Corporations (Fall 2019)

Workshop #1
Organizational Choices
[updated 18 Sep 19]

Relevant law [see TWEN  Course Materials  Statutory materials]:

 Partnerships
o RUPA - Revised Uniform Partnership Act (1997, as harmonized in 2013)
o ULPA - Uniform Limited Partnership Act (2001)
 Limited liability companies
o ULLCA (2006) - Uniform Limited Liability Company Act (2006)
 Corporations
o MBCA – Model Business Corporation Act (2016)
o DGCL - Delaware General Corporation Law

Short essay #1

Please indicate your group letter and the names of your group members.

Fundamentals

Anita and Brandon approach you (their lawyer) to help them organize a new business that will
design and install energy-saving systems in existing homes. They’ll call the business “Your
Green Home,” and they’ll hire home-efficiency designers and skilled installers. Anita has an
MBA and is a business journalist; she has cash to invest. Brandon is an engineer experienced in
home design; he’s taken some courses on energy-efficient buildings at the technical college and
is looking for a new career. Anita will put in capital and oversee the new firm’s finances.
Brandon will run the business. Please consider the following questions about the organizational
options they (and you) face.

1. You contemplate the basic organizational choices for A and B. Which statement is right?
A. A partnership fits their circumstances because they will want equal control, management
and financial rights
B. A corporation fits their circumstances because they will want centralized management
and limited liability
C. A limited liability company is the only one that fits their circumstances because they
will want to customize their relationship – both as to management and finances
D. It’s way too early to know. Each of these three organizational choices can be adapted to
fit their circumstances and their expectations.

2. A and B meet with you. A says she wants to oversee the business and have the potential for
high returns. B wants a fixed pay of some sort, though also wants to share in profits. Both
are worried that if something goes wrong, their personal assets (such as their lovely homes)
will be at risk. What organizational choice might you recommend?
A. A partnership in which A will be the only partner and receive all the profits, and B will
receive a specified salary, but with the authority of a managing partner
 B. A limited partnership in which A as limited partner will receive 75% of the profits, and
B as general partner will receive 25% of the profits
C. An LLC in which their operating agreement will specify: a formula for sharing of
profits, a fixed salary for B, B as manager of the business, and oversight by A
D. A corporation in which the two will be the sole shareholders and directors, with
questions of profit-sharing and salaries decided by the corporation’s board of directors

Formation

3. You talk further with A and B, and learn that A is involved in a messy “domestic
relationship.” She would prefer that her investment in the business with B not be public.
Not knowing much about business organizational choices, she makes the following
statements. Which is true?
A. “If we form a partnership and want limited liability by filing to obtain LLP status, we
will have to disclose who the partners are.” See RUPA § 1001(c).
B. “If we form a limited partnership, we would have to disclose the names and addresses of
all the general and limited partners.” See RULPA § 201(a) (2001).
C. “If we organize a limited liability company, all of the members will have to be disclosed
in the certificate of organization, a filing posted on the Internet.” See RULLCA § 201(b)
(2006).
D. “If we form a corporation in this MBCA jurisdiction, all of the directors and principal
officers will later have to be disclosed in an annual report filed with the state.” See
MBCA §§ 2.02(a), 16.21(a).

4. A asks whether there will be fees if they seek to form a limited liability entity. You say yes.
“Not the answer I was hoping for,” replies A, worried about costs. Instead, she proposes,
“Why don’t B and I simply agree to split profits 70/30, and to have B handle day-to-day
affairs, consulting with me on any major matters?” Your answer?
A. “Well, that might not work. Your business would likely be considered a partnership, and
if the business incurs any liability (in contract or because of negligence), each of you as
partners could be personally liable.” See RUPA § 202(a).
B. “Well, that might work. Your business would be considered a limited partnership, with
B having full liability as a general partner, thought not you unless you became involved
in running the business.” See RULPA § 201(a) (2001).
C. “Well, that might work. Your business would be a limited liability company, and your
operating agreement (which could be written or oral) would specify your profit and
management allocation.” See RULLCA § 201(b) (2006).
D. “Well, that might work. Your business would then be a corporation, and you could
choose to have 70% of the shares and B 30%, and you would both be directors and
officers.” See MBCA § 2.02(a).

