Deck 39: Corporate Formation and Financing

Question 1

Incorporation Jonathan, Gary, and Ricardo are active members of a partnership called Swim City. The partnership manufactures, sells, and installs outdoor swimming pools in the states of Arkansas and Texas. The partners want to continue to be active in management and to expand the business into other states as well. They are also concerned about rather large recent judgments entered against swimming pool companies throughout the United States. Based on these facts only, discuss whether the partnership should incorporate.

Answer 1

The partners should consider forming a corporation. The key advantage here, based on the increased number of suits against swimming pools, is the limited personal liability of the partners. That means that if the partners happened to be sued, they would not be held liable (as long as there was no evidence of fraud.) Corporations enjoy rights to the court, due process, free speech, and freedom from unreasonable searches and seizures. Corporations last indefinitely, unlike partnerships.
There are some cons to corporations, including double taxation. The corporation's profits are taxed and then once dividends are distributed to shareholders, their profits are also taxed.
Since the partners want to expand and grow their business as well as be protected from liability, incorporating would be a good move.

Question 2

William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 A.M. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, fi led a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following questions.
Under what theory might the court in this case make an exception to the limited liability of shareholders and hold Sharp personally liable for the damages? What factors would be relevant to the court's decision?
DEBATE THIS: The sole shareholder of an S corporation should not be able to avoid liability for the torts of her or his employees

Answer 2

The potential for corporate assets to be used for personal benefit is especially great in case of close corporations, in which the shares are held by a single person or by only a few individuals, usually family members.
In such situation, the separate status of the corporate entity and the sole shareholders must be carefully preserved. There can be the situation of lifting the corporate veil.
Under the theory of lifting the corporate veil , an exception can be created to the limited liability of shareholders.
The factors that could be relevant is the observation of the comingling of corporate and personal funds.

Question 3

Cummings, Okawa, and Taft are recent college graduates who want to form a corporation to manufacture and sell personal computers. Peterson tells them he will set in motion the formation of their corporation. First, Peterson makes a contract with Owens for the purchase of a piece of land for $20,000. Owens does not know of the prospective corporate formation at the time the contract is signed. Second, Peterson makes a contract with Babcock to build a small plant on the property being purchased. Babcock's contract is conditional on the corporation's formation. Peterson secures all necessary subscription agreements and capitalization, and he files the articles of incorporation.
(a) Discuss whether the newly formed corporation, Peterson, or both are liable on the contracts with Owens and Babcock.
(b) Discuss whether the corporation is automatically liable to Babcock on formation.

Answer 3

a. Start up businesses and high risk enterprises often obtain venture capital financing. Venture capital is capital provided to new businesses by professional, outside investors, usually in exchange for an ownership interest in the business.
Venture capital investments are high risk - the investor must be willing to lose their invested funds- but offer the potential for well above average returns at some point in the future.
For pre incorporation, the promoters shall be liable.
b. After coming into existence the corporation shall be liable for any of the contracts entered on its behalf even before the incorporation.

Question 4

William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 A.M. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, fi led a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following questions.
Suppose that Chickasaw's articles of incorporation failed to describe the corporation's purpose or management structure as required by state law. Would the court be likely to rule that Sharp is personally liable to Dancause on that basis?
DEBATE THIS: The sole shareholder of an S corporation should not be able to avoid liability for the torts of her or his employees

Question 5

Ultra Vires Doctrine Oya Paka and two business associates formed a corporation called Paka Corp. for the purpose of selling computer services. Oya, who. owned 50 percent of the corporate shares, served as the corporation's president. Oya wished to obtain a personal loan from her bank for $250,000, but the bank required the note to be cosigned by a third party. Oya cosigned the note in the name of the corporation. Later, Oya defaulted on the note, and the bank sued the corporation for payment. The corporation asserted, as a defense, that Oya had exceeded her authority when she cosigned the note on behalf of the corporation. Had she? Explain.

