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164 Cards in this Set

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what is Sole Proprietorships?

1. Business owned by one person.
2. Has sole control over management and profits
3. Personal liability

class notes:
you forming your own business…there’s no separate legal entity… you are the business.
Using an assumed name… there’s no separation
It’s easy to form…everything you earn… u get
Since it’s you…it’s your person liability… operating mom n pops grocery and a kid knocks over a jar and someone slips on it. They far and fracture their tail bone. They’re gonna sue u. Liability insurance. Ocean shipping…under the thread hold because of little business and does not need compliance
One person…owner is liable for everything…ex. if someone slip and falls..
One good thing is that they are small enough to fall under the radar…less regulation… under 15 employees.

what is Partnership? What are the two kinds of partnership?

Definitions: 2/more people involved in a business
Income taxed only at the partner level, not at the entity level

two types: general and partnership


what is general partnership?

a. management and profits are divided (usually equally) among the partners
b. unlimited personal liability for partnership’s debts

class notes:
General….all partner are liable… when getting a loan…all partner are liable. For tax….partnership is flow through… all incomes and losses are distributed equally and currently. K1 statement…shows your share of the profit or loses. In other words Can not hold earnings off of the entity level because they’ve been distributed for tax purposes. If you do decide to hold the money at a partnership level…u’re still liable for tax on the sum of money. Y do that??…if a company throws a lost…. The lost flow through your individual income tax return where you can used to offset capital gains.


what is limited partnership?

a. At least one general partner and one limited partner
b. general partner (responsible for managing the business)
c. limited partner (do not participate in management. Liability limited to the amount of money they put in)

class notes:
limited partnership…puts in $$$$...can only lose their $$ and partnership. Does not take active role in management…like buying stocks…they get earning and lost…if you do take active role (vote)…u lose the limited partner status…and you become general partnership with liability. Like stock

how do you create a partnership?

a. RUPA and RULPA- fills in where agreement does not cover an issue
b. You should INVEST time and money to start an agreement
c. The agreement should cover division of profits, duties, termination, and transfer of interests

creating partnership:

what is RUPA? what do they do?

Fills in where agreement does not cover an issue.

class notes:
If you don’t fill in or left out an agreement … the rupa will fill it in for you

what are classifications of Corporation?

Closely held

publicly held

sub S

Limited liability companies (LLC)


define closely held

Closely held (private)
• owned by a small group of people

class notes:


what is initial public offering?
offering…where the stocks will be sold to the public and no longer by the family

define publicly held

• stock traded on the national securities exchange
• numerous shareholders= investors
• wealthier than any other forms of business organization

class notes:
the ppl/public hold stocks


what is Sub S?

• hybrid of corporation and partnership
• operates like a corporation
• taxes treated like a partnership
• Characteristics:
1. have no more than 35 shareholders (no resident alien)
2. only one class of stock outstanding
3. not a member of an affiliated group of corporations

class notes:
A lot of restrictions…. Max shareholder, one class of stock. All have to vote.

different than C core where income tax paid by corporations and does not flow through. they get $$ by dividends (double tax)

Contrast: C and S…. S… have elections… partnership…there will be taxation (flow through) to the shareholders. Maybe be good… your income tax bracket might be lower than the entity of the corporate level. C is taxed a the entity level….not a flow through. How to get $$$ from dividends… tax of the corporation than anything else is dividends. Some company doesn’t pay dividends…you earn $$ by increase in the share…can sell?? C V S…different in tax. Current gov. No tax bill yet… what are they going to do at the federal tax??? So far…nothing… are they going to change capital gain tax? We’ll have to see.


what is Limited Liability Companies (LLC)?

