its a business law assignment

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UNIVERSITY OF TOLEDO LEGAL AND ETHICAL ENVIRONMENT OF BUSINESS Cohen

CHAPTER 7: BUSINESS FORMATIONCHAPTER 7: BUSINESS FORMATION AND GOVERNANCEAND GOVERNANCE

Business Forms

Selecting a Business Form

Speci�c Business Forms

Corporate Governance

PowerPoint CHAPTER SEVEN: BUSINESS FORMATION AND GOVERNANCE   Business Forms - General Selecting a Business Form Speci�c Business Forms - Sole Proprietor, Partnerships, Corporations Corporate Governance   Business failure rates in the United States are at about 33% within two years of business formation (Source: U.S. Bureau of Labor Statistics). And about 50% of businesses fail or close within �ve (5) years. The most common reason provided for those early business failures or closures is lack of business experience of the business owner, often referred to as an entrepreneur. Only a few early business decisions made by the entrepreneur in forming a business will have a greater impact on the success or failure of the business than picking the appropriate type of legal structure for the business. The importance of selecting the appropriate business form for the venture will be discussed in detail in this chapter.  

BUSINESS FORMS   The type of business entity selected by the entrepreneur will likely hinge on the following business and legal considerations: 1. Shielding personal liability, 2. Tax implications, 3. Capital needs, and 4. Record-keeping. Before getting into the details of these business and legal

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considerations, here’s a quick high-level overview of the di�erences between the most common forms of business entities:

A sole proprietorship is the most common business form, mainly because it’s easy and cheap to form and o�ers total control to the owner.

Partnerships1 (General Partnerships, Limited Partnerships) involve two or more people who agree to share in the businesses pro�ts or losses. Corporations (C-Corp, Closely Held Corporation, S-corporation and Limited Liability Corporation, nonpro�t Corporation) are legally formed entities speci�cally created to conduct business. Corporations can have a pro�t motive or can be created to support economic development

initiatives2 or to aid charitable purposes3.

 

SELECTING A BUSINESS FORM   Entrepreneurs, particularly �rst time business owners, should engage a business attorney and accountant when forming that �rst venture. Often times the experience of creating that �rst venture with a good attorney and accountant may give the entrepreneur welcome experience in forming future ventures. First time venture or not, a good attorney and accountant can be critical to the success or failure of a business. At the very least, the entrepreneur will be given the necessary advice and support to diminish the negative implications of starting the business if things go poorly and the business fails. At best, the right professional help can make your business even more pro�table when the venture takes o�! When making a decision about the type of business to form, several key factors should be evaluated prior to making this important decision.  

Legal liability. Today, not many business owners can a�ord to su�er business losses in a business venture and pay for those losses out of personal

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assets. Frankly, most business owners do not want to have that type of personal risk. For example, if a corporation fails and owes $25,000 to a creditor, then the corporation is on the hook for that debt. Assets from the company will be liquidated to pay for that $25,000 debt to that creditor. If the failed corporation does not have enough assets to cover the $25,000 debt, then the creditor loses. Conversely, if a sole proprietorship or partnership fails, then the sole proprietor or the partners would be legally liable for that debt and the debtor could go after the sole proprietor or partner personal assets, like a home, to satisfy the debt. Further, each partner would be jointly and severally liable for the debt, and if the partnership assets could not pay the debt and one of the partners goes bankrupt or has no personal wealth, then the remaining partner is personally responsible for the entire debt. Tax implications. Most if not all business owners want to minimize overall tax burden. Not all entrepreneurs have the ability to create a business structure to minimize the tax burden on the company as well as the owners. Although sole proprietorships or partnerships have essentially pass through taxes where the individual only pays the tax liability, corporations through S corporation status can eliminate double taxation as well to where the individual is only taxed. An S corporation does have a couple of major restrictions, and as an example, it cannot have more than 75 shareholders. Ultimately, businesses generally lose money in the start-up and growth phase and business losses passed through to individual stockholders can help reduce the stockholders personal tax liability. This is an important consideration as every dollar counts to an entrepreneur trying to bootstrap business growth out of personal cash �ow. Formation and administration costs. A business form may often be selected based on tax advantages, but those tax advantages may come with signi�cant additional costs related to the formation and ongoing administration of the

