Business Law Frequently Asked Questions:

What is Business Law?

Business law includes the many rules and regulations that govern commercial relationships for which businesses may be conducted and managed. Business law includes business formation and organization; transactional business law; contracts, business planning, business negotiations, and mergers and acquisition.

How do I determine what business structure is right for my company?

There are several things to consider when choosing a business structure. Mainly you must consider your preference of taxation and how you intend to profit from the business. If you plan to issue stock and trade it publicly, you must also consider how you intend to organize the management of your business as well as the surrounding the liability of the owners. It is imperative to plan for your business and work closely with a person qualified to help you choose the business structure that meets your needs.

What is the distinction between a subchapter C and S corporation?

The Internal Revenue Code allows for two different levels of corporate tax treatment. Subchapters C and S of the Code define the rules for corporate taxation.

Subchapter C corporations are comprised of mostly large, publicly-held businesses. These corporations are doubly taxed on their profits if they pay dividends. C corporations file their own tax returns and pay taxes on profits before disbursing dividends to shareholders. Additionally, the shareholders are then taxed on their individual tax returns.

Subchapter S corporations meet certain requirements that allow the business to protect shareholders from the debts incurred by the corporation, while avoiding the double taxation of a subchapter C. To meet the criteria for subchapter S treatment, corporations must be domestic; cannot be associated with any larger corporate group; must have no more than one hundred shareholders; may only have one class of stock; must not have any corporate or partnership shareholders; and cannot have any nonresident alien shareholders.

Additionally, after a business is incorporated, all shareholders must agree to subchapter S treatment before selecting that option with the Internal Revenue Service.

What is the meaning of “piercing the corporate veil?”

Occasionally, courts will allow plaintiffs and/or creditors to be compensated from corporate officers, directors, or shareholders for damages instead of restricting recovery to corporate assets. This process bypasses corporate immunity for organizational misconduct, and may be enforced in an array of circumstances. The specific standard for piercing the corporate veil varies from state to state. Collectively, courts may choose not to allow owners to benefit from a corporation’s limited liability if the underlying business is impossible to differentiate from its owners. Also, courts may not allow recovery if a corporation is formed for fraudulent purposes. Courts may enforce liability on the individuals controlling the business, or if a business fails to follow certain corporate formalities in areas such as record-keeping.

What is the difference between a joint venture and a partnership?

Joint ventures and partnerships share certain characteristics. A joint venture is like a partnership in that two or more entities unite for a particular purpose. In both partnerships and joint ventures, each entity has equal ability to legally bind the entire entity. A partner can represent the entire organization in the normal course of business. His or her legal actions on behalf of the joint venture or partnership create legal obligations.

The authority of individuals in a partnership or joint venture can be restricted by an agreement. However, such agreements do not bind third parties. Because business contacts beyond the partnership may not have knowledge of the restrictions, they may be permitted to rely on the apparent authority of an individual partner as determined by the usual course of dealing or customs in the trade.

What is a non-profit corporation?

A non-profit corporation is formed to perform charitable, educational, religious, literary, or scientific purpose. A nonprofit corporation pays no federal or state income tax on any profits it makes from activities it engages in to carry out its purpose. This is because the IRS and state tax agencies consider the public benefit provided by these organizations’ activities entitles them to a tax-exempt status.

For more information on federal tax exemption for nonprofits see Section 501(c)(3) of the Internal Revenue Code. You can find a link to Internal Revenue Code under the Legal Links tab of our website (www.mzmlaw.com.)

How often should a corporation hold meetings and update its minutes?

Any time a corporation carries out a change or transaction, it should be recorded in its minutes. Additionally, shareholder meetings and director meetings should take place annually if for no other reason than to choose new officers and directors. Failure to hold or follow the formality of regular meetings can put the corporation’s ability to shield its officers, directors and shareholders at risk. This may also obstruct a corporation’s ability to protect from personal liability for the corporation’s actions.