• Has limited liability
• Continuity
• Free Transferability
• Centralized Management (Managing Member)
• Members can be corporations, trusts, partnerships, and foreign investors

class notes:
LLC….like sub S…hybrid…part corporation/part partnership… flow through. Has limited liability.
Shareholders are called members. Doesn’t have limitation to numbers of members…have shareholders that are not individuals (can have trust). Many ppl have assets in trust…

In event where someone forms a corporation carries…unlimited liability… both their books are the same…they don’t treat them as a separate entity…because they’ve treated their company as their own…private piggy bank….limited liability goes away…and they can be sue… to fix this…make the corporation a separate entity… so that ppl cant go after you and your assets.

what is debts, equity, and leverage?

debts is like promise's a bank loan..u own ppl

equity is like's what you have or put in

leverage is a ratio of debt to equity

Would look at debt to equity ratios… higher the debt to equity…higher the leverage. Higher leverage…riskier…business cycle does up and down. High leverage… for a down turn in economy…if you go to the bank and said that you can’t pay the principal of interest…the bank will still make you pay because it’s the. High debt to equity is a fixed obligation.

what is common stock?
• No preferences
• Greater risk of loss

class notes:
stock…you don’t have to sell anything…don’t have to pay dividends when the economy is in a downturn
Sometimes high leverage is good in that when you’re debt is 5.4% and you can borrow the money and invest it in the business to expand. If you can translate that into return equity of 8% then you’ll be able to pay bad. But if the economy is bad. And you invest and got an 3% then you’re have negative mortgage….and will lead to bankruptcy
what are two corporate stocks?

common stock

preferred stock

what are some preferred stock? 6

Convertible preferred


Liquidating preferred

participating preferred

what are the steps to create a corporation?
a. State law (Delaware)
More than half of Fortune 500 companies are registered in Delaware
Primary concerns: financing and operation
b. Articles of Incorporation
Number of shares of stock
c. Certificate of Incorporation (Good Standing Certificate)
d. Incorporators call first meeting- Board elected and the by-laws are adopted

Creating a Corporation: step 1.

what is included in State Law?

Pick a state where you want to incorporate. most corporation are in Delaware

Have to incorporate under state law…most of the time it’s in delaware…u don’t have to incorporate in the state u do business. More than 50% are in delaware, because the court favor corporations.

Creating a Corporation: step 2.

what is in articles of incorporation?
Articles of Incorporation
Number of shares of stock

class notes:
an articles of incorporation… info…name of company and they make sure no other company have that name. U cant make a name similar to another company. Also, what does the company do. What kind of stocks and how many shares…issues an authorize. Meets the requirement and they will incorporate you.

Creating a Corporation: step 3

what happens in certificate of incorporation?

Certificate of Incorporation (Good Standing Certificate)

class notes:
File the articles with the fee to the state selected. They go through it and if there’s nothing missing…. U get a good standing certification

Creating a Corporation: step 4

what happens in Incorporators call first meeting?

Incorporators call first meeting- Board elected and the by-laws are adopted

class notes:
call first meeting….board are selected by shareholders. And board elects officer… u also pass bylaws…it covers…shareholders meetings, who are the officers, special meetings. Can be amended by board or shareholders. If give it to the board…shareholders are giving them a lot of power
what does corporate financing include?
a. Notes (short-term loans)
b. Bonds (secured long-term loans)
c. Debentures (unsecured long-term loans)
d. Others (synthetics, off-balance sheet)
a. Classes- voting/non-voting
define debt?
owing ppl... ex. going to bank and getting a loan.
debt: what are notes?
short term debts.. under 5 years
debt: what are bonds?
they are longer… 10-20 years. Can be sold publicly or privately…they have coupon rate. Real estate…long assets bonds
debt: what are debentures?

unsecured long-term loans

class notes:
Debentures are bonds… they are insecure…not many company can attract buyers…relied on the cash flow

what is board of directors and what do the do?

