Fundamentals of Business Law

Business

Quiz 24 :

Corporate Formation, Financing, and Termination

Quiz 24 :

Corporate Formation, Financing, and Termination

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William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 A.M. on July 31, 2005, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 A.M. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, filed a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following question. Under what theory might the court in this case make an exception to the limited liability of shareholders and hold Sharp personally liable for the damages? What factors would be relevant to the court's decision?
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Person WS was a sole manager and shareholder of a S Corporation CC (club). The property where the club was located was owned by WS and he used to pay is personal expenses from the proceeds of the club.
One night, Person AP (18 years old) entered a club, she was already intoxicated while entering in the club. Person below 21 years was not allowed to enter a club, but verification of AP's age was not done by the employees of the club. AP got drunk in the club and while returning lost control of her car, met with an accident and died.
Person JD AP's father filed a suit against the club and state's government.
1.
The theory under which the exception can be made by the court, for the concept of limited liability of members and separate legal entity is Piercing of Corporate Veil.
The Law has put a veil between the company and its member and employees by creating a separate legal entity for the business. However, this veil cannot be used by the members of the company to hide their wrong actions.
Courts pierce the corporate veil when the primary shareholders of the corporation uses the corporation as a shield for conducting personal operations and to gain from the operations.
WS was the shareholder of the corporation but was using its proceeds for paying his personal expenses. The proceeds of the business cannot be used by its member for any personal need. These are the factors is relevant to the court to decide to pierce the corporate veil and hold WS liable for the damages.
2.
Articles of Incorporation refer to an important document that is required to get a company incorporated. If this certificate fails to describe the purpose of the company that is required by the law, the decision of the court decides that whether the company has de jure existence or not.
Some court fixes the problems in the article of incorporation and make is valid, whereas some courts refuses to accept the article as a valid one. If the article of incorporations of CC club fails to define the management structure as required by the law, the decision to accept is valid or invalid remains with the discretion of the court.
The court can hold WS liable for the damages to be paid to AP as when the incorporation article is deemed to be invalid the incorporators are personally liable for the damages of any sort to third person.
3.
Doctrine of Ultra Virus: Ultra Virus means "beyond the power". The doctrine states that, a company cannot act beyond its powers that are expressed or implied in the article of incorporation. Any act outside the bylaws or the powers mentioned in the article is said to be ultra-virus and the person who do such is liable for the damages.
If CC club extends credit to its customers and this is not authorized either by the bylaws or the articles of incorporation, this act will be considered ultra-virus. The personnel who allows such act can be held liable and a proceeding can be instituted against the corporation and its personnel.
4.
Domestic Corporation is the one which is registered under the statute of the nation where it carry on the business. The Foreign Corporation is the one, which is incorporated under the statue of another nation and perform its business operation outside the boundary of that nation.
Public Corporation is the one which is incorporated by the government for meeting out some governmental or political purpose. These are formed for public or nation's welfare Private Corporation, on the other hand, refers to the corporation that, is incorporated solely for the purpose of earning profit.
As Company CC was owned by WS in Georgia and the place of business was also in Georgia, the court can consider this in deciding that the corporation CC is a domestic company.

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How are corporations financed?
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Importance of Finance:
Funds are very important for the operation of the business and to run its day to day activities smoothly. Cash is one of the most vital elements in the survival of a business. No business can function without adequate funds. Corporations use various methods to raise finance from the market.
Corporations may use either of the following sources to finance its activities:
1. Debt or Bonds:
It includes all the sources of finance which are debt for the company. The Company has to pay interest at a fix rate on the amount. The amount raised from this source is to be returned after a fixed period of time (at maturity). For example , loans, debentures and bonds.
2. Equity or Stocks:
It refers to the source in which people invest in the capital of the company by purchasing the shares of the company. This amount is not to be returned by the company until the situation of winding up. All investor's get dividend and capital appreciation as a return. The example includes equity shares and preference shares.

