed by two thirds of the Senate and House of Representatives, according to the Rules and Limitations prescribed in the Case of a Bill.

Section 8

The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

To borrow Money on the credit of the United States;

To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;

To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;

To coin Money, regulate the Value thereof, and of foreign Coin, and �ix the Standard of Weights and Measures;

To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;

To establish Post Of�ices and post Roads;

To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;

To constitute Tribunals inferior to the supreme Court;

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To de�ine and punish Piracies and Felonies committed on the high Seas, and Offences against the Law of Nations;

To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water;

To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years;

To provide and maintain a Navy;

To make Rules for the Government and Regulation of the land and naval Forces;

To provide for calling forth the Militia to execute the Laws of the Union, suppress Insurrections and repel Invasions;

To provide for organizing, arming, and disciplining, the Militia, and for governing such Part of them as may be employed in the Service of the United States, reserving to the States respectively, the Appointment of the Of�icers, and the Authority of training the Militia according to the discipline prescribed by Congress;

To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards, and other needful Buildings;—And

To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Of�icer thereof.

Section 9

The Migration or Importation of such Persons as any of the States now existing shall think proper to admit, shall not be prohibited by the Congress prior to the Year one thousand eight hundred and eight, but a Tax or duty may be imposed on such Importation, not exceeding ten dollars for each Person.

The Privilege of the Writ of Habeas Corpus shall not be suspended, unless when in Cases of Rebellion or Invasion the public Safety may require it.

No Bill of Attainder or ex post facto Law shall be passed.

No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.

No Tax or Duty shall be laid on Articles exported from any State.

No Preference shall be given by any Regulation of Commerce or Revenue to the Ports of one State over those of another; nor shall Vessels bound to, or from, one State, be obliged to enter, clear, or pay Duties in another.

No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.

No Title of Nobility shall be granted by the United States: And no Person holding any Of�ice of Pro�it or Trust under them, shall, without the Consent of the Congress, accept of any present, Emolument, Of�ice, or Title, of any kind whatever, from any King, Prince, or foreign State.

Section 10

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing its inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Controul of the Congress.

No State shall, without the Consent of Congress, lay any Duty of Tonnage, keep Troops, or Ships of War in time of Peace, enter into any Agreement or Compact with another State, or with a foreign Power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay.

Article II

Section 1

The executive Power shall be vested in a President of the United States of America. He shall hold his Of�ice during the Term of four Years, and, together with the Vice President, chosen for the same Term, be elected, as follows:

Each State shall appoint, in such Manner as the Legislature thereof may direct, a Number of Electors, equal to the whole Number of Senators and Representatives to which the State may be entitled in the Congress: but no Senator or Representative, or Person holding an Of�ice of Trust or Pro�it under the United States, shall be appointed an Elector.

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The Electors shall meet in their respective States, and vote by Ballot for two Persons, of whom one at least shall not be an Inhabitant of the same State with themselves. And they shall make a List of all the Persons voted for, and of the Number of Votes for each; which List they shall sign and certify, and transmit sealed to the Seat of the Government of the United States, directed to the President of the Senate. The President of the Senate shall, in the Presence of the Senate and House of Representatives, open all the Certi�icates, and the Votes shall then be counted. The Person having the greatest Number of Votes shall be the President, if such Number be a Majority of the whole Number of Electors appointed; and if there be more than one who have such Majority, and have an equal Number of Votes, then the House of Representatives shall immediately chuse by Ballot one of them for President; and if no Person have a Majority, then from the �ive highest on the List the said House shall in like Manner chuse the President. But in chusing the President, the Votes shall be taken by States, the Representation from each State having one Vote; A quorum for this purpose shall consist of a Member or Members from two thirds of the States, and a Majority of all the States shall be necessary to a Choice. In every Case, after the Choice of the President, the Person having the greatest Number of Votes of the Electors shall be the Vice President. But if there should remain two or more who have equal Votes, the Senate shall chuse from them by Ballot the Vice President.

The Congress may determine the Time of chusing the Electors, and the Day on which they shall give their Votes; which Day shall be the same throughout the United States.