Is it necessary to have a Buy-Sell Agreement?

Corporations with multiple shareholders should consider a buy-sell agreement. A shareholder’s death, divorce, disability or termination of employment can cause severe problems for a corporation and its other shareholders. A buy-sell agreement minimizes problems by providing an orderly progression in such plans. Similar provisions exist and are recommended for partnerships.

What is involved in a corporate merger?

Mergers are regulated at the state level. While these laws vary by jurisdiction, many phases of the merger process are the same across the nation. Generally, a board of directors for each entity will approve a declaration approving a plan for a merger that specifies the names of the entities concerned, the name of the future merged company, the method for adapting shares of both entities, as well as other legal provisions upon which the corporations agree. Each entity notifies all of its shareholders that a meeting will be held to approve the merger. If enough shareholders approve the plan, the directors will sign the papers and file them with the state. The secretary of state issues a certificate of merger to allow the creation of the new corporation.

Each state has its own statutes that govern the process for mergers. Furthermore, state or federal agencies may choose to investigate the potential anticompetitive effects of a proposed merger. Because the requirements and variables involved in merging, a corporation considering a merger should contact a lawyer who is experienced in mergers and acquisitions law.

Choosing a business form

Before business owners can open their doors they must decide how to structure their business. What form should the business take and what legal documentation is required to meet local, state and federal regulations? An attorney can guide you through the steps necessary to structure your business. The first step is to understand the various business forms. The five most common business forms are:

Sole Proprietorship

Sole proprietorships are the most common form of business and the easiest to create. Think of them as a one-owner or traditional family-type business. They have no existence apart from their owners. For legal and tax purposes, they are considered “one and the same” as the owners.

Advantages Owners of sole proprietorships can exercise complete control over their businesses with minimal regulation. Starting a sole proprietorship is the simplest of all the business forms and usually requires the filing of a handful of documents. A federal tax I.D. number may be required for the collection of taxes.

Another advantage is the ease with which sole proprietors file taxes. Profits and losses are personal to the owner, which means any losses the business suffers can be deducted from other earnings made by the owner. The profits are counted only once as income – unlike corporations.

Disadvantages The main drawback with sole proprietorships is that the owners can become personally liable for actions taken by the business. Because the sole proprietorship and owner are treated as one, collection agencies can reach into the personal assets of an owner if they’re not getting the full monies owed to them from the business. Also, owners can become personally liable for lawsuits filed against their businesses. Liability insurance offers some protection. But, as often is the case, that means dealing with escalating premiums.

Another disadvantage is the difficulty sole proprietorships face in securing business loans. Unless the business owner has sufficient collateral and a proven track record, banks may be reluctant to lend to a sole proprietor. Some new business owners resort to mortgaging their homes and other assets to come up with the necessary collateral. This puts their personal assets at direct risk.

Also, sole proprietorships lack continuity beyond the owner and cease to exist once the owner dies. While the business can be left to heirs, it is rare to see a sole proprietorship succeed after the original owner has died.

Partnership

Partnerships are usually based on partnership agreements. Each partner brings money, labor, property or special skills to the partnership. In return, each partner receives a share of the profits. For legal and tax purposes, partnerships usually are required to spell out certain conditions:

Advantages One of the biggest advantages of a partnership is its ability to raise capital. Partnerships rely on the existing partners and new partners to contribute in kind or to boost the partnership’s potential to secure loans.

Partnerships are a good choice when only a handful of people want to operate a business. Start-up costs can be distributed evenly, and the legal and tax requirements of state and local governments are usually simple and straight forward. Like sole proprietorships, any income the partnership derives is taxed at individual tax rates.

Disadvantages Of all business forms, partnerships tend to produce the most conflict. This usually stems from a flaw or oversight in the original partnership agreement. Because each partner accepts a personal controlling interest in the business, each can become personally liable for the business debts, regardless of which partner actually caused that debt.

