Module 25: Business Structure

Overview

A sole proprietorship has only one owner, which creates both advantages and disadvantages. A partnership is an association of two or more persons to carry on a business as co-owners for profit. The major areas tested about partnerships are the characteristics of a partnership, comparisons with other structures, rights and liabilities of the partnership itself, the rights, duties, and liabilities of the partners among themselves and to third parties, the allocation of profits and losses, and the rights of various parties, including creditors, upon dissolution.

A. Nature of Sole Proprietorships

B. Nature of Partnerships

C. Formation of Partnership

D. Partners’ Rights and Operation of Partnership

E. Relationship to Third Parties

F. Termination of a Partnership

G. Limited Partnerships

H. Joint Ventures

I. Limited Liability Companies (LLC)

J. Limited Liability Partnerships (LLP)

K. Subchapter C Corporations

L. Characteristics and Advantages of Corporate Form

M. Disadvantages of Corporate Business Structure

N. Types of Corporations

O. Formation of Corporation

P. Corporate Financial Structure

Q. Powers and Liabilities of Corporation

R. Directors and Officers of Corporations

S. Stockholder’s Rights

T. Stockholder’s Liability

U. Substantial Change in Corporate Structure

V. Subchapter S Corporation

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulation

Simulation Solution

The law of joint ventures is similar to that of partnerships with some exceptions. Note that the joint venture is more limited in scope than the partnership form of business. The former is typically organized to carry out one single business undertaking or a series of related undertakings; whereas, the latter is formed to conduct ongoing business.

Subchapter S corporations are those corporations that elect to be taxed similar to partnerships under Subchapter S. Corporations that do not make this election are called Subchapter C corporations. In both cases, a corporation is an artificial person that is created by or under law and which operates under a common name through its elected management. It is a legal entity, separate and distinct from its shareholders. The corporation has the authority vested in it by statute and its corporate charter. The candidate should understand the characteristics and advantages of the corporate form over other forms of business organization.

Basic to preparation for questions on corporation law is an understanding of the following: the liabilities of a promoter who organizes a new corporation; the liability of shareholders; the liability of the corporation with respect to the preincorporation contracts made by the promoter; the fiduciary relationship of the promoter to the stockholders and to the corporation; the various circumstances under which a stockholder may be liable for the debts of the corporation; the rights of shareholders particularly concerning payment of dividends; the rights and duties of officers, directors, and other agents or employees of the corporation to the corporation, to stockholders, and to third persons; subscriptions; and the procedures necessary to merge, consolidate, or otherwise change the corporate structure.

State laws are now widely based on the Revised Business Corporation Act upon which changes to this module are based.

For all the business structures listed in this module you should know the basic characteristics of each. The Examiners expect you to understand the basic strengths and weaknesses of each business structure and to be able to select the appropriate business structure for given situations. Before beginning the reading you should review the key terms at the end of the module.

A. Nature of Sole Proprietorships

1. There is only one owner of business
a. Business is not a separate legal entity apart from owner
b. Owner does not share power or decision making with other owners
2. Advantages over other business structures
a. Sole proprietorship is simplest type of business structure
(1) Easy to form and to operate
(a) Federal or state governments do not require formal filing or approval to begin operation
(1) If business is operating under name other than that of sole proprietor, most states require that it file fictitious name statement with government
b. Business can be sold without need to obtain approval from others such as shareholders or partners
c. Owner has right to make all business decisions such as direction company should go, who to hire or fire, etc.
d. If business generates profit, sole owner need not share it with other owners or investors
e. The profits of the business are taxed on the personal tax return of the owner—profits are taxed only once
3. Disadvantages over other business structures
a. If company has loss, sole proprietor suffers all of it
b. Sole proprietorship cannot obtain capital from partners, shareholders, etc.
(1) Capital is limited by funds the owner has or can borrow
c. Sole proprietor has unlimited personal liability
NOW REVIEW MULTIPLE-CHOICE QUESTION 1

B. Nature of Partnerships

1. A partnership is an association of two or more persons to carry on a business as co-owners for profit
a. The phrase “to carry on a business” includes almost every trade, occupation, or profession
(1) It does not include passive co-ownership of property (e.g., joint tenants of a piece of land)
(2) Partnerships do not include nonprofit unincorporated associations (e.g., labor unions, charitable organizations, clubs)
b. Co-ownership of the “business” (and not merely of assets used in a business) is an important element in determining whether a partnership exists
(1) The most important and necessary element of co-ownership (and thereby partnership) is profit sharing
(a) Need not be equal, but is treated equally unless otherwise stated
(b) Receipt of a share of profits is prima facie evidence (raises a presumption) of a partnership
(1) Presumption rebutted by establishing that profit sharing was only for payment of debt, interest on loan, services performed, rent, etc.
(2) Another important element of co-ownership is joint control
(a) Each partner has an equal right to participate in management. Right to manage may be contracted away to a managing partner
(3) Under Revised Uniform Partnership Act, now adopted by majority of states, partner is no longer co-owner of partnership property
2. Partnership relationship creates a fiduciary relationship between partners
a. Fiduciary relationship arises because each partner is an agent for partnership and for each other in partnership business
3. Partnership relationship is based on contract but arrangements may be quite informal
a. Agreement can be inferred from conduct (e.g., allowing someone to share in management and profits may result in partnership even though actual intent to become partner is missing)
4. Draws heavily on agency law because each partner is an agent as well as a principal of partnership
a. Most rules can be changed in individual cases by agreement between parties affected (e.g., rights and duties between partners)
EXAMPLE
A, B, and C form a partnership in which all three partners agree that A is liable for all of the product liability cases against the partnership. This agreement is enforceable between A, B, and C but not against other parties that never agreed to this. Therefore, as long as A is solvent, B and C can collect from A even though a third party recovers from all of them for product liability.
5. Generally, any person (entity) who has the capacity to contract may become a partner
a. Corporations
b. Minors—but contract of partnership is voidable
c. Partnerships can become partners
6. Common characteristics of partnerships
a. Limited duration
b. Transfer of ownership requires permission from other partners
c. May sue and be sued as separate legal entities
d. Unlimited liability of partners for partnership debts
e. Ease of formation, can be very informal
f. Partnership does not pay federal income tax; partners must include their share of partnership operations on their tax returns
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 2 THROUGH 4

C. Formation of Partnership

1. By agreement, express or implied
a. Agreement to share profits is prima facie evidence that partnership exists
(1) Need not agree to share losses because agreement to share profits assumes sharing of losses
(2) Sharing of gross receipts does not establish partnership
b. Partnership not implied if profits received for some other purpose such as for payment of debt, wages, or lease
2. Creation of a partnership may be very informal, either oral or written
a. Written partnership agreement not required unless within Statute of Frauds (e.g., partnership that cannot be completed within one year)
EXAMPLE
A, B, and C form a partnership that, although they expect it to last for several years, has no time period specified. This partnership agreement may be oral.
EXAMPLE
X, Y, and Z organize XYZ partnership which by agreement will last at least five years. This partnership agreement must be in writing.
(1) Usually wise to have in writing even if not required by statute or contract law
b. Filing not required
3. Articles of copartnership (partnership agreement)—not legally necessary, but a good idea to have
4. Fictitious name statutes require partners to register fictitious or assumed names
a. Failure to comply does not invalidate partnership but may result in fine
b. The purpose is to allow third parties to know who is in partnership

D. Partner’s Rights and Operation of Partnership

1. Partnership agreement, whether oral or written, is the controlling law for the partnership
2. The Revised Uniform Partnership Act (RUPA) is a law that fills in when relevant provisions are not contained in the partnership agreement
3. Look first to what the partnership agreement says; if the agreement is silent or the Examiners have not given you a relevant provision of the partnership agreement, then apply the RUPA rules that follow below. Remember the partnership agreement supersedes RUPA.
4. Partnership interest
a. Refers to partner’s right to share in profits and return of contribution on dissolution
b. Is considered personal property
c. Does not include specific partnership property, merely right to use it for partnership purposes
d. Freely assignable without other partner’s consent
(1) Assignee is not substituted as a partner without consent of all other partners
(2) Assignee does not receive right to manage partnership, to have an accounting, to inspect books, to possess or own any individual partnership property—merely receives rights in the assigning partner’s share of profits and return of partner’s capital contribution (unless partners agree otherwise)
(a) Typically, assignments are made to secure a loan
EXAMPLE
C, a CPA, wishes to obtain a large loan. He is a member of a CPA firm and assigns his partnership interest to the bank to secure the loan.
(3) Assignor remains liable as a partner
(4) Does not create dissociation unless assignor also withdraws
5. Partnership property
a. Includes
(1) Property acquired with partnership funds unless different intent is shown
(2) Property not acquired in partnership name is partnership property if
(a) Partner acquires title to it in his/her capacity as a partner, or
(b) Property acquired with partnership funds
b. Not assignable or subject to attachment individually, only by a claim on partnership
(1) Property may be assigned by agreement of all partners
(2) Any partner can assign or sell property if for the apparent purpose of carrying on the business of the partnership in the usual way
c. Upon partner’s death, his/her estate is entitled to deceased partner’s share of profits and capital, but not to any specific partnership property
(1) Remaining partners have duty to account to the heirs of the deceased for value of interest
(2) Heirs not automatically partners
6. Participate in management
a. Right to participate equally in management
(1) Ordinary business decisions by a majority vote
(2) Unanimous consent needed to make fundamental changes, which include
(a) Admitting new partners
(b) Any action outside the scope of the normal partnership business
(c) Any action contrary to the partnership agreement, or amending the partnership agreement
b. Power to act as an agent for partnership in partnership business
c. Also has right to inspect books and have full knowledge of partnership affairs
d. Silent partner is one who does not help manage
(1) Still has personal, unlimited liability
7. Share in profits and losses
a. Profits and losses are shared equally unless agreement specifies otherwise
(1) Even if contributed capital is not equal
(2) For example, agreement may specify one partner to receive greater share of profits for doing more work, etc., while losses still shared equally
b. If partners agree on unequal profit sharing but are silent on loss sharing, losses are shared per the profit-sharing proportions
(1) May choose to share losses in a different proportion from profits
EXAMPLE
A, B, and C form a partnership with capital contributions as follows: A, $100,000; B, $20,000; and C, $20,000. Their agreement is silent on how to split profits or losses. Assume that the partnership loses $120,000. A, B, and C would each be liable for $40,000 of the losses.
EXAMPLE
Same as above except that they agree to give A 50% of the profits and B and C each get 25% of the profits. Profits as well as losses will be split based on these stated percentages. A is liable for $60,000 of the losses; B and C are liable for $30,000 each. Even though the partners had not allocated losses specifically, RUPA provides that losses are split the same as profits unless the partnership agreement states otherwise.
EXAMPLE
Assume that A, B, and C agree to a 50%, 25%, 25% split if there is a profit but to a 20%, 40%, 40% split, respectively, for any annual losses. If there is a $100,000 annual loss, A will suffer $20,000 and B and C each will suffer $40,000 of the loss.
8. Other rights
a. Indemnification for expenses incurred on behalf of the partnership
b. General partners may be creditors, secured or unsecured, of the partnership
(1) May receive interest on loans
(2) No interest on capital contributions unless stated in partnership agreement
c. No right to salary for work performed because this is a duty unless they agree otherwise
(1) It is common for partners to agree to pay salaries, especially if only one or two do most of the work, but do not assume this on the CPA exam; the Examiners must tell you that the partners have agreed to pay a partner a salary.
d. May obtain formal accounting of partnership affairs
(1) Each partner has the right if used reasonably
9. Every partner owes a fiduciary duty to every other partner (this is important). These fiduciary duties are essentially the same duties that are discussed in Module 32, section C.2.
a. Each must act in best interest of others
(1) May pursue own self-interest as long as it is not competition and does not interfere with partner’s duty to partnership
(2) Any wrongly derived profits must be held by partner for others
(3) Must abide by partnership agreement
(4) Liable to others partners for liability caused by going beyond actual authority
10. Incoming partners new to partnership have same rights as previous partners
a. Requires consent of all partners to admit new partner unless otherwise stated in the partnership agreement
b. Profit sharing, loss sharing, and capital contributions are by agreement between all partners
c. A partnership may also be partner of separate partnership if all partners agree
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 5 THROUGH 10

E. Relationship to Third Parties

1. Partners are agents of the partnership; therefore the liability rules discussed in Module 32, section D. are applicable to partnerships
a. Can bind partnership to contracts with third parties
(1) Even where no actual authority, can bind partnership where there is apparent authority
(2) Third parties are reasonable believing that a partner has authority to enter into contracts on the partnership’s behalf
(3) Contract must be for something related to the normal partnership business for apparent authority to exist
EXAMPLE
A, B, and C form a partnership to sell widgets. Contrary to the wishes of B and C, A decides to buy in the partnership name some “super-widgets” from T. Even though A did not have actual authority to buy these, T can enforce the contract based on apparent authority. A, of course, breached his fiduciary duty to B and C.
EXAMPLE
A and B have a partnership to sell furniture in a retail outlet. A and B agreed that neither would buy more than $10,000 of furniture from suppliers without the consent of the other. A, however, buys $20,000 of furniture from a regular supplier who was unaware of this limitation. When the supplier attempts to deliver, B refuses the furniture. Since A has apparent authority, the supplier can enforce the contract for the full $20,000.
If A had purchased $20,000, or any amount, of automotive supplies without B’s consent, the partnership would not be liable since automotive supplies are unrelated to the furniture business.
b. Partnership is not liable for acts of partners outside the scope of the partnership business
EXAMPLE
A partner of a hardware store attempts to buy some real estate in the name of the partnership. Here apparent authority does not exist.
c. Partnership is liable for partner’s torts committed in course and scope of business and for partner’s breach of trust (i.e., misapplication of third party’s funds)
EXAMPLE
A partner takes a third party’s money on behalf of the partnership to invest in government bonds. Instead he uses it himself to build an addition onto his home. Both partner and partnership are liable to the investor.
EXAMPLE
A partner, while driving on partnership business, injures a third party. If the partner is negligent, the partnership is also liable.
2. Unanimous consent of partners is needed unless otherwise stated in the partnership agreement (so no apparent authority) for
a. Admission of a new partner
b. Amending the partnership agreement
c. Assignment of partnership property
d. Making partnership a surety or guarantor
e. Admitting to a claim against partnership in court
f. Submitting partnership claim to arbitrator
g. Any action outside the scope of the partnership business
3. Partner’s liability is personal, that is, extends to all his/her personal assets (not just investment in partnership) to cover all debts and liabilities of partnership
a. Partners are jointly and severally liable for all debts
(1) RUPA requires creditors to first attempt collection from partnership before partners unless partnership is bankrupt
b. Partners may split losses or liability between themselves according to any proportion agreed upon; however, third parties can still hold each partner personally liable despite agreement
(1) If any partner pays more than his/her agreed share, s/he can get reimbursed from other partners
EXAMPLE
X, Y, and Z as partners agreed to split losses 10%, 20%, and 70% respectively. A third party recovers $100,000 from X only based on a partnership tort. X can get $20,000 from Y and $70,000 from Z so that X ends up paying only her 10%.
EXAMPLE
Same as before except that Y is insolvent. X can recover the proportionate share from Z or $87,500 ($100,000 × 70%/80%).
EXAMPLE
A, B, and C are partners who agree to split losses 10%, 10%, and 80%, respectively. Y sues the partners for a tort based on the partnership business. C files for bankruptcy. Y can recover from A and B and is not bound by the agreement between A, B, and C
c. New partners coming into a partnership are liable for existing debts only to the extent of their capital contributions (i.e., the new partners have no personal liability on these preexisting debts)
(1) Unless new partners assume personal liability for old debts
d. Partners withdrawing are liable for existing liabilities
e. Partners withdrawing are liable for subsequent liabilities unless notice of withdrawal or death is given to third parties
(1) Actual notice to creditors who previously dealt with partnership
(2) Constructive (e.g., published) notice is sufficient for others who merely knew of partnership’s existence
(3) Notice can also be provided by filing a statement of dissociation with the state’s secretary of state
(a) 90 days after statement is filed third parties have notice that partner is no longer affiliated with the partnership, regardless of whether the third party has actually seen the statement
(b) Failure to file a statement, or give other adequate notice, may allow third parties to believe partner is still a partner for up to 2 years after the partner’s departure
f. Estates of deceased partners are liable for partners’ debts
g. Liability of withdrawing partner may be limited by agreement between partners but agreement is not binding on third parties (unless they join in on agreement)
h. Partners are not criminally liable unless they personally participate in some way or unless statute prescribes liability to all members of management (e.g., environment regulation or sale of alcohol to a minor)
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 11 THROUGH 15