No Person except a natural born Citizen, or a Citizen of the United States, at the time of the Adoption of this Constitution, shall be eligible to the Of�ice of President; neither shall any Person be eligible to that Of�ice who shall not have attained to the Age of thirty �ive Years, and been fourteen Years a Resident within the United States.

In Case of the Removal of the President from Of�ice, or of his Death, Resignation, or Inability to discharge the Powers and Duties of the said Of�ice, the Same shall devolve on the Vice President, and the Congress may by Law provide for the Case of Removal, Death, Resignation or Inability, both of the President and Vice President, declaring what Of�icer shall then act as President, and such Of�icer shall act accordingly, until the Disability be removed, or a President shall be elected.

The President shall, at stated Times, receive for his Services, a Compensation, which shall neither be increased nor diminished during the Period for which he shall have been elected, and he shall not receive within that Period any other Emolument from the United States, or any of them.

Before he enter on the Execution of his Of�ice, he shall take the following Oath or Af�irmation:—"I do solemnly swear (or af�irm) that I will faithfully execute the Of�ice of President of the United States, and will to the best of my Ability, preserve, protect and defend the Constitution of the United States."

Section 2

The President shall be Commander in Chief of the Army and Navy of the United States, and of the Militia of the several States, when called into the actual Service of the United States; he may require the Opinion, in writing, of the principal Of�icer in each of the executive Departments, upon any Subject relating to the Duties of their respective Of�ices, and he shall have Power to grant Reprieves and Pardons for Offences against the United States, except in Cases of Impeachment.

He shall have Power, by and with the Advice and Consent of the Senate, to make Treaties, provided two thirds of the Senators present concur; and he shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Of�icers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Of�icers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.

The President shall have Power to �ill up all Vacancies that may happen during the Recess of the Senate, by granting Commissions which shall expire at the End of their next Session.

Section 3

He shall from time to time give to the Congress Information of the State of the Union, and recommend to their Consideration such Measures as he shall judge necessary and expedient; he may, on extraordinary Occasions, convene both Houses, or either of them, and in Case of Disagreement between them, with Respect to the Time of Adjournment, he may adjourn them to such Time as he shall think proper; he shall receive Ambassadors and other public Ministers; he shall take Care that the Laws be faithfully executed, and shall Commission all the Of�icers of the United States.

Section 4

The President, Vice President and all civil Of�icers of the United States, shall be removed from Of�ice on Impeachment for, and Conviction of, Treason, Bribery, or other high Crimes and Misdemeanors.

Article III

Section 1

The judicial Power of the United States shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish. The Judges, both of the supreme and inferior Courts, shall hold their Of�ices during good Behaviour, and shall, at stated Times, receive for their Services a Compensation, which shall not be diminished during their Continuance in Of�ice.

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Section 2

The judicial Power shall extend to all Cases, in Law and Equity, arising under this Constitution, the Laws of the United States, and Treaties made, or which shall be made, under their Authority;—to all Cases affecting Ambassadors, other public Ministers and Consuls;— to all Cases of admiralty and maritime Jurisdiction;—to Controversies to which the United States shall be a Party;—to Controversies between two or more States;—between a State and Citizens of another State,—between Citizens of different States,—between Citizens of the same State claiming Lands under Grants of different States, and between a State, or the Citizens thereof, and foreign States, Citizens or Subjects.

In all Cases affecting Ambassadors, other public Ministers and Consuls, and those in which a State shall be Party, the supreme Court shall have original Jurisdiction. In all the other Cases before mentioned, the supreme Court shall have appellate Jurisdiction, both as to Law and Fact, with such Exceptions, and under such Regulations as the Congress shall make.

The Trial of all Crimes, except in Cases of Impeachment, shall be by Jury; and such Trial shall be held in the State where the said Crimes shall have been committed; but when not committed within any State, the Trial shall be at such Place or Places as the Congress may by Law have directed.

