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In many ways, legal rights and legal responsibilities can impact a client's overall progress toward desired personal or business goals. A wise financial manager or advisor is aware of relevant legal issues and their impact on the analysis of factors such as costs, benefits, returns, and management of risk.

While it is not a financial advisor's role to provide legal advice, (and to do so without a law license in the jurisdiction may well constitute the unauthorized practice of law), proceeding without consideration of the law can bite a client in the bottom line!

So fasten your seat belt as we take off to gain an aerial view of the main features of the legal landscape that provides the ever-present, but sometimes unnoticed, backdrop for clients' business and financial endeavors.

The Constitution of the United States, including its amendments, is the foundational legal document for the United States of America. The Constitution creates three branches of government:
Legislative Branch Makes statutory laws that are enacted	Executive Branch Enforces the laws and sometimes issues executive orders	Judicial Branch Interprets and applies laws to decide cases (and it's course decisions become part of the body of common law precedents)

The table below will give you a refresher on the different levels of government and the types of laws at each.

Administrative agencies (which may be part of the executive branch or may be independent agencies created by statute) sometimes engage in quasi-legislative activities like making regulations and sometimes engage in quasi-judicial activities like holding hearings to decide cases. The Social Security Administration is an example of a federal administrative agency has published regulations to carry out its statutory authority and holds benefits hearings.

The illustration below defines the three key areas of law:

Illustration of the Interplay Among These Areas of Law

A mother takes her child to a play area featuring large inflatable slides. The business that owns or leases the space where the play area is located has the right, under property law, to keep other people out of that space. If someone were to get hurt in the play area, the business might be liable, under tort law , to compensate the hurt person for his/her injuries. The business wants to make money from its play area without too much risk of loss due to injuries, so the business manages the potential risk, under contract law, by requiring two things in order for the parent and child to enter the play area:

1. The parent is required to sign an agreement acknowledging the risk of injury to the child and agreeing to release the business from all liability if the child gets hurt; and

2. The parent must pay an admission fee.

Key Terms and Concepts

Distinguishing Legal Wrongdoing from Moral Wrongdoing

Ethical principles often call people to aspire to a higher standard of what they ought to do, while laws generally define a minimum level of acceptable conduct below which one cannot fall without penalty. Not everything that is considered legally permissible is also considered morally right, but most laws reflect some ethical thinking and moral values prevalent in the community governed by those laws. The table below illustrates the interplay between these concepts.

Legally Wrong	Crime (Criminal Case)	Tort (Civil Case)
· An act or omission is considered legally wrong based on the legal standards of a society. · Under applicable federal and/or state law in the United States, the wrongdoer may be held accountable by a civil court, a criminal court, or possibly both.	· May be based on common law or statute · Crime is prosecuted by the government (State v. Defendant) at the prosecutor's discretion · Defendant has a constitutional right to be legally represented by counsel (privately retained lawyer or public defender) · A criminal defendant is presumed innocent unless the prosecutor proves "beyond a reasonable doubt" that the defendant is guilty of the crime(s) charged. · A defendant found guilty may be sentenced to jail time, be required to pay fines, or incur other penalties.	· May be based on common law or statute · Claim or action is brought by a complaining party (Plaintiff v. Defendant) · Defendant may be legally represented by counsel, but generally no court-appointed lawyer is provided · A civil defendant is not liable unless the plaintiff proves "by a preponderance of the evidence" that it is more likely than not that the defendant is responsible for the wrongdoing claimed. · If defendant is found liable, plaintiff may be awarded damages or other legal or equitable remedies, but civil liability is not grounds for imprisonment.
Morally Wrong · An act or omission is considered morally wrong based on the ethical standards of a society. · The wrongdoer may be held accountable by members of the community through their attitudes or through their future willingness to interact, socialize, or do business with the wrongdoer.

Illustration

In the criminal trial in which O.J. Simpson was charged with two counts of murder, the jury reached a verdict of "not guilty." However, under different procedural rules in the civil trial, with the lower civil standard of proof and a different judge allowing different evidence to be admitted, the jury in the civil trial found O.J. Simpson liable for the wrongful death of Ronald Goldman and for state law survivor claims relating to the killing of Ronald Goldman and Nicole Brown Simpson. Rufo, et al. v Simpson, 86 Cal. App. 4th 573, 103 Cal. Rptr. 2d 492, (Cal. Ct. App. 2001), available at http://law.justia.com/cases/california/caapp4th/86/573.html . Many people would view killing as morally wrong, even if it were not against the law.

Case Study

Your neighbor Bob builds beautiful things out of scrap wood. When people see the things Bob has made things for you and for others around the neighborhood, they want to know where they can buy them or whether they can hire Bob to make things for them, too. Bob is thinking the time is ripe for opening his wood-working business.