Owner oversight

5. Comfortable that you seem to know what you’re saying and energized by your explanations
of business law, A and B begin to bandy about the “alphabet soup” of business organizations
– GP, LLP, LP, LLLP, LLC, even PLLC. (For some reason, “corporation” keeps its vaunted
unabbreviated moniker.) They ask you, “How can we get both limited liability, share profits,
and let B run the show, but with A’s close oversight – while keeping costs low?”
A. You recommend a GP, because no state filing is required. See RUPA §§ 202(a),
1001(c).
 B. You recommend an LP, because A as limited partner is given unlimited veto rights and
the ability to bind the business on any matter involving the business. See RULPA § 302
(2001).
C. You recommend an LLC, because their operating agreement can do all the things they
want (though there are fees to organize and for filing annual reports). See ULLCA §§
110(a), 205(a), 902.
D. You recommend a corporation, because a shareholders’ agreement can accomplish all
these things (and, after incorporating, corporations have no ongoing filing obligations or
fees). See MBCA §§ 1.22(a)(23), 7.32.

6. A and B are getting more and more curious. They ask about how they will share control of
their business – at least under the organizational default rules. A says that she took a course
on business law in her MBA program, and she makes the following assertions. You raise
your eyebrow. Which statement is true?
A. “If we form a partnership, all decisions will have to be unanimous, even if we take on
other partners. The partnership is a contract and requires consent by all the parties on all
matters.” See RUPA § 401.
B. “If we form a partnership, ordinary matters will be decided by majority vote, but
extraordinary decisions (such as bringing on a new partner) must have unanimous
consent. But we could change this rule, for example in decisions to bring on new
partners.” See RUPA § 401.
C. “If we organize an LLC, ordinary matters must be approved by a majority of the
members, but extraordinary matters by all. That’s the law; we couldn’t change it.” See
ULLCA § 407.
D. “If we incorporate, ordinary matters must be decided by the board, with shareholders
voting only on fundamental transactions. That’s the law, we can’t agree otherwise.” See
MBCA §§ 2.02(b)(2)(iii), 7.32.

7. B mentions to you that his brother-in-law Fred will likely work in the business as one of the
“energy efficient system” installers. If B hires F, but A objects, what are A’s options?
A. In a GP, A cannot veto an ordinary matter decided by B, but could withdraw from the
partnership and be paid (in cash) A’s share of the business assets. See RUPA §§ 404(k),
801.
B. In an LP, A as a limited partner would be able to vote against such a conflict-of-interest
transaction and prevent the general partner B from hiring Fred. See ULPA § 302.
C. In a member-managed LLC, each member has a veto power over ordinary decisions,
which must be approved unanimously by the members. See ULLCA § 407.
D. In a corporation, each director has the authority to act on behalf of the corporation and
bind it in the “ordinary course of business.” See MBCA § 8.01.

Owner liability

8. A and B mention that they have approached Probity Bank to obtain a loan for their new
business. The bank has said it would agree to lend money to the business, but suggests that
the Bank might ask A and B to give personal guarantees on Bank’s loan to the business. How
would you advise the parties?
A. If they form a GP, their personal assets will be at risk, and Bank can sue either of them
individually for non-payment -- even if the business has assets to cover the loan. See
RUPA §§ 306, 307(d).
 B. If they form an LP, only the assets of the general partner B will be at risk, and Bank
cannot obtain a personal guarantee from the limited partner A. See ULPA §§ 404, 303.
C. If they organize an LLC, their personal assets will not be at risk, even if after the loan
from Bank they immediately (and wrongfully) distribute all of the loan proceeds to
themselves. See ULLCA § 406.
D. If they incorporate, their personal assets will not be at risk, even if they sign the Bank
loan on behalf of the corporation -- assuming Bank decides not to insist on their
personal guarantees. See MBCA §§ 2.02(b), 2.03, 2.04.

9. B wonders about the extent of his liability if he runs the business. Suppose he brings on an
employee who negligently installs foam insulation in a customer’s house, causing the house
to become unlivable. B asks you, “Will I avoid liability under the different organizational
choices you have outlined?” Your answer?
A. Yes, if the partnership chooses (and files) to be an LLP, no partner can become liable for
any liabilities of the business, even if the partner negligently directed the faulty foam
installation. See RUPA § 306(c).
B. Yes, if the LP chooses (and files) to be an LLLP, no partner can become liable for any
liabilities of the business, even if the partner gave verbal assurances to the home owner
the installation would be safe. See ULPA § 404(c).
C. Not necessarily, if the business is organized as an LLC, the member who commits a tort
by improperly hiring an employee (known to botch insulation jobs) can become liable.
See ULLCA § 304.
D. Not necessarily, if the business is incorporated, the officer who supervises an employee
who commits a tort while acting within the scope of the business becomes liable --
whether or not the officer’s supervision is negligent. See MBCA § 8.42(d).