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company. And the high cost of record-keeping, paperwork, and associated incorporation costs are the main reason business owners opt for the sole proprietorship or partnership. “Paperwork” requirements often take up signi�cant time and therefore create unnecessary business costs. In fact, in instances where the sole proprietor can eliminate all personal liability through low-cost insurance – then sole proprietor is highly favorable because administration costs are minimal. There’s no reason to burden the business with all the reporting requirements of a corporation unless there is a signi�cant bene�t from tax implications or protection from liability. Accordingly, the main reason for choosing a corporate form over sole proprietor or partnership is capital requirements. Capital needs. “Bootstrapping” is a term used to describe businesses that mainly utilize business cash �ow and pro�ts to grow. Most businesses cannot a�ord to “bootstrap” because the rate of growth is slowed and often sti�ed without access to capital. And most companies don’t make any pro�ts in the �rst couple of years, and without pro�ts, the company cannot bootstrap. As a result, early stage businesses usually seek to raise capital to support formation and growth. Company form and structure is relevant to access to capital. Whether the company is raising money through an equity sale by selling a portion of the company or raising money through loans (borrowing debt), certain business forms are more conducive to either type of capital raise. As a very simple example, a sole proprietor cannot sell equity in a sole proprietorship. A sole proprietor could essentially only raise debt, which greatly limits options for the business owner. And in general, banks do not like to loan money to start up business ventures. Flexibility and Future. Aside from the aforesaid considerations, business form should be �exible enough to adapt for future needs. No two-business situations will be the same. Health, family, marriage/divorce, and business partner

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considerations create an in�nite range of possible future needs and the structure must be �exible enough to adapt to any potential needs of the business.

 

SPECIFIC BUSINESS FORMS   The types of corporate forms and the technical nuances between each structure is numerous and numbingly detailed. An attorney will spend three years in law school, maybe more, and then years of legal practice gaining the necessary experience to understand each type of business form and how to create and manage each type. The following sections discuss the most relevant and used “for-pro�t” business forms, and naturally, this is a high- level overview that does not nearly address all the technical requirements required for each form.

a. Sole Proprietorship

  Sole proprietorship is the simplest business form and involves just one individual who owns and operates the enterprise. People that want to work alone, make all decisions, and not manage others should strongly consider this form of business. Under this type of business structure, the owner is generally personally liable for all of business’s �nancial obligations, which is the major drawback of this business form as personal assets are subject to seizure if a business claim is �led against the entrepreneur. Further, raising money for a sole proprietorship is also challenging as banks and other �nancial resources are reluctant to make business loans to individuals for business endeavors because of the high risk. In most cases, the entrepreneur will have to pledge personal assets to secure business capital such as personal savings, home equity, or rely on the kindness of friends and family. But these funding sources tend to be small and run out quickly.  

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On the other hand, tax prep and paperwork for a sole proprietorship are the least complicated among business forms. Sole proprietors �le taxes on a personal tax return, Form 1040, using Schedule C Pro�t or Loss from Business (Sole Proprietorship), which lists revenue and expenses of the company as well as any assets.   The bottom-line from Schedule C is transferred to the personal tax return. If the sole proprietor su�ers business losses, then those losses may be used to o�set the taxpayer’s income earned from other sources. Sole proprietor must also �le a Schedule SE with Form 1040, which calculates self-employment tax, essentially the individual’s contribution to social security.   As an example, the business owner might be a teacher and earn $50,000 annually as a teacher. During the summer, the teacher might have a business and assume that it loses $10,000. That $10,000 loss may be used to o�set and partially reduce the teacher’s $50,000 annual salary and thus reduce net tax liability. And based on the gross revenue earned by the sole proprietorship, she may also have to pay self-employment taxes even though the business lost money.   Further, self-employed individuals with net earnings (revenue minus expenses) above $400 must make estimated quarterly tax payments to cover the annual tax liability. If such payments are not made, then penalties and interest may be imposed on the taxpayer. Estimated federal taxes may be made in four equal payments on the April, June, September, and January 15th. Tax returns are generally due to be �led on April 15 annually with one extension allowed extending the due date until October 15. Previous years taxes must be made when �ling an extension on April 15. With a sole proprietorship, your business earnings are taxed only once, unlike other business structures. (See I.R.C. § 61 (2006) which is the abbreviated reference to the Internal Revenue Code, which are the tax regulations promulgated by the Internal Revenue Service.)