F. Termination of a Partnership

1. The process of termination begins when a partner dissociates from the partnership
a. Dissociation occurs when a partner ceases to be associated with the partnership
b. Actions that constitute dissociation are
(1) Partner withdraws from the partnership
(a) Partner leaves voluntarily in accordance with the partnership agreement
(b) Partner leaves voluntarily in violation of the partnership agreement
(c) Partner is forced to leave the partnership because of a vote by other partners or partner violated partnership agreement
(2) Partner engages in conduct that interferes with the ability of the partnership to conduct business
(3) Bankruptcy of a partner
(4) Death of a partner
(5) Incapacity of a partner
2. After dissociation occurs the partnership will either
a. Commence dissolution and liquidation (winding up), or
b. Continue the partnership business
3. Dissolution can occur by
a. Prior agreement (e.g., partnership agreement)
b. Present agreement of partners
c. By decree of court in such cases as
(1) Partner continually or seriously breaches partnership agreement
(2) Partner guilty of conduct that harms business
d. Assignment, selling, or pledging of partnership interest does not cause dissolution even if there is no consent of other partners; recall a partnership interest is only the partner’s right to profits.
e. Under RUPA, unlike previous law, partner’s withdrawal, death, or bankruptcy does not automatically cause dissolution of partnership
(1) Partners that own majority of partnership may choose to continue general partnership within ninety days of partners’ withdrawal, death, or bankruptcy. If the partners fail to agree to continue partnership though, dissolution will occur.
(2) Any partner has power to dissociate from partnership even if partner had agreed not to, but is liable for breach of such a contract
4. Winding up
a. Remaining partners may elect to wind up and terminate partnership or not wind up and continue business
5. Order of distribution upon termination of general partnership
a. To creditors including partners as creditors
b. Capital contributions and profits or losses are calculated together
(1) Partners may receive money or even need to pay money at this stage
6. Partners are personally liable to partnership for any deficits in their capital accounts and to creditors for insufficiency of partnership assets
EXAMPLE
A, B, and C formed the ABC partnership. The capital contributions were A $50,000, B $30,000, and C $20,000. After three years, the partners voted to dissolve the partnership. After liquidating its assets and paying off its creditors, ABC had $40,000 in cash. The $40,000 needs to be used to pay back the aforementioned capital contributions, but there is still $60,000 that will go unpaid. The $60,000 is treated as a loss. Each partner will have to pay his/her proportionate share of the $60,000. Since there is no information on how the partners agreed to split profits or losses, the RUPA rule of splitting profits and losses equally must apply. Therefore each partner will need to pay $20,000 to the partnership. Once that is done, the partnership will then pay each partner his/her capital contribution.
a. Priority between partnership creditors and partner’s personal creditors
(1) Partnership creditors have first priority to partnership assets; any excess goes to personal creditors
(2) Usually, personal creditors have first priority to personal assets; any excess goes to partnership creditors
7. During the winding up process all partners actual authority is terminated, other than those partners who are engaged in the winding up process
a. No new business is permitted, other than transactions necessary to wind up
b. Apparent authority can still exist, however
8. Partners can bind other partners and the partnership on contracts until third parties who have known of the partnership are given notice of dissolution
a. Actual notice must be given to third parties who have dealt with the partnership prior to dissolution
b. Constructive notice (e.g., notice in newspaper) is adequate for third parties who have only known of the partnership
c. Partnership may also file a statement of dissolution with the state’s secretary of state. All third parties are assumed to have knowledge of the dissolution 90 days after the filing, thus eliminating any apparent authority
9. The partnership may choose to continue instead of dissolving if either
a. A majority of the remaining partners, after dissociation, vote to continue the partnership business, or
b. A continuation agreement (clause) is contained in the partnership agreement
10. If the partnership continues, only the dissociated partner’s actual authority is terminated
a. Notice, however, must be provided to remove the apparent authority of the dissociated partner
(1) Actual notice to creditors who previously dealt with partnership
(2) Constructive (e.g., published) notice is sufficient for others who merely knew of partnership’s existence
(3) Notice can also be provided by filing a statement of dissociation with the state’s secretary of state
(a) 90 days after statement is filed, third parties have notice that partner is no longer affiliated with the partnership, regardless of whether the third party has actually seen the statement
(b) Failure to file a statement, or give other adequate notice, may allow third parties to believe partner is still a partner for up to 2 years after the partner’s departure
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 16 THROUGH 18

G. Limited Partnerships

1. Revised Uniform Limited Partnership Act (RULPA) is designed to modernize law because today many limited partnerships are very large with many limited partners.
a. RULPA has been adopted by majority of states
2. Creation of limited partnership
a. Unlike a general partnership that requires no formal procedures to create it, a limited partnership requires compliance with state statute to create it
b. Must file certificate of limited partnership with secretary of state; if the partnership does not, it will be treated as a general partnership
(1) Must be signed by all general partners and include names of all general partners
(a) Name and address of the limited partnership
(b) Name and address of its agent
(c) Latest date the partnership is to dissolve
(d) Names of limited partners not required
(e) Must amend certificate of partnership to show any additions or deletions of general partners
(1) Must also amend certificate if any general partner becomes aware of false information in certificate
c. Requires at least one general partner and at least one limited partner
(1) Sole general partner may be a corporation
(2) Liability of limited partner(s) is limited to amount of capital contributions (with some exceptions below)
d. General or limited partners’ capital contributions may not only be in cash, services performed, or property, but may also now be in promise to perform services, to give cash, or property in future
e. Name of limited partner may not be used in name of limited partnership unless name is also name of a general partner.
(1) If a limited partner knowingly or negligently allows his/her name to be part of limited partnership name, then the partner is personally liable to creditors who extend credit to business (unless creditors knew that limited partner was not a general partner)
f. “Limited partnership” words or abbreviation must be in firm’s name
g. Partnership interests may be purchased with cash, property, services rendered, promissory note
h. Defective formation of limited partnership causes limited partners to be liable as general partners
(1) Under RULPA, partner who believes s/he is limited partner may avoid liability of general partner if upon learning of defective formation either
(a) Withdraws from partnership and renounces all future profits
(b) Files amendment or new certificate that cures defect
(2) However, limited partner is liable for past transactions before withdrawal or amendment to any third party transacting business while believing partner was general partner
i. Foreign limited partnership is one doing business in given state but was formed in another state
(1) Foreign limited partnership must register with secretary of state before doing business in state
3. Rights of partners in limited partnership
a. General partners manage partnership
b. Limited partners invest
(1) Limited partner who substantially manages partnership like general partner obtains liability like general partner to third parties who believed s/he was general partner
(2) Limited partner allowed to do following without risking loss of limited liability
(a) Acting as an agent or employee of limited partnership
(b) Consulting with and advising general partner or limited partnership about partnership business
(c) Approving or disapproving amendments to limited partnership agreement
(d) Voting on dissolution or winding up of limited partnership
(e) Voting on loans of limited partnership
(f) Voting on change in nature of business
(g) Voting on removal of a general partner
(h) Bringing derivative lawsuit on behalf of limited partnership
(i) 6 surety for limited partnership
c. Profit or loss sharing
(1) Profits or losses are shared as agreed upon in certificate agreement
(a) Losses and any liability are limited to capital contributions for limited partners
(b) If no agreement on profit and losses exists, then shared based on percentages of capital contributions
(1) Note how this differs from a general partnership in which losses and profits are shared equally unless agreed otherwise
d. Admission of new partner requires written agreement of all partners unless partnership agreement provides otherwise
e. Limited partnership interests (right to profits) may be assigned in part or in whole
(1) Similar to general partnerships, assignee is only a creditor of the partner
(2) Assignee acquires no rights of the limited partner other than the right to the limited partner’s right to profits
f. Limited partners have right to inspect partnership books and tax return information
g. Can be a limited and general partner at same time
(1) Has rights, powers, and liability of a general partner
(2) Has rights against other partners with respect to contribution as a limited partner and also as a general partner
h. Limited partners may own competing interests
i. Limited partner may be a secured or unsecured creditor of partnership
j. Limited partner may not withdraw capital contribution if it impairs creditors
4. Duties of partners
a. General partners owe fiduciary duties to general and limited partners—limited partners in general do not owe fiduciary duties since they do not engage in the management of the business.
5. Dissolution of limited partnership takes place upon the following events:
a. Completion of time period specified in certificate
b. Upon event specified in partnership agreement
c. Unanimous written consent of all partners
d. Dissolution of court decree when not practical to continue partnership
e. Event that causes partnership business to be illegal
f. Withdrawal of general partner by retirement, removal, bankruptcy (but not mere insolvency), fraud against other partners, insanity, death
(1) Unless all partners agree in writing to continue business
(2) Unless partnership agreement allows partners to continue business
(3) Withdrawal of limited partner does not cause dissolution
(4) Death of limited partner does not cause dissolution
6. If partnership not continued, winding up takes place with the following distribution of assets of partnership in order of priority
a. To creditors including partners who are creditors
b. To partners and ex-partners to pay off unpaid distributions
c. To partners to return capital contributions
d. To partners for partnership interests in proportions they share in distributions
e. Note that in these priorities general and limited partners share equally
f. Also, note that partners can vary their rights by agreement of all parties affected
7. Upon dissolution, remaining partners typically complete winding-up process
8. Dissolution of a limited partnership requires the filing of a dissolution document with the state.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 19 THROUGH 29

H. Joint Ventures

1. Joint venture—An association of two or more persons (or entities) organized to carry out a single business undertaking (or series of related undertakings) for profit
a. Generally, corporations may engage in joint ventures
EXAMPLE
X Corporation, O Corporation, and N Corporation decide to form a joint venture to bring oil from the north to the south of Alaska.
2. Law of joint ventures is similar to that of partnerships with some exceptions
a. Each joint venturer is not necessarily an agent of other joint venturers—limited power to bind others; there is no apparent authority for joint venturers
b. Death of joint venturer does not automatically dissolve joint venture
c. Joint venture is interpreted as special form of partnership
(1) Fiduciary duties of partners in partnership law apply
(2) Each member has right to participate in management
(3) Liability is unlimited and each joint venturer is personally liable for debts of joint venture
3. Generally a joint venture is not required to file a document or certificate with the state
NOW REVIEW MULTIPLE-CHOICE QUESTION 30

I. Limited Liability Companies (LLC)

1. Laws for this form of business generally follow the Revised Uniform Limited Liability Company Act (RULLCA 2006)
2. LLC is not considered a corporation but a majority of states provide
a. All owners (often called members) have limited liability and therefore no personal liability
(1) Liability of owners limited to their capital contributions (including any obligation to make contributions) plus any equity in LLC
(a) Typically, limited liability is retained even if members fail to follow usual formalities in conducting business
EXAMPLE
Members of LLC fail to keep minutes of the LLC’s meetings. This failure does not expose them to personal liability for the debts of the LLC.
1] Note that if a corporation does not follow the corporate formalities such as corporate meetings with relevant minutes, the corporate veil can be pierced, thus the corporate entity is disregarded and then shareholders of company obtain personal liability for corporation’s debts
(a) This is another important advantage of LLC
(2) Compare with limited partnership in which only limited partners can have limited liability
(3) In many states a sole proprietorship may be formed into LLC to obtain its advantages
b. LLC must be formed according to limited liability company statute of the state in which it is formed
(1) Some general partnerships or limited partnerships convert over to an LLC in which case partners retain liability they had in former partnership; they obtain benefits as new members of LLC only for transactions that take place after conversion date to LLC
(2) LLC is foreign LLC in other states in which it does business, and laws of state where it was formed typically govern LLC in those other states
c. LLC is separate legal entity so can sue or be sued in own name
(1) Foreign LLC must register with secretary of state and obtain a certificate of authority to transact business in the state before doing business in another state, or cannot sue in state courts
d. The name of a LLC must include the words “limited liability company” or “limited company” or the abbreviation “L.L.C.,” “LLC,” “L.C.,” or “LC” to give notice to public
e. To form LLC, one or more persons may act as organizers by filing a Certificate of Organization with secretary of state
(1) May be amended by filing amendment with secretary of state
(2) The Operating Agreement specifies the manner in which the company will conduct and wind up operations
f. Think of an LLC as a large S corporation
(1) There is no limit on the number of members (owners/shareholders)
(2) The LLC itself is not taxed; the tax liability flows through the LLC to the individual members
3. Member (owner) of LLC has no interest in any specific property in LLC but has interest (personal property interest) in LLC in general
a. Member has right to distributions according to profit and loss sharing agreed upon in operating agreement
(1) Under the majority of state laws, in the absence of an agreement otherwise, members divide profits in proportion to their capital contributions
(2) Under the RULLCA, in absence of agreement otherwise, members divide profits and losses equally
(3) If the question does not specify RULLCA assume the majority state rule
(4) Members may agree to divide profits differently than losses based on different formulas
EXAMPLE
The members agree that the various members each receive profits and losses on bases that are different for each member. Member Q, for example, receives 15% if there is a profit in a given year, but suffers a loss of 20% if the LLC were to suffer a loss. Member R, however, is allocated 12% whether there is a profit or a loss. This is enforceable since the members agree to it.
b. Member has management interest
(1) Includes rights to manage affairs of firm, vote within firm, and get information about LLC
(2) Unless agreed otherwise, each member has equal voice in management
c. Member may assign financial interest (right to profits) in LLC unless operating agreement specifies otherwise
(1) Assignee does not become member, only receives assignor’s share of profits assigned unless other members agree otherwise
(2) Member may not assign any other right, including the right to be a member, without the consent of the other members
d. Right to information
(1) Members of member-managed companies (and managers in manager-managed companies) have right to receive (without demand) business information to properly exercise their rights and duties.
(2) Other members, on demand, may inspect information (e.g., books and records) during reasonable times, at the business location and for appropriate purpose
e. Members may be dissociated as members at any time, by notification of desire to dissociate, expulsion, sale of interest, etc.
4. Authority and duties in LLCs
a. When LLC designated as member-managed LLC, all members have authority to bind LLC under agency law to contracts on behalf of LLC
b. When LLC designated as manager-managed LLC, only managers have authority to bind LLC to contracts for LLC
(1) LLC is bound only to contracts that
(a) Either LLC has authorized under agency law, or
(b) Are made in the ordinary course of business
c. In either case
(1) Authority of both members and managers to bind LLC to contracts can be restricted in a statement of authority (filed with the Secretary of State) or in operating agreement
(2) Apparent authority of either members or managers to make contracts with third parties not affected for those who have proper notice of restrictions on contract-making authority
(a) Restrictions in statement of authority are deemed proper notice to third parties if they are filed with Secretary of State
(b) Restrictions in operating agreement are deemed to be proper notice to those third parties who actually receive direct notification of those restrictions
5. Other compensation
a. Member who is not manager has no right to compensation for services performed
(1) Exception is for services performed in winding up LLC
b. Managers of LLCs receive compensation according to agreed contract
c. LLC must reimburse members and managers for payments they made in name of LLC
d. LLC is required to indemnify managers and/or members
6. Fiduciary duties owed by members and managers to LLC; these are essentially the same fiduciary duties discussed in Module 32, section C.2.
a. Managers of manager-managed LLC and members of member-managed LLC owe LLC fiduciary duties
(1) Both owe duty of loyalty and due care to LLC
(a) Duty of loyalty includes
(1) To account to the company and hold as trustee for it any property, profit, or benefit derived by the member
(2) To refrain from dealing with the company on behalf of a party having an adverse interest in the company
(3) To refrain from competing with the company
(b) Duty of due care includes
(1) Act with the care that a person in a like position would reasonably exercise and in a manner the member reasonably believes to be in the best interests of the company
(c) The member shall discharge the duties under the operating agreement and exercise any rights consistently with the contractual obligations or good faith and fair dealings
b. A member of a manager-managed company does not have any fiduciary duty to the company or other members solely as a result of being a member
7. Dissolution of LLC
a. Most state LLC statutes cause LLC to dissolve when
(1) All members agree in writing to dissolution
(2) Time period passes or event happens as specified in operating agreement
(3) Member withdraws, is voted out, dies, goes bankrupt, or becomes incompetent
(a) Most states allow remainder of members to continue LLC if agreed upon unanimously
(4) Court order dissolves it
8. Distribution of assets upon dissolution are made in following priorities:
a. To creditors including managers and members except for their shares in the distribution of profits
b. To members and past members for unpaid distributions unless agreed otherwise
c. To members to receive back capital contributions, unless agreed otherwise
d. To members for their distributions as agreed in operating agreement, or if not agreed upon, in proportion to contributions they had made
9. Dissolution of a LLC may require the filing of a dissolution document with the state.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 31 THROUGH 35