Legal liability is another concern. Each partner can become personally liable for the negligent actions of another partner or employee. It’s important to consult with an attorney early in the development of the partnership in order to provide the best protection to each partner while allowing flexibility for the business to grow.

Partnership agreements should anticipate as many contingencies as possible. For example, many partnerships any up dissolving when a partner dies even though the remaining partners want to keep the business going because the partnership agreement did not anticipate such a hardship. A properly structured partnership agreement can chart a course through such difficulties to ensure the business continues.

Likewise, it’s important to create a partnership agreement that spells out the duties and legal responsibilities of each partner. The Uniform Partnership Act adopted by each state provides an outline for legal responsibilities. But it’s important to talk with an attorney to make sure your partnership agreement meets the needs of your particular business.

Limited Liability Company

Limited liability companies are a relatively new business form. But they’re among the fastest growing in the nation and for good reason. This form, a hybrid of a partnership and corporation, offers the personal liability protection of a corporation and the tax advantages of a partnership.

Advantages Members of an LLC are liable only to their own investment. They have no personal liability for debts or legal judgments against the business and can choose an active or limited role in its day-to-day oversight.

Because LLCs are taxed like partnerships, income is passed through to the members and taxed accordingly at individual rates. The business itself pays no income tax, though like other business forms, LLCs are subject to sales taxes.

Another advantage of an LLC is flexibility in income distribution. Corporations require income to be distributed strictly according to how shares are distributed. LLCs allow their members to decide how they want profits distributed at the outset. A founding member, for example, may receive a larger share in proportion to his initial contribution to the business.

Disadvantages Limited Liability Companies are creatures of statute. While LLCs are mostly similar from one state to the next, differences can arise in how they are formed and regulated after that formation.

LLCs generally are subject to more paperwork than partnerships and sole proprietorships, both in their creation and operation, and because they’re subject to more regulation they are likely to incur higher filing and reporting fees than partnerships and sole proprietorships.

The first step in forming an LLC is usually to file Articles of Organization with the state. It’s important that these articles detail the responsibilities of each member and anticipate as many problems ahead as possible, such as the death of member. Properly structured articles can help keep an LLC running through difficult times.

“C” Corporation

“C” Corporations also are governed by state laws. They are more complex and incur more regulation than other business forms but increasingly are the favored choice of large businesses because of the protections they offer investors.

Advantages Liabilities for the corporation’s debts are limited to each owner’s individual investment. Generally, if the corporation fails the owners (shareholders) are not put at risk – a feature that can be helpful early on when trying to attract investors and raise capital.

Another advantage is that corporations are relatively independent from owners. They exist perpetually regardless of whether an investor dies and thus are able to cultivate a solid, lasting image.

Also, in a corporation shares can be bought and sold freely by each investor and without approval from other investors. This is an attractive feature that can entice other investors and help a fledgling company generate capital. The purchase and sale of shares is subject to state and federal regulations, however.

Disadvantages Corporations operate through boards of directors. When a business entity opts to become a corporation, its owners in effect agree to cede control to a board of directors. This can be difficult for an owner who is used to deciding how to run the business and tends to the day-to-day affairs.

Also, corporations are required to hold formalized meetings and are subject to far more regulation that other business forms. They regularly file copious and detailed records and are subject to scrutiny by public agencies. As such, corporations can expected to pay higher filing and reporting fees than other business forms.

Lastly, any dividends paid out by the corporation are taxed twice – once at the corporate level and a second time at the individual tax-filer’s level.

“S” Corporation

This last form of business entity is very popular  among small businesses that want the protection from liabilities that C corporations offer while avoiding double-taxation, like an LLC.

S-corporations are similar to LLCs. Taxes are passed through to the individual investor. But S Corporations are subject to certain specific federal regulations that limit their growth: They cannot have more than 100 shareholders; all of the shareholders must be individuals and U.S. citizens; and the business must offer only one class of stock to investors.