Corporate & Commercial Law II: Business Forms,

Financing & Governmental Regulation

Professor Michael R Fricke
Module 1: Business Organizations

Table of Contents
Module 1: Business Organizations ........................................................................................... 1
About the Course ............................................................................................................................. 2
Course Overview ...................................................................................................................................................2
About Professor Fricke ..........................................................................................................................................4
Learn on Your Terms .............................................................................................................................................6

Lesson 1-1: Introduction to Sole Proprietorships and Partnerships ................................................... 7

Lesson 1-1.1: Introduction to Sole Proprietorships and Partnerships ..................................................................7

Lesson 1-2: Partner Rights & Duties ................................................................................................ 23

Lesson 1-2.1: Partner Rights & Duties ................................................................................................................23

Lesson 1-3: Special Forms of Partnerships ...................................................................................... 44

Lesson 1-3.1: Special Forms of Partnerships.......................................................................................................44

Lesson 1-4: Introduction to Corporations ....................................................................................... 58

Lesson 1-4.1: Introduction to Corporations ........................................................................................................58

Lesson 1-5: Corporate Formation ................................................................................................... 81

Lesson 1-5.1: Corporate Formation ....................................................................................................................81

Lesson 1-6: Shareholder Rights, Powers, & Liability ...................................................................... 103

Lesson 1-6.1: Shareholder Rights, Powers, & Liability ......................................................................................103

Lesson 1-7: Director & Officer Rights, Duties, & Liability ............................................................... 131
Lesson 1-7.1: Director & Officer Rights, Duties, & Liability...............................................................................131

Lesson 1-8: Limited Liability Companies ....................................................................................... 146

Lesson 1-8.1: Limited Liability Companies ........................................................................................................146

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
About the Course

Course Overview

Hi and welcome to part two of my Corporate and Commercial Law class. This second
four weeks, we're going to broaden the scope a little bit and talk about a number of
different legal issues. The title of the second half of the course is technically Business
Forms: Financing and Governmental Regulation, and that's generally what we're going
to be talking about. In the first of our four modules, we're going to talk about business
forums or business organizations or business entities. All of those terms generally mean
the same thing as things like corporations, partnerships, limited liability companies. How
do you know what type of business organization is right for your business and what are
the characteristics of each one? Then module two, were going to shift into discussion of
debtor-creditor relationships and this is a very broad subject. We're going to try and
narrow it as much as we can, but we're going to be talking about things like secure
transactions. What does it mean to give someone collateral to secure a debt? How do
banks collect on debts when they're not paid? We're going to talk a little bit about
bankruptcy. What happens when a business debtor or any other debtor is unable to pay
its debts? How does the bankruptcy process work? And then in the last two modules,
we're broadly going to talk about governmental regulation of business. I'm going to start
this off by talking about administrative agencies, how they make rules, how they
investigate violations, how they adjudicate disputes, and then talk about some very
specific agencies and the types of things that they regulate: The Environmental
Protection Agency, the FTC. We're going to talk significantly about anti-trust laws and

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
how those are enforced, meaning, how do we make sure that businesses compete
fairly? And then we'll wrap it up by talking about securities laws, issuing stocks and
bonds, trading stocks in the stock market. What are the rules required there to make
sure everyone plays a fair game? So now I'm going to kick it over to one of my former
students to tell you a little bit about her experience in this class.

Not only did I enjoy learning the material in the business online class but Professor
Frikkie is hilarious and has a good sense of humor to keep things rolling, but also cuts it
to you straight and gives you the information that you need. There's no fluff and that's
what I liked, really liked about Professor Frikkie is that I got to the point, I knew that
what I was hearing or what I was reading wasn't a waste, and I would be using it. And
later on, the quizzes that we had fully made sure that you fully understood the concept
but also had a sense of humor using different characters and situations. And so, you'll
definitely be entertained. It's not boring.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
About Professor Fricke

Little bit about me, I don't know what you want to know about me. My title here is I'm a
Teaching Assistant Professor in the Department of Business Administration at the Gies
College Business at the University of Illinois, which is a mouthful really, that's hard to fit
on a business card. What does that mean? It means, I teach courses in the fields of
business law and business ethics. I teach our core undergrad business law class that all
college business undergrads have to take, I teach a couple of business ethics classes, I
teach a really cool class, that's where I coach a team of students to go to business
ethics case competitions around the country. I teach an MBA ethics class. I teach this
class which is basically, business law for people who are going into accounting focused
on the legal topics in the CPA exam. So I teach a lot of things around here, I'm also the
director of undergraduate studies in the Department of Business Administration, which
means if there is an undergrad issue from one of our seven majors, my committee and I
deal with it. So that's what I do here. But how do I get here? I'm originally from Austin,
Texas. You might not notice from the accent I never got one but I grew up in Austin and
I have a deep and abiding love for all things Austin, barbecue, tacos, not the Longhorns
but everything else from Austin I love. And I came up here to the University of Illinois
actually for college. I studied engineering and philosophy here as an undergrad and
moved away for a few years after college and then came back. I went to law school
here, I got my MBA from Gies College of Business, long before it was the Gies College
of Business and just college business at that time. But I got my MBA here, my law
degree here, and then I went and practiced law for about six and a half years, mostly in
the field of corporate and commercial law. That's this class. And also, a lot of real estate

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
work. A little bit of litigation but I tried to steer away from that. Then after about six and a
half years of practicing law, opportunity came up for me to come back here to my alma
mater and teach, and I jumped at it. I've been here for four years now and I absolutely
love it. I love working with students, undergrads, grads, in person online you name it. I
really enjoy working with students. So I'm looking forward to working with all of you over
this course and please reach out to me if you have any questions, concerns, comments
or you just want to talk.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
Learn on Your Terms

Too often, smart hardworking busy people miss out on education because of traditional
linear learning. Learn on your terms. With stackable online content from Gies College of
Business, you can take self-paced classes, earn transcriptable credit, pause, earn a
degree. Switch in stack coursework, earn a certificate, or learn however you want. You'll
get expert-led education and big or bite-sized increments. Wherever you are in your
learning journey, the right time to start this is your time.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
Lesson 1-1: Introduction to Sole Proprietorships and Partnerships

Lesson 1-1.1: Introduction to Sole Proprietorships and Partnerships

In this lesson, we're going to introduce the concepts of sole proprietorships and
partnerships, the two most foundational forms of business entities. In future lessons,
we're going to build on the knowledge from this lesson to discuss more complex forms
of business. So, this module is all about forms of business organizations. In this lesson,
we're going to introduce the two most basic types of business entities, sole
proprietorships, and partnerships. Now, there are tons of business organizations out
there in the world. If I were just naming off the top of my head, you'd have sole
proprietorships, general partnerships, limited partnerships, limited liability partnerships,
limited liability limited partnerships, corporations, S corporations, limited liability
companies. There's tons, right? We're going to start slow and build up and we're not
going to care about all of those. We're going to talk about a lot of those that I just listed.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

So, the most foundational type of business form is called the sole proprietorship and its
partner, the general partnership. These are very closely related ways of doing business.
They are both the default method of doing business. If you don't take some action to file
something with the Secretary of State or form some

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Financing & Governmental Regulation
Professor Michael R Fricke

other organization like a corporation, then you will automatically be either a sole
proprietorship or a general partnership. They're the only two forms of business that don't
require you to register something with the state. So, what's the difference between a
sole proprietorship and a partnership? Well, this is easy.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

A sole proprietorship is one person engaged in a business for profit. A general

partnership is two or more people engaged in a business for profit. That's the main
difference. Now obviously, when you add more people, you add more complexity. So,
sole proprietorships are really easy to understand because it's just one person.
Partnerships become more complicated

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

because you have to talk about the relationships between the owners of this business.
So, let's start easy and talk about sole proprietorships.