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b. Partnership (General Partnership and Limited Partnership)

  The two main types of partnership structures discussed in this section are general partnerships (GP) and limited partnerships (LP). The limited liability partnership (LLP) is another form of partnership but not discussed herein.   In a general partnership, the partners (at least two (2)) manage the company and assume responsibility for the partnership’s debts and other obligations. Any business owned and operated by at least two individuals may be treated as a partnership without any formal paperwork �ling. Most states do have formal paperwork available to form a partnership through each state’s Secretary of State (SOS) or related business desk. (A link to each SOS is provided at the end of this chapter).   The main disadvantage of a partnership is that each partner is jointly and severally liable for the �nancial obligations of the business, which means in a claim against the partnership, any partner could have to pay the entire amount of the claim, regardless of the individual partner’s total share of the liability or partnership. It is important to note that each general partner can act on behalf of the partnership, even take out loans and make business decisions that will a�ect and be binding on all the partners (if the general partnership agreement permits).   The main advantage to a general partnership is that the partnership is not directly taxed and the losses or pro�ts “pass through” to partners and are reported on individual income tax returns. This allows partners to o�set other income and reduce personal taxes when the partnership shows a loss, and also eliminates double taxation on the pro�ts as just the individual is taxed (not the partnership). So during tax season, the partners each receive a Schedule K-1 form from the partnership, which shows the partners share of partnership income, plus deductions and or tax credits. Each partner is then required to include

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this Schedule K-1 on his/her individual tax return. The partnership pays no income tax but still must �le a Form

1065.4 Personal liability is a major concern if you use a general partnership to structure your business.   A limited partnership has one (1) general partner and at least one (1) limited partner. The general partner may be an individual or any other type of business form such as a corporation. The general partner(s) own and operate the business and assume liability for the partnership, which is why the general partner is often a corporation – to limit personal liability. Limited partners serve mainly as investors; they have no control over the company and are not subject to the same liabilities as the general partners. A general partner can lose their investment in the partnership and potentially lose personal assets as well in a legal claim against the limited partnership. A limited partner’s risk in a limited partnership is just the extent of their investment.   Limited partnerships have many required �lings and administrative complexities, and are not generally recommended for early stage businesses unless you anticipate numerous limited partners. And if a company has two or more partners who want to be actively involved, a general partnership is much easier to form and operate. i)          Partnership Agreement: Personal Protection. With a high business failure rate in the �rst �ve (5) years since inception, a solid partnership agreement is necessary. Unfortunately, these types of documents are akin to a prenuptial agreement for newlyweds. No one wants to discuss the possibility of future problems during the honeymoon stage, but that is time to have those exact discussions. A written partnership agreement helps guides the partners when challenges, to be expected, arise.   In practice, the partnership agreement needs to answer questions framed by the following discussion points:

Identify each partner’s investment: Some partners bring cash. Some partners provide human capital.