5. Board of Directors (manage corporation)
• Overseers
• Authorize payment of dividens
• Selection of Officers
• Executive Compensation
• Audit

Directors are in charged of managements…they meet periodically…3-6 times a years….does have all the info on what goes on in the company
Independent directors who are not officers of the company…they maybe officers of other companies, professor, etc.
Over the years… large companies are trying to get more independent directors. Directors need to be feed with information.
Corporation…separation of ownership and control…the board of directors vote for the officers and their decision is to benefit the shareholder
Directors get together and break down into committees. Most common is the audit committees that audit the books and a compensation committee for the officers and the government committee which helps filled director vacancy and do self assessment on the board themselves (they would do an evaluation every year).
board of directors:

what does an audit committee do?

very important…there’s external and internal to audit the book. The external reports to the audit committee so that officers management doesn’t do any thing fishy or fraud.

board of directors:

what does a compensation committee to?
they pay commission to officers. supposed to be structured to produce results…paid for performance.
what is shareholder derivative lost?
when shareholders sue directors. Because they’ve breach their duty…duty of care. Duty of loyalty…to the shareholder and not themselves. Duty of good faith….what they believe to be the best interest of the shareholders. Directors do make mistake…therefore, there’s a presumption that if a director act in the best interest of the shareholder…than they cannot be sue. If you think about it.. This rule is for directors to take risk.
what are Director “Independence”?

they are directors who are not related to the corporation. they are not officers.

class notes:

Independent directors who are not officers of the company…they maybe officers of other companies, professor, etc.
Over the years… large companies are trying to get more independent directors.

what are officers and what do they do?
a. Day to day management and control of corporation
b. Used to require president, vp, and treasurer. Now relaxed.
c. Fiduciary responsibility
1. In a good faith
2. Be prudent
3. best interests of a corporation

class notes:
Officers are agent of the corporation….they have an idea of day to day stuff happening in the company.
what are the duites of shareholders?

a. Vote at Annual Meeting of Shareholders in person or by Proxy
b. Proxy Solicitation
c. Shareholder Resolutions
d. Consent to action w/o a formal meeting
(shareholders or directors)

class notes:
The vote at the annual meeting for directors. One slated director….where you can either vote for them or not…they only need on vote and they’re elected. Some have majority voting so that in the event where the director does not get at least 50% cast…cant be director… relatively new

what is proxy solicitation?
Attempt by a group to obtain the authorization of other members to vote on their behalf in an organizational ballot. In corporate settings, a proxy solicitation is usually accompanied by a 'proxy statement.'
what is conflicts of interest?
Occurs when an officer/director enters into a transaction with the corporation in which he or she has a personal interest

class notes:
okay as long as the shareholders are aware of the conflict

Business Judgment Rule

- Legal presumption that the management of a firm is acting in the best interest of the firm, and therefore its decisions are protected from judicial review.

smith v. Van Gorkom

business judgment rule case

case in Chicago….gorkum was the ceo of tran union… old guy…wants to cash out this stock so he found someone to buy his stock…he goes to his friend…didn’t go to gordan. Friend paid $55 per share. gordan goes back to the board… the board agree to sell the company. It took them 20mins. Did the director think about the shareholder? Is $55 a good number? Where did it come from? Should they’ve done research? They were found guilty for non duty of care.
In re Walt Disney company derivative litigation
business judgment rule

director getting friend to be on board member… mike didn’t know how to run the company. Court said no breach of care. They have to be grossly negligent. Gave mike 140 million to leave the position.

What do most courts require to pierce the corporate veil?

(1) you must be a SH at the time of the alleged wrongdoing and at time of filing ("contemporaneous ownership" rule)

(2) named plaintiff must be a fair and adequate representative

(3) demand requirement - you must demand that the bd does what you want before you bring the suit (unless there is an exception)

What are the requirements to be a plaintiff in shareholder derivative suit?

Some affirmative fraud or wrongdoing by the SH, or a gross failure to follow formalities of the corporate existence

Cts check if SH has ignored the existence of the corporation - co-mingling funds for personal use

Is a parent liable for the actions of the subsidiaries it controls?

(1) when majority of bd is indp - then the BoP is on the SH.

(2) when the majority of the bd is not independent, then burden is on the corp.

What is a Shareholder Deriviative action?