What are the pros, what are the cons of a sole proprietorship? Now, the pros of a sole
proprietorship is that it's super easy. If you're just one person and you start selling
something to other people,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

you're a sole proprietorship. You don't have to do anything. You don't have to file
anything with anybody. You don't have to get approval. You don't have shareholders
that have to vote on anything. Nothing. You just start doing business and you're
automatically a sole proprietorship. Super easy. Super cheap to create. There's no filing
fees, you don't need to have to see a lawyer. None of that stuff. You don't have to pay
double taxation, as we'll see in future lessons, some types of business entities are
subject to double taxation. Not so is sole proprietorships. All of your income goes
straight on your personal income tax return. And as the owner of a sole proprietorship,
you have complete control. There's nobody else telling you what to do with your
business but yourself. So, those are pretty attractive, right? It's easy, it's cheap, you
have tax advantages, you have complete control. Why wouldn't everybody form a sole
proprietorship?

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Well, there's one giant con that's usually in most situations makes a sole proprietorship
a bad idea. And that giant negative is unlimited personal liability. If you have a sole
proprietorship, all of the businesses debts and obligations are

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Financing & Governmental Regulation
Professor Michael R Fricke

your personal debts and obligations. There's no separation. You are the business.
Therefore, if the business gets sued for injuring someone, or for breaching a contract, or
for a slip and fall, or whatever, you are personally liable for that, meaning your house is
at stake, your car is at stake, your savings accounts are at stake. You could be forced to
go into personal bankruptcy. This is a giant negative for sole proprietorships. That's why
when I was practicing law I almost always advise people to never form a sole
proprietorship. Unlimited personal liabilities, something you want to avoid if at all
possible. And that's really all I have to say about sole proprietorships. They're not
complicated, they're pretty easy to understand. So, let's move into partnerships.
Partnerships get a little more complex because you got more people, you got to talk
about how they relate to one another,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

and every state has adopted a statute that governs how partnerships work. Now, it's
usually one of two statutes. It's either the Uniform Partnership Act or the Revised
Uniform Partnership Act, UPA, and RUPA as they're called. And depending on which
one of these acts your state has adopted, the rules might change a little bit.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

What we're going to talk about in this lesson and future lessons are sort of general
rules, but as always, if you want a formal partnership, it's a good idea to talk with an
attorney in your state who knows the specific rules in your state. But a couple of big
concepts that are important to know for partnerships.

You have more than one person so you need to have an agreement as to how this thing
operates. How do we divide up the money in all this? Who has the management rights?
So all those kind of stuff,

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Financing & Governmental Regulation
Professor Michael R Fricke

that's called a partnership agreement. Every partnership should have one. Can you get
by with not having one? You can, but it's a good idea to have a written partnership
agreement. The other big concept about partnerships that applies to all partnerships is
that

they also have what's called flow-through taxation. All the profits made by the
partnership itself, the taxes on those profits are not paid by the partnership. The profits
flow through to each individual partner and the partners claim them

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Financing & Governmental Regulation
Professor Michael R Fricke

as in personal income on their income taxes, and pay taxes on them that way. So,
again, there's no double taxation for partnerships just like sole proprietorships, which is
a good thing. Now, the negative for partnerships is the same negative for sole
proprietorships and that's that there is unlimited personal liability for partners in a
general partnership. And it actually is even a little worse because not only is there
unlimited personal liability for each partner,

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Financing & Governmental Regulation
Professor Michael R Fricke

there's this idea called joint and several liability. Now joint and several liability means
that every partner is liable for the entire amount of all partnership debts.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

So, say, for example, we have a partnership in you and three other people. So there's
four partners in your partnership. One of your partners goes and takes out a loan for a
million dollars and then the partnership can't pay back the loan. Now, who has to pay
that million dollars back? Well, anybody. The bank or whoever lends the money can sue
you, or another partner, or all four of you, and whoever has the money to pay, can be
forced to pay. Now, you can always go back to your other partners and say, "Hey, I paid
more than my fair share, please reimburse me." But if they don't have the money, you
could be stuck having to pay the entire amounts without them paying any. That's joint
and several liability. So, there's a lot of risk. You need to really, really trust the people
with whom you form partnerships.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

So, to wrap up this lesson, one more little concept that goes along with this idea of
partnership liability and that's question of, what is a partner liable for when they join a
pre-existing partnership?

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

And what are they liable for when they leave a partnership? So, in general, if you join a
partnership, so say I'm a lawyer. There's a law firm that's a partnership that already
exists out there in the world. I come in and I join it as a partner. They have some debt,
some obligations that existed before I came along. I'm not liable for those. When you're
an incoming new partner, you are not liable for any pre-existing debts. But, anything that
happens while you're a partner, you remain liable for even after you leave. So, if I
become a partner in an organization, and we take out a loan for a million dollars, and
then I leave and I'm no longer a partner and then in six months, they default on that loan
for a million dollars. I could still be liable for that personally because the debt was
incurred while I was a partner. So, this is again, you got to be really, really careful with
whom you enter into partnerships because you have personal liability. Now, as we
move on to future lessons, we're going to see some other types of partnerships, and
some other forms of business organizations that limit this personal liability, that are
usually a better idea than a sole proprietorship or a general partnership.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
Lesson 1-2: Partner Rights & Duties

Lesson 1-2.1: Partner Rights & Duties

In this lesson, we continue our discussion of partnerships by focusing on the rights and
duties of partners in a general partnership. Okay, in the last lesson we learned a little bit
about general partnerships. There's unlimited personal liability, which is a big con. But in
a future lesson, we're going to learn about some other forms of partnerships that can
help with that liability problem. And in this lesson, we're going to talk about rights and
duties of partners. Now, these rights and duties apply to general partnerships, but also
these other forms of partnerships that we'll see in a future lesson. And also to a lot of
other types of business entities beyond partnerships. So, this is a good foundation for
our future discussion.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Remember we said more owners equals more complexity. So, as partnerships grow
from two to more owners, things get more complicated.

Now, in a partnership, every partner has certain rights and those rights are usually given
by the whatever statute the state in which your partnership is organized has adopted.
So, UPA, RUPA, we talked about those in the last lesson, they give partner certain
rights. And partners also have certain duties.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Now, oftentimes a partner's rights can be altered by the agreement of the partners.

So, you say you know I have this right, I don't need it. We can agree to alter it by the
partnership through the partnership agreement. That's usually okay.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Most of the time your duties cannot be altered by the parties.