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Some partners invest hard assets, like equipment. Example: Tom, Dick, and Harry start a lawn service in a partnership form. Tom puts in working capital cash to start the business. Dick agrees to mow all the lawns during the start-up phase – human capital. Harry provides a truck and tractor – hard assets. When partners make noncash investments, like the labor and the assets, then the partners need to establish how they value each noncash investment so that the initial capital contribution is documented. Partner responsibilities and duties: Some partners are active in the partnership and some are intended to be silent. The importance of specifying each partner’s day-to-day role in operation of the company is extremely important. Remember each partner has a right to equal management of the partnership, UNLESS, the partnership agreement establishes the actual partner roles. Without limiting a partner’s role in the partnership agreement, then a partner who was intended to be a silent partner can come into the partnership and exert management power. Impact of death or disability of a partner: Disability insurance or life insurance can remedy the challenge a partnership faces when one of the partners is either disabled or dies. Regardless, the partnership agreement should have a plan in place that deals with partnership succession in the event of death or disability of a partner. If all else fails, then insurance purchased at the beginning of the partnership and renewed annually can be used to support a buyout of the disabled partner or the deceased family’s ownership interest. Moonlighting: Does the partner have to put 100% e�ort into this particular venture? Or, can the partner have a day job? Buy/Sell Agreement: Plan for a divorce because one partner typically will want to get bought out from the other partner and the reason is usually money, control, or both. The buy/sell agreement

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needs to be negotiated up front. Avoid a Russian roulette clause where you have to bid against your partner to own the business. And in any event, the partnership should get a noncompete clause from the partner who is bought out. Noncompete agreements are generally good for three years and in a tightly formed geographic boundary. Planning for Divorce and Death: With death and divorce, people often want to sell or transfer partnership interests. Some partnership agreements allow for a partner to transfer his or her ownership to anyone, while other partnership agreements limit transferability. Limiting transferability reduces the likelihood of ownership being transferred to someone the remaining partner(s) doesn’t like. Partner Asset: Is the partnership interest an asset that the partner may pledge as collateral on a loan? Funding losses or growth: If the business needs capital in the future, then does the partnership agreement require partners to make more capital contributions? Dispute Resolution: Most often, the partnership agreement will dictate the form of dispute resolution, which is usually arbitration or mediation, when the partners get into a disagreement with an impasse.

  Ultimately, the main reason for having all of these issues covered in a partnership agreement at the inception of the partnership is to avoid the need for attorneys at a later date, which is usually if not always a costly proposition.  

c. Corporation (C-Corporation, S-Corporation, and Limited Liability Corporation)

 

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Using the corporate structure is more complex and expensive than most other business structures. A corporation is an independent legal entity, separate from its owners, and as such, it requires complying with more regulations and tax requirements. Corporations are so important to the American way of life that recent court cases have actually given rights to corporations expressly reserved for individuals in the Bill of Rights to the Constitution (See Citizens United v. Federal Election Commission, No. 08-205, 558 U.S. 310 (2010) a case where the Supreme Court held (5–4) that First Amendment rights prohibited the government from restricting money spent by a nonpro�t corporation and by extension for-pro�t corporations, labor unions and other associations on political speech.)    Corporations can be For-pro�t corporations (those seeking to earn a return for investors) or Not-For-pro�t corporations. Corporations can also be domestic, foreign, or alien. A corporation is domestic in any state where it is incorporated. A corporation is foreign in every state that it is not incorporated. An alien corporation is incorporated outside the United States.   A group of doctors, lawyers, or accountants may form a professional corporation, which only exists on a state- by-state basis. Professional corporation shareholders have no personal liability for corporate liabilities but will not be shielded from liability for professional negligence.   Close corporations, sometimes referred to closely held corporations, have few shareholders and often are family owned. Public corporations have shares traded through public stock exchanges and usually have a signi�cant number of shareholder owners. Although signi�cantly di�erent in size, both close and public corporations are generally formed by the same method using the secretary of state or some similar state o�ce to �le the appropriate paperwork.   Corporations are taxed and legally liable for its actions. Corporations can pro�t or lose money. One key bene�t of