Demand is excused if P shows a reasonable doubt that either (1) a majority of the bd has a material financial or familial interest; (2) a majority of the bd is incapable of acting independently for some other reason such as domination or control; or (3) the underlying transaction is not the product of a valid exercise of business judgment

What is the main prereq to filing a deriviative suit?

(1) bd members didn't follow adequate procedures; OR (2) Bd's deci

sion was so irrational as to be outside the bounds of rxble business


When trying to get demand futility exception - what must a Plaintiff show in order to prove that the underlying transaction was not the product of valid business judgment?

Must post bond to cover corp's legal fees if suit is deemed frivolous

What is a Special Litigation Committee?

If demand is excused, a corp can set up an independent group (SLC) and it will investigate and make its own decision on whether to pro

ceed on its claims. Corp hopes that Ct will defer to business judgment of SLC.

Difference between Direct and Deriviative suits:

Direct suit: no money would go to the corporation; Deriviative: plaintiff asks for money to go to the corporation.

Constituency Statutes

- Allow corporate directors to consider non-shareholder interests when making business decision.

- Allows for environmentally or socially conscious decisions with protections for directors.

- Hybrid of for-profit and not-for-profit entities.

Compensation Committee

Group appointed to evaluate and set the pay rate for senior level management. May also choose other compensation options such as stocks, bonuses, profit sharing, and additional perks.

Debt Capital

- Type of security in capital structure.

- Represents a debtor-creditor relationship w/ the corp, where a corp has borrowed $ from an outside creditor and promises to repay them.

- Usually loan-capital & short term bank loans like overdrafts.

Equity Capital

- Instrument representing an investment in the corp where its holder becomes a part owner in the business, not repaid in the normal course of business.

- Equity securities are shares of the corp & investor=shareholder

- Value computed by estimating the current market value of everything owned by the corp minus liabilities.

Common Stock

Type of security that serves as an evidence of proportionate ownership, imparts proportionate voting rights, and gives its holder unlimited proportionate claim on the assets and income of the firm (after the claims of lenders, and other obligations, are satisfied). Common stock constitutes the equity capital (also called risk capital) of the firm which is never paid back (redeemed), and is lost if the firm fails. Common stock usually has a par value (amount for which each share is sold for when first issued) but has no guaranteed value afterwards. In bad years, common stock holders may receive little or no income (dividends) at all. But, in good years, there is no limit to the amount they may receive except the limits imposed by the government, the lenders, or the financial position of the firm.

Common Enterprise

Arrangement in which two or more firms together follow common objectives. Even if a common enterprise does not formally exist, it may be implied by the intent of the involved parties expressed in (1) sharing of the employees and/or management, (2) sharing of profits and losses, and (3) joint ownership. It may also be deemed to exist if the involved parties give an impression of being together as one, and outside parties rely on this impression to their detriment.

Check-The-Box Regulations

- IRS Regulations passed in 1996 that allow unincorporated entities to choose whether to be taxed as partnerships or corps.

- Partnership is default.

- If entity has 2+ owners, it can be either.

- If state law LLC or LLP, then its a domestic eligible entity, can choose either.

- If state law corp - then also fed corp = no part.


Wealth in the form of money or assets, taken as a sign of the financial strength of a company and assumed to be available for development and investment.

Audit Committee

Members of a company's board of directors (BOD) who are responsible for the conduct of internal and external auditors.

Administrative Dissolution

- Involuntary cessation of the existence of a corporation by a government authority.

- Usually prompted by the corps failure to comply with certain statutory requirements such as file an annual report or pay taxes.

Blue Sky Laws

- US state laws that regulate the offering of securities to protect the public from fraud.

- All require registration of all offerings and sales, stockbrokers, and brokerage firms.

34 Act

- Securities Exchange Act of 1934

- Covers secondary trades, i.e. stocks, bonds, & debentures.

- Established SEC & gave them authority over proxy solicitation and registration of organized exchanges.

- Regulated insider trading

- gives Federal Reserve power over credit purchases of securities.