And as we go through the list of rights and duties, it will probably become more clear
why this is. So, let's start with rights.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

As a partner in a partnership, you have some rights. You have the right to manage the
partnership. The right to manage is one of the foundational rights that partners have.
Why would you be in a partnership if you didn't have the right to manage?

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Now, again, this you can modify this. So, say your partnership gets huge. You have a
law firm or an accounting firm with 100 partners. You don't want every single one of
those 100 partners to be able to write checks on behalf of the organization. So, you can
modify the right to manage such that only a small group or one person has the right to
do certain management activities.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

But, as a general rule, partners have the right to manage, they have the right to profits
and losses. This again, very, very important.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Why would you be an owner of a partnership if you didn't want to share in the profits?
Now, you can modify the share of profits and losses you get. So, the default rule is that
all partners share equally in all profits and losses regardless of your capital contributions
or the amount of work you do on behalf of the partnership or anything like that. Default
rule is everybody splits equally pro-rata share based on the number of partners there
are. Now, you can modify that. So, if there's three partners and you say well this one
partner should get half of the profits because he or she invested half of the capital and
the other two partners should each get 25 each. You can do that. You can modify that.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Next right is the right to information.

All partners have the right to inspect the books and records of the partnership to be
privy to contractual negotiations and all sorts of things like that. Again, the right to
information can be modified. Say you have a giant partnership. It's just not feasible
sometimes for every partner to be involved in every contract negotiation, and that's fine.
But every partner still does have the right to inspect the books and records of the
partnership. That's pretty foundational and usually can't be modified.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

A couple of other rights. The right to be repaid. If you spend your own money on behalf
of the partnership, whether that's through actual expenses

or like you get sued in your capacity as a partner and you had to pay attorney's fees or
you had to pay out a judgment or you made a loan to the partnership or you invested
capital in the partnership. All of those things, you have the right to be repaid for either
immediately or when you leave the partnership. Now, the one time you don't have the
right to be paid is for your labor.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Partners have no right to compensation. So, it doesn't matter how many hours you
work, how much blood sweat and tears you pour into a partnership,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

you don't get paid for that. You don't have a right to a salary or an hourly wage as a
partner because you own the business. Your compensation for your hard work is your
right to share in the profits that hopefully will come down the road. So, you have the
right to be repaid when you pay your own money out, but not just for your hard work.
So, those are most of the important rights that partners have. Now, let's shift over and
talk about duties a little bit.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Now again, most of these you can't modify. So, for instance, the first one is called the
duty of loyalty. Even if your partnership agreement says partners in this partnership will
not have the duty of loyalty,

that's invalid. You can't do that because it's a foundational idea that partners owe each
other a duty of loyalty.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

We call these duties fiduciary duties, and this is a term that we use in a lot of different
contexts in the legal world. That basically means,

a fiduciary duty is a duty owed to somebody because you have some heightened
expectation of trust. So, family members often are fiduciaries duties, healthcare
providers have fiduciary duties to their patients, lawyers have fiduciary duties to their
clients, things like this. Partners owe fiduciary duties to one another because we expect
them to have a heightened obligation of trust. So, what are these duties.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

First, I already mentioned the duty of loyalty. This means that you are not allowed to
enrich yourself at the expense of your partnership.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

There's a lot of ways that this can be manifested, so self-dealing, say you cause your
partnership to engage in a deal with some third party, but you have an interest in that
third party. So, you are benefited by your partnerships dealings with the third party,
that's self-dealing. And that's a violation of a duty of loyalty, usurping partnership
opportunities. That's one of my favorite words, usurping. Say,you become aware of an
opportunity that would be a great business investment for your partnership, but instead
of telling the partnership you do it yourself. That's usurping partnership opportunities,
that's a violation of a duty of loyalty. You can't enrich yourself at the expense of your
partnership.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Next duty is the duty of care. This basically just means you have the right to manage
this partnership,

but your co-partners are counting on you to act in a reasonable way when you do that.
You know, not just take out crazy loans, not sign contracts on behalf of the partnership
that are unreasonable. These types of things. This is the duty of care. You have the
obligation to manage the partnership in a reasonable manner.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Third duty, the duty of obedience. This is a little more specific than the others,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

but if you have a partnership agreement it's going to say some things and give you
some obligations, right? So, it might say that only people in this group of partners have
the authority to enter into contracts on behalf of the partnership. Well, if you're not in
that group of partners, you don't have that authority and you have a duty to obey that.
You can't go out and misrepresent that you have some authority. If the partnership
agreement says something, you have the duty to obey what the partnership agreement
says.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Then finally, you have the duty to inform. This just means that as a partner you have the
duty,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

the obligation to inform your other partners of any material information that you come
across that would impact your partnerships business. Because in a court of law if you
ever get to that point, all of your other partners will be held to know something if you
know it as well. This is called the doctrine of imputed knowledge. All partners are held
to, in a court of law to know anything material that one partner knows. So, you have to
inform your other partners in anything relevant that comes across your desk.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke
Lesson 1-3: Special Forms of Partnerships

Lesson 1-3.1: Special Forms of Partnerships

In this lesson we expand our discussion of partnerships and look at some specific forms
of special partnerships including the limited partnership, limited liability partnership and
limited liability limited partnership. In this lesson we're going to wrap up our discussion
of partnerships by looking at some special forms of partnerships that have some
advantages over a general partnership. So, general partnerships can be really great if
you're able to protect yourself and shield yourself from liability.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

But then joint and several liability issue is not great if you're a partner.

So, to try and mitigate the risk associated with unlimited personal liability for partners in
a partnership,

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

states began to adopt other forms of partnerships. Now, this is the first time that we will
be dealing with

any sort of business entity that has limited liability for its owners. And from here on out,
every type of business organization that has any form of limitation on liability for the
owners

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

in order to form it you have to file something with the secretary of state in your state.
You cannot ever

get limited liability as an owner of any type of business organization no matter what it is
without filing something with the secretary of state. That's the trade off you make in
order to get limited liability. So, what are these unique forms of partnerships?

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

We'll start with the LLP the limited liability partnership. Now, I got to warn you these
names are going to get confusing.

So, start with the LLP limited liability partnership.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

This is exactly the same thing as a general partnership. I mean exactly the same thing
as a partnership. The only difference is that the partners aren't personally liable for
partnership debts.

So, you might say, "Well why would anyone ever form a general partnership, when a
limited liability partnership exists." Well, the answer is that there's a catch

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

and that limited liability partnerships are only available for certain industries, usually like
professional types of industries.

So accountants, lawyers, architects I think, things like that. So, you can form a limited
liability partnership in those industries. For example when I used to practice law, my law
firm was a limited liability partnership. It was great, it was exactly like a general
partnership, but none of the partners had personal liability. If you are in an industry that
allows this, it can be a really great option.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Next form of special partnership is called a limited partnership an LP. So we lost an L

and this actually is quite different from the general partnership or the limited liability
partnership. The limited partnership or LP, is actually a partnership where there are two
classes of partners, there's a general partner, one or more general partners and one or
more limited partners.

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 Corporate & Commercial Law II: Business Forms,
Financing & Governmental Regulation
Professor Michael R Fricke

Now, the way this functions is that, the general partners are just like general partners in
a general partnership.