J. Limited Liability Partnerships (LLP)

1. Majority of states now allow LLP
2. Formation of LLP
a. Must file articles of LLP with Secretary of State
b. Statutes of all jurisdictions require firm’s name to include phrase of limited liability partnership or registered limited liability partnership or initials LLP or RLLP to notify public
c. Majority of states require only majority, not unanimous, approval of partners to become LLP
d. Generally, laws of state in which the LLP is formed govern affairs of the LLP in all other states
e. The LLP often works well for professionals who want to do business as professionals in a partnership but still pass through tax benefits while limiting personal liability of the partners
f. Most states allow an easy transition from conventional partnership into limited liability partnership
g. Most common law and statutory law from partnership law applies to LLP
3. Liability provisions of partners in LLP
a. Under traditional general partnerships and limited partnerships, big disadvantage is that general partners in both firms have unlimited personal liability for partnership obligations
(1) Most states allow LLP to be formed so the general partners have no personal liability for the contractual obligations of the firm
EXAMPLE
The ABC LLP got a loan from 1st Bank. ABC subsequently defaulted on the loan. 1st Bank may only satisfy its claim against ABC; it may not go after the individual partners even if partnership assets are exhausted.
(2) Partners also have no personal liability for the debts arising from the torts of the LLP. Partners do have personal liability, however
(a) If the partner actually committed the tort
(b) In most states for the torts committed by parties under the partners’ supervision or control
EXAMPLE
Anson is a partner in the ABC LLP. Dietz is a junior partner at ABC and is under Anson’s supervision. Dietz commits malpractice. Dietz has personal liability for the damages arising from the malpractice because Dietz committed the tort. Anson has personal liability because Anson is Dietz’s supervisor.
b. Popular for professionals such as accounting firms and law firms
NOW REVIEW MULTIPLE-CHOICE QUESTION 36

K. Subchapter C Corporations

1. Under Federal Subchapter S Revision Act, all corporations are divided into two categories
a. Subchapter S corporations are discussed later in this module
b. Subchapter C corporations are all corporations that are not Subchapter S corporations
(1) Majority of this module covers “regular corporation” also referred to as Subchapter C corporation
(a) In general, most provisions for Subchapter C corporations and Subchapter S corporations are similar such as limited liability of shareholders and structure of corporate management
(1) Main distinction is tax treatment
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 37 THROUGH 40

L. Characteristics and Advantages of Corporate Form

1. Limited liability
a. Generally a shareholder in a corporation risks only his/her investment
2. Transferability of ownership interest
a. Shares in corporations are represented by stocks and can be freely bought, sold, or assigned unless shareholders have agreed to restrictions
3. Continuous life
a. Unlike a partnership, a corporation is not terminated by death of a shareholder, or his/her incapacity
(1) Regarded as perpetual, and continues to exist until dissolved, merged, or otherwise terminated
4. Separate entity
a. A corporation is a legal entity in itself and is treated separately from its stockholders
(1) Can take, hold, and convey property
(2) Can contract in own name with shareholders or third parties
(3) Can sue and be sued
5. Financing
a. Often easier to raise large amounts of capital than in other business organizations by issuance of stock or other securities (e.g., bonds)
b. More flexible because can issue different classes of stock and/or bonds to suit its needs and market demands
6. Corporate management
a. Persons who manage corporations are not necessarily shareholders and therefore may be more qualified
b. Management of a corporation is usually vested in board of directors elected by shareholders
c. Directors could be removed from office before their elected term is finished only for cause under common law
(1) Increasingly states have been passing laws that allow directors to be removed at any time with shareholders’ consent
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 41 THROUGH 45

M. Disadvantages of Corporate Business Structure

1. Tax treatment
a. Tax burdens may be more than on other business structures because of double taxation
(1) This often happens when income is taxed at corporate level and then dividends paid from after-tax income are taxed again at shareholder level
(2) Corporation may alleviate double taxation as Subchapter S corporation by being taxed similar to partnership
2. Costs of incorporating, because must meet formal creation requirements
3. Formal operating requirements must be met
4. If the corporation goes public
a. There substantial costs of compliance with federal securities laws
b. May be subject to hostile takeover
NOW REVIEW MULTIPLE-CHOICE QUESTION 46

N. Types of Corporations

1. Domestic corporation is one that operates and does business within the state in which it was incorporated
2. Foreign corporation is one doing business in any state except the state in which it was incorporated
a. Foreign corporations, if “doing business” in a given state, are not exempt from many requirements and details that domestic corporations must meet
(1) Doing business in state is typically defined as maintaining an office or selling personal property in state
(a) These are not considered doing business in state
(1) Defending against a lawsuit
(2) Holding bank account
(3) Using mail to solicit orders
(4) Collecting debts
(5) Using independent contractors to make sales
(2) Foreign corporations can be required to qualify to do business in state; accomplished by obtaining certificate of authority from state
(a) Must appoint agent to receive service of process for suits against corporation
(b) Must pay specified fees
(c) Must file information with secretary of state
3. Professional corporations are ones under state laws that allow professionals to incorporate (e.g., doctors, accountants, attorneys)
a. All states allow professional corporations
b. Typically, shares may be owned only by licensed professionals
c. Retain personal liability for their professional acts (i.e., personal liability for malpractice)
d. Obtain other corporation benefits (e.g., limited liability for corporate debts, some tax benefits)
4. Model Statutory Close Corporation Supplement was passed to allow corporations to choose to be close corporations.
a. Often helps corporations made up of entrepreneurial individuals
b. Close corporations can also be called closely held corporations or closed corporations
c. Only corporations having 50 or fewer shareholders may choose status of statutory close corporations
(1) To choose such status, two-thirds of shares of each class of shares of corporation must approve it
(2) Articles of corporation must contain a statement it is a statutory close corporation
(3) All share certificates must clearly state they are issued by statutory close corporation
d. Close corporations may function without some of formalities of operating corporations
(1) If all shareholders approve, close corporation may function without board of directors
(a) It is then managed by shareholders
(2) Close corporation need not hold shareholders’ meetings unless at least one shareholder demands in writing that meetings be held
(3) Basically, shareholders may treat close corporation as a partnership for purposes of governing
(a) Very importantly, statutory close corporation status allows shareholders to have limited liability
(4) Usually the transfer of ownership interests (sale of stock) is restricted
5. De facto corporation has been formed in fact but has not been formed properly under the law
a. Usually defective because of some small error
b. Now, filing by secretary of state of Articles of Incorporation is deemed conclusive proof that incorporators did all that was necessary to incorporate
(1) Third parties cannot now challenge that corporation exists
(2) Only state can challenge existence and dissolve or cancel corporation
6. De jure corporation has been formed correctly in compliance with the incorporation statute
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 47 THROUGH 51

O. Formation of Corporation

1. Promoters are persons who form corporations and arrange capitalization to begin corporations
a. Promoter handles issuing of the prospectus, promoting stock subscriptions, and drawing up charter
b. Promoter has a fiduciary relationship with corporation, and is not permitted to act against interests of corporation
(1) Does not prevent personal profit if fully disclosed
c. Promoter is not an agent of the corporation, because the corporation is still not in existence
(1) Any agreements (preincorporation contracts) made by promoter are not binding on the future corporation unless adopted by the corporation after it comes into existence
(a) Requires actual resolution of board of directors
(b) Normally promoter is personally liable on contract. Adoption by corporation does not relieve promoter; novation is required to relieve promoter. The other party must agree to substituting the corporation
(1) Promoter has liability even if promoter’s name does not appear on contract
(2) However, promoter is not liable if third party clearly states that s/he would look only to corporation for performance
(c) Corporation is not liable to promoter for his/her services unless adopted by corporation
2. Formed only under state incorporation statutes (“Creature of statute”)
3. Incorporation
a. Articles of Incorporation (corporate charter) are filed with the state and contain
(1) Proposed name of corporation and initial address
(2) Purpose of corporation
(3) Powers of corporation
(4) Name of registered agent of corporation
(5) Name and address of each incorporator
(a) Incorporators may be promoters
(6) Number of authorized shares of stock
b. First shareholders’ meeting
(1) Stock certificates issued to shareholders
(2) Resignation of temporary directors and election of new
c. At same meeting or subsequent meeting, directors
(1) Elect officers
(2) Adopt or reject preincorporation contracts
(3) Begin business of corporation
(4) Adopt initial bylaws
(a) These need not be filed with any government agency
(b) Provide specific rules for management
4. Articles of Incorporation may be subsequently amended
a. Approval of any adversely affected shareholders of amendment needed
(1) Often majority vote or sometimes two-thirds vote required
(a) Dissenting minority shareholders may assert right of appraisal and therefore receive fair value for shares
1] Fair value is value just before vote
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 52 THROUGH 57

P. Corporate Financial Structure

1. Definitions
a. Uncertificated securities—securities not represented by written documents
b. Authorized stock—amount permitted to be issued in Articles of Incorporation (e.g., amount and types)
c. Issued stock—authorized and delivered to shareholders
d. Unissued stock—authorized but not yet issued
e. Outstanding stock—issued and not repurchased by the corporation (i.e., it is still owned by shareholders)
f. Treasury stock—issued but not outstanding (i.e., corporation repurchased it)
(1) Are not votable and do not receive dividends
(2) Corporation does not recognize gain or loss on transactions with its own stock
(3) Must be purchased out of unreserved or unrestricted earned surplus as defined below and as permitted by state law
(a) If Articles of Incorporation so permit or if majority of voting shareholders permit, unrestricted capital surplus (see below) may also be used
(4) May be distributed as part of stock dividend
(5) May be resold without regard to par value
(6) Can be resold without regard to preemptive rights
(7) No purchase of treasury stock may be made if it renders corporation insolvent
g. Canceled stock—stock purchased or received by corporation that is canceled
(1) No longer issued or outstanding
(2) Makes room for more stock to be issued
h. Par-value stock
(1) Par value is amount set in Articles of Incorporation
(2) Stock should be issued for this amount or more
(3) May subsequently be traded for any amount
(4) Creditors may hold purchaser liable if stock originally purchased at below par
(a) Contingently liable for difference between amount paid and par value
(b) Subsequent purchaser also liable unless purchased in good faith without notice that sale was below par
i. No-par stock—stock issued without a set par value
(1) May have a stated value
j. Stated capital (legal capital)—number of shares issued times par value (or stated value)
(1) If no par or stated value, then includes total consideration received by corporation
(a) Under limited circumstances, portion may be allocated by board of directors to capital surplus as permitted by law
(2) Dividends normally may not be declared or paid out of it
(3) Following also increase stated capital by number of shares increased times par value (or stated value)
(a) Exercise of stock option
(b) Small common stock dividend
(4) Following do not change stated capital
(a) Acquisition or reissuance of treasury stock under cost method
(b) Stock splits
(1) Increase number of shares issued and decrease par or stated value (e.g., 2-for-1 stock split doubles the number of shares issued and cuts in half the par or stated value)
(2) Do not distribute assets or capital
(c) Payment of organization costs
k. Earned surplus (retained earnings)—cumulative amount of income (net of dividends) retained by the corporation during its existence or since a deficit was properly eliminated
(1) Note that under modern terminology, this is correctly referred to as retained earnings as indicated above; since laws written using old terms, CPA candidates should be familiar with old as well as new terms as learned in accounting
l. Net assets—excess of total assets over total debts
m. Surplus—excess of net assets over stated capital
n. Capital surplus—entire surplus of corporation less earned surplus
(1) Note that paid-in capital is considered capital surplus
o. Contributed capital—total consideration received by corporation upon issuance of stock
2. Classes of stock
a. Common stock usually gives each shareholder one vote per share and is entitled to dividends if declared by the directors
(1) Has no priority over other stock for dividends
(2) Shareholders entitled to share in final distribution of assets
(3) Votes may be apportioned to shares in other ways (e.g., one vote per ten shares)
(4) Corporation may issue more than one class of common stock with varying terms (e.g., class may have no voting rights or different par value, etc.)
(5) All stock is common stock unless specifically told otherwise
b. Preferred stock is given preferred status as to some characteristic of the stock, often liquidations and dividends, but the Examiners will state what the preference is
(1) Usually nonvoting stock; however, assume it is voting stock unless the Examiners specifically state otherwise
(2) Dividend rate is generally a fixed rate
(3) Cumulative preferred means that if a periodic dividend is not paid at the scheduled time, it accumulates and must be satisfied before common stock may receive a dividend
(a) These arrearages are not liabilities of corporation until declared by board of directors
(1) Disclosed in footnotes to financial statements
(b) Noncumulative preferred means that if the dividend is passed, it will never be paid
(4) Participating preferred stock participates further in corporate earnings remaining after a fixed amount is paid to preferred shares
(a) Participation with common shares is generally on a fixed percentage basis
c. Callable (or redeemable) stock may be redeemed at a fixed price by the corporation
(1) Call price is fixed in Articles of Incorporation or may be subject to agreement among shareholders themselves
d. Convertible preferred gives shareholder option to convert preferred stock to common stock at a fixed exchange rate
3. Marketing of stock
a. Stock subscriptions are contracts to purchase a given number of shares in an existing corporation or one to be organized
(1) Subscription to stock is a written offer to buy and is not binding until accepted by the corporation
(2) Under the Model Business Corporation Act, preincorporation stock subscriptions are irrevocable for six months
(3) Once accepted, the subscriber becomes liable
(a) For the purchase
(b) As a corporate shareholder
b. Watered stock
(1) Stock is said to be watered when the cash or property exchanged is less than par value or stated value
(2) Stock must be issued for consideration equal to or greater than the par or stated value under most state laws
(a) No-par stock may be issued for consideration that the directors determine to be reasonable
(3) Creditors of the corporation may recover from the stockholders the amount of water in their shares; that is, the amount the stockholders would have paid to the corporation had they paid the full amount required (i.e., par value less amount paid)
(a) If the corporation becomes insolvent
(b) Subsequent purchaser of watered stock is not liable unless s/he had knowledge thereof
c. Valid consideration or value for shares can be any benefit to corporation
(1) Including cash, property, services performed, intangible property, promissory notes, other securities, or services contracted to be performed in future
(a) Directors have duty to set value on property received
(1) Directors’ value set is conclusive unless fraud shown
4. Debt securities (holders are not owners but creditors)
a. Debenture is instrument for long-term unsecured debt
b. Bond is instrument for long-term secured debt
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 58 THROUGH 69

Q. Powers and Liabilities of Corporation

1. Corporations generally have following powers
a. To acquire their own shares (treasury stock) or retire their own shares
(1) Typically limited to amount of surplus
b. To make charitable contributions
c. To guarantee obligations of others only if in reasonable furtherance of corporation’s business
d. Loans to directors require shareholder approval
e. Loans to employees (even employees who are also directors) do not need shareholder approval and are appropriate if they benefit corporation
f. Generally, a corporation may also be a partner of a partnership
2. Crimes
a. Corporations are liable for crimes they are capable of committing
b. Punishment generally consists of fines or forfeiture, although directors have been faced with prison sentences for crimes of the corporation
3. Contracts
a. Rules under agency law apply in corporate dealings with third parties; see Module 32, Section D. 1-7
b. The corporation is the principal
c. Corporate officers, employees, and the board of directors are the agents
d. Individual directors are not agents of the corporation; therefore an individual director cannot have apparent authority to enter into a contract on behalf of the corporation
4. Torts
a. Corporations are liable for the damages resulting from torts committed by their officers, agents, or employees within the course and scope of their corporate duties
b. Rules of agency law apply; see Module 32, section D. 8-15
5. Ultra vires acts
a. Illegal and ultra vires acts are not the same
(1) Illegal acts are acts in violation of statute or public policy
EXAMPLE
False advertising.
(2) Whereas ultra vires acts are merely beyond the scope of the corporate powers (i.e., a legal act may be ultra vires)
EXAMPLE
Although legal to become a surety, the Articles of Incorporation may not allow it.
b. The state’s attorney general may dissolve corporation for ultra vires act
c. Stockholders have right to object to ultra vires acts
d. Directors or officers may be sued by shareholders, known as derivative action, behalf of the corporation or by the corporation itself if there are damages to the corporation for ultra vires acts
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 70 THROUGH 72