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the corporation is that it (usually) shields owners from personal liability for bad (negligent or illegal) corporate action. However, individuals who guaranty payments for the corporation can be held liable for payment when the corporation does not pay. Also, when a court �nds the corporation acts illegally, then it might pierce the corporate veil and �nd individuals guilty or liable for acts of the corporation. It is much more likely that the close corporation will have its corporate veil pierced than a publicly traded company. This is discussed more under corporate governance.   Corporations also survive the death of their owners whereas sole proprietorships and partnerships usually end with the death of an owner. Corporate overhead related to administrative and legal costs as well as formation costs and extensive record-keeping requirements are signi�cant and a drawback. Each state has its own regulations related to corporation formation so the rules in each state to form a corporation are di�erent.   For companies seeking capital from outside investors, a corporate form is a good structure to raise capital. A corporation can sell stock, either common or preferred (or “units” when through an limited liability company [LLC]) to raise funds. Corporations are also called a “going concern,” and so shares are readily transferable even if a shareholder dies or becomes disabled.   While double taxation is regularly cited as a corporate drawback, the U.S. Tax Code provides for an S corporation (a tax structure speci�cally designed by the Internal Revenue Code referring to “Subchapter” corporation), which avoids this situation by allowing income or losses to be passed through on individual tax returns, just like a partnership. Typical corporations are subject to corporate income tax at both the federal and state levels, and any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal income tax returns as well (double tax).  

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The S corporation is more attractive to small-business owners than a standard (or C) corporation. That’s because an S corporation has some appealing tax bene�ts and still provides business owners with the liability protection of a corporation. With an S corporation, income and losses are passed through to shareholders and included on their individual tax returns. As a result, there’s just one level of federal tax to pay. Total number of shareholders is capped at 75.   S corporations do come with some downsides. For example, they’re subject to many of the same requirements corporations must follow, and that means higher legal and tax service costs. They also must �le articles of incorporation, hold directors and shareholders meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions. The legal and accounting costs of setting up an S corporation is similar to those of a standard corporation.   Another major di�erence between a standard corporation and an S corporation is that it can only issue common stock, which can only be owned by individuals, estates, certain types of trusts, and tax-exempt organizations such as quali�ed pension plans.   To avoid double taxation, at least in smaller closely held corporations where the owners are also signi�cant shareholders, the company may pay out salaries and other bene�ts to executives and any other corporate shareholders. Corporations are not required to pay taxes on earnings paid as reasonable compensation, and it can deduct the payments as a business expense. The Internal Revenue Service (IRS) does scrutinize these types of payment and may put limits on compensation if deemed excessive.   States have in the past 40 years created a hybrid form of business called the LLC, which has gained signi�cant popularity because it allows owners to take advantage of the bene�ts of both the corporate and partner form of business. An LLC has the advantage of pass-through

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pro�ts and losses much as a partnership where the relevant pro�t or loss is simply reported on the individual’s personal tax return without double taxation. The LLC also provides business owners with the liability protection o�ered by corporations but not available to partnerships.   Further, unlike the S corporation, LLC’s can have an unlimited number of shareholders. In addition, any member or owner (shareholders) of the LLC may have full participatory role in the business’s operation; while in a limited partnership, limited partners have no say in the operation.   Like partnerships, LLCs end at a stated time or may technically dissolves when a member dies, quits, or retires. And since an LLC is relatively new, its tax treatment across di�erent states may be a challenge.   Ultimately, the decision to select a corporate form should be made in conjunction with sound legal and accounting advice.  

d. Incorporation

  Usually, to incorporate, an incorporator working on behalf of the prospective corporation will utilize resources from the state’s secretary of state o�ce or relevant state o�ce to register the corporation in the state. Instructions and fee schedules through the applicable secretary of state or state o�ce are usually online.   The �rst task to forming a corporation is preparing the articles of incorporation, which are usually a simple form provided by the applicable state. The incorporator �lls in common data points into forms such as the proposed corporate name, the business purpose, name(s) and address(es) of incorporating parties, and the location of the principal o�ce.  

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The corporation will have bylaws or an operating agreement that describe in detail how the corporation functions with descriptions such as shareholders duties, directors and o�cers and their duties; board and shareholder meeting(s) obligations (note: keep proper meeting minutes); and other relevant management details. Once the articles of incorporation have been properly submitted with the appropriate fee, the secretary of state will send a certi�cate of incorporation to the principle o�ces, after which the corporation is registered to operate in the state. Corporations should issue stock certi�cates at this point to validate shareholder ownership.  