They have unlimited personal liability and they can manage the partnership, and votes,
and do everything that a general partner

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can in a general partnership. But you have these weird other people over here called
limited partners,

and they don't have any of those rights but they're also not liable for anything. A limited
partner has limited liability,

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they are not personally liable for the debts of the partnership but they also don't have
the right to manage the partnership. You might think, well why would you do this?
Essentially a limited partner is an investor and in fact this is a really common form of
business organization to use in investment vehicles. Hedge funds, private equity all
these kinds of things, it's really common to have a limited partnership because the
general partner will be a corporation or something like that, and you have all these
limited partners out there who invest funds into the limited partnership and then they
expect a return on their investment, it's really really common.

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Though thing to remember is that limited partners are not liable for partnership debts
and obligations and also have no right to manage.

Okay now, the last form, and this is pretty uncommon in fact, you could probably go
your entire life as a lawyer and never come across a limited liability limited partnership,

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LLLP. This is exactly the same as LP, a limited partnership, but an LP have general
partners and limited partners. The general partner is usually liable for partnership debts
and obligations.

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While in an LLLP limited liability limited partnership, that general partner now has limited
has limited liability so everybody has limited liability. Again this is not super common but
these three forms, the LLP, the LP and the LLLP, are sort of newer types of
partnerships that states have adopted, that help owners get around this problem of
unlimited personal liability.

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Lesson 1-4: Introduction to Corporations

Lesson 1-4.1: Introduction to Corporations

In this lesson, we introduce the topic of corporations and we learn about some of the
key characteristics of corporations and how we categorize corporations. All right. We're
[inaudible] partnerships into corporations. Now, corporations are like the 800 pound
gorilla of business entities.

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They are by far the most common form of business entity, especially in terms of limited
liability business entity.

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Again, you have to file something with the secretary of state to form a corporation, but
the tradeoff is that you as an owner are not going to be personally liable for the
corporation's debts. And an interesting thing about corporations is that, they exist
separate and apart from their owners. So if you're thinking about a sole proprietorship,
the sole proprietorship and the owner are the same. There is no separate existence, but
a corporation exists separately from its owners. Owners can come and go and the
corporation still carries on as it's been. And because of the separate existence,

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as a general rule, corporations are people. Now if you watch the media then this can be
sort of a controversial thing.

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But honestly, in the legal world, this idea that corporations are people has been well
settled law for a long, long time. Now, what exact rights does a corporate person have?
Not exactly the same rights as a regular person, but corporations have certain free
speech rights. We saw this in the very controversial Citizens United Supreme Court
case. Corporations have free speech rights. They can engage in political speech things
like that. So corporations are people too, not exactly the same type of people as you
and I are, but they have a lot of rights. Now a couple of terms we're going to toss around
in this lesson and in the future lessons,

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shareholder is what we call an owner of a corporation. A shareholder owns a share or

more than one share

of that corporation. A share is just one unit of ownership in a corporation. Now, a

corporation could have five total shares. It could have 5 million total shares. Either way,
you own one share, you own a little slice of that corporation.

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So in general, there are about four key characteristics that set corporations apart from
the old days of just partnerships or sole proprietorships. Now again, the biggest one we
already talked about is limited liability for the owners.

The shareholders are not personally liable for the debts of the corporation.

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Second one, free transferability of shares. We mentioned corporations are separate

legal entities. Owners can come and go.

An owner generally, is free to sell or otherwise transfer his or her shares to somebody
else and that old owner is no longer an owner, the new person comes in, they have all
the rights that the old shareholder had.

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Third key core characteristics, centralized management. Now this is uncharted territory
for us in this module.

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The owners of a corporation do not manage the affairs of the business. They appoint
other people to do that. Now in a small corporation sometimes the owners can appoint
themselves to manage the corporation, but you know in the kind of legal sense they're
acting in two totally different capacities even though they're the same person. But in a
big corporation, you buy a share of stock in a publicly traded company. You don't have
the right to manage that company. You have the right to vote on other people to do that
for you.

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Then the fourth key characteristic, perpetual existence. While it is possible for a
corporation to die,

there is no set termination date for most corporations. They just exist forever until
someone takes some action to terminate them.

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Quick note about taxation of corporations now. This is not a class about tax, but it's
important to make the distinction that you've probably heard these words C corporation
or S corporation, c corp, s corp. These are tax designations. They have nothing to do
with the structure of a corporation.

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All corporations are corporations from a legal standpoint. From a tax standpoint, a
corporation can elect to be taxed under subchapter S of the IRS code or the default is
subchapter C of the tax code. That has nothing to do with how they function. They still
are structured the same way they're just taxed differently. A C corporation is taxed at
the corporate level. So the corporation pays income tax on its profits and then if it pays
those profits out to its shareholders, then the shareholders also pay tax. That's called
double taxation. An S corporation is tax just like a partnership where all of the profits of
the corporation flows straight through to the owners, which usually results in less tax.
But there's a risk in that. The profits get allocated to the owners and they have to pay
taxes on those profits, even if the corporation doesn't actually payout any distributions to
the owner. So this could be risky in a S corporations. I might say, "why aren't all
corporations S corporations?" Well, there's limits on who can be in S corporations. You
have to have fewer than 100 shareholders. You can't have foreign citizens as
shareholders, you can only have one class of stock. So a large company that's publicly
traded can never be an S corp because it has more than 100 shareholders.

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Now to wrap up this introduction of corporations, let's just talk about a few different ways
that we can classify corporation. S so you have this whole publicly held versus privately
held dichotomy. Most small corporations, the family business, even some very, very
profitable corporations

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can be privately held. This just means that there is no open market to buy a share of
this corporation. You can be a big giant company, but if you're all held closely by a
family or a small group of people and there's no open market for your shares, you're
privately held versus if you go to the New York Stock Exchange and you buy a share of
Motorola or "why did I say Motorola?" That's an old company from when I was a kid.
Nobody even knows about Motorola anymore. Apple, there's a more modern company
or Google or General Motors, I was trying to say General Motors and I trip myself up.
You can buy those on the open market, right? New York Stock Exchange, NASDAQ,
these are places you can buy stock in publicly held corporations.

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Next classification will be public versus private.

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A public corporation is actually a corporation that's owned by a governmental entity and

these exist are, really, one that I'm familiar with because where my family lives is the
Tennessee Valley Authority. This is a corporation in the Tennessee Valley region that
does like public works and things like this. It's a corporation, but it's controlled by the
government versus a private corporation, this is what you and I would normally think of
as a corporation. I start a business, register it as a corporation, that's a private
corporation.

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The next sort of classification would be for-profit versus not for profits. All businesses
that we think of would

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fall into the for-profit category, but charities, hospitals, religious organizations, these are
all nonprofit entities that we know about, but there are actually organized as
corporations. So in a lot of ways they operate like corporations as we'll see in a future
lesson. You know they have a board of directors. They might call it something else
besides that like the board of trustees, but it's the same thing as a board of directors. So
there are not for profit corporations again, in this class, we're dealing with for-profit
corporations, but just to be aware that there's another category of corporations out
there.