Section 3

Treason against the United States, shall consist only in levying War against them, or in adhering to their Enemies, giving them Aid and Comfort. No Person shall be convicted of Treason unless on the Testimony of two Witnesses to the same overt Act, or on Confession in open Court.

The Congress shall have Power to declare the Punishment of Treason, but no Attainder of Treason shall work Corruption of Blood, or Forfeiture except during the Life of the Person attainted.

Article IV

Section 1

Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State. And the Congress may by general Laws prescribe the Manner in which such Acts, Records and Proceedings shall be proved, and the Effect thereof.

Section 2

The Citizens of each State shall be entitled to all Privileges and Immunities of Citizens in the several States.

A Person charged in any State with Treason, Felony, or other Crime, who shall �lee from Justice, and be found in another State, shall on Demand of the executive Authority of the State from which he �led, be delivered up, to be removed to the State having Jurisdiction of the Crime.

No Person held to Service or Labour in one State, under the Laws thereof, escaping into another, shall, in Consequence of any Law or Regulation therein, be discharged from such Service or Labour, but shall be delivered up on Claim of the Party to whom such Service or Labour may be due.

Section 3

New States may be admitted by the Congress into this Union; but no new State shall be formed or erected within the Jurisdiction of any other State; nor any State be formed by the Junction of two or more States, or Parts of States, without the Consent of the Legislatures of the States concerned as well as of the Congress.

The Congress shall have Power to dispose of and make all needful Rules and Regulations respecting the Territory or other Property belonging to the United States; and nothing in this Constitution shall be so construed as to Prejudice any Claims of the United States, or of any particular State.

Section 4

The United States shall guarantee to every State in this Union a Republican Form of Government, and shall protect each of them against Invasion; and on Application of the Legislature, or of the Executive (when the Legislature cannot be convened), against domestic Violence.

Article V

The Congress, whenever two thirds of both Houses shall deem it necessary, shall propose Amendments to this Constitution, or, on the Application of the Legislatures of two thirds of the several States, shall call a Convention for proposing Amendments, which, in either Case, shall be valid to all Intents and Purposes, as Part of this Constitution, when rati�ied by the Legislatures of three fourths of the several States, or by Conventions in three fourths thereof, as the one or the other Mode of Rati�ication may be proposed by the Congress; Provided that no Amendment which may be made prior to the Year One thousand eight hundred and eight shall in any Manner affect the �irst and fourth Clauses in the Ninth Section of the �irst Article; and that no State, without its Consent, shall be deprived of its equal Suffrage in the Senate.

Article VI

All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution, as under the Confederation.

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This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.

The Senators and Representatives before mentioned, and the Members of the several State Legislatures, and all executive and judicial Of�icers, both of the United States and of the several States, shall be bound by Oath or Af�irmation, to support this Constitution; but no religious Test shall ever be required as a Quali�ication to any Of�ice or public Trust under the United States.

Article VII

The Rati�ication of the Conventions of nine States, shall be suf�icient for the Establishment of this Constitution between the States so ratifying the Same.

The Word, "the," being interlined between the seventh and eighth Lines of the �irst Page, the Word "Thirty" being partly written on an Erazure in the �ifteenth Line of the �irst Page, The Words "is tried" being interlined between the thirty second and thirty third Lines of the �irst Page and the Word "the" being interlined between the forty third and forty fourth Lines of the second Page.

Attest William Jackson Secretary

done in Convention by the Unanimous Consent of the States present the Seventeenth Day of September in the Year of our Lord one thousand seven hundred and Eighty seven and of the Independance of the United States of America the Twelfth In witness whereof We have hereunto subscribed our Names.

Amendments

[The �irst 10 amendments are known as the "Bill of Rights."]

Amendment I

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

Amendment II

A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

Amendment III

No Soldier shall, in time of peace be quartered in any house, without the consent of the Owner, nor in time of war, but in a manner to be prescribed by law.

Amendment IV

The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or af�irmation, and particularly describing the place to be searched, and the persons or things to be seized.