R. Directors and Officers of Corporations

1. Directors are elected by shareholders
2. Directors’ duties and powers
a. A director as an individual has no power to bind the corporation—must act as a board member at a duly constituted meeting of the board
(1) Majority vote of those present is needed for most business decisions if quorum is present
(2) Action may be taken by board with no meeting
(a) Unless prohibited by Articles of Incorporation or by corporate bylaws, and
(b) There must be unanimous written consent by board members for action to be taken
b. Powers and duties in general
(1) Declaration of dividends
(2) Selection of officers
(3) Must comply with Articles of Incorporation. The Articles of Incorporation can only be amended by voting shareholders.
(4) Typically delegate some authority (e.g., day to day or routine matters to officers and agents)
(5) Directors are not entitled to compensation unless so provided in articles, bylaws, or by a resolution of the board passed before the services are rendered
(a) May be reimbursed for expenses incurred on behalf of corporation
3. Director’s liability
a. General rule is that directors must exercise ordinary care, due diligence in performing the duties entrusted to them by virtue of their positions as directors, and acts in a manner he or she believes to be in the best interests of the corporation
(1) Directors are liable for own torts committed even if acting for corporation
(a) Corporation is also liable if committed within the scope of corporate duties
(2) Business judgment rule—as long as director is acting in good faith s/he will not be liable for errors of judgment unless s/he is negligent
(3) Directors are chargeable with knowledge of the affairs of the corporation
(a) If director does not prevent (intentionally or negligently) wrongs of other directors, may be held liable
(b) Normally may rely on reports of accountants, officers, etc. if reasonable judgment used
(4) If corporation does not actually exist, then director as well as others in business have personal liability
b. Directors liable for negligence if their action was the cause of the corporation’s loss
(1) Corporation may indemnify directors (also officers, employees, agents) against suits based on their duties for the corporation if acted in good faith and in best interests of corporation
(a) Also applies to criminal actions if s/he reasonably believed that actions were lawful
(2) Corporation may purchase liability insurance for officers and directors
(a) Corporation pays premiums
(b) Policies usually cover litigation costs as well as judgment or settlement costs
c. Directors owe a fiduciary duty to the corporation
(1) Owe fiduciary duties of loyalty, due care, and obedience to the corporation. These are the fiduciary duties of an agent. Even though individual directors are not considered agents of the corporation, directors owe the fiduciary duties of an agent.
(2) Conflicts of interest
(a) Transactions of a corporation with director(s) or other corporation in which director(s) has interest are valid as long as at least one of the following can be established
(1) Conflict of interest is disclosed or known to board and majority of disinterested members approve of transaction
(2) Conflict of interest is disclosed or known to shareholders and those entitled to vote approve it by a majority
(3) Transaction is fair and reasonable to corporation
EXAMPLE
A plot of land already owned by a director is sold at the fair market value to the corporation. This contract is valid even without approval if the land is needed by the corporation.
d. Directors are personally liable for ultra vires acts of the corporation unless they specifically dissented on the record
e. Directors are personally liable to corporation for approving and paying dividends that are illegal
(1) Directors who act in good faith may use defense of business judgment rule
4. Officers
a. Typically operate day-to-day business
(1) Delegated from directors
b. An officer of the corporation is an agent and can bind corporation by his/her individual acts if within the scope of his/her authority as set forth in the bylaws
c. Officers and directors may be the same persons
d. Officers are selected by the directors for a fixed term under the bylaws
(1) If a term is not definite, it is governed by the directors
e. Officers have a fiduciary duty to corporation
f. Courts recognize a fiduciary duty owed by majority shareholders to minority shareholders when the majority shareholders have de facto control over the corporation
5. Officers, like directors, are liable for own torts, even if committed while acting for corporation
a. Corporation is also liable if officer was acting within the scope of his/her authority
6. Requirements of the Sarbanes-Oxley Act of 2002
a. Requires all members of the audit committee of the board of directors to be independent and one must be a financial expert
b. The audit committee must appoint, compensate, and oversee the work of the firm’s public accounting firm
c. The CEO and CFO must certify that the financial statements are fairly presented
d. Prohibits officer or director from exerting improper influence on the conduct of the audit
e. CEO and CFO must return compensation that was derived from misstated financial statements resulting from material noncompliance with the reporting requirements
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 73 THROUGH 81

S. Stockholder’s Rights

1. Right to transfer stock by endorsement and delivery or by separate assignment
a. Stock certificates are negotiable instruments
b. Limitations on transfer may be imposed, but they must be reasonable
(1) UCC requires that any restrictions must be plainly printed on the certificate to be effective against third party
(2) These limitations are most often imposed in closely held corporations
EXAMPLE
Existing shareholders of the corporation may have first option to buy.
2. Stockholder has no right to manage corporation unless s/he is also officer or director
a. If stockholder is also an officer, the stockholder retains limited liability unlike limited partner who participates in management
3. Right to vote for election of directors, decision to dissolve the corporation, and any other fundamental corporate changes
a. Governed by the charter and class of stock owned
b. Annual meetings are required as specified in the bylaws
c. Stockholders may have voting agreements that are enforceable which provide that they will vote a certain way on issues or vote for specified people for the board of directors
d. Cumulative voting may be required (i.e., a person gets as many votes as s/he has shares times the number of directors being elected)
EXAMPLE
100 shares × 5 directors is 500 votes.
(1) Gives minority shareholders an opportunity to get some representation by voting all shares for one or two directors
e. Can vote by proxy—an assignment of voting rights
f. Directors have the power to amend or repeal the bylaws unless reserved to the shareholders by the Articles of Incorporation
g. Amendment of the Articles of Incorporation and approval of fundamental corporate changes such as a merger, consolidation, or sale of all assets generally require majority approval by shareholders
4. Right to dividends
a. Shareholder generally has no right to dividends unless they are declared by the board of directors
(1) Power to declare is discretionary based on the board’s assessment of business needs
b. Dividends become a liability of corporation only when declared
(1) True for all types of stock such as common stock or even cumulative preferred stock
c. Cash dividends may be paid out of unrestricted and unreserved earned surplus (retained earnings) unless corporation already is or will be insolvent because of dividend
(1) Some states have other regulations, sometimes allowing reductions in other accounts, too
(2) Under Model Business Corporation Act, dividends are prohibited that cause total liabilities to exceed total assets after effect of the distribution is considered. Dividends may not be declared if payment of same will cause the corporation to become insolvent.
5. Right of stockholders to inspect books and records exists
a. These books and records include minute books, stock certificate books, stock ledgers, general account books
b. Demand must be made in good faith and for a proper purpose
(1) May get list of shareholders to help wage a proxy fight to attempt to control corporation
(2) May not get list of shareholders or customers to use for business mailing list
6. Preemptive right
a. This is the right to subscribe to new issues of stock (at fair market value) so that a stockholder’s ownership will not be diluted without the opportunity to maintain it
EXAMPLE
A corporation has one class of common stock. Stockholder A owns 15%. A new issue of the same class of stock is to be made. Stockholder A has the right to buy 15% of it.
b. Usually only applies to common stock, not preferred
c. Not for treasury stock
d. There is no preemptive right to purchase stock unless Articles of Incorporation so provide; on the CPA exam the Examiners must tell you the shareholder has a preemptive right or it does not exist
7. Stockholder’s right to sue
a. Stockholder can sue in his/her own behalf where his/her interests have been directly injured, for example
(1) Denial of right to inspect records
(2) Denial of preemptive right if provided for
b. Stockholders can sue on behalf of the corporation (i.e., a derivative suit)
(1) In cases where a duty to the corporation is violated and corporation does not enforce, for example
(a) Director violates his/her fiduciary duty to corporation
(b) Illegal declaration of dividends (e.g., rendering corporation insolvent)
(c) Fraud by officer on corporation
(2) Unless demand would be futile, must first demand that directors sue in name of corporation and then may proceed if they refuse
(a) Suit may be barred if directors make good faith business judgment that the suit is not in corporation’s best interests
(3) Damages go to corporation, not to the stockholders who sued; this is because the stockholders are suing on behalf of the injured corporation, not themselves.
8. Right to a pro rata share of distribution of assets on dissolution after creditors have been paid
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 82 THROUGH 87

T. Stockholder’s Liability

1. Generally stockholder’s liability is limited to his/her price paid for stock
2. May be liable to creditors for
a. Original issue stock sold at below par value
(1) Contingently liable for the difference between par value and original issuance price
b. Unpaid balance on no-par stock
c. Dividends paid which impair capital if the corporation is insolvent
3. Piercing the corporate veil—courts disregard corporate entity and hold stockholders personally liable
a. Rarely happens but may occur if
(1) Corporation used to perpetrate fraud (e.g., forming an undercapitalized corporation)
(2) Owners/officers do not treat corporation as separate entity
(3) Shareholders commingle assets, bank accounts, financial records with those of corporation
(4) Corporate formalities not adhered to
4. Majority shareholders owe fiduciary duty to minority shareholders and to corporation
a. Even shareholder who controls corporation (majority ownership not now needed) has fiduciary duty
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 88 THROUGH 90

U. Substantial Change in Corporate Structure

1. Merger
a. Union of two corporations where one is absorbed by other
(1) Surviving corporation issues its own shares (common and/or preferred) to shareholders of original corporations
2. Consolidation
a. Joining of two (or more) corporations into a single new corporation
b. All assets and liabilities are acquired by the new company
c. New corporation is liable for debts of old corporations
3. Requirements to accomplish a merger or consolidation
a. Boards of both corporations must prepare and submit plan to shareholders of both corporations
b. Approval of board of directors of both companies
c. Shareholders of both corporations must be given copy or summary of merger plan
d. Majority vote of shareholders of each corporation
e. Surviving corporation gets all assets and liabilities of merging corporations
f. Dissatisfied shareholders of subsidiary may dissent and assert appraisal rights, thereby receiving the fair market value of their stock
4. Dissolution
a. Once corporation is dissolved, it may do business only to wind up and liquidate business
(1) Liquidation is the winding up of affairs and distribution of assets
(a) Liquidation occurs in the following order
(1) Expenses of liquidation and creditors
(2) Preferred shareholders
(3) Common shareholders
(2) Termination occurs when winding up and liquidation are completed
b. May be done by voluntary dissolution or involuntary dissolution by state for cause
(1) Voluntary dissolution occurs when board of directors passes resolution to dissolve
(a) Resolution must be ratified by majority of stockholders entitled to vote
c. Shareholder may petition for judicial dissolution if directors or shareholders are deadlocked
5. Dissolution of a corporation requires the filing of a dissolution document with the state.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 91 THROUGH 96

V. Subchapter S Corporation

1. When corporation elects to be Subchapter S corporation it can avoid double taxation by not paying tax at the corporate level
a. Instead, the corporation income flows through to the income tax returns of the individual shareholders
b. Shareholders report the income or loss even when income not distributed to them
c. This flow-through may nevertheless be an advantage under some situations
2. Rules involving the criteria needed to be met to be taxed as a Subchapter S corporation can change to one’s detriment, creating another potential disadvantage of needing to stay abreast of rule changes
a. Some of the rules to watch out for involve
(1) Corporation must be incorporated in the US and have only one class of stock
(2) Number of shareholders Subchapter S corporation can have is limited to no more than 100 shareholders
(3) Shareholders are limited to individuals, estates, qualified trusts, and similar entities
(4) No foreign ownership of shares
(5) The corporation cannot have excessive amounts of passive income
NOW REVIEW MULTIPLE-CHOICE QUESTION 97

KEY TERMS

Business judgment rule. Officers and/or directors of a corporation will not breach their fiduciary duty of care by simply making a poor business decision. Rather their action must be negligent to breach the duty of care.

C corporation. The assumed corporate form unless party affirmatively selects S corporation status. The typical form for large publically traded companies subject to double taxation. Generally, no personal liability for shareholders.

Derivative action. When a shareholder, or group of shareholders, sue, on behalf of the corporation a director or corporate officer for damages caused to the corporation.

Dissociation. When a partner is no longer affiliated with the partnership.

Dissolution. The process of ending a partnership.

General partnership. An association of two or more persons to carry on a business as co-owners for profit. Partners have unlimited personal liability.

Joint venture. An association of two or more persons/entities engaged in a business for a specific purpose.

Limited liability company (LLC). A business entity that is run primarily like a general partnership, but affords its members (owners) limited liability.

Limited liability partnership. A general partnership that affords its partners limited liability from the actions of the other partners.

Limited partner. In a limited partnership this partner has no personal liability; however, the limited partner is not allowed to participate in the running of the business.

Limited partnership. A partnership with two types of partners; general and limited. General partners have unlimited liability; limited partners have no personal liability.

Partnership agreement. The rules by which a partnership is run. When a partnership agreement is silent about a particular rule, then the Revise Uniform Partnership Act (RUPA) will apply to the situation.

Partnership interest. The partner’s right to profits. This is freely transferable. Contrast this with the ownership interest, the right to be a partner, which can only be transferred with the consent of all the other partners.

S-corporation. A type of corporation which must be affirmatively elected by the organizers. Taxed like a partnership, but the shareholders have no personal liability.

Sole proprietorship. One-owner business, owner has unlimited liability.

Ultra vires (Latin). An action that goes beyond the power or the authority of the corporation. Such actions violate the fiduciary duty of obedience.

Winding up. The liquidation of the partnership.

Multiple-Choice Questions (1–97)

A. Nature of Sole Proprietorships

1. Which of the following statements is not true of a sole proprietorship?

a. Federal and state governments typically require a formal filing with the appropriate government officials whether or not the sole proprietorship uses a fictitious name.

b. The sole proprietorship is not a separate legal entity apart from its owner.

c. The capital to start the business is generally limited to the funds the sole proprietor either has or can borrow.

d. It is generally considered to be the simplest type of business structure.

B. Nature of Partnerships

2. A general partnership must

a. Pay federal income tax.

b. Have two or more partners.

c. Have written articles of partnership.

d. Provide for apportionment of liability for partnership debts.

3. Which of the following can be a partnership?

a. Karen and Sharon form a charitable organization in which they received donations to give to their favorite charities.

b. Frank and Pablo are members of a union at work that has 150 members.

c. Janice and Stanley form a club to encourage business contacts for computer programmers.

d. None of the above.

4. A silent partner in a general partnership

a. Helps manage the partnership without letting those outside the partnership know this.

b. Retains unlimited liability for the debts of the partnership.

c. Both of the above are correct.

d. None of the above is correct.

C. Formation of Partnership

5. A partnership agreement must be in writing if

a. Any partner contributes more than $500 in capital.

b. The partners reside in different states.

c. The partnership intends to own real estate.

d. The partnership’s purpose cannot be completed within one year of formation.

D. Partner’s Rights and Operation of Partnership

6. Sydney, Bailey, and Calle form a partnership under the Revised Uniform Partnership Act. During the first year of operation, the partners have fundamental questions regarding the rights and obligations of the partnership as well as the individual partners. Which of the following questions can correctly be answered in the affirmative?

I. Is the partnership allowed legally to own property in the partnership’s name?

II. Do the partners have joint and several liability for breaches of contract of the partnership?

III. Do the partners have joint and several liability for tort actions against the partnership?

a. I only.

b. I and II only.

c. II and III only.

d. I, II, and III.

7. Which of the following is not true of a general partnership?

a. Ownership by the partners may be unequal.

b. It is a separate legal entity.

c. An important characteristic is that the partners share in the profits equally.

d. The partner may agree on unequal rights to participate in management.

8. The partnership agreement for Owen Associates, a general partnership, provided that profits be paid to the partners in the ratio of their financial contribution to the partnership. Moore contributed $10,000, Noon contributed $30,000, and Kale contributed $50,000. For the year ended December 31, 2012, Owen had losses of $180,000. What amount of the losses should be allocated to Kale?

a. $ 40,000

b. $ 60,000

c. $ 90,000

d. $100,000

9. Lark, a partner in DSJ, a general partnership, wishes to withdraw from the partnership and sell Lark’s interest to Ward. All of the other partners in DSJ have agreed to admit Ward as a partner and to hold Lark harmless for the past, present, and future liabilities of DSJ. As a result of Lark’s withdrawal and Ward’s admission to the partnership, Ward

a. Acquired only the right to receive Ward’s share of DSJ profits.

b. Has the right to participate in DSJ’s management.

c. Is personally liable for partnership liabilities arising before and after being admitted as a partner.

d. Must contribute cash or property to DSJ to be admitted with the same rights as the other partners.

10. Cobb, Inc., a partner in TLC Partnership, assigns its partnership interest to Bean, who is not made a partner. After the assignment, Bean asserts the rights to

I. Participate in the management of TLC.

II. Cobb’s share of TLC’s partnership profits.

Bean is correct as to which of these rights?

a. I only.

b. II only.

c. I and II.

d. Neither I nor II.