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And then finally, there is a difference between what we call domestic corporations,
foreign corporations, and alien corporations. Now in this sense, foreign and alien

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do not mean what you think they mean. A domestic corporation is a corporation that's
been organized in the state in which it is doing business. So we're here sitting in the
state of Illinois. Illinois has a statute called the Illinois Business Corporation Act that
governs how corporations in this state can be organized and operate. Every state has
their own business corporation act. So you can organize a corporation under the laws of
any state that you want to regardless of where you live or where the corporation is going
to be doing business. So if I'm here in Illinois and I want to organize a corporation under
the

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Delaware corporate statute which I can, which many, many corporations do, I can do
that.

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I just got to send my paperwork to Delaware. File it there. Now I'm a Delaware
corporation, even though I'm headquartered in Illinois and doing business in Illinois.
Saying why would somebody do that? There's a ton of reasons. Sort of beyond the
scope of this discussion. But if you are organized in the same state in which you're
doing business, you're called a domestic corporation. If you're organized in another
state besides the state in which you're doing business you're called a foreign
corporation. So if I'm here in Illinois and I organized my corporation as a Delaware corp
but I'm doing business in Illinois, then I'm a foreign corporation in Illinois. Because I'm
not organized in Illinois. If I was doing business in Delaware, then I'd be a domestic
corporation. And finally, an alien corporation is not a corporation from Mars. It's a
corporation that's organized in another country. So foreign just means in another state,
alien means in another country.

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Lesson 1-5: Corporate Formation

Lesson 1-5.1: Corporate Formation

In this lesson, we continue our discussion of corporations by walking through the steps
of forming a new corporation. What documents are required to be filed, what meetings
do you have to have, what are all the rules for forming a new corporation. All right, so in
the last lesson, we learned some of the basics of corporations. In this lesson, we're
going to start getting into the weeds a little bit more, we're going to work on how do we
actually form a corporation. Because there's several steps that have to be taken in order
to form a corporation. It's pretty important that you follow the rules. So here we go.

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The four steps to form a corporation, one, choose a state. Second, choose a name.
Third, file the documents you need to file. And fourth, hold some meetings and appoints
people who will actually run the organization and that's it.

So let's walk through each one of these steps individually.

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First, selecting a state. Now, on the previous lesson we mentioned that you can

operate your corporation in a state different from the corporation in which you organize
your business. Now, why would you want to do this? Every state's corporation law is a
little bit different and some states have a reputation for being more friendly to managers,
some states have a reputation for being more friendly to shareholders.

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So the reason a lot of corporations, large corporations, are incorporated in Delaware,

it's not because Delaware is so great, even though it might be, it's because and you
know Delaware is a tiny state, but the vast majority of large publicly traded companies
are incorporated in Delaware, why? A lot of reasons.

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They're known to be management friendly but maybe even more so than that, it's one of
these self reinforcing things, because so many corporations are housed in Delaware.
Their courts have seen, if there's an issue related to corporate law, their courts have
seen it. Everybody knows exactly what the law is pertaining to corporations in Delaware,
there's not any confusion and lawyers really like that. We really like knowing what's
going to happen before it actually happens. So if you have a Delaware corporation, and
some sort of dispute comes up about directors rights or appointing managers or
something like that, in Delaware all you have to do is go look, there's been a case about
your issue, whatever your issue is, guaranteed there's been a case because so many
corporations are incorporated in Delaware. So, you can pick whatever state you want.
And in fact, states sometimes advertise. I remember some time ago here in Illinois, I
would hear advertisements on the radio to incorporate in Nevada. The state was making
a big push to try to get more corporations there.

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So, you can incorporate it wherever you want, but you've got to pick a state. Most
people with small businesses pick the state that they're in because it's easy but you can
pick whatever state you want.

Next step, you've got to pick a name.

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Now, you might think, oh, that's easy. I just pick whatever I want.

It's not quite that simple.

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So first rule, your name cannot be confusingly similar with another name in your state.

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And you can do this by searching, every state has a secretary of state's website where
you can search all the corporations that are registered in that state, so just go look. If
there's something else that's really similar to yours, such that it would, like people might
confuse them with one another, they probably won't let you use that name. But, that's
only in your state, so if I'm registering a corporation in Illinois, there can be a corporation
in Indiana next door that has the exact same name and that's fine, because we're
different states.

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Second rule about choosing a name is you have to include one of the magic words to
identify that this is a corporation. The magic words are corporation incorporated, limited
and company or an abbreviation of one of those words corp, inc,

ltd or co. So you have to include those, if you don't, they will not allow you to form a
corporation, got to have one of those words in it.

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And then, this isn't a legal requirement but just as a practical matter, it's probably a good
idea to consider like trademark issues and domain name issues. If form a new
corporation, can I get a domain name that

matches it? Are there trademarks out there that other people have filed that I might
need to be aware of if I want to use my corporate name as a brand name also? Those
are just things to be aware.

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Okay. Third step in the process, you got to actually file some paperwork. Now, the
document you file to start your corporation is called the Articles of Incorporation. This is
not a long document, it's only a couple of pages long. It contains what's the name of the
corporation, what's the corporate address, what's the contact information for the
registered agents.

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Now, registered agent is basically like just the contact person for your organization in
the states in which you are organized. So, I mentioned, you can organize and whatever
state you want, you don't have to do business there but you have to have a person
there that the state can communicate with if they need to send you some official notice
or something like that. Now, it doesn't have to be an employee, in fact, every state has
tons of businesses that will serve as a registered agent for you for like 100 bucks a year
or something. You pay this company some money, they'll be your registered agent in
that state but your registered agent has to go on your articles of incorporation

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as does the contact information for the incorporators. The incorporators are just the
people who fill out the articles of incorporation.

They don't have to be like shareholders or directors or anything like that, but they're the
people who organize it, oftentimes those are lawyers.

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And then finally, on all articles of incorporation, you're going to be asked how many
shares are you going to be authorizing

meaning how many shares are created. So you can say, we're creating a million shares
or 100 million shares or three shares. It doesn't matter how many shares you're creating
and how many are issuing to shareholders. So you can say, I'm authorizing a million
shares and I'm issuing 100,000 shares. Meaning there will be 100,000 outstanding
shares in the hands of shareholders once this corporation has been formed.

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And then, the last step is to have some meetings. So the way it works in a corporation is
that

you have some shareholders, these are your initial people who get those issued shares,
your shareholders,

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their job is to have a meeting and elect some directors. They also adopt bylaws. Bylaws
are just a document that governs the corporate governance of a corporation,

when do we have meetings, who gets to vote on stuff, these kind of things are in the
bylaws. So the shareholders adopt some bylaws, they elect some directors.

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Now, once the directors have been elected, they get to have a meeting and the
directors appoint officers.

These are like your president, vice president, chief marketing officer, all these people,
the directors appoint the officers. So, there's two steps, right? Shareholders, elect
directors, directors appoint officers.

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Officers are the people who actually are the boots on the ground in an organization that
run the things.

Directors we'll seen a future lesson. Directors are more responsible for big picture
strategy like what markets are going to be in, what kind of products that we're going to
do. Officers are more like who are we going to buy our paper products from, that sort of
stuff.