Amendment V

No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offence to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

Amendment VI

In all criminal prosecutions, the accused shall enjoy the right to a speedy and public trial, by an impartial jury of the State and district wherein the crime shall have been committed, which district shall have been previously ascertained by law, and to be informed of the nature and cause of the accusation; to be confronted with the witnesses against him; to have compulsory process for obtaining witnesses in his favor, and to have the Assistance of Counsel for his defence.

Amendment VII

In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law.

Amendment VIII

Excessive bail shall not be required, nor excessive �ines imposed, nor cruel and unusual punishments in�licted.

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Amendment IX

The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.

Amendment X

The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.

AMENDMENT XI

Passed by Congress March 4, 1794. Rati�ied February 7, 1795.

Note: Article III, section 2, of the Constitution was modi�ied by amendment 11.

The Judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State.

AMENDMENT XII

Passed by Congress December 9, 1803. Rati�ied June 15, 1804.

Note: A portion of Article II, section 1 of the Constitution was superseded by the 12th amendment.

The Electors shall meet in their respective states and vote by ballot for President and Vice-President, one of whom, at least, shall not be an inhabitant of the same state with themselves; they shall name in their ballots the person voted for as President, and in distinct ballots the person voted for as Vice-President, and they shall make distinct lists of all persons voted for as President, and of all persons voted for as Vice-President, and of the number of votes for each, which lists they shall sign and certify, and transmit sealed to the seat of the government of the United States, directed to the President of the Senate;— the President of the Senate shall, in the presence of the Senate and House of Representatives, open all the certi�icates and the votes shall then be counted;—The person having the greatest number of votes for President, shall be the President, if such number be a majority of the whole number of Electors appointed; and if no person have such majority, then from the persons having the highest numbers not exceeding three on the list of those voted for as President, the House of Representatives shall choose immediately, by ballot, the President. But in choosing the President, the votes shall be taken by states, the representation from each state having one vote; a quorum for this purpose shall consist of a member or members from two-thirds of the states, and a majority of all the states shall be necessary to a choice. [And if the House of Representatives shall not choose a President whenever the right of choice shall devolve upon them, before the fourth day of March next following, then the Vice-President shall act as President, as in case of the death or other constitutional disability of the President.—]* The person having the greatest number of votes as Vice-President, shall be the Vice-President, if such number be a majority of the whole number of Electors appointed, and if no person have a majority, then from the two highest numbers on the list, the Senate shall choose the Vice-President; a quorum for the purpose shall consist of two-thirds of the whole number of Senators, and a majority of the whole number shall be necessary to a choice. But no person constitutionally ineligible to the of�ice of President shall be eligible to that of Vice-President of the United States.

*Superseded by section 3 of the 20th amendment.

AMENDMENT XIII

Passed by Congress January 31, 1865. Rati�ied December 6, 1865.

Note: A portion of Article IV, section 2, of the Constitution was superseded by the 13th amendment.

Section 1

Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.

Section 2

Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XIV

Passed by Congress June 13, 1866. Rati�ied July 9, 1868.

Note: Article I, section 2, of the Constitution was modi�ied by section 2 of the 14th amendment.

Section 1

All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside. No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

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Section 2

Representatives shall be apportioned among the several States according to their respective numbers, counting the whole number of persons in each State, excluding Indians not taxed. But when the right to vote at any election for the choice of electors for President and Vice-President of the United States, Representatives in Congress, the Executive and Judicial of�icers of a State, or the members of the Legislature thereof, is denied to any of the male inhabitants of such State, being twenty-one years of age,* and citizens of the United States, or in any way abridged, except for participation in rebellion, or other crime, the basis of representation therein shall be reduced in the proportion which the number of such male citizens shall bear to the whole number of male citizens twenty-one years of age in such State.

Section 3

No person shall be a Senator or Representative in Congress, or elector of President and Vice-President, or hold any of�ice, civil or military, under the United States, or under any State, who, having previously taken an oath, as a member of Congress, or as an of�icer of the United States, or as a member of any State legislature, or as an executive or judicial of�icer of any State, to support the Constitution of the United States, shall have engaged in insurrection or rebellion against the same, or given aid or comfort to the enemies thereof. But Congress may by a vote of two-thirds of each House, remove such disability.