33 Act

- Securities Exchange Act of 1933

- After crash of 1929 and Great Depression, part of New Deal.

- Covers initial offerings of stock.

- Requires that any initial offer or sale of securities using the means of interstate commerce (mail, phone, anything) be registered with the SEC.

- Left Blue Sky Laws in place

- Based on a philosophy of full disclosure.

Record Date / Record Ownership

Date established by an issuer of a security for the purpose of determining the holders who are entitled to receive a dividend or distribution.


Substitution of a new contract for an old one. Applies to releasing promoters from contracts entered into before corporation was formed.


- Secure capital commitments to help forming companies.

- May also secure goods/services for corp once it is formed.

- Enter into contracts with 3rd parties who are interested in becoming shareholders once the corp is formed.

- Absent another agreement, promoters are joint venturers w/ fiduciary duty to one another

Capital Structure

In corporations, the mixture of long term debt and equity, i.e. common stock and preferred stock, used to finance the corporations operations.

Elements Justifying Piercing the Corporate Veil

(1) When corp formalities are ignored; or,

(2) When corp is not formed correctly from the outset; or,

(3) Fraud/Fraud prevention.

*Bottom line = operations of corp, bad formation, or fraud must constitute a basic injustice that the indv. shareholders should be held personally responsible for.

Corporation by Estoppel

Persons who treat an entity as a corp are estopped from later claiming the entity was not a corp. Applied to either:

(1) Outsider seeking to avoid liability on a K w/ the purported corp.; or,

(2) Purported corp seeking to avoid liability on a K w/ an outsider.

De Facto Corporation

A corp that is legally recognized as such, even if the articles of incorporation were not properly filed. Test:

(1) Relevant state incorporation statute available,

(2) Good faith attempt to comply with it,

(3) Evidence that the business is run as a corp.

*may also happen under estoppel*


- Rules adopted by a corp to govern internal operations & external dealings.

- Adopted by directors, modified by directors or shareholders.

- May contain any provision for managing the corp that is not inconsistent w/ state law or the articles of incorporation.

Ultra Vires


- If a corp undertakes activities beyond the scope of its stated purpose, it is said to be operating ultra vires.

- Default = corp formed for any reason.

- If corp narrows scope in AoI, then it may not undertake activities that are unrelated to the stated purpose.

Ultra Vires

(in practice)

- Common law = if a corp acted U.V., then K wasn't enforceable & action was void.

- Modern law & RMBCA = U.V. is enforceable now

- U.V. can be raised if:

(1) SH sues corp to enjoin ultra vires activity,

(2) Corp sues officer or director for damages from commission of an U.V. act they authorized,

(3) State sues corp to dissolve for U.V. action.

Articles of Incorporation (AoI)

RMBCA Mandatory Provisions:

- Name of Corp (must incl corp, co, ltd, or inc.)

- # of Shares

- Street address and name of initial registered agent and office

- Name and address of each incorporator


Person who signs the AoI. Only one needed, but can be 2+. Most states can be natural persons or artificial entities.

De Jure Corporation

Business that has complied w/ all the requirements of its state incorporation statutes and is legally allowed to do business as a corp.

S Corp vs. C Corp

C Corp - double taxation, corp tax rate is lower than personal rates. Unlimited # of SH, multiple stock classes

S Corp - pass-through taxation (like partnerships)(advantageous when losses are expected the 1st few yrs), no more than 100 SHs, limited to 1 class of stock

Contemporaneous Ownership Rule

Under FRCP 23.1: Plaintiff in a derivative action must be a shareholder at the time of the transaction complained of, or that the plaintiff's share or membership later devolved on it by operation of law.

* Intended to prevent strike suits by parties who could not have been injured by the conduct at issue.

Control Shares / Control Premium

The amount an investor will pay to acquire control of a company, typically an amount higher than the current market value of the company. An investor seeking to acquire control of a company is highly motivated, and is typically willing to pay more; this often is comes into play when one company is trying to acquire another, and is trying to convince the second company to agree to the deal. The amount above the market price that the investor offers for the shares is known as the control premium.