E. Relationship to Third Parties

11. The apparent authority of a partner to bind the partnership in dealing with third parties

a. Will be effectively limited by a formal resolution of the partners of which third parties are aware.

b. Will be effectively limited by a formal resolution of the partners of which third parties are unaware.

c. Would permit a partner to submit a claim against the partnership to arbitration.

d. Must be derived from the express powers and purposes contained in the partnership agreement.

12. In a general partnership, which of the following acts must be approved by all the partners?

a. Dissolution of the partnership.

b. Admission of a partner.

c. Authorization of a partnership capital expenditure.

d. Hiring an employee.

13. Under the Revised Uniform Partnership Act, partners have joint and several liability for

a. Breaches of contract.

b. Torts committed by one of the partners within the scope of the partnership.

c. Both of the above.

d. None of the above.

14. Which of the following actions require(s) unanimous consent of the partners under partnership law?

I. Making partnership a surety.

II. Admission of a new partner.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

15. Which of the following statements best describes the effect of the assignment of an interest in a general partnership?

a. The assignee becomes a partner.

b. The assignee is responsible for a proportionate share of past and future partnership debts.

c. The assignment automatically dissolves the partnership.

d. The assignment transfers the assignor’s interest in partnership profits and surplus.

F. Termination of a Partnership

16. Under the Revised Uniform Partnership Act, in which of the following cases will property be deemed to be partnership property?

I. A partner acquires property in the partnership name.

II. A partner acquires title to it in his/her own name using partnership funds.

III. Property owned previously by a partner is used in the partnership business.

a. I only.

b. I and II only.

c. II only.

d. I, II, and III.

17. Wind, who has been a partner in the PLW general partnership for four years, decides to withdraw from the partnership despite a written partnership agreement that states, “no partner may withdraw for a period of five years.” Under the Uniform Partnership Act, what is the result of Wind’s withdrawal?

a. Wind’s withdrawal causes a dissolution of the partnership by operation of law.

b. Wind’s withdrawal has no bearing on the continued operation of the partnership by the remaining partners.

c. Wind’s withdrawal is not effective until Wind obtains a court-ordered decree of dissolution.

d. Wind’s withdrawal causes a dissolution of the partnership despite being in violation of the partnership agreement.

18. Dowd, Elgar, Frost, and Grant formed a general partnership. Their written partnership agreement provided that the profits would be divided so that Dowd would receive 40%; Elgar, 30%; Frost, 20%; and Grant, 10%. There was no provision for allocating losses. At the end of its first year, the partnership had losses of $200,000. Before allocating losses, the partners’ capital account balances were: Dowd, $120,000; Elgar, $100,000; Frost, $75,000; and Grant, $11,000. Grant refuses to make any further contributions to the partnership. Ignore the effects of federal partnership tax law.

After losses were allocated to the partners’ capital accounts and all liabilities were paid, the partnership’s sole asset was $106,000 in cash. How much would Elgar receive on dissolution of the partnership?

a. $37,000

b. $40,000

c. $47,500

d. $50,000

G. Limited Partnerships

19. Which of the following statements is correct with respect to a limited partnership?

a. A limited partner may not be an unsecured creditor of the limited partnership.

b. A general partner may not also be a limited partner at the same time.

c. A general partner may be a secured creditor of the limited partnership.

d. A limited partnership can be formed with limited liability for all partners.

20. Sharif, Hirsch, and Wolff formed a limited partnership with Sharif and Hirsch as general partners. Wolff was the limited partner. They failed to agree upon a profit-sharing plan but put in capital contributions of $120,000, $140,000, and $150,000, respectively. At the end of the first year how should they divide the profits?

a. Sharif and Hirsch each receives half and Wolff receives none.

b. Each of the three partners receives one-third.

c. The profits are shared in proportion to their capital contribution.

d. None of the above.

21. Which of the following is (are) true of a limited partnership?

I. Limited partnerships must have at least one general partner.

II. The death of a limited partner terminates the partnership.

a. I only.

b. II only.

c. Neither I nor II.

d. Both I and II.

22. Alchorn, Black, and Chan formed a limited partnership with Chan becoming the only limited partner. Capital contributions from these partners were $20,000, $40,000, and $50,000, respectively. Chan, however, helped in the management of the partnership and Ham, who had several contracts with the partnership, thought Chan was a general partner. Ham won several breach of contract actions against the partnership and the partnership does not have sufficient funds to pay these claims. What is the potential liability for Alchorn, Black, and Chan?

a. Unlimited liability for all three partners.

b. Unlimited liability for Alchorn and Black; $50,000 for Chan.

c. Up to each partner’s capital contribution.

d. None of the above.

23. To create a limited partnership, a certificate of limited partnership must be filed with the Secretary of State. Which of the following must be included in this certificate under the Revised Uniform Limited Partnership Act?

I. Names of all of the general partners.

II. Names of the majority of the general partners.

III. Names of all of the limited partners.

IV. Names of the majority of the limited partners.

a. I only.

b. II only.

c. I and III only.

d. I and IV only.

24. Mandy is a limited partner in a limited partnership in which Strasburg and Hua are the general partners. Which of the following may Mandy do without losing limited liability protection?

I. Mandy acts as an agent of the limited partnership.

II. Mandy votes to remove Strasburg as a general partner.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

25. In a limited partnership, the limited partners’ capital contribution may be in which of the following forms?

a. A promise to perform services in the future for the partnership.

b. An agreement to pay cash.

c. A promise to give property.

d. All of the above.

26. Hart and Grant formed Hart Limited Partnership. Hart put in a capital contribution of $20,000 and became a general partner. Grant put in a capital contribution of $10,000 and became a limited partner. During the second year of operation, a third party filed a tort action against the partnership and both partners. What is the potential liability of Hart and Grant respectively?

a. $20,000 and $0.

b. $20,000 and $10,000.

c. Unlimited liability and $0.

d. Unlimited liability and $10,000.

27. The admission of a new general partner to a limited partnership requires approval by

I. A majority of the general partners.

II. All of the general partners.

III. A majority of the limited partners.

IV. All of the limited partners.

a. I only.

b. II only.

c. I and III only.

d. II and IV only.

28. The admission of a new limited partner to a limited partnership requires approval by

I. A majority of the general partners.

II. All of the general partners.

III. A majority of the limited partners.

IV. All of the limited partners.

a. I only.

b. II only.

c. I and III only.

d. II and IV only.

29. Riewerts, Morgan and Stonk form a limited partnership. Riewerts is the one general partner. Which of the following events will cause this limited partnership to be dissolved?

I. Riewerts dies and is survived by the other two partners.

II. Morgan dies leaving Riewerts and Stonk.

III. Riewerts takes out personal bankruptcy.

IV. Stonk takes out personal bankruptcy.

a. I only.

b. I and II only.

c. I and III only.

d. III and IV only.

H. Joint Ventures

30. Which of the following is not true of a joint venture?

a. Each joint venturer is personally liable for the debts of a joint venture.

b. Each joint venturer has the right to participate in the management of the joint venture.

c. The joint venturers owe each other fiduciary duties.

d. Death of a joint venturer dissolves the joint venture.

I. Limited Liability Companies (LLC)

31. Which form(s) of a business organization can have characteristics common to both the corporation and the general partnership?

Limited liability company Subchapter S corporation
a. Yes Yes
b. Yes No
c. No Yes
d. No No

32. Which of the following is true of a limited liability company under the laws of the majority of states?

a. At least one of the owners must have personal liability.

b. The limited liability company is a separate legal entity apart from its owners.

c. Limited liability of the owners is lost if they fail to follow the usual formalities in conducting the business.

d. All of the above are true.

33. Which of the following is not characteristic of the typical limited liability company?

a. Death of a member (owner) causes it to dissolve unless the remaining members decide to continue the business.

b. All members (owners) are allowed by law to participate in the management of the firm.

c. The company has, legally, a perpetual existence.

d. All members (owners) have limited liability.

34. Owners and managers of a limited liability company (LLC) owe

a. A duty of due care.

b. A duty of loyalty.

c. Both a duty of due care and a duty of loyalty.

d. None of the above.

35. Which of the following is true of the typical limited liability company?

a. It provides for limited liability for some of its members (owners), that is, those identified as limited members (owners).

b. The members’ (owners’) interests are not freely transferable.

c. Voting members (owners) but not all members can help choose the managers of the company.

d. No formalities are required for its formation.

J. Limited Liability Partnerships (LLP)

36. In which of the following respects do general partnerships and limited liability partnerships differ?

I. In the level of liability of the partners for torts they themselves commit.

II. In the level of liability of the partners for torts committed by other partners in the same firm.

III. In the amount of liability of the partners for contracts signed by other partners on behalf of the partnership.

a. I only.

b. II only.

c. I and II only.

d. II and III only.

K. Subchapter C Corporations

37. Under the federal Subchapter S Revision Act, all corporations are designated as

a. Subchapter S corporations only.

b. Either a Subchapter S corporation or a Subchapter C corporation.

c. One of seven different types of corporations.

d. Both a Subchapter S corporation and a Subchapter C corporation at the same time.

38. Under the federal Subchapter S Revision Act all corporations are

a. Now treated as Subchapter S corporations.

b. Divided into either a Subchapter C corporation or a Subchapter S corporation.

c. Divided into either a Subchapter C corporation, a Subchapter E corporation, or a Subchapter S corporation.

d. None of the above.

39. Which of the following statements is (are) true?

a. Both Subchapter C corporations and Subchapter S corporations have limited liability for their shareholders.

b. Both Subchapter C corporations and Subchapter S corporations are similar in their corporate management structure.

c. All of the above are true.

d. None of the above are true.

40. The main difference between Subchapter S corporations and Subchapter C corporations is

a. Their tax treatment.

b. That the federal Subchapter S Revision Act covers Subchapter S corporations but does not cover Subchapter C corporations.

c. Their limited liability of their shareholders.

d. Their structure of their corporate management.

L. Characteristics and Advantages of Corporate Form

41. Which of the following statements best describes an advantage of the corporate form of doing business?

a. Day-to-day management is strictly the responsibility of the directors.

b. Ownership is contractually restricted and is not transferable.

c. The operation of the business may continue indefinitely.

d. The business is free from state regulation.

42. Which of the following is not considered to be an advantage of the corporate form of doing business over the partnership form?

a. A potential perpetual and continuous life.

b. The interests in the corporation are typically easily transferable.

c. The managers in the corporation and shareholders have limited liability.

d. Persons who manage the corporation are not necessarily shareholders.

43. Which of the following is not a characteristic of a corporation?

a. It has a continuous life.

b. Shares in the corporation can normally be freely transferred.

c. A corporation is treated as a legal entity separate from its shareholders.

d. A corporation is automatically terminated upon the death of a majority of its shareholders.

44. A corporation as a separate legal entity can do which of the following?

a. Contract in its own name with its own shareholders.

b. Contract in its own name with its own shareholders only if a majority of its shareholders agree that such a contract can be made.

c. Contract in its own name with third parties.

d. Both a. and c. are correct.

45. Which of the following are characteristics of the corporate form of doing business?

a. Persons who manage corporations need not be shareholders.

b. The corporation may convey or hold property in its own name.

c. The corporation can sue or be sued in its own name.

d. All of the above are true.

M. Disadvantages of Corporate Business Structure

46. Which of the following is a disadvantage of a Subchapter C corporation?

a. It may face higher tax burdens than a Subchapter S corporation.

b. The shareholders lose their limited liability when they switch from a general partnership to a corporation.

c. A Subchapter C corporation is not well defined under the law.

d. A Subchapter C corporation does not protect its shareholders from liability as well as a Subchapter S corporation does.

N. Types of Corporations

47. Bond Company is incorporated in Florida but not in Georgia. Bond has branch offices in both states. Which of the following is correct?

I. Bond is a domestic corporation in Georgia.

II. Bond is a domestic corporation in Florida.

III. Bond needs to incorporate also in Georgia.

a. I and II only.

b. II only.

c. II and III only.

d. I, II, and III.

48. Colby formed a professional corporation along with two other attorneys. They took out loans in the name of the corporation. During the first year, Colby failed to file some papers on time for a client causing the client to lose a very good case. For which does Colby have the corporate protection of limited liability?

I. The negligence for failure to file the papers on time.

II. The corporate loans.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

49. Macro Corporation was incorporated and doing business in Illinois. It is doing business in various other states including Nevada. Which of the following statements is (are) true?

a. Macro must incorporate in Nevada.

b. Macro is a domestic corporation in Nevada.

c. Macro is a domestic corporation in Illinois.

d. All of the above are true.

50. Cleanit Corporation was incorporated in Colorado. Cleanit wishes to perform some transactions in other states but does not want to incorporate or obtain a certificate of authority to qualify to do business in those other states. Which of the following normally would require Cleanit to obtain a certificate of authority in other states?

a. Using the US mail to solicit orders in those states.

b. Holding bank accounts in those states.

c. Collecting debts in those states.

d. None of the above.

51. Which of the following statements is true of professional corporations under the various state laws?

I. The professionals in the corporation have personal liability for their professional acts.

II. Normally under state laws, only licensed professionals are permitted to own shares in professional corporations.

a. I only is true.

b. II only is true.

c. Both I and II are true.

d. Neither I nor II is true.

O. Formation of Corporation

52. Which of the following statements is correct with respect to the differences and similarities between a corporation and a limited partnership?

a. Stockholders may be entitled to vote on corporate matters but limited partners are prohibited from voting on any partnership matters.

b. Stock of a corporation may be subject to the registration requirements of the federal securities laws but limited partnership interests are automatically exempt from those requirements.

c. Directors owe fiduciary duties to the corporation and limited partners owe such duties to the partnership.

d. A corporation and a limited partnership may be created only under a state statute and each must file a copy of its organizational document with the proper governmental body.

53. Under the Revised Model Business Corporation Act, which of the following must be contained in a corporation’s Articles of Incorporation?

a. Quorum voting requirements.

b. Names of stockholders.

c. Provisions for issuance of par and nonpar shares.

d. The number of shares the corporation is authorized to issue.

54. Which of the following facts is (are) generally included in a corporation’s Articles of Incorporation?

Name of registered agent Number of authorized shares
a. Yes Yes
b. Yes No
c. No Yes
d. No No

55. Absent a specific provision in its Articles of Incorporation, a corporation’s board of directors has the power to do all of the following, except

a. Repeal the bylaws.

b. Declare dividends.

c. Fix compensation of directors.

d. Amend the Articles of Incorporation.

56. Which of the following statements is correct concerning the similarities between a limited partnership and a corporation?

a. Each is created under a statute and must file a copy of its certificate with the proper state authorities.

b. All corporate stockholders and all partners in a limited partnership have limited liability.

c. Both are recognized for federal income tax purposes as taxable entities.

d. Both are allowed statutorily to have perpetual existence.

57. Promoters of a corporation which is not yet in existence

a. Are persons that form the corporation and arrange for capitalization to help begin the corporation.

b. Are agents of the corporation.

c. Can bind the future corporation to presently made contracts they make for the future corporation.

d. Are shielded from personal liability on contracts they make with third parties on behalf of the future corporation.

P. Corporate Financial Structure

58. Johns owns 400 shares of Abco Corp. cumulative preferred stock. In the absence of any specific contrary provisions in Abco’s Articles of Incorporation, which of the following statements is correct?

a. Johns is entitled to convert the 400 shares of preferred stock to a like number of shares of common stock.

b. If Abco declares a cash dividend on its preferred stock, Johns becomes an unsecured creditor of Abco.

c. If Abco declares a dividend on its common stock, Johns will be entitled to participate with the common stock shareholders in any dividend distribution made after preferred dividends are paid.

d. Johns will be entitled to vote if dividend payments are in arrears.

59. Gallagher Corporation issued 100,000 shares of $40 par value stock for $50 per share to various investors. Subsequently, Gallagher purchased back 10,000 of those shares for $30 per share and held them as treasury stock. When the price of the stock recovered somewhat, Gallagher sold this treasury stock to Thomas for $35 per share. Which of the following statements is correct?

I. Gallagher’s purchase of the stock at below par value is illegal.

II. Gallagher’s purchase of the stock at below par value is void as an ultra vires act.

III. Gallagher’s resale of the treasury stock at below par value is valid.

a. I only.

b. II only.

c. III only.

d. I and II only.

60. An owner of common stock will not have any liability beyond actual investment if the owner

a. Paid less than par value for stock purchased in connection with an original issue of shares.

b. Agreed to perform services that were worth less than par value for the corporation in exchange for original issue par value shares.

c. Purchased treasury shares for less than par value.

d. Failed to pay the full amount owed on a subscription contract for no-par shares.