FORM/ ISSUE TAXES LIABILITY

SHAREHOLDER MANAGEMENT

CA RA

         

Sole Proprietorship

Direct on personal tax return

Personal  Total control by owner

Hard, throu perso loans by pe asses

(individual)        

C corporation Double Tax Shielded Voting Rights, access to annual shareholder meeting

Sell co and p stock Share loans assets invoic factor

(Shareholder owned, Board/O�cer controlled)

Can deduct health care bene�t, can't on LLC.

     

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FORM/ ISSUE TAXES LIABILITY

SHAREHOLDER MANAGEMENT

CA RA

LLC Pass- through

Shielded Voting and Apportioned Management

Sell C and p stock Memb loans assets invoic factor

(Member owned, Board/Member controlled)

Self employment tax, CMS taxes totaling 15.3% of gross earnings

  Can be individual, partnership, corporation..any owner.

 

S corporation Pass- through

Shielded Voting Comm stock limite share and re owne individ trust, funds non-p

(Shareholder owned, board/mgmt controlled)

    Individuals, trusts, non- pro�ts, pension funds

 

Partnership Pass- through

Joint and Several

Voting and Equal Management

Often to the perso wealt curren partn which limitin

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FORM/ ISSUE TAXES LIABILITY

SHAREHOLDER MANAGEMENT

CA RA

(Partner owned, partner contolled through partnership agreement)

       

Limited Partnership

Pass- through

Shielded  Voting Hard limite numb limite partn want struct

(Limited partner owned, general partner controlled)

       

  Secretary of State and Commerce Web Sites. Various state links for business formation are provided below:  

Alabama Montana

Alaska Nebraska

Arizona Nevada

Arkansas New Hampshire

California New Jersey

Colorado New Mexico

Connecticut New York

Delaware North Carolina

Florida North Dakota

Georgia Ohio

Hawaii Oklahoma

Idaho Oregon

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Illinois Pennsylvania

Indiana Rhode Island

Iowa South Carolina

Kansas South Dakota

Kentucky Tennessee

Louisiana Texas

Maine Utah

Maryland Vermont

Michigan Virginia

Minnesota West Virginia

Mississippi Wisconsin

Missouri Wyoming

   

CORPORATE GOVERNANCE    Corporate governance is dictated by various legal factors. The four (4) main areas that dictate corporate governance are: 1. Common Law; 3. State Statutes; and 4. Federal Statutes.   Under common law, one would review the corporation’s articles of organization, bylaws, operating agreement or other documents germane to the relationship between the company and shareholder to determine whether or not the corporation is abiding by its contract with its shareholders. For example, the corporate operating agreement may require four (4) quarterly board meetings and one (1) annual shareholder’s meeting. If the corporation has four (4) quarterly board meetings and one (1) annual shareholder’s meeting, then it is abiding by this contractual requirement. If the corporation does not adhere to its own internal organizational documents, then it could be liable in contract to its shareholders. This type of common law contract claim lawsuit however is rarely if ever pursued as state and federal statutes provide many