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Purchase of Assets. Grand Adventures Tour Travel Publishing Corp. (GATT), a Texas corporation, provided travel services to interliners (airline employees). Duane Boyd was a GATT director when the firm hired him as an unpaid consultant to address its financial problems. Consequently, Boyd resigned his directorship and made loans to GATT for security interests in its assets. GATT defaulted on the loans. Boyd incorporated Interline Travel Tour, Inc., and transferred all rights under his loans to GATT to Interline. At a public sale, Interline bought GATT's assets. Interline moved into GATT'soffice building, began to provide travel services to GATT's customers, and hired former GATT employees. Another GATT creditor, Call Center Technologies, Inc., filed a complaint in a federal district court to collect the unpaid amount on a contract with GATT from Interline. Is Interline liable? Why or why not? [ Call Center Technologies, Inc. v. Grand Adventures Tour Travel Publishing Corp., 635 F.3d 48 (2d Cir. 2011)]
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Company G provided travel services to Company I. Person DB, a former director of Company G provided loans to G. G defaulted in repaying the loans. DB incorporated a new Company IT and transferred the right of loan recovery to company IT.
Later IT purchased the assets of the Company G and started to provide services to the clients of Company G. Another creditor of G, Company CCT filed a complaint claiming that IT should be liable for the unpaid amount payable to CCT.
Successor's liability purchase of assets:
Normally, when a company purchases assets of another company, the former is not responsible for the liabilities of the latter one. As the company only purchases the assets of another company so they cannot be held liable for any debt that is payable by that company.
However, there are some exceptions to this concept. The successor company can be held liable:
1. When the purchase is done as a result acquisition or merger.
2. When the sales were made to escape the liability.
3. When the successor company continues the business of selling company with same shareholder, officers and directors.
4. When the successor company expressly or impliedly accepts the seller's liability.
In the given case, the facts show that the Company G was purchased by IT in a public auction. Although, IT hired the former employees of Company G but it cannot be said that the business of G was continued by Company IT.
So, the successor company should not be held liable for the debt of Company CCT. The facts of the case do not fall under any of the exceptions. Thus, it can be concluded that Company IT should not be held liable for the liabilities of Company G.