Convertible Security

Bond, preferred stock, or debenture that is exchangeable at the option of the holder for common stock of the issuing corporation.

Conversion Security


Corporate Opportunity Doctrine

Legal principle that the members of the board of directors, executives, and other employees of a firm owe it a fiduciary duty, and may not use the information acquired in their official capacity for personal gain.

Cumulative Voting

System of voting which (unlike regular or statutory voting) allows minority stockholder (shareholders) a chance to name one or more directors to the firm's board. In cumulative voting, each share has as many votes as there are vacant positions on the board, and each shareholder can apportion the shares as he or she wishes, or can cast all votes for any one of the candidates.

D & O Insurance

Personal liability insurance that provides general cover to a firm's directors and senior executives. Paid usually by the firm, it reimburses (in part or in full) the costs resulting from law suits and judgments arising out of poor management decisions, employee dismissals, shareholder grievances, and other such acts committed in good faith. Criminal offenses are not covered under this insurance.

Judicial Dissolution

The termination of a corporation's existence handled by the courts located within the state of the company's incorporation. A dissolution may be obtained when the attorney general of the state of the incorporation petitions for it due to a company's failure to comply with regulations of tax laws, administration or statutory regulations. A shareholder may also file a petition for dissolution based on a deadlock situation between the directors when the shareholders can not break the deadlock. Abuse of power, fraudulent activities, and other illegal acts may also result in a petition being filed by shareholders for dissolution.


Person who leads, manages, or supervises an organization, program, or project. See also company director.

Dissenters' Right to Appraisal

Shareholders right to have their shares appraised and purchased by the issuing firm if it decides to proceed with decisions the dissenting shareholders disapprove of.


A share of the after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them.

Duty of Care

The responsibility or the legal obligation of a person or organization to avoid acts or omissions (which can be reasonably foreseen) to be likely to cause harm to others.

Duty of care is owed by an accountant in correctly preparing a company's accounts, by an auditor in confirming an company's financial statements correctly present its financial position; by a director to shareholders in husbanding the enterprise's resources; by a manufacturer to consumers for the safety of product; and by every party to a contract to the other contracting parties.

Duty of Loyalty

A corporate law term used to describe a corporate fiduciary's fidelity to the company's interests. A breach of a fiduciary's duty of loyalty occurs when the entrusted fiduciaries, such as the CFO of the business for example, divert corporate assets or information and opportunities for their own personal benefit.

Efficient Market Hypothesis

Early 1990's capital market theory that it is impossible to earn abnormal capital gains or profit on the basis of the market information. It states that the price of a financial instrument (bond, share, etc.) reflects all the information currently available and, if the price is rumored to increase in the near future, investors or traders will buy the instrument now thus driving its price up and negating the anticipated increase. And that it is impossible to predict movement of prices with any degree of certainty because prices follow a random walk and therefore, on average, no one is likely to beat the market. The critics of this theory point out that only a few individuals are as rational as it presumes them to be, and that information gathering is expensive and tedious enough to make it unlikely to be reflected in the prices.

Entire Fairness

Courts will generally adjudge lawsuits against director and officer actions to meet the duty of care, under the business judgment rule. The business judgment rule stands for the principle that courts will not second guess the business judgment of corporate managers and will find the duty of care has been met so long as the fiduciary executed a reasonably informed, good faith, rational judgment without the presence of a conflict of interest. The burden of proof lies with the plaintiff to prove that this standard has not been met. If the the plaintiff meets the burden, the defendant fiduciary can still meet the duty of care by showing entire fairness, meaning that both a fair process was used to reach the decision and that the decision produced a substantively fair outcome for the corporation's shareholders.

Equitable Subordination

In the law of corporations, describes decision by a court to subordinate a controlling shareholder’s claims upon debt owed her by her own firm, to those of other “outside” (i.e., bona fide third party) creditors in bankruptcy. Equitable subordination protects unaffiliated creditors by giving them rights to corporate assets superior to those of creditors who happen to also be significant shareholders of the firm. For this doctrine to apply, the creditor to be subordinated must be an equity holder and an insider at the company, typically an officer, and must have in some manner behaved unfairly or wrongly toward the corporation and its outside creditors.