What kind of business structure should Bob choose if he doesn't like paperwork hassles?

The easiest kind of business to start is a sole proprietorship. When a business has only one owner and that owner is a natural person (in other words, a real, live human being) the sole proprietorship is established. Sole proprietors report their business income and expenses on a separate part ( Schedule C ) of their own personal federal income tax return. Depending on the jurisdiction where the sole proprietorship business is carried on, though, there may be other filing requirements, such as state income tax returns, state personal property tax returns, licenses to conduct certain kinds of business activities, or registration of trade names (business names other than the owner's own name). So while there is no hassle-free, paperwork-free business entity, sole proprietorships are about as simple as business entities come.

Also, as sole owner, management of the business is ultimately centralized in Bob alone, so Bob avoids the hassles and potential conflicts of having to share management decision-making with others.

Are there any drawbacks to doing business as a sole proprietor?

Yes.

1. Sole proprietorship offers no protection for the owner's non-business-related personal assets. If someone won a lawsuit over a business claim, the winner could seek to recover the judgment not only from Bob's business assets, but also from his personal non-business assets (such as Bob's house or personal bank accounts.) Another way of saying this is to say that Bob's liability for business obligations is not limited to the amount Bob has invested in the business.

2. If Bob needs more funding for his business, he will either need to earn more money in the business, invest more of his own money, borrow money, sell business assets, or seek grants or gifts. For a sole proprietor, neither selling off part of the ownership in the business nor seeking capital investments from one or more partners is an option. Another way of saying this is to say that ownership interests in a sole proprietorship are not freely transferable.

3. Bob's sole proprietorship lasts only as long as Bob carries on the business, so when Bob dies or when Bob sells off the business assets or otherwise ceases doing business, the sole proprietorship ends at that point, too. If Bob were to sell off the assets of the business, including any intangible property like a trade name (such as "Bob's Woodworks") or goodwill of the business (such as customer lists), it might seem as though the business lasted beyond Bob's lifetime, but it would actually be a different sole proprietorship of the then-current owner . . . and the new owner might even be doing business under a different form of business entity altogether. The characteristic of a business that relates to the business lasting beyond the life or involvement of all or most of its original owners is known as "perpetual life" or "continuity of life."

What are the pros and cons of Bob's taking on a partner in the business?

1. On the plus side, a partner could invest needed capital or bring other assets or skills to the business.

2. A general partnership offers no protection for a partner's non-business-related personal assets. If someone were to win a lawsuit over a business claim, the winner could seek to recover the judgment not only from Bob's business assets, but also from the personal assets of Bob and/or any of Bob's general partners. This is known as "joint and several liability."

3. Unless there is a partnership agreement that states otherwise, all general partners have a say in how the affairs of the partnership are managed, and all general partners have authority to bind the partnership by their acts and commitments. Bob may not like sharing control of his business.

What are some options for protection against personal liability for one's business obligations?

1. State law provides for creating and maintaining certain types of business entities that are recognized as "persons" for legal purposes, such as corporations and limited liability companies (LLCs) . The requirements vary from state to state. Just as a living person has a birth certificate to give legal recognition to his or her existence, the corporation or LLC has a charter document that attests to the existence of the entity, once the document is accepted for filing with the state where the corporation is incorporated or the LLC is organized. The governing documents (charter document and bylaws) describe the structure of the organization, the kinds of activities the organization is authorized to undertake, and the means by which the organization can act through duly authorized persons. Failing to comply with the formalities required by the state or by the entity's governing documents may result in administrative dissolution of the entity or loss of limited liability protection.

Comparison of Corporations and Limited Liability Companies (LLCs)

	Corporation	Limited Liability Company
Charter Document	Articles of Incorporation	Articles of Organization
Attributes of Entity	· Limited Liability · Continuity of Life · Centralized Management · Free Transferability of Shares	· Limited Liability · Centralized Management (if a manager-managed LLC) · Continuity of Life (if state law so provides and the governing documents for the entity do not provide otherwise) Note: For tax-related reasons, LLCs may have no more than two of the four attributes listed for a corporation.
Tax Considerations	Double Taxation The corporation pays tax on the income it reports on its corporate tax return. When dividends are distributed to shareholders from the corporation's income, each shareholder pays tax on the dividend income reported on the shareholder's tax return. Thus, the same income is taxed twice - once at the corporate level and once at the shareholder level. A corporation may choose not to pay all of its earnings as dividends in a given year.	Pass-Through Treatment Unless the LLC files specific forms to elect to be taxed as a corporation, income is passed through to the member or members. A single member LLC would report income like a sole proprietor would, on the member's individual income tax return; otherwise, the LLC's income would be reported on a partnership tax return and tax would be paid on each partner's share as reported on that partner's tax return.