10. B is a bit concerned about one matter. “What if A begins to act as though she runs the
business? Would the business become bound if A, for example, decides to employ a new
marketing executive to help promote the business?” Your answer?
A. Don’t worry. If A and B operate as a partnership, only the managing partner may bind
the partnership in its ordinary business matters. See RUPA § 301.
B. This is a concern. In a partnership, any partner can bind the partnership; even if third
parties know about limits on a partner’s authority, that partner can bind the business. See
RUPA § 301.
C. Don’t worry. In an LLC set up as a “manager-managed” LLC, only the manager has the
authority to bind the business. See ULLCA § 407.
D. This is a concern. In a close corporation, where the same persons are shareholders,
directors and officers, any one of them can bind the corporation. See MBCA §§ 2.02,
7.21, 8.01, 8.40-41.

Special agreements

11. A and B are learning a lot. They now understand the difference between mandatory rules and
default rules. They ask you, “What if A decides to invest in other start-up ‘home energy-
system’ companies like ours. Can fiduciary duties, including duties not to compete, be
waived by agreement?”
A. In a partnership, fiduciary duties are mandatory terms and cannot be waived or modified
by the parties. See RUPA §§ 105(c)-(d), 409.
 B. In an LLC, all terms of the members’ relationship are contractual, and the courts will
accept (and apply) whatever terms or waivers the parties agree to – even if there is bad
faith. See ULLCA § 110.
C. In an LLC, members’ duties generally can be waived, though there are some duties that
cannot be waived – including certain aspects of fiduciary duties – if they would be
inconsistent with contractual good faith. See ULLCA § 110(d).
D. In a corporation, fiduciary duties of directors cannot be modified by agreement, even if
placed in the articles of incorporation. See MBCA §§ 2.02(b)(iii), 8.70.

12. A continues to be interested in having oversight over B. She asks that whatever business
form they choose, she would want to be able sign all contracts and checks over $1000. B is
agreeable, figuring that A’s involvement will keep things running better. And, of course, they
want limited liability. What should you advise them?
A. “An LLP accomplishes this, given that all ordinary business matters require the approval
of a majority of partners (two of you) or as you specify.” See RUPA §§ 102 (definition
of Partnership includes LLP), 401(k).
B. “An LLLP accomplishes this, given that a limited partner has authority to vote on all
matters affecting the business.” See ULPA §§ 102 (definition of Limited Partnership
generally includes LLLPs), 302.
C. “An LLC accomplishes this, though it would have to be structured as a manager-
managed LLC, given that management matters cannot be agreed to internally.” See
ULLCA § 407.
D. “A corporation accomplishes this, given that any action by the business must be
approved specifically by the board of directors (here the two of you). There can be no
delegation of authority.” See MBCA §§ 8.20-24, 8.40-41.

OK. You’re half-way through. Stand up, take a breather. Have a brew or a spritzer. Or even
some sugar water, if that’s your thing.

Withdrawal

You’re back! Remember Anita and Brandon – the capitalist and entrepreneur planning a
business to design and install energy-saving home systems, “Your Green Home.” A will supply
capital for the business; B will run it. After your advice on issues of formation, liability, control
and management, they are still asking questions. Please consider the following questions about
the organizational options they (and you) face.

13. During a break, A engages you in a side conversation. (We’ll later talk about your ethical
responsibilities in advising on the formation of a business.) She says that she worries that B
might create a reputation for himself and leave the business. Is there anything to prevent him
from walking away?
A. “Yes, in a general partnership (or LLP) you could specify that B’s withdrawal before a
specified term would be wrongful, entitling the partnership (and you) to damages.” See
RUPA §§ 601, 602.
B. “Yes, in a limited partnership, the general partner cannot withdraw without the
permission of the limited partners.” See ULPA §§ 603, 604, 605.
C. “No, in a manager-managed limited liability company, the manager has full autonomy to
leave whenever he wants, without repercussions, regardless of any agreement
otherwise.” See ULLCA §§ 601, 602, 603.
 D. “No, in a corporation, the directors and officers can always resign, and shareholders can
always force the corporation to buy their shares from them, even if there’s no
agreement. It’s the capitalistic model.” MBCA §§ 1.40(6), 6.31, 6.40(a) 8.07(b), 8.43,

Distribution of profits

14. B rejoins the meeting. A remembers from MBA school that different business forms result in
profits being divided differently. She asks you how profits would be divided if their business
succeeds. Feeling more comfortable that you’re now advising both of them together, you
answer:
A. In a partnership, profits are divided among the partners according to capital
contributions, so they’d have to agree otherwise if B wanted to share equally in profits.
See RUPA § 401(a).
B. In a limited partnership, profits are divided among the partners equally, so that A (as
limited partner) and B (as general partner) would share equally, even though their
capital contributions were different. See ULPA § 503.
C. In an LLC, profits are shared equally among the members -- though profits are not
shared with the managers, if any, who are compensated only by agreement. See ULLCA
§§ 404, 405.
D. In a close corporation (which is treated as an “incorporated partnership”), any profits
must be paid as dividends and each shareholder receives an equal dividend, regardless
of the number of shares owned. See MBCA §§ 1.40(6), 6.40.

