Chapter 12: Business Organizations
Learning Objectives
- Compare sole proprietorships, general and limited partnerships, LLCs, and corporations on formation, liability, taxation, management, and transferability.
- Explain the rights and duties of partners and how partnerships dissolve and wind up.
- Describe how an LLC is formed and managed, and why it has become the most popular choice for small businesses.
- Explain how a corporation is formed and financed, the roles of directors, officers, and shareholders, and when courts will pierce the corporate veil.
- Apply the fiduciary duties of care and loyalty and the business judgment rule, and outline the basics of securities regulation.
Week 12. Chapter content to be written. The description below sets out what the chapter will cover.
Choosing a business form is one of the first legal decisions an entrepreneur makes, and the choice affects personal liability, taxes, control, and the ability to raise money. This chapter surveys each major form, then spends the most time on the corporation and on the duties of the people who run it.
12.1 Planned Sections
Sole Proprietorships and Franchises. Formation, advantages, and unlimited personal liability. Franchising as a way to expand a business: types of franchises, the FTC Franchise Rule, the franchise agreement, and franchisor liability.
Partnerships. General partnerships under the Uniform Partnership Act, partnership by estoppel, partners' rights, fiduciary duties, and joint and several liability. Dissociation, dissolution, and winding up. Limited partnerships and limited liability partnerships.
Limited Liability Companies. Formation, the operating agreement, member-managed and manager-managed LLCs, pass-through taxation, members' duties, and dissolution. Series LLCs and other newer forms such as benefit corporations.
Corporations. Classifications (domestic and foreign, public and close, S corporations, professional corporations, and benefit corporations), promoters and preincorporation contracts, incorporation procedures, corporate powers, piercing the corporate veil, and financing through debt and equity.
Corporate Governance. The board of directors, officers, and shareholders. Shareholder meetings, voting, and derivative suits. The fiduciary duties of care and loyalty, conflicts of interest and corporate opportunities, and the business judgment rule. Sarbanes-Oxley and modern governance concerns such as ESG and board oversight duties (Caremark).
Securities Regulation Overview. What counts as a security (the Howey test), registration under the Securities Act of 1933 and its exemptions (including crowdfunding), the Securities Exchange Act of 1934, Rule 10b-5, and insider trading.
12.2 Featured Case
Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545 (1928). Salmon managed a 20-year lease on a Manhattan hotel property as a joint venture, and Meinhard supplied much of the money. Near the end of the lease, the landowner offered Salmon a much larger redevelopment deal. Salmon took it through his own company and never told Meinhard. Judge Cardozo held that Salmon had breached his duty of loyalty. Co-venturers owe each other "the duty of the finest loyalty . . . not honesty alone, but the punctilio of an honor the most sensitive," and that includes telling a partner about business opportunities that come out of the venture.
Why this case: It is the classic statement of fiduciary duty among business co-owners. Its reasoning carries over to partners, LLC members, and corporate directors, and the corporate opportunity doctrine builds on it.
Discussion question: Salmon never lied. Was keeping quiet really a breach? How would a well-drafted partnership or operating agreement have changed the outcome?
12.2.1 Short Case Summaries
- Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Directors who approved a cash-out merger after a two-hour meeting, without adequate information, breached their duty of care and lost the protection of the business judgment rule. (Corporate governance)
- SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Sales of citrus grove plots bundled with service contracts were "investment contracts," and therefore securities, under the Howey test. (Securities regulation)
12.3 Planned Features
- A comparison table of business forms that students can use when advising a hypothetical startup.
- A capstone-style exercise: recommending an entity type for three founders with different goals and risk tolerances.
- Key terms: sole proprietorship, franchise, general partnership, joint and several liability, limited partnership, LLC, operating agreement, articles of incorporation, piercing the corporate veil, duty of care, duty of loyalty, business judgment rule, derivative suit, security, insider trading.