A valid contract is a legally enforceable agreement. In general, human relations work best when people can trust each other, and in some situations, society considers agreements and promises important enough to support by holding the parties legally accountable for keeping their promises and doing what they say they are going to do and by imposing legal penalties for failing to uphold their end of their bargains. As a matter of civil law, courts look at the parties' intentions and mutual understandings in the formation of agreements to decide which agreements are legally enforceable. The interactive chart below describes the essential elements of a legally enforceable contract.

Choose Your Contract Terms

When reading contract language and considering what contract terms to accept, some important questions are:

· Which party receives the benefit of this particular clause?

· Will this language, if enforced as written, be suitable to accomplish my (or my client's) intended goals?

· What alternatives are available if I do not agree to the contract terms? Are any of those alternatives better than living with the contract terms that are not to my liking?

Each of the typical contract clauses below includes the likely effect of having that language in a contract versus the effect of leaving the language out of the contract.

Severability Clause

For Example: If any provision of this contract is determined by a court not to be valid or enforceable, the remaining provisions of this contract shall remain in full force and effect.

· Including this clause helps make sure that the invalidity or unenforceability of a small part of the contract will not render the entire contract invalid and unenforceable.

· Omitting this clause: If a party who is trying to get out of the contract can prove that any part of the contract is invalid or unenforceable, that party may be able to have the entire contract deemed invalid and unenforceable.

Entire Agreement Provision

For Example: This agreement is the entire agreement of the parties.

· Including this clause clarifies that any discussions or promises made orally are not part of the contract, unless such matters appear in writing in the contract.

· Omitting this clause: Parties may argue about whether oral promises relating to the subject matter of the written contract are legally binding and enforceable.

Choice of Law Provision

For Example: This contract shall be governed by the laws of the state of North Carolina.

· Including this clause clarifies which jurisdiction's law governs for choice of law purposes, so that this does not become a disputed issue.

· Omitting this clause: In case of dispute, parties may argue about what jurisdiction's law governs, with each party probably seeking to apply the law most favorable to its position.

Dispute Resolution Clause

For Example: Any disputes arising out of this agreement shall be resolved through arbitration in accordance with the Rules of Procedure of the American Arbitration Association.

· Including this clause: Parties agree not to use litigation and designate in advance an alternative dispute resolution process to be used instead of litigation and the specific rules of procedure which will govern that process.

· Omitting this clause: Parties are free to sue each other in court over disputes arising out of the contract. They can still choose, at the time of the dispute, to use an alternative dispute resolution process, but it is less likely for parties to cooperate in working toward an out of court resolution if they have not already planned and agreed in advance to do so.

Output Contract Language

For Example: Traditional Toy Sellers agrees to purchase the entire output of corn husk dolls produced by A-Maize-ing Playthings for a period of one year from the date of this agreement, at the price of ten cents per corn husk doll.

· Including this clause: No matter how many corn husk dolls A-Maize-ing Playthings produces during the year - whether it is 500 dolls or 5,000,000 dolls - Traditional Toy Sellers must buy them all at the stated price for the one-year contract term, even if the output is more dolls than they want, and even if they could buy the dolls cheaper elsewhere. A-Maize-ing Playthings gets a guaranteed buyer for the one-year contract term, but must sell every corn husk doll they produce to Traditional Toy Sellers during that year, even if they could get a better price for the dolls elsewhere.

· Omitting this clause: A-Maize-ing Playthings will need to find a market for the dolls they do not sell to Traditional Toy Sellers, and each party remains free to negotiate contract terms and re-negotiate terms of subsequent contract. Traditional Toy Sellers may not be able to get all the corn husk dolls they need at the price they want to pay, but they are not bound by contract to purchase more than they may need.

Property Law

As in so many areas of law, property law sometimes uses familiar-sounding words in special ways. You may have heard the word "estate" in contexts such as "real estate," an "estate sale," being an executor or administrator of the "estate" of someone who died, or even the management of a bankruptcy "estate." Black's Law Dictionary defines "estate" as "the interest which anyone has in lands or in any other subject of property." (Black's Law Dictionary, 2d ed., retrieved from http://thelawdictionary.org/estate/#ixzz2A2fEWd96).