Exculpation Clause / Raincoat Provision

A provision in a contract under which either of two things is stipulated: (1) one party is relieved of any blame or liability arising from the other party's wrongdoing, or (2) one party (usually the one that drafted the agreement) is freed of all liability arising out of performance of that contract.

Fiduciary Duty

A legal obligation of one party to act in the best interest of another. The obligated party is typically a fiduciary, that is, someone entrusted with the care of money or property.

Fairness Opinion

The professional opinion of an investment bank, provided for a fee, regarding the fairness of a price offered in a merger or takeover.

Holding Company

Type of business organization that allows a firm (called parent) and its directors to control or influence other firms (called subsidiaries). This arrangement makes venturing outside one's core industry possible and, under certain conditions, to benefit from tax consolidation, sharing of operating losses, and ease of divestiture. The legal definition of a holding company varies with the legal system. Some require holding of a majority (80 percent) or the entire (100 percent) voting shares of the subsidiary whereas other require as little as five percent.

Impairment of Capital Test

A situation wherein the surplus fund of a stock insurer has been depleted to the point where the insurer has to invade the accounts made up of stockholder contributions to pay their liabilities. This is permitted in some locations and not permitted in others.


Protection against loss or damage.

Independent / Outside Director

A member of a corporation's board of directors who is not an employee of the company and has no operational responsibilities within the company.

Inside Basis

Inside basis is the basis that the partnership tax records compute for each partner. Inside tax basis is the initial investment (cash or the value of some other asset) plus profits minus loses minus distributions.


Basis is the value of an asset or liability according to numerous accounting and tax rules. Listed below are general descriptions of some of the various tax basis concepts.

Partnership Basis

example, Johns father and Marys father each put $1,000 into a partnership. The partnership buys a piece of land for $2,000. There are never any profits or losses. Years later the land is worth $1,000.000. Johns father gives John his partnership interest. As a gift, John assumes his fathers basis of $1,000. Johns outside partnership basis is $1,000. Marys father dies and she inherits her fathers partnership interest. As an inheritance, Mary can step up the basis to fair market value. Marys outside partnership basis is $500,000. John and Mary put their partnership interests into a new partnership. Their inside basis in the new partnership is $500,000 each, half the value of the land. Johns outside basis is still $1,000 and Marys is $500,000.

Outside Basis

Outside basis is what the tax rules say a partners share has cost the partner. Outside basis is effected by what the tax rules say the investment in the partnership is worth. Outside basis begins with the basis of the partners original investment plus profits minus loses minus distributions.

Insider Trading

Buying or selling the securities of a publicly traded firm by an insider to benefit from insider information. Insider trading is commonly restricted or prohibited by law.

Insolvency Test

Two tests for insolvency

There are really two primary tests for determining insolvency

1. Balance sheet test: a company is insolvent if its liabilities exceed the fair value of its assets.

2. Cash flow test: a company is insolvent if it is unable to pay its debts as they become due in the ordinary course of business.

Institutional Investors

Large organizations (such as banks, finance companies, insurance companies, labor union funds, mutual funds or unit trusts, pension funds) which have considerable cash reserves that need to be invested. Institutional investors are by far the biggest participants in securities trading and their share of stockmarket volumes have consistently grown over the years. For example, on a typical day, about 70 percent of the trading on the NYSE is on the behalf of institutional investors. Because they are considered knowledgeable and strong enough to safeguard their own interests, institutional investors are relatively less restricted by the security regulations designed to protect smaller investors.

Intrinsic Fairness

The actual value of a security, as opposed to its market price or book value. The intrinsic value includes other variables such as brand name, trademarks, and copyrights that are often dificult to calculate and sometimes not accurately reflected in the market price. One way to look at it is that the market capitalization is the price (i.e. what investors are willing to pay for the company) and intrinsic value is the value (i.e. what the company is really worth).