61. Which of the following securities are corporate debt securities?

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62. All of the following distributions to stockholders are considered asset or capital distributions, except

a. Liquidating dividends.

b. Stock splits.

c. Property distributions.

d. Cash dividends.

63. Which of the following constitute(s) valid consideration or value to purchase shares of stock?

a. Services performed.

b. Intangible property.

c. Services contracted to be performed in the future.

d. All of the above.

64. Brawn subscribed to 1,000 shares of $1 par value stock of Caldo Corporation at the agreed amount of $20 per share. She paid $5,000 on April 1 and then paid $9,000 on August 1. Caldo Corporation filed for bankruptcy on December 1 and the creditors of the corporation sought to hold Brawn liable under her subscription agreement. Which of the following is true?

a. Brawn has no liability to the creditors because subscription contract was with the corporation, not the creditors.

b. Brawn has no liability to the creditors because she has paid more than $1,000 to the corporation which is the par value of the 1,000 shares.

c. Brawn is liable for $6,000 to the creditors for the amount unpaid on the subscription price.

d. Brawn is liable for $6,000 to the creditors based on the doctrine of ultra vires.

65. Pearl Corporation has some treasury stock on hand. Which of the following is (are) true?

a. Pearl may not vote these shares of treasury stock.

b. Pearl’s treasury stock does not receive any dividends.

c. Both of the above statements are true.

d. None of the above statements are true.

66. Treasury stock of a corporation is stock that

a. Has been issued by that corporation but is not outstanding.

b. Was purchased from another corporation and is retained for a specified purpose.

c. Has been cancelled.

d. None of the above is true.

67. By law, a corporation

a. Must issue both common stock and preferred stock.

b. May issue more than one class of common stock as well as more than one class of preferred stock.

c. Must issue dividends if it has earned a profit.

d. Must issue at least some cumulative preferred stock.

68. Mesa Corporation is planning on issuing some debt securities. Which of the following statements is true?

a. The holders of debt securities are owners of the corporation.

b. A bond is an instrument for long-term secured debt.

c. A debenture is an instrument for long-term secured debt.

d. None of the above is true.

69. Stock of a corporation is called watered stock when the cash or property exchanged to acquire the stock is

a. Less than the market value of the stock.

b. More than the market value of the stock.

c. Less than the par value or stated value of the stock.

d. More than the par value or stated value of the stock.

Q. Powers and Liabilities of Corporation

70. Corporations generally have which of the following powers without shareholder approval?

I. Power to acquire their own shares.

II. Power to make charitable contributions.

III. Power to make loans to directors.

a. I only.

b. I and II only.

c. II and III only.

d. I, II, and III.

71. Murphy is an employee of Landtry Corporation. Which of the following acts would make the corporation liable for Murphy’s actions?

I. Murphy deceived a customer to convince him to purchase one of Landtry’s products.

II. Murphy hit a customer with his fist, breaking his jaw. The management had warned Murphy that he and not the corporation would be responsible for any aggression against customers.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

72. Which of the following statements is (are) true?

I. Corporations can be found liable for crimes.

II. Directors can face prison sentences for crimes committed by their corporations.

III. Employees can be found guilty of crimes they commit while working for their corporation.

a. I only.

b. I and II only.

c. III only.

d. I, II, and III.

R. Directors and Officers of Corporations

73. Norwood was a promoter of Parker Corporation. On March 15, Norwood purchased some real estate from Burrows in Parker’s name and signed the contract “Norwood, as agent of Parker Corporation.” Parker Corporation, however, did not legally come into existence until June 10. Norwood never informed Burrows on or before March 15 that Parker Corporation was not yet formed. After the corporation was formed, the board of directors refused to adopt the preincorporation contract made by Norwood concerning the real estate deal with Burrows. Burrows sued Parker, Norwood, and the board of directors. Which of the following is correct?

a. None of these parties can be held liable.

b. Norwood only is liable.

c. Norwood and Parker are liable but not the board of directors.

d. Norwood, Parker, and the board of directors are all liable.

74. Under the Revised Model Business Corporation Act, which of the following statements is correct regarding corporate officers of a public corporation?

a. An officer may not simultaneously serve as a director.

b. A corporation may be authorized to indemnify its officers for liability incurred in a suit by stockholders.

c. Stockholders always have the right to elect a corporation’s officers.

d. An officer of a corporation is required to own at least one share of the corporation’s stock.

75. The officers of West Corporation wish to buy some used equipment for West Corporation. The used equipment is actually owned by Parks, a director of West Corporation. For this transaction to not be a conflict of interest for Parks, which of the following is (are) required to be true?

I. Parks sells the used equipment to West Corporation in a contract that is fair and reasonable to the corporation.

II. Parks’ ownership of the used equipment is disclosed to the shareholders of West who approve it by majority vote.

III. Parks’ ownership of the used equipment is disclosed to the board of directors, who approve it by a majority vote of the disinterested directors.

a. Any one of I, II, or III.

b. I and II are both required.

c. I and III are both required.

d. All three of I, II, and III are required.

76. The following are two statements concerning a fiduciary duty in a corporation.

I. Officers and directors of a corporation owe a fiduciary duty to that corporation.

II. Majority shareholders of a corporation can owe a fiduciary duty to the minority shareholders.

Which of the statements is (are) correct?

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

77. Hogan is a director of a large corporation. Hogan owns a piece of land that the corporation wishes to purchase and Hogan desires to sell this land at the fair market price. If he sells the land to the corporation, has he breached any fiduciary duty?

a. No, a director does not owe a fiduciary duty to his corporation.

b. No, since Hogan is selling the land to his corporation in a fair and reasonable contract.

c. Yes, unless he discloses his conflict of interest to the shareholders who must then approve the sale of by a simple majority.

d. Yes, unless he discloses his conflict of interest to the shareholders who must then approve the sale by a two-thirds vote.

78. Which of the following is not a power of the board of directors?

a. May select the officers of the corporation.

b. May declare the dividends to be paid to the shareholders.

c. May amend the Articles of Incorporation.

d. All of the above are powers of the board of directors.

79. Which of the following statements is (are) true under the law affecting corporations?

I. A corporation may indemnify directors against lawsuits based on their good-faith actions for the corporation.

II. A corporation may indemnify officers against lawsuits based on their good-faith actions for the corporation.

III. A corporation is allowed to purchase liability insurance for its directors.

a. I only.

b. I and II only.

c. I and III only.

d. I, II, and III.

80. Which of the following is (are) true concerning corporations?

a. Directors owe a fiduciary duty to the corporation.

b. Officers owe a fiduciary duty to the corporation.

c. Both of the above are true.

d. None of the above are true.

81. McGarry is an officer of Norton Corporation. McGarry has committed a tort while acting for Norton Corporation within the scope of her authority. Which of the following is (are) true?

a. Only McGarry is liable for the tort committed.

b. Only Norton Corporation is liable for the tort committed.

c. Both McGarry and Norton are liable for the tort committed.

d. Neither McGarry nor Norton are liable for the tort committed.

S. Stockholders’ Rights

82. Acorn Corp. wants to acquire the entire business of Trend Corp. Which of the following methods of business combination will best satisfy Acorn’s objectives without requiring the approval of the shareholders of either corporation?

a. A merger of Trend into Acorn, whereby Trend shareholders receive cash or Acorn shares.

b. A sale of all the assets of Trend, outside the regular course of business, to Acorn for cash.

c. An acquisition of all the shares of Trend through a compulsory share exchange for Acorn shares.

d. A cash tender offer, whereby Acorn acquires at least 90% of Trend’s shares, followed by a short-form merger of Trend into Acorn.

83. Price owns 2,000 shares of Universal Corp.’s $10 cumulative preferred stock. During its first year of operations, cash dividends of $5 per share were declared on the preferred stock but were never paid. In the second year, dividends on the preferred stock were neither declared nor paid. If Universal is dissolved, which of the following statements is correct?

a. Universal will be liable to Price as an unsecured creditor for $10,000.

b. Universal will be liable to Price as a secured creditor for $20,000.

c. Price will have priority over the claims of Universal’s bond owners.

d. Price will have priority over the claims of Universal’s unsecured judgment creditors.

84. Under the Revised Model Business Corporation Act, when a corporation’s Articles of Incorporation grant stockholders preemptive rights, which of the following rights is (are) included in that grant?

The right to purchase a proportionate share of a newly issued stock The right to a proportionate share of corporate assets remaining on corporate dissolution
a. Yes Yes
b. Yes No
c. No Yes
d. No No

85. Under the Revised Model Business Corporation Act, which of the following actions by a corporation would entitle a stockholder to dissent from the action and obtain payment of the fair value of his/her shares?

I. An amendment to the articles of incorporation that materially and adversely affects rights in respect of a dissenter’s shares because it alters or abolishes a preferential right of the shares.

II. Consummation of a plan of share exchange to which the corporation is a party as the corporation whose shares will be acquired, if the stockholder is entitled to vote on the plan.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

86. To which of the following rights is a stockholder of a public corporation entitled?

a. The right to have annual dividends declared and paid.

b. The right to vote for the election of officers.

c. The right to a reasonable inspection of corporate records.

d. The right to have the corporation issue a new class of stock.

87. Which of the following is correct pertaining to the rights of stockholders in a corporation?

a. Stockholders have no right to manage their corporation unless they are also directors or officers.

b. Stockholders have a right to receive dividends.

c. Stockholders have no right to inspect the books and records of their corporation.

d. Stockholders have a right to get a list of their corporation’s customers to use for the stockholder’s personal business mailing list.

T. Stockholders’ Liability

88. The limited liability of a stockholder in a closely held corporation may be challenged successfully if the stockholder

a. Undercapitalized the corporation when it was formed.

b. Formed the corporation solely to have limited personal liability.

c. Sold property to the corporation.

d. Was a corporate officer, director, or employee.

89. The corporate veil is most likely to be pierced and the shareholders held personally liable if

a. The corporation has elected S corporation status under the Internal Revenue Code.

b. The shareholders have commingled their personal funds with those of the corporation.

c. An ultra vires act has been committed.

d. A partnership incorporates its business solely to limit the liability of its partners.

90. Which of the following is correct about the law of corporations?

a. Each shareholder owes a fiduciary duty to his or her corporation.

b. Majority shareholders owe a fiduciary duty to their corporation.

c. Majority shareholders do not owe a fiduciary duty to minority shareholders.

d. All of the above are correct.

U. Substantial Change in Corporate Structure

91. A parent corporation owned more than 90% of each class of the outstanding stock issued by a subsidiary corporation and decided to merge that subsidiary into itself. Under the Revised Model Business Corporation Act, which of the following actions must be taken?

a. The subsidiary corporation’s board of directors must pass a merger resolution.

b. The subsidiary corporation’s dissenting stockholders must be given an appraisal remedy.

c. The parent corporation’s stockholders must approve the merger.

d. The parent corporation’s dissenting stockholders must be given an appraisal remedy.

92. Under the Revised Model Business Corporation Act, a merger of two public corporations usually requires all of the following except

a. A formal plan of merger.

b. An affirmative vote by the holders of a majority of each corporation’s voting shares.

c. Receipt of voting stock by all stockholders of the original corporations.

d. Approval by the board of directors of each corporation.

93. Which of the following statements is a general requirement for the merger of two corporations?

a. The merger plan must be approved unanimously by the stockholders of both corporations.

b. The merger plan must be approved unanimously by the boards of both corporations.

c. The absorbed corporation must amend its articles of incorporation.

d. The stockholders of both corporations must be given due notice of a special meeting, including a copy or summary of the merger plan.

94. Which of the following must take place for a corporation to be voluntarily dissolved?

a. Passage by the board of directors of a resolution to dissolve.

b. Approval by the officers of a resolution to dissolve.

c. Amendment of the certificate of incorporation.

d. Unanimous vote of the stockholders.

95. A corporate stockholder is entitled to which of the following rights?

a. Elect officers.

b. Receive annual dividends.

c. Approve dissolution.

d. Prevent corporate borrowing.

96. When a consolidation takes place under the law of corporations, which of the following is true?

a. Two or more corporations are joined into one new corporation.

b. All assets are acquired by the new corporation.

c. The new corporation is liable for the debts of each of the old corporations.

d. All of the above are true.

V. Subchapter S Corporation

97. When a corporation elects to be a Subchapter S corporation, which of the following statements is (are) true regarding the federal tax treatment of the corporation’s income or loss?

I. The corporation’s income is taxed at the corporate level and not the shareholders’ level.

II. The shareholders report the corporation’s income on their tax returns when the income is distributed to them.

III. The shareholders report the corporation’s income on their tax returns even if the income is not distributed to them.

IV. The shareholders generally report the corporation’s loss on their tax returns.

a. I only is true.

b. II only is true.

c. III only is true.

d. III and IV only are true.

Multiple-Choice Answers and Explanations

Answers

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Explanations

1. (a) Federal or state governments do not typically require any formal filing. If the business operates under a name different from that of the sole proprietor, most states require that a fictitious name statement be filed. Answer (b) is incorrect because the sole proprietorship and the sole proprietor are not separate legal entities. Answer (c) is incorrect because a sole proprietor does not have partners or shareholders from whom to obtain capital. Answer (d) is incorrect because the simplicity of this business structure is one of its advantages in its formation and operation.

2. (b) A general partnership is an association of two or more persons to carry on a business as co-owners for profit. There must be at least two partners involved in order for a partnership to exist. Answer (a) is incorrect because a general partnership is normally not recognized as a taxable entity under federal income tax laws. Answer (c) is incorrect because execution of written articles of partnership is not required to create a general partnership. A partnership agreement may be oral or in writing. Answer (d) is incorrect because a partnership does not have to provide for apportionment of liability for partnership debt. Note that even if the partners agreed to split partnership liability in a specified proportion, third parties can still hold each partner personally liable despite the agreement.

3. (d) A partnership involves two or more persons to carry on a business as co-owners for a profit. Partnerships do not include nonprofit associations such as charitable organizations, labor unions or clubs.

4. (b) A silent partner does not help manage the partnership but still has unlimited liability.

5. (d) A partnership agreement may be expressed or implied based upon the activities and conduct of the partners. The expressed agreement may be oral or in writing with, in general, one exception. A partnership agreement that cannot be completed within one year from the date on which it is entered into must be in writing. Answer (b) is incorrect because the partners may reside in different states without having to put the partnership agreement in writing. Answer (a) is incorrect because the $500 amount applies to the sale of goods which must be in writing, not partnerships. Answer (c) is incorrect because the purpose of the partnership is irrelevant. Agreements to buy and sell real estate must be in writing, while an agreement to form a partnership whose principal activity will involve the buying and selling of real estate normally need not be in writing unless the stated duration exceeds one year.

6. (d) Under RUPA, the partnership is a legal entity that can own property in its own name. The partners also have joint and several liability for all debts whether they are based in contract or tort.

7. (c) The partners may agree to share profits as well as losses unequally. Answer (a) is incorrect because the partners may agree that ownership in the partnership is unequal. Answer (b) is incorrect because under RUPA, the partnership is a separate legal entity. Answer (d) is incorrect because the partners may agree to unequal management rights.

8. (d) Profits and losses in a general partnership are shared equally unless otherwise specified in the partnership agreement. If partners agree on unequal profit sharing but are silent on loss sharing, then losses are shared per the profit sharing proportions. The partnership agreement for Owen Associates provided that profits be paid to the partners in the ratio of their financial contribution to the partnership. The ratios are as follows:

Total contributed $10,000 + 30,000 + 50,000 = $90,000

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For the year ended December 31, 2012, Owen had losses of $180,000. Therefore, Kale would be allocated $100,000 of the losses ($180,000 × 5/9).

9. (b) An incoming partner has the same rights as all of the existing partners. Thus, an incoming partner has the right to participate in the management of the partnership. Answer (a) is incorrect since the incoming partner acquires more than just the right to profits. Answer (c) is incorrect since a person admitted as a partner into an existing partnership is only liable for existing debts of the partnership to the extent of the incoming partner’s capital contribution. Answer (d) is incorrect because a partner need not make a capital contribution to be admitted with the same rights as the other partners.

10. (b) A partner is free to assign his interest in any partnership to a third party. However, the assignee does not become a partner by virtue of this assignment, but merely succeeds to the assignor’s rights as to profits and return of partner’s capital contribution. The assignee does not receive the right to manage, to have an accounting, to inspect the books, or to possess or use any individual partnership property. Since Bean was not made a partner, he is entitled to Cobb’s share of TLC’s profits, but does not have the right to participate in the management of TLC.