"Real estate" refers to interests in real property (land and the buildings on it and the things attached to the land and buildings as fixtures that are not moveable). Sometimes, as in administering a decedent's estate or a bankruptcy estate, it is necessary to figure out what assets the person or entity has and to distribute assets according to law and according to the terms of relevant documents such as contracts, wills or deeds. A "decedent's estate" includes everything that a person owned at the time of that person's death. A "bankruptcy estate" includes everything that the person or entity owned at the time the bankruptcy petition was filed (or in some cases, for a period of time thereafter). An "estate sale" involves the sale of someone's property, either because the person had died or because the person needs to sell off possessions to downsize, to raise money by liquidating assets, or for some other reason.

In working with estates, it is helpful to be familiar with different types of property, different types of interests in property, and the various ways that rights, title, and interests in property can be conveyed and held.

Another word that appears frequently in property law is "tenancy." Most people are familiar with the term "tenant" as a person who rents property from a landlord, and indeed, "tenancy" can refer to a lease period. But since the word "tenancy" comes from a root word meaning "to hold," it can also refer to ways that owners "hold" the property they own.

Types of Property

Property Rights Held By Multiple Owners at the Same Time

Tenancy in Common: Each owner holds an undivided interest in the same property. They may acquire their portions by different instruments and at different times and may hold unequal shares. A creditor may be able to force the partition and sale of the interest of one tenant in common to satisfy the debt of that tenant in common.

Joint Tenancy (sometimes called Joint Tenancy with Right of Survivorship): All owners acquire by the same instrument an undivided share of exactly the same interest in exactly the same property for exactly the same amount of time. If one of the joint tenants dies, the remaining joint tenants share the decedent's portion by right of survivorship (instead of having to go through the administrative) hassle of probate and potential tax consequences of inclusion in the decedent's taxable estate. However, if one joint tenant tries to transfer his or her share to someone else, the transfer breaks the joint tenancy and converts it to a tenancy in common. Also, a creditor may be able to force the partition and sale of one joint tenant's interest to satisfy a debt.

Tenancy by the Entirety (or Tenancy by the Entireties): Recognized in some jurisdictions, tenancy by the entirety is a joint tenancy with right of survivorship held by married persons. No transfer of the property is effective unless both spouses consent to the transfer. Upon the death of one spouse, the surviving spouse is sole owner of the property.

Examples of Legal Instruments for Transferring Rights

	Real Property	Personal Property
Ownership of Property (Title)	Deed Will	Bill of Sale Assignment Stock Certificate Will
Use of Property	Lease Easement	License
Security Interest	Mortgage Deed of Trust	UCC Filing

One asset protection consideration is that some forms of joint ownership may expose property to the claims of the creditors of one of the joint owners.

Depending on the laws of the jurisdiction, the specific words used in a deed or will can make a big difference in whether a court would consider property to be held in one form of ownership or another, and even whether the conveyance will be legally effective in the manner the grantor intended, if at all.

If having use of certain property, real or personal, is the most important thing, it may be wise to weigh the relative merits of leasing the property against the merits of purchasing the property. Depending on the terms of the lease agreement, it may be more beneficial to lease dwelling space or business space, or to lease an automobile or furniture or office equipment, instead of tying up a chunk of capital (or incurring debt) to purchase the same or similar property.

Consider these examples:

1. Jane rented an apartment when she moved across the country to take a new job. When she was laid off from that job two years later and needed to move again to another city for a different job, Jane only had to pay the early termination fee to get out of her lease. She did not have to worry about how quickly a house would sell or about how to pay the cost of maintaining two properties (the one she would have to maintain in the old city while trying to sell it and the one in the new city, where she would be living and working). While Jane might miss out on some tax deductions available to homeowners, she might also spare herself some of the headaches of homeownership, which can be especially troublesome when circumstances change unexpectedly.

2. Steve lives in a big city with good public transportation, which he uses for commuting to work and for his everyday needs. He saves on the year-round costs of maintaining, garaging, and insuring an automobile by choosing not to own a car. Instead, on the few occasions each year when it is convenient for Steve to drive a car, he rents the type of vehicle that is best suited to that particular trip or event.

3. Tasha drives tens of thousands of miles each year. She considered leasing a vehicle, but the mileage allowances on the leases would leave her owing a staggering amount of excess mileage charges at the end of the lease. Given Tasha's driving habits, it would actually cost less over the useful life of the car, for Tasha to purchase the vehicle.

4. In the early years of his business, Greg leased office equipment to keep his payments fairly low and to have the flexibility under the lease agreement to be able to upgrade the equipment as needed to meet the demands of his growing business. This has been a very profitable year for Greg, so he plans to purchase before the end of the year some equipment that he knows he will need to use over the next couple years. By purchasing it and taking advantage of tax provisions that will allow him to take the purchase price as a business expense deduction in the current year, Greg will get the equipment he needs and reduce the amount of income on which he will have to pay taxes this year.