Section 4

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

Section 5

The Congress shall have the power to enforce, by appropriate legislation, the provisions of this article.

*Changed by section 1 of the 26th amendment.

AMENDMENT XV

Passed by Congress February 26, 1869. Rati�ied February 3, 1870.

Section 1

The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of race, color, or previous condition of servitude—

Section 2

The Congress shall have the power to enforce this article by appropriate legislation.

AMENDMENT XVI

Passed by Congress July 2, 1909. Rati�ied February 3, 1913.

Note: Article I, section 9, of the Constitution was modi�ied by amendment 16.

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

AMENDMENT XVII

Passed by Congress May 13, 1912. Rati�ied April 8, 1913.

Note: Article I, section 3, of the Constitution was modi�ied by the 17th amendment.

The Senate of the United States shall be composed of two Senators from each State, elected by the people thereof, for six years; and each Senator shall have one vote. The electors in each State shall have the quali�ications requisite for electors of the most numerous branch of the State legislatures.

When vacancies happen in the representation of any State in the Senate, the executive authority of such State shall issue writs of election to �ill such vacancies: Provided, That the legislature of any State may empower the executive thereof to make temporary appointments until the people �ill the vacancies by election as the legislature may direct.

This amendment shall not be so construed as to affect the election or term of any Senator chosen before it becomes valid as part of the Constitution.

AMENDMENT XVIII

Passed by Congress December 18, 1917. Rati�ied January 16, 1919. Repealed by amendment 21.

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Section 1

After one year from the rati�ication of this article the manufacture, sale, or transportation of intoxicating liquors within, the importation thereof into, or the exportation thereof from the United States and all territory subject to the jurisdiction thereof for beverage purposes is hereby prohibited.

Section 2

The Congress and the several States shall have concurrent power to enforce this article by appropriate legislation.

Section 3

This article shall be inoperative unless it shall have been rati�ied as an amendment to the Constitution by the legislatures of the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress.

AMENDMENT XIX

Passed by Congress June 4, 1919. Rati�ied August 18, 1920.

The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of sex.

Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XX

Passed by Congress March 2, 1932. Rati�ied January 23, 1933.

Note: Article I, section 4, of the Constitution was modi�ied by section 2 of this amendment. In addition, a portion of the 12th amendment was superseded by section 3.

Section 1

The terms of the President and the Vice President shall end at noon on the 20th day of January, and the terms of Senators and Representatives at noon on the 3d day of January, of the years in which such terms would have ended if this article had not been rati�ied; and the terms of their successors shall then begin.

Section 2

The Congress shall assemble at least once in every year, and such meeting shall begin at noon on the 3d day of January, unless they shall by law appoint a different day.

Section 3

If, at the time �ixed for the beginning of the term of the President, the President elect shall have died, the Vice President elect shall become President. If a President shall not have been chosen before the time �ixed for the beginning of his term, or if the President elect shall have failed to qualify, then the Vice President elect shall act as President until a President shall have quali�ied; and the Congress may by law provide for the case wherein neither a President elect nor a Vice President shall have quali�ied, declaring who shall then act as President, or the manner in which one who is to act shall be selected, and such person shall act accordingly until a President or Vice President shall have quali�ied.

Section 4

The Congress may by law provide for the case of the death of any of the persons from whom the House of Representatives may choose a President whenever the right of choice shall have devolved upon them, and for the case of the death of any of the persons from whom the Senate may choose a Vice President whenever the right of choice shall have devolved upon them.

Section 5

Sections 1 and 2 shall take effect on the 15th day of October following the rati�ication of this article.

Section 6

This article shall be inoperative unless it shall have been rati�ied as an amendment to the Constitution by the legislatures of three-fourths of the several States within seven years from the date of its submission.

AMENDMENT XXI

Passed by Congress February 20, 1933. Rati�ied December 5, 1933.

Section 1

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The eighteenth article of amendment to the Constitution of the United States is hereby repealed.