11. (a) A partner’s apparent authority is derived from the reasonable perceptions of third parties due to the manifestations or representations of the partnership concerning the authority each partner possesses to bind the partnership. However, if third parties are aware of a formal resolution which limits the partner’s actual authority to bind the partnership, then that partner’s apparent authority will also be limited. Answer (b) is incorrect because if third parties are unaware of such a resolution which limits the partner’s actual authority, then the partner retains apparent authority to bind the partnership. Answer (c) is incorrect because third parties should be aware that in order for a partner to submit a claim against the partnership to arbitration, unanimous consent of the partners is needed. Therefore, a partner has no apparent authority to take such an action. Answer (d) is incorrect because as stated above, the apparent authority of a partner to bind the partnership is not derived from the express powers and purposes contained in the partnership agreement.

12. (b) In a general partnership, unanimous consent is required of all of the partners to admit a new partner. Answer (a) is incorrect because any one partner can cause a dissolution by actions such as withdrawing. Answer (c) is incorrect because each partner is an agent of the general partnership and thus may purchase items for the business of the firm. Answer (d) is incorrect; an individual partner may hire an employee because such an action is viewed as within the regular course of business.

13. (c) Under the Revised Uniform Partnership Act, partners have joint and several liability for not only torts but also breaches of contract. This is a change from previous lawand differs from the normal rules of agency law.

14. (c) Although individual partners normally have implied authority to buy and sell goods for the partnership; they do not have implied authority to do such things as making the partnership a surety or admitting a new partner. Such matters are not considered to be the ordinary business of the partnership, and thus require the consent of all partners.

15. (d) A partner’s interest in a partnership is freely assignable without the other partners’ consent. A partner’s interest refers to the partners’ right to share in profits and return of contribution. Answer (a) is incorrect because the assignee does not become a partner without the consent of all the other partners. Answer (b) is incorrect because the assignor remains liable as a partner. The assignee has only received the partner’s right to share in profits and capital return. Answer (c) is incorrect because assignment of a partner’s interest does not cause dissolution unless the assignor also withdraws.

16. (b) Under RUPA, partnership property not only includes property purchased in the partnership name but also includes property purchased by a partner, who is an agent of the partnership, with partnership funds. Note that a partner may use property in the partnership business without it becoming partnership property.

17. (d) Even if a partner has agreed not to withdraw before a certain period of time, s/he has the power to do so anyway. That partner’s withdrawal is a break of contract and causes a dissolution of the partnership. If the remaining partners agreed to continue the partnership, this would prevent the dissolution, but there is no mention of such an agreement in the facts presented here. Answer (a) is incorrect because this dissolution is caused by an act of a partner rather than by operation of law. Answer (b) is incorrect because Wind’s withdrawal does have an effect on the remaining partners because they must decide on what new terms they will operate or else wind up and terminate the partnership. Answer (c) is incorrect because the dissolution is effective once Wind does withdraw from the partnership. A court decree is not necessary.

18. (a) The best approach to answer this question is to make a chart as follows:

image image

A capital deficit may be corrected by the partner investing more cash or assets to eliminate the deficit or by distributing the deficit to the other partners in their resulting profit and loss sharing ratio. The latter was done in this case, as the facts in the question indicated that Grant refuses to make any further contributions to the partnership. The remaining cash is then used to pay the three partners’ capital balances.

19. (c) A general partner has a voice in management and has unlimited personal liability. Anyone, including a secured creditor of the limited partnership, may be a general partner if he/she takes on these responsibilities. Answer (a) is incorrect because an unsecured creditor of the limited partnership may also be a limited partner. A limited partner is defined as having no voice in management and his/her liability is limited to the extent of his/her capital contribution. Answer (b) is incorrect because a general partner may also be a limited partner at the same time. This partner would have the rights, powers, and liability of a general partner, and the rights against other partners with respect to his/her contribution as both a limited and a general partner. Answer (d) is incorrect because every limited partnership must have at least one general partner who will be liable for the partnership obligations.

20. (c) Under the Revised Uniform Limited Partnership Act, when the partners do not agree how to split profits, the split is made in proportion to their capital contributions. Note that this is different for general partners under the Revised Uniform Partnership Act.

21. (a) Limited partnerships must have at least one general partner who has the unlimited personal liability of the firm. Unlike a general partner, the death of a limited partner does not cause a dissolution or termination of a partner.

22. (a) Since Chan acted like a general partner and Ham thought he was a general partner, Chan has the liability of a general partner to Ham. Answers (b), (c), and (d) are incorrect because Ham believed Chan was a general partner based on Chan’s actions. Therefore, Chan had the liability of a general partner, that is, unlimited liability.

23. (a) Under the Revised Uniform Limited Partnership Act, none of the names of the limited partners need to be listed in the certificate of limited partnership that is filed with the Secretary of State. However, all of the general partners must be listed.

24. (c) A limited partner is allowed, without losing the protection of limited liability, to act as an agent of the limited partnership. The limited partner may also vote on the removal of a general partner.

25. (d) Partners’ capital may not only be in cash, property, or services already performed, but also may be in the form of promises to give or perform these at a future date.

26. (d) If the liability is more than the partnership can pay, each partner loses its capital contribution and then the general partner has personal, unlimited liability for the debt.

27. (d) The admission of a new general partner to a limited partnership under the Revised Uniform Limited Partnership Act requires the approval of all partners, including limited partners.

28. (d) The admission of a new limited partner requires the approval of all the partners.

29. (c) Death or bankruptcy of a general partner in a limited partnership will cause dissolution of the limited partnership. However, this is not true if a limited partner dies or goes bankrupt.

30. (d) The law of joint ventures is similar to the law of partnerships with some exceptions. One of these exceptions is that the death of a joint venturer does not automatically dissolve the joint venture. Answers (a), (b), and (c) are all incorrect because these are all examples in which joint venture law and partnership law are similar, involving liability, right to participate in management, and fiduciary duties.

31. (a) A limited liability company provides for limited liability of its members, similar to the limited liability of the shareholders of a corporation. However, it typically has a limited duration of existence, similar to that of a partnership in which the death or withdrawal of a member or partner causes the business to dissolve unless the remaining members or partners choose to continue the business. The limited liability company can also be taxed similar to a partnership if formed to do so. The Subchapter S corporation has the limited liability of the corporation but is taxed similar to a partnership.

32. (b) The limited liability company statutes provide that it is a separate legal entity apart from its owners. Thus it may sue or be sued in its own name. Answer (a) is incorrect because all owners have limited rather than personal liability. Answer (c) is incorrect because limited liability is normally retained even if the owners fail to follow the formalities usual in conducting the business. Answer (d) is incorrect because (b) is correct.

33. (c) Limited liability companies typically have a limited life. Provisions often provide that they exist for thirty years at most and dissolve if a member dies. Therefore (a) is an incorrect response. Answer (b) is also not chosen because members (owners) are permitted to participate in the management of the LLC or can choose the management. Answer (d) is an incorrect response because one of the main benefits of an LLC is the limited liability of its members (owners).

34. (c) Owners and managers of an LLC owe a duty of due care. They also owe a duty to be loyal to their LLC.

35. (b) In the typical limited liability company (LLC), unlike the common corporation, the interests of the members are not freely transferable. The other members have to agree to admit new members. Answer (a) is incorrect because it provides for limited liability of all of its members. Answer (c) is incorrect because all members have a voice in the management of the LLC. Answer (d) is incorrect because a limited liability company must be formed pursuant to the filing requirements of the relevant state statute.

36. (d) In most states a limited liability partnership (LLP), insulates partners from personal liability for all debts and obligations of the partnership regardless of whether those debts arose from contract or tort. Answer (a) is incorrect because both in the LLP and the general partnership, the partners have unlimited liability for their own torts. Answer (b) is incorrect because partners are insulated from contractual debts as well as debts arising from tort. Answer (c) is incorrect because partners have personal liability for their own actions.

37. (b) The federal Subchapter S Revision Act specifies that all corporations that do not meet the criteria of a Subchapter S corporation are categorized as a Subchapter C corporation. Answers (a), (c), and (d) are incorrect because the Act provides that a corporation is either a Subchapter S or Subchapter C corporation but not both at the same time.

38. (b) All corporations are divided under the federal Subchapter S Revision Act as being either a Subchapter C corporation or a Subchapter S corporation. Answer (a) is incorrect because the federal Subchapter S Revision Act provides that there are two categories of corporations: Subchapter C and Subchapter S corporations. Answer (c) is incorrect because this federal law provides for only two categories of corporations. A Subchapter E corporation is not one of these. Answer (d) is incorrect because answer (c) is correct.

39. (c) Both Subchapter C corporations and Subchapter S corporations are similar in their provisions for the limited liability of their shareholders and also in their corporate management structures. Answer (a) is incorrect because it does not include the similarity of the corporate management structures. Answer (b) is incorrect because it does not mention the similarity of the shareholders’ limited liability. Answer (d) is incorrect for the reason that answer (c) is correct.

40. (a) Tax treatment is the main reason why Subchapter S corporations are formed instead of Subchapter C corporations. Answer (b) is incorrect because this federal Act covers both types of corporations. Answers (c) and (d) are incorrect because the provisions on the limited liability of shareholders and the provisions for the structure of corporate management are some of the ways that Subchapter C and Subchapter S corporations are generally similar.

41. (c) One advantage of the corporate form of business is that it has a continuous life and is not terminated by the death of a shareholder or manager. Answer (a) is incorrect because although the power to manage the corporation is vested in the board of directors, they usually delegate the day-to-day management responsibilities to various managers. Answer (b) is incorrect because in most corporations, ownership is not contractually restricted. In fact, free transferability of the shares of stock is a major advantage of the corporate form of business. Answer (d) is incorrect because corporations are not free from state regulation.

42. (c) A major advantage is that shareholders have limited liability, that is, typically limited to what they paid for the stock. However, managers do not have limited liability for their actions as managers. If a manager is also a shareholder, that person has limited liability for the ownership in the stock but can still be sued for misdeeds as a manager. Answers (a), (b), and (d) are all considered to be advantages of a corporation. Note that since a person can manage a corporation without necessarily being an owner, this can encourage professional managers to get involved.

43. (d) The death of one or more of a corporation’s shareholders does not automatically terminate it. Answer (a) is incorrect because a corporation continues to exist until it is dissolved, merged or otherwise terminated. Answer (b) is incorrect because shares in a corporation, represented by stocks, can be freely bought, sold, or assigned unless the shareholders have agreed to restrict this. Answer (c) is incorrect because a corporation is legally a separate entity apart from its shareholders.

44. (d) A corporation may make contracts in its own name with both its shareholders and third parties. Answer (a) is incorrect because it may also make contracts with third parties. Answer (b) is incorrect because corporations do not generally need the consent of other shareholders to contract with one shareholder. Answer (c) is incorrect because it may also contract with its shareholders.

45. (d) Persons who manage a corporation may be, but need not be, shareholders of that corporation. Also, a corporation as a separate legal entity may convey or hold property. It may also sue or be sued in its own name. Answers (a), (b), and (c) are not comprehensive enough.

46. (a) A Subchapter S corporation is often formed to help avoid the double taxation that a Subchapter C corporation may face. Answer (b) is incorrect because partners in a general partnership have unlimited personal liability. Shareholders of a corporation have limited liability with few exceptions. Answer (c) is incorrect because a Subchapter C corporation is any corporation that is not a Subchapter S corporation. Answer (d) is incorrect because both Subchapter C and Subchapter S corporations provide their shareholders with limited liability with few exceptions.

47. (b) Bond is a domestic corporation in Florida since it incorporated there. It is a foreign corporation in Georgia since it did not incorporate there. Bond does not need to incorporate in Georgia but must qualify to do business there because it has branch offices in Georgia. This qualifying normally entails filing required documents with the state.

48. (b) In a professional corporation, the professional has most of the benefits of a corporation such as limited liability for corporate debts. However, the professional has personal liability for professional acts. Colby cannot avoid liability for the damage caused the client due to negligence in a professional act.

49. (c) A domestic corporation is one that operates and does business in the state in which it was incorporated. Answer (a) is incorrect because Macro, instead of incorporating in Nevada, may qualify to do business by obtaining a certificate of authority from Nevada. Answer (b) is incorrect because Macro is a foreign corporation in Nevada because it did not incorporate there. Answer (d) is incorrect because the statement in (c) is the only one that is true.

50. (d) None of the listed items are normally considered doing business in the other states such that Cleanit would be required to qualify to do business and thus have to obtain certificates of authority from those states. Therefore, answers (a), (b), and (c) are incorrect.

51. (c) Normally, under state laws, only licensed professionals may own shares in professional corporations. Furthermore, the licensed professionals retain personal liability for their professional acts in the professional corporation. Therefore (a), (b), and (d) are incorrect.

52. (d) Corporations and limited partnerships may only be created pursuant to state statutes. Normally, both the Articles of Incorporation and a Certificate of Limited Partnership must be filed with the Secretary of State. Answer (c) is incorrect since limited partners do not owe fiduciary duties to the partnership. Answer (a) is incorrect since limited partners have the right to vote on partnership matters such as the dissolution or winding up of the partnership, loans of the partnership, a change in the nature of the business of a partnership, and the removal of a general partner without jeopardizing their limited partner status. Answer (b) is incorrect since sale of limited partnership interests is not automatically exempted from the general securities laws’ registration requirements.

53. (d) Under the Revised Model Business Corporation Act, a corporation’s Articles of Incorporation generally must include the name of the corporation, the purpose of the corporation, the powers of the corporation, the name of the incorporators, the name of the registered agent of the corporation and the number of shares of stock the corporation is authorized to issue.

54. (a) The Articles of Incorporation are filed with the state and contain the names of the corporation, registered agent, and incorporators. This document also contains the purpose and powers of the corporation as well as a description of the types of stock and number of authorized shares.

55. (d) Normally, the board of directors of a corporation has the power to adopt, amend, and repeal the bylaws. It also has the power to declare dividends and fix the compensation of the directors. However, it does not have the power to amend the Articles of Incorporation.

56. (a) Corporations and limited partnerships may only be created pursuant to state statutes. Normally, both the Articles of Incorporation and a Certificate of Limited Partnership must be filed with the Secretary of State. Answer (b) is incorrect because a limited partnership requires at least one general partner who retains unlimited personal liability. Answer (c) is incorrect because a limited partnership is treated the same as a general partnership for tax purposes in that it is not recognized as a separate taxable entity. Answer (d) is incorrect because a limited partnership is not statutorily allowed perpetual existence.

57. (a) The basic concept of a promoter is one who forms a corporation with the goal of the corporation eventually coming into existence. Answer (b) is incorrect because for there to be an agent, there must be a principal. There is no principal yet because the corporation is not yet formed. Answer (c) is incorrect because the promoters are not agents, since there is no principal yet, thus have no authority to bind the future corporations to contracts. Answer (d) is incorrect because the promoters are not agents and thus cannot use agency law to protect them.

58. (b) The Articles of Incorporation must include, among other things, the amount of capital stock authorized and the types of stock to be issued. Specific provisions applicable to stock must also be stated. Examples of stock provisions which must be authorized by the Articles of Incorporation include number of authorized shares, whether the stock is to be par value or no-par value, and classes of stock, including voting rights and dividend provisions. When, as here, a shareholder owns a cumulative stock the shareholder becomes an unsecured creditor of the corporation to the extent declared dividends are not paid; this includes dividends that were declared, but not paid, in previous years. Therefore, Johns becomes an unsecured creditor upon Abco’s declaration of preferred stock dividend. In order for Johns to be entitled to convert his/her preferred shares to common shares, to participate with common shareholders in any dividend distribution made after preferred dividends are paid, or to be entitled to vote if dividend payments are in arrears, it must be stated in the Articles of Incorporation; therefore, (a), (c), and (d) are incorrect.

59. (c) Par value is the minimum amount that a corporation may sell stock initially. Par value does not apply to the corporation’s purchase of stock; nor does par value apply to treasury stock. Gallagher originally sold the stock at above par value.

60. (c) A corporation may resell treasury shares without regard to par value. Therefore, an owner of common stock who purchased treasury shares for less than par value will not have any liability beyond actual investment. Answer (a) is incorrect because an owner of common stock who paid less than par value for stock purchased in connection with an original issue of shares is contingently liable in many states to creditors for the difference between the amount paid and par value. Answer (b) is incorrect because a promise to perform services is valid consideration, but only if it is for at least par value. Answer (d) is incorrect because once the corporation accepts an offer to buy stock subscriptions, the subscriber becomes liable for the purchase. Therefore, an owner of common stock who failed to pay the full amount owed on a subscription contract for no-par shares is liable for the difference between any amounts already paid and the full amount owed according to the contract.