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The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What steps are involved in bringing a corporation into existence?
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Involuntary Dissolution. Charles Brooks began working as an independent supplier for Georgia-Pacific, LLC, when the paper products manufacturer acquired a mill in Crossett, Arkansas. Brooks soon organized Charles Brooks Co. in corporate form. Each of the parties' contracts provided, "there is absolutely no guarantee as to the amount of work to be performed." Charles Brooks Co. borrowed funds to buy new equipment. When Georgia-Pacific reduced the quantity of timber that it bought from the supplier, the firm was unable to pay its loans. In 2002, some of the new equipment was returned to the seller. The rest was sold, but the proceeds were not enough to eliminate the debt. The same year, the Arkansas secretary of state revoked Charles Brooks Co.'s corporate status for nonpayment of franchise taxes. In 2006, Charles Brooks Co. filed a suit in a federal district court against Georgia-Pacific, alleging breach of contract. Can the plaintiff maintain this suit? Explain. [ Charles Brooks Co. v. Georgia-Pacific, LLC, 552 F.3d 718 (8th Cir. 2009)]
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The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What are the two ways in which a corporation can be voluntarily dissolved?
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The incorporators of Precision Systems, Inc., want their new firm to have the authority to transact virtually all types of business. Can they grant this authority to their firm? Why or why not?
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Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text. In what circumstances might a court disregard the corporate entity ("pierce the corporate veil") and hold the shareholders personally liable?
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Ultra ViresDoctrine. Oya Paka and two business associates formed a corporation called Paka Corp. for the purpose of selling computer services. Oya, who owned 50 percent of the corporate shares, served as the corporation's president. Oya wished to obtain a personal loan from her bank for $250,000, but the bank required the note to be cosigned by a third party. Oya cosigned the note in the name of the corporation. Later, Oya defaulted on the note, and the bank sued the corporation for payment. The corporation asserted, as a defense, that Oya had exceeded her authority when she cosigned the note on behalf of the corporation. Had she? Explain.
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What are the steps of a merger, a consolidation, or a share exchange procedure?
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Economic Recession Fuels the "Amazon Tax" Debate Governments at the state and federal levels have long debated whether states should be able to collect sales taxes on online sales to in-state customers. State governments claim that their inability to tax online sales has caused them to lose billions of dollars in sales tax revenue. The issue has taken on new urgency as the states search desperately for revenue in the wake of the economic recession that began in December 2007. Supreme Court Precedent Requires Physical Presence In 1992, the United States Supreme Court ruled that no individual state can compel an out-of-state business that lacks a substantialphysicalpresence (such as a warehouse, office, or retail store) within that state to collect and remit state taxes. a The Court recognized that Congress has the power to pass legislation requiring out-of-state corporations to collect and remit state sales taxes, but Congress so far has chosen not to tax Internet transactions. In fact, Congress temporarily prohibited the states from taxing Internet sales, and that ban was extended until 2014. b Thus, only online retailers that also have a physical presence within a state must collect state taxes on any Web sales made to residents of that state. (Otherwise, state residents are required to self-report their purchases and pay use taxes to the state, which rarely happens.) New York Changed Its Definition of Physical Presence In an effort to collect taxes on Internet sales made by out-of-state corporations, New York changed its tax laws in 2008 to redefine physical presence. Under the new law, if an online retailer pays any party within the state to solicit business for its products, that retailer has a physical presence in the state and must collect state taxes. c For example, Amazon. com, America's largest online retailer, pays thousands of associates in New York to post ads that link to Amazon's Web site. Consequently, the law requires Amazon to collect tax on any sales to New York residents. Both Amazon and Overstock.com, a Utah corporation, filed lawsuits in 2009 claiming that the new law was unconstitutional. A New York court dismissed Amazon's case, finding that the law provided a sufficient basis for requiring collection of New York taxes. As long as the seller has a substantial connection with the state, the taxes need not derive from instate activity. The court also observed that "out-of-state sellers can shield themselves from a tax-collection obligation by altogether prohibiting instate solicitation activities … on their behalf." d As a result, Amazon now collects and pays state sales taxes on shipments to New York. Overstock canceled agreements with its New York affiliates. The "Amazon Tax" Since then, a number of states have changed their law on physical presence in an effort to collect sales tax from online retailers and close substantial gaps in their state budgets. These new laws, which many call the "Amazon tax" because they are largely aimed at Amazon, affect all online sellers (including Overstock.com and Drugstore.com)-especially those that pay affiliates to direct traffic to their Web sites. California enacted such a law in 2011, and Amazon quickly announced that it had canceled agreements with its California affiliates. By 2012, the Amazon tax had caused Amazon to end its arrangements with affiliates in Colorado, Illinois, North Carolina, and Rhode Island as well. When California officials insisted that its law still applied to Amazon because of other contacts with the state, such as the presence of a firm that handles some of Amazon's advertising, Amazon announced that it would support a proposed ballot initiative to repeal the law in 2012. FOR CRITICAL ANALYSIS Should the fact that an out-of-state corporation pays affiliates in a state to direct consumers to its Web site be sufficient to require the corporation to collect taxes on Web sales to state residents? Why or why not?
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The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: In what circumstances might a court disregard the corporate entity ("pierce the corporate veil") and hold the shareholders personally liable?
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What are the two ways in which a corporation can be voluntarily dissolved?
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How are corporations financed?
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What steps are involved in bringing a corporation into existence?
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ISSUE SPOTTERS Name Brand, Inc., is a small business. Twelve members of a single family own all of its stock. Ordinarily, corporate income is taxed at the corporate and shareholder levels. How can Name Brand avoid this double taxation of income? (See page 578.)
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Incorporation. Jonathan, Gary, and Ricardo are active members of a partnership called Swim City. The partnership manufactures, sells, and installs outdoor swimming pools in the states of Arkansas and Texas. The partners want to continue to be active in management and to expand the business into other states as well. They are also concerned about rather large recent judgments entered against swimming pool companies throughout the United States. Based on these facts only, discuss whether the partnership should incorporate.
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Preincorporation. Cummings, Okawa, and Taft are recent college graduates who want to form a corporation to manufacture and sell personal computers. Peterson tells them he will set in motion the formation of their corporation. First, Peterson makes a contract with Owens for the purchase of a piece of land for $20,000. Owens does not know of the prospective corporate formation at the time the contract is signed. Second, Peterson makes a contract with Babcock to build a small plant on the property being purchased. Babcock's contract is conditional on the corporation's formation. Peterson secures all necessary subscription agreements and capitalization, and he files the articles of incorporation. Discuss whether the newly formed corporation, Peterson, or both are liable on the contracts with Owens and Babcock. Is the corporation automatically liable to Babcock on formation? Explain.
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The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What are the basic differences between a merger, a consolidation, and a share exchange?
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Case Problem with Sample Answer Tony Smith was the sole owner of Smith Services, Inc. Bear, Inc., operated Laker Express, a fueling station in London, Kentucky. Smith charged fuel to an account at Laker Express and owed approximately $35,000. There was no written agreement regarding who was liable in the event of default, but all invoices had been issued to Smith Services. Even though Smith Services ceased doing business and was dissolved, Smith continued his business as a sole proprietor after the corporate form had been abandoned. Laker Express sued Smith Services to collect on the debt, but there were no assets in the corporation. Laker Express sued Tony Smith personally and asked the court to pierce the corporate veil, claiming that Smith was engaged in fraud and was using the corporate form only to protect himself. The trial court dismissed the case, and Laker Express appealed. Should the court pierce the corporate veil and hold Smith personally liable for the unpaid corporate debt? Or should Laker Express have been more careful when dealing with clients? Explain. [ Bear, Inc. v. Smith, 303 S.W.3d 137 (Ky.App. 2010)]
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