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better alternatives for shareholders to recover damages for poorly behaving o�cers and directors. One such area where common laws bleed into statutory law, would be the �ling of a derivative lawsuit. For example, a stock purchase agreement might indicate in the “Sources and Uses of Funds” section that the CEO of the company receives $150,000 in annual compensation when in fact the CEO is paid $200,000 in annual compensation. A shareholder could �le a derivative lawsuit against the company to get the company repaid that $50,000 from the CEO.   A derivative lawsuit is a preliminary step shareholders must take prior to �ling a suit to recoup losses from the company’s management for failure to abide by the business judgment rule. These suits by shareholders are called derivative suits because the shareholders have their right to sue derived from their ownership and their recovery belongs to the corporation. The types of actions can be extremely time consuming and therefore costly as in the case of AIG, Inc. v Greenberg, 965 A.2d 763 (Del. Ch. 2009), where the Delaware Chancery court dealt with a derivative suit �led by AIG shareholders against the company’s directors and o�cers related to transactions that did not exist. The shareholders followed the rules outlined in the company bylaws and therefore the court allowed the plainti�’s to move forward with the lawsuit.   More often, however, state and federal laws, are better suited for pursuing legal action against o�cers and directors. State and federal laws create speci�c duties on the corporate o�cers and directors as corporate �duciaries. A �duciary must act in the best interests of the corporation. The �duciary cannot gain at the corporation’s expense, which would be a breach of duty of loyalty. The standard used to examine the decisions made by the o�cers and directors is explained through the business judgment rule. The business judgment rule allows for o�cers and directors to make bad decisions, provided that the �duciaries go through a careful study and deliberation of the decision prior to the decision being made. O�cer and directors often protect

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themselves when making challenging decisions by consulting experts, who are credible, reliable, and well chosen, such as attorneys, accountants, and �nancial analysts. This is why corporations often rely on academics with doctorates to help fashion decisions. Please note that recent court cases have also shielded o�cers and directors from carelessness and negligence.   State laws regulating corporate governance are often tied into securities regulations and referred to as “Blue Sky Laws.” Many companies choose Delaware as a corporate home because of Blue Sky Laws that are very favorable to corporations. Federal regulations, generally promulgated by the Securities and Exchange Commission, also regulate corporate executive action of companies that are a certain size (e.g. companies that are not exempt through Regulation D, which might be a company that raises more than $5mm in one year) or are publicly traded on an organized stock exchange (e.g. Nasdaq, CBOE).   Speci�c federal laws, such as Sarbanes–Oxley (aka SOX), have been passed to address the need for criminal penalties for directors and o�cers after several large, publicly traded companies collapsed due to illegal activities designed to enhance company values (See: Enron and WorldCom; HCA came under �re several years later but its size and �nancial strength did not lead to a collapse, only the ouster and humiliation of its CEO). SOX imposed detailed requirements on boards and o�cers of publicly traded companies that went much further than previous statutory requirements imposed by state laws. Further, Wall Street was also brought under a similar regulatory umbrella as SOX with the passage of the Dodd– Frank Wall Street Reform and Consumer Financial Protection Act on July 21, 2010. This law was primarily the result of the 2008 �nancial crises where banks and Wall Street traders were selling collateralized debt obligations in the subprime loan market, which led to the largest �nancial downturn since the Great Depression.   As an example of a new restriction created by these laws, corporations can no longer make loans to o�cers and

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directors.   Further, companies must now have codes of ethics in place for the �nancial o�cers and provided corporate ethics training. Even with the code of ethics, corporate �nancial o�cers are subject to federal penalties for certifying false �nancial statements, even when the mistakes on the �nancial statements are correctable errors, statistically irrelevant or accidental.   Also under these new laws, corporate lawyers have more detailed duties and disclosure requirements. For example, if a lawyer suspects material legal violation, then she must investigate (or cause to investigate) to determine whether a violation occurred. The lawyer has a legal duty to inform the CEO of the investigation, and should do so in writing. If any material violation has occurred, then the attorney must report the material violation of the law to the CEO. If the CEO takes no corrective measures, then the lawyer must report the material violations to the audit committee or a group of independent board members. The ultimate challenge for the attorney is a strict duty of client con�dentiality to the company. So during this process, the attorney must balance her ethical duty to keep client information con�dential and the duty to inform others about potential illegal activity.   In general, managers, o�cers, and directors at companies whose employees actually commit criminal acts can be held liable if the managers, o�cer, or directors 1. Authorized the conduct, 2. Knew about the conduct and did nothing, or 3. Failed to act reasonably in their capacity for the company. So by the lawyer putting managers, o�cers, and directors on notice of material violation or criminal activity according to SOX, Dodd Frank and the like, she is essentially expanding the number of people within the corporation who could be subject to penalties if nothing is done to prevent further serious violations or criminal acts.