Question 6

William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 A.M. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, fi led a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following questions.
Suppose that the club extended credit to its regular patrons in an effort to maintain a loyal clientele, although neither the articles of incorporation nor the corporate bylaws authorized this practice. Would the corporation likely have the power to engage in this activity? Explain.
DEBATE THIS: The sole shareholder of an S corporation should not be able to avoid liability for the torts of her or his employees

Question 7

Corporate Powers InterBel Telephone Cooperative, Inc., is a Montana corporation organized under the Montana Rural Electric and Telephone Cooperative Act. This statute limits the purposes of such corporations to providing "adequate telephone service" but adds that this "enumeration … shall not be deemed to exclude like or similar objects, purposes, powers, manners, methods, or things." Mooseweb Corp. is an Internet service provider that has been owned and operated by Fred Weber since 1996. Mooseweb provides Web site hosting, modems, computer installation, technical support, and dial-up access to customers in Lincoln County, Montana. InterBel began to offer Internet service in 1999, competing with Mooseweb in Lincoln County. Weber filed a suit in a Montana state court against InterBel, alleging that its Internet service was ultra vires. Both parties filed motions for summary judgment. In whose favor should the court rule, and why? [ Weber v. InterBel Telephone Cooperative , Inc., 2005 MT 320, 318 Mont. 295, 80 P.3d 88 (2003)]

Question 8

William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 A.M. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, fi led a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following questions.
How would the court classify the Chickasaw Club corporation-domestic or foreign, public or private?
DEBATE THIS: The sole shareholder of an S corporation should not be able to avoid liability for the torts of her or his employees

Question 9

CASE PROBLEM WITH SAMPLE ANSWER: Torts and Criminal Acts.
Thomas Persson and Jon Nokes founded Smart Inventions, Inc., in 1991 to market household consumer products. The success of their first product, the Smart. Mop, continued with later products, which were sold through infomercials and other means. Persson unci Nokes were the firm's of?cers and equal shareholders, with Persson responsible for product development and Nokes in charge of day-to-day operations. By 1998, they had become dissatisfied with each other's efforts. Nokes represented the firm as financially "dying," "in a grim state, … worse than ever," and offered to buy all of Persson's shares for $1.6 million. Persson accepted. On the day that they signed the agreement to transfer the shares, Smart Inventions began marketing a new product-the Tap Light-that was an instant success, generating millions of dollars in revenues. In negotiating with Persson, Nokes had intentionally kept the Tap Light a secret. Persson fled a suit in a California state court against Smart Inventions and others, asserting fraud and other claims. Under what principle might Smart Inventions be liable for Nokes's fraud? Is Smart Inventions liable in this case? Explain. [ Persson v. Smart Inventions, Inc., 125 Cal.App.4th 1141, 23 Cal.Rptr.3d 335 (2 Dist. 2005)]

Question 10

Improper Incorporation Denise Rubenstein and Christopher Mayor agreed to form Bayshore Sunrise Corp. (BSC) in New York to rent certain premises and operate a laundromat. BSC entered into a twenty-year commercial lease with Bay Shore Property Trust on April 15,1999. Mayor signed the lease as the president of BSC. The next day-April 16-BSC's certificate of incorporation was filed with New York's secretary of state. Three years later, BSC defaulted on the lease, which resulted in its termination. Rubenstein and BSC filed a suit in a New York state court against Mayor, his brother-in-law Thomas Castellano, and Planet Laundry, Inc., claiming wrongful interference with a contractual relationship. The plaintiffs alleged that Mayor and Castellano conspired to squeeze Rubenstein out of BSC and arranged the default on the lease so that Mayor and Castellano could form and operate their own business, Planet Laundry, at the same address. The defendants argued that they could not be liable on the plaintiffs' claim because there had never been an enforceable lease-BSC lacked the capacity to enter into contracts on April 15. What theory might Rubenstein and BSC assert to refute this argument? Discuss. [ Rubenstein v. Mayor , 41 A.D.3d 826, 839 N.Y.S.2d 170 (2 Dept. 2007)]