Section 2

The transportation or importation into any State, Territory, or Possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.

Section 3

This article shall be inoperative unless it shall have been rati�ied as an amendment to the Constitution by conventions in the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress.

AMENDMENT XXII

Passed by Congress March 21, 1947. Rati�ied February 27, 1951.

Section 1

No person shall be elected to the of�ice of the President more than twice, and no person who has held the of�ice of President, or acted as President, for more than two years of a term to which some other person was elected President shall be elected to the of�ice of President more than once. But this Article shall not apply to any person holding the of�ice of President when this Article was proposed by Congress, and shall not prevent any person who may be holding the of�ice of President, or acting as President, during the term within which this Article becomes operative from holding the of�ice of President or acting as President during the remainder of such term.

Section 2

This article shall be inoperative unless it shall have been rati�ied as an amendment to the Constitution by the legislatures of three-fourths of the several States within seven years from the date of its submission to the States by the Congress.

AMENDMENT XXIII

Passed by Congress June 16, 1960. Rati�ied March 29, 1961.

Section 1

The District constituting the seat of Government of the United States shall appoint in such manner as Congress may direct:

A number of electors of President and Vice President equal to the whole number of Senators and Representatives in Congress to which the District would be entitled if it were a State, but in no event more than the least populous State; they shall be in addition to those appointed by the States, but they shall be considered, for the purposes of the election of President and Vice President, to be electors appointed by a State; and they shall meet in the District and perform such duties as provided by the twelfth article of amendment.

Section 2

The Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XXIV

Passed by Congress August 27, 1962. Rati�ied January 23, 1964.

Section 1

The right of citizens of the United States to vote in any primary or other election for President or Vice President, for electors for President or Vice President, or for Senator or Representative in Congress, shall not be denied or abridged by the United States or any State by reason of failure to pay poll tax or other tax.

Section 2

The Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XXV

Passed by Congress July 6, 1965. Rati�ied February 10, 1967.

Note: Article II, section 1, of the Constitution was affected by the 25th amendment.

Section 1

In case of the removal of the President from of�ice or of his death or resignation, the Vice President shall become President.

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Section 2

Whenever there is a vacancy in the of�ice of the Vice President, the President shall nominate a Vice President who shall take of�ice upon con�irmation by a majority vote of both Houses of Congress.

Section 3

Whenever the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his written declaration that he is unable to discharge the powers and duties of his of�ice, and until he transmits to them a written declaration to the contrary, such powers and duties shall be discharged by the Vice President as Acting President.

Section 4

Whenever the Vice President and a majority of either the principal of�icers of the executive departments or of such other body as Congress may by law provide, transmit to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declaration that the President is unable to discharge the powers and duties of his of�ice, the Vice President shall immediately assume the powers and duties of the of�ice as Acting President.

Thereafter, when the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his written declaration that no inability exists, he shall resume the powers and duties of his of�ice unless the Vice President and a majority of either the principal of�icers of the executive department or of such other body as Congress may by law provide, transmit within four days to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declaration that the President is unable to discharge the powers and duties of his of�ice. Thereupon Congress shall decide the issue, assembling within forty-eight hours for that purpose if not in session. If the Congress, within twenty-one days after receipt of the latter written declaration, or, if Congress is not in session, within twenty-one days after Congress is required to assemble, determines by two-thirds vote of both Houses that the President is unable to discharge the powers and duties of his of�ice, the Vice President shall continue to discharge the same as Acting President; otherwise, the President shall resume the powers and duties of his of�ice.

AMENDMENT XXVI

Passed by Congress March 23, 1971. Rati�ied July 1, 1971.

Note: Amendment 14, section 2, of the Constitution was modi�ied by section 1 of the 26th amendment.

Section 1

The right of citizens of the United States, who are eighteen years of age or older, to vote shall not be denied or abridged by the United States or by any State on account of age.

Section 2

The Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XXVII

Originally proposed September 25, 1789. Rati�ied May 7, 1992.

No law, varying the compensation for the services of the Senators and Representatives, shall take effect, until an election of representatives shall have intervened.