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Officers do the work in a corporation.

Now, when I say you have to have a meeting, that doesn't actually mean you have to
have a meeting, you have to have an agreement. So the shareholders can meet, by
actually having a meeting or they can meet by what's called written consent. You can
actually just have a document, all the shareholder sign it, that can count as a meeting.

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And in a small corporation, can the same person be the shareholder and the director
and the sole officer? Yes, one person can fill all three roles.

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But in a technical sense, you've got to make sure you know which capacity you are, in
which you are acting. So if you're signing a document on behalf of the corporation, you
better make sure you sign it in your capacity as president and not in your capacity as
shareholder, because shareholders don't have the authority to sign anything on behalf
of the corporation. So while one person can fill all three roles, in a legal perspective, we
think of them as three different people even though they're the same person filling these
three roles.

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Lesson 1-6: Shareholder Rights, Powers, & Liability

Lesson 1-6.1: Shareholder Rights, Powers, & Liability

In this lesson, we continue our discussion of corporations by talking about the rights,
powers, and liability of shareholders in a corporation. Okay, we're still hearing the role of
corporations. Corporations are really important. So, we're going to spend a lot of time
talking about corporations. In this lesson, specifically we're going to focus on
shareholders, the owners of the corporation. What rights the shareholders have? What
powers do they have? When are they subject to liability? Usually never but sometimes.

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So, as a general rule shareholders must have at least one meeting every year. If you
own stock in any publicly traded companies, you've probably at some point in the mail
received a notice that your annual shareholders meeting is coming up.

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Usually, this is super boring, and it exists in a conference room somewhere in some
hotel, and the management of the corporation gets up in front and talks about how
things went past that year. But if you own even one share of a corporation, you can go
to the shareholders meeting and vote on stuff. There's one really kind of famous
exception to this, the shareholders meeting for Berkshire Hathaway, Warren Buffett's
company is like Woodstock for finance geeks. I think is how I heard it described once.
It's a very big deal, it happens in Omaha every year because people get to hear Warren
Buffett and Charlie Munger pontificate about the state of the economy. But other than
that, shareholders meetings usually are not super exciting.

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You have to have at least one every year. You can also call special meetings of the
shareholders. So, say, someone has an offer to buy your company or there's some
major issue going on, and you need to call a special meeting, you can do that. There
are rules about the percentage of shareholders who can call special meetings and
things like that. Now, in general, if you are having a shareholder meeting, you are
required to send a notice of the meeting to all of the shareholders,

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and also send an agenda to all shareholders, and you can only discuss and vote on the
things that are on the agenda. Just because we want it to be fair, right? You can't call a
meeting, send an agenda, and then if somebody says, "Well, I don't want to go and talk
about the things on the agenda," and then you get there and you say, "There's a
surprise agenda item that wasn't on there," well, maybe that person really would have
wanted to talk about the surprise issue. So, you could only discuss the things that are
on the agenda.

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Now, I mentioned that at the meetings, shareholders can vote on various things.

The main thing they vote on is the board of directors. So, usually, a director has a term
for their appointment to the board. It could be a year, it could be three years, it just
depends on the corporation, but the shareholders vote to replace directors when their
term is up. Sometimes, if they resign, or are removed from office for cause, things like
that shareholders vote on that.

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Now, as a general rule, corporate shareholders usually have one vote per share. So,
this means if there are a million outstanding shares

in a corporation, and you own 100,000 of those shares, you get 100,000 votes or 10
percent of the total votes are yours.

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Now, you don't have to vote your own shares in person, you can give someone else the
right to vote your shares for you. This is called giving your proxy to someone.

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So, if you own stock in any publicly held corporations, when you get that annual notice
that, "Hey, we're having a shareholder meeting", somewhere in that envelope, there's
probably a form that you can fill out, and it might say, "Okay. This decision is being put
before the shareholders of this corporation. If you don't want to come to the meeting,
and you just want somebody else to vote your shares for you, just fill out this thing and
sign it, send it and then somebody else will vote your shares for you." That's called
giving them proxy to vote on your behalf.

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Now, when it comes to voting, especially when it comes to voting on seats on the board
of directors, you can imagine that if you don't own very many shares,

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it would be nearly impossible for you to get someone that you like appointed to the
board of directors, unless you can get other people on board with you. So, for instance,
if there are a million outstanding shares, and you own a 100,000 of those shares, that's
a lot, but so, is only 10 percent. So, if the other 900,000 shares, the owners of those
shares all wanted somebody else on the board of directors that you didn't like, you're
out of luck.

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For this reason, this sort of minority shareholder oppression reason, a lot of
corporations have adopted this scheme called cumulative voting.

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Cumulative voting can be sort of complicated and involves math. So, lawyers don't like
it, but it's not complicated math. So, I'll explain how cumulative voting works. Imagine
there are three seats on the board of directors that are up for election at a meeting. So,
there's seat A, there's maybe a couple of people running to fill that spot on seat A, there
is seat B, there's a couple of different people who are in the running to be elected to
seat B, and there is seat C, there's a couple of people who are up for election to seat C.
Now, under what we call straight voting, the typical way, you own 100,000 shares, you
can vote 100,000 votes for whichever person you want to be in seat A, 100,000 votes
for whoever you want to fill the spot on seat B, 100,000 votes for seat C. But under
cumulative voting, you could actually pull all of your votes across all of the open director
seats, and put them on one, or divide them however much you want. So, under straight
voting, you have 100,000 here, 100,000, here and 100,000 here, that will be 300,000
total votes. So, under cumulative voting, you could take those 300,000, and put them
wherever you want. You can vote 300,000 votes on seat A, and no votes on seats B
and C if you want. This gives minority shareholders a much greater ability to have
someone that they like appointed to at least one director seat, but probably not more
than one.

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Now one more note about shareholder voting is that, shareholders often enter into what
we call voting agreements with one another. This is where they agree to vote the same
way,

or they can even transfer legal title to their shares to a trustee who votes the shares of
multiple shareholders at the same time. These are both ways to get more power for
minority shareholders. If you all agree to vote the same way, you can go have more of a
voice at the shareholder meeting.

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What about liability for shareholders? We know that corporations have limited liability for
their owners. In fact, almost all of the time, a shareholder is only liable up to the amount
of your investments. What's your investment? How much did you purchase the stock
for?

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If I go buy a share of Google stock, I pay some money for that. The money I paid for
that stock is at risk right. If the company goes bankrupt, if the price of the stock goes to
zero, I lose my investment, but I'm not going to lose my house or my car. I'm not
personally liable for a corporation's debts,

except there is this doctrine called piercing the corporate veil, which is a terrific name for
a legal doctrine. Piercing the corporate veil.

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Imagine that here's you the shareholder, there's a corporation over here, and in
between you and the corporation, there's this veil. The corporations debts and liabilities
can't go through the veil unless it's pierced, and the way that you pierce that veil, there
are two ways really.

First, if the shareholders or the corporation fail to do what we call observing the
corporate formalities, then you can pierce the veil. What does it mean to observe
corporate formalities?