15. Well, A and B ask, how is the decision made whether profits are distributed to the owners or
re-invested in the business?
A. In a GP, partners have a right to receive profits only if there is a vote by all the partners,
given that a decision to distribute profits is extraordinary. See RUPA § 401(a), (k).
B. In a GP, partners have a right to receive profits only if there is a majority vote by the
partners, given that a decision to distribute profits is ordinary. See RUPA § 401(a), (k).
C. In an LLC governed by ULLCA (2006), members do not generally have a right to
receive profits; instead, pre-dissolution distributions must be approved by majority vote
of the members, though their operating agreement can specify otherwise. See ULLCA
§§ 110(a), 404, 407(b).
D. In a corporation, shareholders have a right to be paid dividends whenever the
corporation has sufficient profits -- that is, whenever there is a surplus after the
corporation has met its obligations to creditors. See MBCA § 6.40; see Dodge v. Ford
Motor Co (Mich. 1919).

Liquidity

16. A and B are impressed by your erudition. They now are curious about what might happen if
the business is not profitable, but instead a bust. They ask, “How might each of us get out?”
A. In an at-will GP, any partner may withdraw by so stating, and the partnership is
dissolved, entitling the withdrawing partner to cash for her share of net business assets.
See RUPA §§ 601(1), 602(a), 801(1), 802.
B. In an at-will GP, any partner may withdraw but only in writing, and the partnership then
pays creditors and divides its remaining assets on an in-kind basis. See RUPA §§ 601(1),
602(a), 801(1), 802.
 C. In an LLC without a specified term, any member may withdraw and has a right to
demand payment from the LLC for a buyout of her financial interest. See ULLCA §§
601(a), 602(1), 603(3).
D. In a corporation, a shareholder has a right to have the corporation repurchase her shares
at “fair value,” which the shareholder can demand be set in a judicial proceeding. See
MBCA §§ 6.31, 6.40, 13.02.

17. “Hmm, that’s not what we expected to hear,” they say. “Well, let’s assume things go a bit
better for the business, even much better. Could we go to a bank and use our ownership
interest in the business as collateral to take out a personal loan?” You think to yourself that
these are pretty smart folks, because this would be a way for them to get money if the
business succeeds, even without receiving a distribution from the business. Your answer:
A. “In a GP, any transfer of your interest would require the consent of all the partners –
including if you pledged your partnership interest as collateral for a bank loan.” See
RUPA §§ 501, 502, 503.
B. “In an LLP, any transfer of your interest would require the consent of a majority of the
partners – including a pledge of a partner’s interest to a bank.” See RUPA §§ 501, 502,
503.
C. “In an LLC, the pledge of an a member’s financial interest is valid, though only the
financial interest can be used as collateral, not the member’s management/voting
interest.” See ULLCA §§ 501, 502.
D. “In a corporation, shares are freely transferable, even if the articles of incorporation (or
a shareholders’ agreement) forbids their pledge in a loan transaction.” See MBCA
§3.02(5), 6.27.

18. A and B say, “OK, that covers things if we wanted to transfer our ownership interests to
outsiders. But what about the having the business itself buy back our interest? Can this be
done?” You have an answer:
A. “In a GP, the partnership (whether for a specific term or open-ended) must always be
prepared to buy a withdrawing partner’s interest, whatever the partners’ agreement.”
RUPA §§ 105(a), 701, 801.
B. “In an LP, the limited partners can have the partnership agreement provide that the
partnership will repurchase their interests (provided the partnership’s buyback does not
jeopardize creditors).” See ULPA §§ 102(5), 110(a), 507, 508.
C. “In a manager-managed LLC, the company cannot be obligated to repurchase member
interests, because the manager has the sole authority to make such decisions, regardless
of any agreement otherwise.” See ULLCA §§ 102(5), 110(a), 404, 407(c).
D. “In a corporation, shareholders are entitled to have the corporation repurchase their
shares at “fair value” if the shares are not traded on a public stock market.” MBCA §§
6.31, 6.40, 14.30(a)(2)(ii).