Question 11

Piercing the Corporate Veil Smith Services, Inc., was a corporation solely owned by Tony Smith. Bear, Inc., owned and operated Laker Express, a fueling station in Kentucky. Smith charged fuel to an account at Laker Express and owed approximately $35,000. There was no written agreement indicating who was liable on the account in the event of default, but all invoices had been issued to Smith Services. Smith later dissolved Smith Services and continued to run his business as a sole proprietorship. When Laker Express sued Smith Services to collect on the debt, there were no assets in the corporation. Laker Express sued Tony Smith personally and asked the court to pierce the corporate veil, claiming that Smith was engaged in fraud and was using the corporate form only to protect himself. The trial court dismissed the case, and Laker Express appealed. Should the court pierce the corporate veil and hold Smith personally liable for the unpaid corporate debt? Why or why not? Or should Laker Express have been more careful when dealing with clients? Explain. [ Bear, Inc. v. Smith , 303 S.W.3d 137 (Ky.App. 2010)]

Question 12

Closely Held Corporations Mark Burnett and Kamran Pourgol were the only shareholders in a corporation that built and sold a house in North Hempstead, New York. The town revoked the certificate of occupancy on the ground that the house exceeded the amount of square footage allowed by the building permit. The corporation agreed with the buyers to pay a certain amount to renovate the house to conform with the permit and to obtain a new certificate of occupancy. Burnett, however, bought the house and then filed a suit in a New York state court against Pourgol. Burnett charged that Pourgol had submitted incorrect plans to the town without Burnett's knowledge, had assumed responsibility for the error in square footage in discussions with the buyers, had knowingly misrepresented the extent of the renovations, and had failed to undertake any work to fix the house. Do the charges indicate misconduct? How might this situation have been avoided? Discuss. [Burnett v. Pourgol, 83 A.D.3d 756, 921 N.Y.S.2d 280 (2011)]

Question 13

A QUESTION OF ETHICS: Improper Incorporation.
Mike Lyons incorporated Lyons Concrete, Inc., in Montana, but did not file its first annual report, so the state involuntarily dissolved the firm in 1996. Unaware of the dissolution, Lyons continued to do business as Lyons Concrete. In 2003, he signed a written contract with William Weimar to form and pour a certain amount of concrete on Weimar's property in Lake County for $19,810. Weimar was in a rush to complete the entire project, and he and Lyons orally agreed to additional work on a time-and-materials basis. When scheduling conflicts arose, Weimar had his own employees set some of the forms, which proved deficient. Weimar also directed Lyons to pour concrete in the rain, which undercut its quality. In mid-project, Lyons submitted an invoice for $14,389, which Weimar paid. After the work was complete, Lyons sent Weimar an invoice for $25,731, but he refused to pay, claiming that the $14,389 covered everything. To recover the unpaid amount, Lyons filed a mechanics lien as "Mike Lyons d/b/a Lyons Concrete, Inc." against Weimar's property. Weimar filed a suit in a Montana state court, to strike the lien, and Lyons filed a counterclaim to reassert it. [ Weimar v. Lyons, 338 Mont. 242,164 P.3d 922 (2007)]
(a) Before the trial, Weimar asked for a change of venue on the ground that a sign on the courthouse lawn advertised "Lyons Concrete." How might the sign affect a trial on the parties' d?spute? Should the court grant this request?
(b) Weimar asked the court to dismiss the counterclaim on the ground that the state had dissolved Lyons Concrete in 1996. Lyons immediately filed new articles of incorporation for "Lyons Concrete,
Inc." Under what doctrine might the court rule that Weimar could not deny the existence of Lyons Concrete? What ethical values underlie this doctrine? Should the court make this ruling?
(c) At the trial, Weimar argued, in part, that there was no "fixed price" contract between the parties and that even if there were, the poor quality of the work, which required repairs, amounted to a breach, excusing Weimar's further performance. Should the court rule in Weimar's favor on this basis?

Question 14

To watch this chapter's video, Corporation or LLC: Which Is Better?, go to www.cengagebrain.com and register your access code that came with your new book or log in to your existing account. Select the link for the "Business Law Digital Video Library Online Access" or "Business Law CourseMate." Click on "Complete Video List," view Video 46, and then answer the following questions:
(a) Compare the liability that Anna and Caleb would be exposed to as shareholders/owners of a corporation versus as members of an LLC.
(b) How does the taxation of corporations and LLCs differ?
(c) Given that Anna and Caleb conduct their business (Wizard Internet) over the Internet, can you think of any drawbacks to forming an LLC?
(d) If you were in Anna and Caleb's position, would you choose to create a corporation or an LLC? Why?