61. (c) Corporate debt securities include the following: (1) registered bonds, (2) bearer bonds, (3) debenture bonds, (4) mortgage bonds, (5) redeemable bonds, and (6) convertible bonds. A warrant is not a corporate debt security, but rather is written evidence of a stock option which grants its owner the option to purchase a specified amount of shares of stock at a stated price within a specified period of time.

62. (b) A stock split increases the number of shares outstanding and proportionately decreases the par value per share. However, the total outstanding par value does not change and therefore no charge is made to retained earnings or capital. Answer (a) is incorrect because liquidating dividends represent a return of the stockholders’ capital and are considered a capital distribution. Both cash and property distributions are considered asset distributions; therefore answers (c) and (d) are incorrect. Property distributions are recorded at the fair market value of the asset at the date of transfer.

63. (d) Valid consideration or value to purchase shares of stock can be any benefit to the corporation including any services contracted for that are yet to be performed in the future.

64. (c) Since Brawn had a contract to purchase 1,000 shares at $20 per share, this is binding. Therefore, the creditors can recover in bankruptcy the remainder of the price not paid. Answer (a) is incorrect because the creditors have the right to see that the bankruptcy estate includes this amount owed the corporation. Answer (b) is incorrect because the contract required that the full $20,000 be paid, not just the par value. Answer (d) is incorrect because ultra vires acts are acts that are beyond the scope of the powers of the corporation. These do not apply to this fact pattern.

65. (c) Treasury stock are not votable nor do they receive dividends. Therefore, answers (a), (b), and (d) are incorrect.

66. (a) Treasury stock is stock that a corporation issued previously but is no longer outstanding because the corporation repurchased it back. Answer (b) is incorrect because treasury stock is a corporation’s own stock that it has repurchased. Answer (c) is incorrect because canceled stock is no longer issued or outstanding. Answer (d) is incorrect because (a) is correct.

67. (b) A corporation by law may issue one or more classes of common stock. This is also true for preferred stock. Answer (a) is incorrect because a corporation is not required to issue preferred stock. Answer (c) is incorrect because it is at the discretion of the board of directors to declare a dividend. They may wish to keep the earnings in the corporation for expansion purposes, etc. Answer (d) is incorrect because if it issues preferred stock, it may be either cumulative preferred stock or noncumulative preferred stock.

68. (b) A bond represents long-term secured debt. Answer (a) is incorrect because holders of debt securities are creditors rather than owners of the corporation. Answer (c) is incorrect because a debenture represents long-term unsecured debt not long-term secured debt. Answer (d) is incorrect because there was one correct answer.

69. (c) The definition of watered stock refers to when the stock is acquired by exchanging cash or property worth less than the par or stated value of the stock.

70. (b) Corporations generally have the power to acquire or retire their own shares without shareholder approval. They can also make charitable contributions without such approval. Loans to directors require shareholder approval.

71. (c) A business is liable for the torts of its employees committed within the course and scope of employment. Intentional torts usually fall outside the scope of employment, but there are situations where intentional torts fall within the scope of employment. Principals can be held liable for the agent’s fraud where the agent is authorized or appears to be authorized to make such statements. As an employee of Landtry, it can be assumed that Murphy has authority to discuss the features of Landtry’s products. Torts involving violence can fall within the scope of employment if they are foreseeable. Here Lantry has previously warned Murphy not to engage in violent actions against customers, which provides evidence that Murphy’s violent actions are foreseeable. The injured third party can hold both the employee and the corporation liable in either case.

72. (d) All three statements are true in the interest of punishing all parties who commit crimes.

73. (b) Norwood is personally liable on the contract because he signed the contract and agency law will not protect him. This is true because he was not an agent, even though he claimed to be, because there was no principal to authorize him when the contract was made on March 15. Answer (a) is incorrect since Norwood is liable. Answers (c) and (d) are incorrect; since the corporation never adopted the contract by words or actions, it is not liable. The board of directors is not personally liable either because they never agreed to the contract.

74. (b) Under the Revised Model Business Corporation Act, a corporation is authorized to indemnify its officers for expenses, attorney fees, judgments, fines and amounts paid in settlement incurred in a suit by stockholders when the liability is a result of the officer’s good faith, nonnegligent actions on behalf of the best interest of the corporation. Answer (a) is incorrect because a corporate officer may also serve as a director. Answer (c) is incorrect because officers are appointed by the directors of a corporation who are in turn elected by the shareholders. Answer (d) is incorrect because there is no requirement that an officer must own any shares of the corporation’s stock.

75. (a) The transaction the director wishes to have with the corporation is not a conflict of interest if any one of the following is true. (1) The transaction is fair and reasonable for the corporation. (2) The shareholders are given the relevant facts and they approve it by a majority vote. (3) The board of directors are given the relevant facts and they approve it by a majority vote of the disinterested members of the board of directors.

76. (c) Officers and directors are in important positions in a corporation. As such, they owe a fiduciary duty to the corporation to act in the best interests of the corporation. Courts have also recognized that because majority shareholders can exercise a lot of power in a corporation from their stockholdings and voting rights, they owe a fiduciary duty to the minority shareholders when these majority shareholders have de facto control over the corporation by virtue of their concentrated ownership.

77. (b) A contract between a director and his/her corporation is valid if it is reasonable to the corporation. Hogan has not breached his fiduciary duty with the corporation since he is selling the land at fair market value. Answer (a) is incorrect because a director does owe a fiduciary duty to his/her corporation to act in its best interests. Answers (c) and (d) are incorrect because since the transaction is fair and reasonable to the corporation, the shareholders need not approve it.

78. (c) The Articles of Incorporation may be amended by the shareholders’ vote, not by the board of directors. Answer (a) is incorrect because one of the important powers of the directors is to select the officers of the corporation. Answer (b) is incorrect because it is up to the board of directors to declare any dividends to the shareholders. Answer (d) is incorrect because answer (c) is correct.

79. (d) A corporation may indemnify both its directors as well as its officers against suits based on their duties for the corporation if they acted in good faith and in the best interests of the corporation. A corporation may also purchase insurance to cover the liability for lawsuits lost based on actions of its directors and also its officers.

80. (c) Both directors as well as officers owe a fiduciary duty to their corporation.

81. (c) McGarry is liable for the tort she committed. Because she was acting within the scope of her authority in the corporation, Norton corporation is also liable. Note that McGarry is not relieved of liability even though Norton Corporation is also liable because McGarry is the one who committed the tort. Therefore, answers (a), (b), and (d) are incorrect.

82. (d) When Acorn pays cash and buys 90% or more of Trend’s shares, it has control of the Trend stock. It can then accomplish a short-form merger of Trend Corp. into Acorn Corp. Answer (a) is incorrect because this can require the approval of Acorn shareholders. Answer (b) is incorrect because this is not a regular sale of Trend’s assets and will require shareholder approval. Answer (c) is incorrect because the entire compulsory exchange for Acorn shares to accomplish the acquisition does require Trend’s shareholder approval.

83. (a) Upon declaration, a cash dividend on preferred stock becomes a legal debt of the corporation, and the preferred shareholders become unsecured creditors of the corporation. However, any dividends not paid in any year concerning cumulative preferred stock are not a liability of the corporation until they are declared. Therefore, Universal will be liable to Price as an unsecured creditor for $10,000, which is the amount of the declared dividends. Answers (c) and (d) are incorrect because Price has become a general unsecured creditor for the declared dividends and will have the same priority as the debenture (unsecured) bond owners and the unsecured judgment creditors. Answer (b) is incorrect because the undeclared dividends did not become a legal liability to Universal.

84. (b) The preemptive right gives the shareholder the right to purchase newly issued stock so as to keep the same overall percentage of ownership of the corporation. The Revised Model Business Corporation Act only provides this right if it is set forth in the Articles of Incorporation. The right to a proportionate share of assets upon dissolution is a right that all shareholders have and is not limited to preemptive shareholders.

85. (c) When the rights of individual shareholders may be adversely affected, the shareholder is given the right to dissent and receive payment of the fair value of his/her shares. This is true even if the dissenting shareholder has voting rights when s/he is being outvoted. In I., the shareholder has this right because his/her preference rights are being abolished. In II., the dissenting shareholder has this right because his/her shares being acquired by another corporation may affect the value and rights of the shares of stock.

86. (c) Shareholders have the right to inspect the corporate records if done in good faith for a proper purpose. Answer (a) is incorrect because shareholders do not have a right to dividends. It is the decision of the board of directors whether or not to declare dividends. Answer (b) is incorrect because although at least one class of stock must have voting rights to elect the board of directors, the officers may be selected by the board of directors. Answer (d) is incorrect because the shareholders cannot force an issuance of a new class of stock.

87. (a) Stockholders do not have the right to manage their corporation. However, stockholders who are also directors or officers do have the right to manage as part of their rights as directors and officers. Answer (b) is incorrect because stockholders generally have no right to receive dividends unless the board of directors declares such dividends. Answer (c) is incorrect because stockholders are given the right to inspect the books and records of their corporation. Answer (d) is incorrect because the stockholders may demand a list of shareholders for a proper purpose such as to help wage a proxy fight; however, they may not require the corporation to give them a list of its customers to use for a mailing list.

88. (a) Normally, the liability of shareholders of corporations is limited to their capital contribution. However, the court will “pierce the corporate veil” and hold the shareholders personally liable for the debts of the corporation if the corporate entity is being used to defraud people or to achieve other injustices. Thus, if the shareholders establish a corporation, knowing that it would have less capital than required for it to pay its debts, then the court will “pierce the corporate veil” and hold the shareholders personally liable. Answer (c) is incorrect because a shareholder may sell property to the corporation without becoming personally liable for the debts of the corporation. Answer (d) is incorrect because shareholders may also be corporate officers, directors or employees without jeopardizing their limited liability status. Answer (b) is incorrect because the formation of a corporation solely to limit personal liability is a valid purpose so long as it is done without intent to defraud.

89. (b) The court will disregard the corporate entity and hold the shareholders individually liable when the corporate form is used to perpetrate a fraud or is found to be merely an agent or instrument of its owners. An example of when the corporate veil is likely to be pierced is if the corporation and its shareholders commingle assets and financial records. In such a situation, the shareholders lose their limited liability and will be held personally liable for the corporation’s legal obligations. Answer (a) is incorrect because the election of S corporation status is allowable under the law and is not, in itself, grounds for piercing the corporate veil. Answer (d) is incorrect because the desire of shareholders to limit their personal liability is a valid reason to form a corporation. Limited personal liability is one advantage of the corporate entity. Answer (c) is incorrect since the court will hold personally liable only those corporate officers responsible for the commission of an ultra vires act. The court will not pierce the corporate veil and hold the shareholders personally liable for such an act.

90. (b) Majority shareholders now owe a fiduciary duty to their corporation. Answer (a) is incorrect because minority shareholders do not owe a fiduciary duty to their corporation. Their main purpose normally is to be investors. Answer (c) is incorrect because majority shareholders now not only owe a fiduciary duty to their corporation but also to the minority shareholders. Answer (d) is incorrect because answer (b) is correct.

91. (b) Under the Revised Model Business Corporation Act, a corporation that owns at least 90% of the outstanding shares of each class of stock of the subsidiary may merge the subsidiary into itself without approval by the shareholders of the parent or subsidiary; thus answer (c) is incorrect. Answer (a) is incorrect because the approval of the shareholders or the subsidiary’s board of directors is unnecessary since the parent owns 90% of the subsidiary. This ownership assures that the plan of the merger would be approved. The only requirement is a merger resolution by the board of directors of the parent corporation. Furthermore, the dissenting shareholders of the subsidiary must be given an appraisal remedy, which is the right to obtain payment from the parent for their shares. The shareholders of the parent do not have this appraisal remedy because the merger has not materially changed their rights; thus answer (d) is incorrect.

92. (c) In order for a merger of two public corporations to be accomplished, it is required that a formal plan of merger be prepared and that the merger plan be approved by a majority of the board of directors and stockholders of both corporations; therefore answers (a), (b), and (d) are incorrect.

93. (d) As one of the steps leading up to a merger of two corporations, the stockholders need to be given notice of the merger plan. This is true of the stockholders of both corporations, so a special meeting is called inviting both sets of stockholders. Answers (a) and (b) are incorrect because unanimous approval is not needed by either the stockholders or the boards of either corporation. Answer (c) is incorrect because the absorbed corporation will no longer exist after the merger plan is accomplished.

94. (a) A corporation voluntarily dissolves when its board of directors passes a resolution to dissolve and liquidate. Answer (d) is incorrect because this resolution must be ratified by a majority of stockholders who are entitled to vote. Following ratification, the corporation must file a certificate of dissolution with the proper state authority, cease business, wind up its affairs, and publish notice of its dissolution. Answers (b) and (c) are incorrect because they are not requirements of a voluntary dissolution.

95. (c) Shareholders have the right to vote on the dissolution of the corporation. Answer (a) is incorrect because stockholders also have the right to elect the directors of the corporation, not the officers, the directors, in turn, elect the officers. Answer (b) is incorrect as shareholders do not have the right to receive dividends unless they are declared by the board of directors. Answer (d) is incorrect as shareholders are not necessarily involved in the management of the corporation and cannot prevent corporate borrowing.

96. (d) Under corporate law when a consolidation takes place, one new corporation comes from the joining of two or more corporations. Also, the assets and liabilities of the old corporations are acquired by the new corporation and the new corporation is liable for the debts of the old corporations.

97. (d) When a corporation elects to be a Subchapter S corporation, the corporate income and loss flow through to the income tax returns of the individual shareholders even when the income is not distributed to them. Answer (a) is incorrect because the corporation’s income is not taxed at the corporate level when the Subchapter S election is made. Answer (b) is incorrect because the income flows through to the stockholders’ tax returns regardless of when the distribution takes place. Answer (c) is incorrect because Statement IV as well as Statement III are both correct as discussed above.

Simulation

Task-Based Simulation 1

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Situation

In 2010 Anchor, Chain, and Hook created ACH Associates, a general partnership. The partners orally agreed that they would work full time for the partnership and would distribute profits based on their capital contributions. Anchor contributed $5,000: Chain $10,000; and Hook $15,000.

For the year ended December 31, 2011, ACH Associates had profits of $60,000 that were distributed to the partners. During 2012, ACH Associates was operating at a loss. In September 2012, the partnership dissolved.

In October 2012, Hook contracted in writing with Ace Automobile Co. to purchase a car for the partnership. Hook had previously purchased cars from Ace Automobile Co. for use by ACH Associates partners. ACH Associated did not honor the contract with Ace Automobile Co. and Ace Automobile Co. sued the partnership and the individual partners.

Required:

For each item, determine whether (A) or (B) is correct.

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Simulation Solution

Task-Based Simulation 1

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Explanations

1. (A) The creation of a partnership usually may be either oral or written. A written partnership agreement is not required unless it falls within the Statute of Frauds (e.g., the partnership cannot be completed within one year). Even though the partnership actually lasted longer than one year, the Statute of Frauds focuses on the term in the partnership agreement, not what actually happens. Since no term was specified in the oral agreement, it is possible that the partnership could have been completed in less than a year so no writing is required under the Statute of Frauds.

2. (A) A partnership is an association of two or more persons to carry on a business as co-owners for profit. Co-ownership of property is one element of a partnership; however, the most important and necessary element of a partnership is profit sharing. Another important element of co-ownership is joint control.

3. (B) Partnership profits and losses are shared equally unless the partnership agreement specifies otherwise. The agreement for ACH Associates specified that the partners would distribute profits based on their capital contributions. As such, Anchor’s share of ACH Associates’ 2011 profits would be

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Hook’s share of ACH Associates’ 2011 profits would be

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4. (B) Since the partners agreed on profit sharing in the creation of the partnership, but were silent on loss sharing, losses are shared on the same basis as profits. Therefore, Anchor’s capital account would be reduced by

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Hook’s capital account would be reduced by

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5. (B) During dissolution, partners can bind other partners and the partnership on contracts until third parties who have known of the partnership are given notice of dissolution. Actual notice must be given to third parties who have dealt with the partnership prior to the dissolution. Constructive notice is adequate for third parties who have only known of the partnership.

6. (B) Under the Revised Uniform Partnership Act, the partners are jointly and severally liable for all debts of the partnership. Creditors are required to first attempt collection from the partnership unless it is bankrupt. Once a ACH Associates has paid off what it can, the partners are jointly and severally liable.

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