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Well, the biggest thing is keeping the finances separate. If the corporate bank accounts
and the personal bank account of the shareholders are commingled, that's a failure to
observe corporate formalities. Now, obviously this never happens in big giant
corporations, right? This is almost always small family controlled corporations, where
you use the corporate checking account to buy a new TV for your house, or you don't
even have a separate corporate account. The reason that you can pierce the veil in this
situation and have a court say, "Shareholder, you are personally liable for the corporate
debts now", is because, a court will look at that and say, "Look, if you didn't treat the
corporation like a separate entity, then the court's not going to treat it like a separate
entity either." So, we're just going to consider you all part of the same person in terms of
liability.

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Now, the second way you can pierce the corporate veil is if you form the corporation
with insufficient capital. If I just former Shell Corporation and don't put any money in it,
and I start incurring liability,

that's form a corporation with insufficient capital, you can have the veil pierce pretty
quickly in that situation also.

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Okay. Finally, let's wrap up by talking about the rights of shareholders. Now,
shareholders can enter into agreements with one another or with the company called
shareholders agreements, and they can get some contractual rights.

Now, these contractual rights can be as broad or as narrow as you want. It's just a
contract.

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A common example is something like a buy/sell agreement or a right of first refusal.

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Buy/sell agreement is when the shareholders enter into an agreement that says, "None
of us are allowed to sell our shares to anyone outside the current group of shareholders.
If you want to leave the company, you have to sell your shares back to the current
shareholders or to the corporation itself." A buy/sell agreement will have some sort of
mechanism in there for pricing those shares. A right of first refusal, sort of similar, it's
where the shareholders all agree that you can only sell your shares to someone outside
the current group of shareholders, if you first offer them to the current shareholders.
They have the first right of refusal, and if they don't want them, then you can sell them to
a third party outside the current group of shareholders. Those are shareholders
agreements contractual rights.

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Corporations could also grant their shareholders what we call preemptive rights. This
can be important if the corporation wants to issue new stock. So, let's do a little math
again.

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But I promise this will be easy math. So, say a corporation has a million outstanding
shares, and I own 100,000 shares. That means I own 10 percent of the votes in that
corporation, right? Now, say the corporation wants to issue another million shares to
raise some money. They're going to sell a million more shares, raise some money for a
big expansion. Now, if they issue a million more shares, and I don't get any of them,
they're going to have 2 million shares out there, and I'm still going to have 100,000
shares. That means my vote went from 10 percent to five percent. I've been deluded. If
your corporation grants preemptive rights to its shareholders, then all current existing
shareholders have the right to purchase a pro-rata share of any new stock issuances in
order to maintain their percentage ownership of the corporation. So, if I owned 10
percent, and the corporation was issuing new stock, I would have the right to purchase
10 percent of that new stock. Now, I don't get it for free. I sort buy it. So, if I don't have
the money, or if I just choose not to, then I would still be deluded. But if I had the
money, and I choose to buy, then I can prevent myself from having my vote deluded.

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The final shareholder right is the right to sue. Now, usually, not suing the corporation,

you are suing oftentimes, the directors and officers of the Corporation for
mismanagement.

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There's two types of shareholder lawsuits, direct and derivative. A direct lawsuit is when
you allege, because of some action of the directors or managers of the corporation, I
have been damaged.

Usually, the price of my stock has gone down, or I didn't get a dividend when I was
supposed to get a dividend or something like that.

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A derivative lawsuit is actually a really interesting creature in that,

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the shareholder sues the directors or the managers not themselves, but on behalf of the
corporation. You're basically saying, "Hey, I'm an owner of this corporation, and your
mismanagement is causing harm to the corporation, and therefore on behalf of the
corporation, I'm suing you." The director's job is to take care of the corporation. But if
you're not doing that job, somebody has to stand up and represent the corporation. The
shareholders can do that in a derivative suit.

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Lesson 1-7: Director & Officer Rights, Duties, & Liability

Lesson 1-7.1: Director & Officer Rights, Duties, & Liability

In this listen we wrap up our discussion of corporations by focusing on directors and

officers. What are their rights, what are their duties, and what is their liability? Okay. We
are almost done with corporations. We've had a lot of discussion about corporations,
shareholders, classifications of corporations, how to form a corporation. Here in our last
lesson on corporations we're going to discuss directors and officers. What are their
rights, their duties, their liability? So, let's start with directors.

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Now, director's job is to set the strategy for the company, and appoint the officers. They
don't actually do the day to day management of the corporation. That's the officers job.

Actually, many directors aren't even employees, or full time engaged with the
organization.

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Many corporations have what we call, both inside, and outside directors. An inside
director, somebody who is also an employee of the corporation.

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So, oftentimes the CEO will be an employee and an officer, but also a director. That's
called an inside director. A lot of corporations also have outside directors. So, just
someone else from the business world, or from politics, or from academia. There are
folks here in the College of Business at the University of Illinois who serve on the board
of directors for corporations. Those would be an outside director because they're not an
employee of the organization.

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Now, as a general rule, directors of a corporation are not liable for the decisions they
make, even if those decisions caused the corporation to lose money, or similar bad
consequences as long as they make reasonable decisions. Directors are protected by
this thing called the business judgment rule.

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If a reasonable person could have made a decision that the directors made using good
faith, and reasonable care of the corporation, then the director would be liable even if
that decision turns out to be really, really wrong, and they lose tons of money.

Now, directors are liable if they breach their duties to the corporation, or if they mislead
shareholders.

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So, sometimes you'll see a conference call that a corporation is on. They have a duty to
provide accurate, not misleading information to their shareholders. You can be held
liable for that, or for breaching their duties. Now, speaking of duties let's talk about what
the director duties are.

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As a general rule the duties of directors to their corporation are about the same as the
duties of partners in a partnership. So, we talked about the duty of loyalty, the duty of
care, the duty of obedience back when we talked about partnerships. Same duties for
directors, loyalty, you can't engage in self dealing,

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you can't usurp corporate opportunities to benefit yourself. Directors are not allowed to
enrich themselves personally at the expense of their corporation. Duty of care: They
have this obligation to use reasonable care in carrying out your duties as a director of a
corporation. And then obedience. If the shareholders vote on something, it's your job to
obey that. If something's in the bylaws of your corporation and you're a director, it's your
job to obey that you have the duty of obedience.

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Now, on the flip side directors have some rights. One right the directors have that's
much different from the rights of partners and partnerships is that they have the right of
compensation.

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Directors don't do this job out of the goodness of their own hearts. They are entitled to
be paid. Being a corporate director can be a lot of work, and because they're not
necessarily also owners, the really only mechanism for a director to be reimbursed for
the time and effort they put into being a director is through compensation. So, directors
have the right to get paid for their work.

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They also the right to be indemnified by the corporation. This is a weird thing about
shareholder litigation,

if a director is actually sued by a shareholder for mismanagement, the corporation itself

will probably indemnify that director and be the one paying for the defense in the case
which can lead to weird consequences.

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And then the last right that a director has is the right to inspection or participation.

Directors have the right to understand what's going on in their business, inspect the
books and records, know what's going on. Nom they don't manage the day to day
affairs, but they have the right to know what's going on.