Change/combination

19. “Fair enough,” say the two business types. They then begin to talk about the future,
“Suppose we want to make some changes, expand and bring in new owners -- and then hope
to get an offer to sell to another company. How might we do this?” You answer:
A. If you’re a GP or LLP, you could agree to bring in new partners who would pay to join
the business, though both of you would have to agree to this. See RUPA §§ 402(b)(3),
403.
 B. If you’re an LP, A could sell her limited partner interest to outside investors, but the
proceeds of the sale would go to the LP. See ULPA §§ 601(b)(1), 602(a)(3).
C. If you’re a manager-managed LLC, new members could be brought in by the manager –
even though some of the existing members might object. See ULLCA § 401(d).
D. If you’re a corporation, new shareholders can be brought in by the board issuing
authorized shares – subject to a vote by a majority of the shareholders, who must
approve any new share issuance. See MBCA § 6.21.

20. “OK, now let’s talk about what would happen if the business succeeds and we want to sell to
another business.” They say this no doubt thinking about how startups regularly sell to
established companies for millions and sometimes billions of dollars.
A. In a partnership, any one of you can always sell your partnership interest to a new
partner – such as an acquiring corporation -- and thus receive stock in the acquiring
company. See RUPA §§ 601(1), 602(a), 701(a).
B. In an LP, the partnership could merge with another entity, provided all of the partners
agreed. See ULPA § 1103(a).
C. In an LLC, it’s sufficient if a majority of the members agree to a merger, much as in a
corporation. See ULLCA § 1003(a).
D. In a corporation, a majority of shares must be voted for the merger, though the board’s
consent is not required. See MBCA §§ 11.04(a), 11.04(b).

Tax implications

21. “Enough about our rights, what about tax?” they ask. You offer an overview:
A. If you form a partnership, you will be required to file an IRS information form, but you
individually will pay federal income tax only on business profits that are actually
distributed to you
B. If you form a limited partnership, with A as limited partner and B as general partner,
business profits will be taxable only to B, even though A also shares in the profits
C. If you form an LLC, you must elect to be treated as a pass-through entity by making a
filing with the IRS; otherwise, the LLC will be subject to entity-level tax – it’s called
“check the box”
D. If you form a corporation, you must elect pass-through treatment by filing under
Subchapter S of the Internal Revenue Code; otherwise, there will be corporate-level tax

22. As you explain the curious federal income tax rules for business entities, A and B are a bit
perplexed. “Are you saying that there are times with pass-through tax treatment that we
might become subject to individual taxes, even though the business never distributed any
income to us?” Your answer:
A. Yes, that’s it. If the business is subject to pass-through tax treatment, any business
income (even if not distributed) will be treated as income to the individual owners
B. Yes, that’s it. If the business is incorporated, you will personally have to pay individual
taxes on business income even if the corporation declares no dividends
C. No, that’s not quite right. If the business is subject to pass-through tax treatment, only
payments actually received from the business are taxable to the individual owners
D. No, that’s not quite right. As you know the Tea Party has been successful in getting
Congress to do away with all corporate and personal income taxes
23. A and B appreciate that you have a sense of humor. But they still have questions about tax.
“What if there are losses in the business – that is, we don’t make enough to cover expenses?
How are those losses treated from a tax standpoint?” Your answer:
A. In a partnership or LLC, those losses result in the IRS giving the business a tax credit,
which would result in a cash payment from the US Treasury to the money-losing
business
B. In a partnership or LLC, those losses would be reported to the IRS and then each owner
(depending on how you allocate losses in the operating agreement) could reduce your
individual taxable income and thus your income tax
C. In a C corporation, those losses result in the IRS giving the business a tax credit, which
results in a cash payment from the US Treasury to the money-losing business entity
D. In an S corporation, those losses are not reported on the shareholders’ individual tax
returns, but instead are carried forward and deducted from the corporation’s income in
the future

24. “All of this is very interesting,” say A and B. But A (the MBA) has a final question: “Before
we take you to lunch, we want to know whether if we incorporate (hoping to go public after a
while), can we reduce our corporate-level tax by making payments to ourselves?” Your
answer:
A. Yes, you can “zero out” income at the corporate level by making payments to
yourselves, to your kids, even to your pets – it’s all deductible
B. Yes, you can “zero out” income at the corporate level by paying yourselves for such
things as services, rents, intellectual property – and deducting these amounts. But the
payment amounts have to be reasonable
C. No, you cannot “zero out” income at the corporate level because any payments to
yourselves would be a conflict of interest, and thus disallowed under IRS rules
D. No, you cannot “zero out” income at the corporate level because the country needs
every dime it can get from corporations

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