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Now finally, shifting away from directors to officers, there's not a whole lot to say about
officer rights duties and liability, because they're mostly the same as directors especially
when it comes to duties and liabilities, the officers are pretty much the same as
directors.

Same duties loyalty, care, obedience, that kind of stuff. Their liability is essentially the
same as directors. And when it comes to rights, since officers are just employees of an
organization,

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they don't really have many statutory rights. Any rights of an officer are generally just
those given to them in

their employment agreement which is the contract between the company and the
officer.

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Lesson 1-8: Limited Liability Companies

Lesson 1-8.1: Limited Liability Companies

In this lesson we wrap up the module by learning about limited liability company, is
essentially a hybrid between a partnership and a corporation. We're done with
partnerships, we're done with corporation, we have one form of business entity left to
discuss in this module and that's called a limited liability company or an LLC. Now, a lot
of people group limited liability companies with partnerships but they're different. Some
people might group them in with corporations, they're different.

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Actually if a partnership in a corporation ever got together and had a baby, it would be
an LLC. It is essentially a hybrid between

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those two business forms. So, in the history of business for a long time you had nothing
but sole-proprietorship and partnerships. Then several hundred years ago this thing
called a corporation came along, and corporations kind of dominated business for a
long time. Then, beginning in the late 70's here in the United States, the State of
Wyoming was the first state to adopt a Limited Liability Company Statute, and other
States came on board, and by the mid 1990's every State in the United States had
adopted a Limited Liability Company Act. So they're pretty young I mean honestly the
late 1970's up until now in the grand scheme of the legal history of the US, and of
common law countries is not very much time.

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So, there's still a lot sort of being figured out about how LLC works. But the real key
concept behind an LLC is flexibility.

You can choose how you want it to be structured, how you want it to be taxed, how you
want all sorts of things with your LLC it's super flexible. You want it to look like a
partnership? Great, it can look like a partnership. You want it to look like a corporation?
Great, it can look like a corporation.

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Another key concept with LLC is again limited liability of the owners. The owners which
we call members are not personally liable for the debts of the LLC, and again the great
thing about this there are no formalities to be observed. So, remember we talked about
corporations we said; you could pierce the veil if they don't observe certain corporate
formalities. That can include things like,

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if you don't have your annual meeting of shareholders, that's a corporate formality. Even
if you're the only shareholder you have to have a meeting with yourself in a corporation.
Now, the LLC statutes say; that's dumb you don't need to do that. So, you don't have to
have all these meetings with yourself and appoint people. You still do have to keep your
funds separate, commingling of funds is always a bad idea and will expose you to
liability. But, it's a lot easier to manage an LLC from that standpoint.

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A few key terms because LLCs have their own terminology, and these terms have
analogues in the corporate world. So, in an LLC we call someone a member if they're
an owner, that's the same as a shareholder in a corporation,

in an LLC we just call them a member.

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Now they have a membership interest, their membership interest is the same as

a share or their stock interest in a corporation is just what do they own. A membership
interest carry some voting rights, some distribution rights, some things like that.

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When you form a limited liability company, you file a document called articles of
organization.

That's the same as the articles of incorporation in a corporation. They're just called a
different name, and it looks a little bit different but it's the same general information that
you're passing on.

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Then LLCs are governed by a document called an operating agreement,

that's the same thing as the bylaws in a corporation, which is called an operating
agreement in the world of LLCs. Now when I said LLCs are flexible, the biggest ways in
which LLCs are flexible are in terms of taxation and management. So there is two
primary ways that LLC can be taxed, and two primary ways that can be managed,

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and if you put those in a grid you can see there's four different ways your LLC can look.
So, first option for taxation you can be taxed as a partnership or as a corporation, and
it's as easy as just checking a box when you file your articles of organization. So, if
you're taxed like a partnership again you're a flow through tax entity, meaning all of the
profits just get allocated directly to the individual members as personal income on their
income tax returns.

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If you'd elect to be taxed as a corporation, it's taxed like every other corporation. So, the
corporation pays income tax and then the shareholders pay tax on the distributions they
receive.

Or it could actually elect to be taxed as a corporation and then elect to be taxed as an

S-corporation.

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So you can choose either one. Tax as a partnership tax as a corporation. On the
management side of things,

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there are two options an LLC can be member managed or manager managed, and
again you choose this when you file your articles of incorporation which one you want to
be. If you're a member managed, that means every member, every owner of the
organization has the right to participate in the management of the organization,

where have we heard that before? Oh yeah, tha sounds like a partnership.

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In a partnership all the partners have the right to manage the organization same thing in
a member managed LLC, every member has the right to manage.

On the flip side, a manager managed LLC is the opposite, the members elect a
manager and the manager is the person or people or whatever who has the right to
manage the business, the owners don't themselves.

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Where have we seen that before? Well, in a corporation the shareholders don't have the
right to manage the company. They elect somebody else who does that. So, if you put
these on a grid you can see,

well look if you choose to be a member managed LLC that's taxed as a partnership, you
basically look exactly like a partnership.

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If you elect to be a manager managed LLC that's taxed as a corporation, you look really
similar to a corporation. Then you have these weird hybrids where you could be a
manager managed LLC that's taxed as a partnership, where you look a lot like an escort
actually.

Or a member managed LLC that's taxed as a corporation that sort of looks like a unique
entity that we don't really have an analogy for.

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Now, when we come to form a limited liability company, the process is basically the
same as for a corporation, it just has different nomenclature.

Again, you got to choose a state. Every state has their own LLC act, you get to pick
which one you want,

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you got to choose a name, same rules basically apply as corporations.

You can't have a name that's the same as another LLC in your state. You have to have
the magic words in there, and now in the case of LLCs the magic word is limited liability
company or magic phrase I should say. So you have to have the words limited liability
company in your name or the abbreviation LLC.

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Then you file your articles of organization. Again, this has all the important information
on there: what's the name of your company, who's the registered agent, all this kind of
stuff.

Then you adopt an operating agreement just like adopting bylaws. Now, notice the
difference is you don't have to have all these meetings that corporations have.

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In a corporation the shareholders meet, appoint directors, the directors meet appoint
officers, you don't have to do any of that kind of stuff in an LLC. The members can go
right ahead and start operating the business.

Finally, let's look at the rights and duties of the key people in limited liability companies.
Now, for the members of an LLC, their rights and duties

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depend on which management structure they have elected when they formed the
company.

In a member managed LLC, remember a member managed LLC means every member
has the right to manage the business, that sounds like a partnership. Therefore, their
rights and duties are basically the same as partners in a general partnership.

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They have the duty of loyalty, the duty of care, all of that kind of stuff because they act
just like partners in a member managed LLC. Now, flip that on the other side,

in a manager managed LLC, the owners are basically just like shareholders, right?
They'll elect the manager. So, in a manager managed LLC, the owners, the members
have the same rights and duties as shareholders in a corporation.

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Meaning, there's no duty of loyalty, you're allowed to have competing interests as an

owner in a manager managed LLC, because you're not the actual person managing the
business.

So, those are the members, now the manager himself or herself or itself is basically like
a corporate director or an officer all rolled into one.

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So, the rights and duties that we discussed in a previous lesson about corporate
directors and officers, those all apply to managers in a limited liability company.

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