Legal Restrictions on Distributions

States restrict the payment of dividends and other distributions to protect creditors. All States impose the equity insolvency test, which prohibits the payment of any dividend or other distribution when the corporation either is insolvent or would become so through the payment of the dividend or distribution. Insolvent in the equity sense indicates the inability of a corporation to pay its debts as they become due in the usual course of business. In addition, almost all States impose further restrictions regarding the funds that are legally available to pay dividends and other distributions. These additional restrictions are based upon the corporation’s assets or balance sheet, whereas the equity insolvency test is based upon the corporation’s cash flow.

Majority Independent Board

NASDAQ Rule 4350(c) requires that a majority of a board of directors of a NASDAQ listed company must be comprised of independent directors. A director is “independent” if he/she is not an officer or employee of the company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.


Measure of the estimated effect that the presence or absence of an item of information may have on the accuracy or validity of a statement. Materiality is judged in terms of its inherent nature, impact (influence) value, use value, and the circumstances (context) in which it occurs. Opposite of triviality.

Nominal plaintiff / nominal defendant



Person appointed by the board of directors of a firm, such as a president, CEO, vice president, etc., to manage the day-to-day business of the firm and to carry out the policies set down by the board.

Parent Company

Firm that owns or controls other firms (called subsidiaries) which are legal entities in their own right. Also called parent corporation. See also holding company.

Pooling Agreement / Voting Trust

A voting trust is created by an agreement between a group of stockholders and the trustee towhom they transfer their voting rights or by a group of identical agreements between individualshareholders and a common trustee. Such agreements ordinarily provide that control of stock isgiven to the trustee for a term of years, for a time period contingent upon a certain event, or untilthe termination of the agreement. Voting trust agreements may provide that the stockholderscan direct how the stock is to be voted.

Preemptive Rights

The privilege of a stockholder to maintain a proportionate share of the ownership of acorporation by purchasing a proportionate share of any new stock issues.

In most jurisdictions, an existing stockholder has the right to buy additional shares of a newissue to preserve Equity before others have a right to purchase shares of the new issue.

Preferred Stock

Stock shares that have preferential rights to dividends or to amounts distributable on liquidation,or to both, ahead of common shareholders.

Preferred stock is given preference over common stock. Holders of preferred stock receivedividends at a fixed annual rate. The earnings of a corporation are applied to this paymentbefore common stockholders receive dividends. If corporate earnings are insufficient for thefixed annual dividend, the preferred stock will absorb the total amount of earnings, and thecommon stockholders will be precluded from receiving a dividend.

Property Theory


Provisional Director

Provisional director is a temporary director appointed by a court to serve on a close corporation’s deadlocked board of directors. A provisional director has the same rights and duties as other directors.

Publicly held / traded

A publicly held corporation is a publicly traded corporation. The shares of such corporations are traded on a public stock exchange. The shares of stock of publicly held corporations are bought and sold by and to the general public at the public stock exchanges. Although, a publicly held corporation is dependant on the market, publicly traded companies generally have more working capital and can delegate debt throughout all shareholders


Redemption right refers to the right of a stockholder to make the startup repurchase such stockholder’s capital stock, typically at a previously agreed-to price or formula.


Under a cross-purchase plan, each company shareholder agrees in advance to buy the shares of the withdrawing shareholder while the withdrawing shareholder agrees to sell his or her shares to the remaining shareholders. The corporation is not involved in the transaction.

Therefore, when shareholders execute a cross-purchase agreement to buy each others’ stock, they must have the personal funds to do so when a shareholder withdraws. For this reason, life insurance is commonly used to provide such funding.

Registration / Exemption

Registration is the process by which shares of a corporation are registered with the SEC in preparation for a sale of the shares to the public. The process includes a significant amount of disclosure as well as representations and warranties regarding the status of the corporation.

Reporting Company



Proposition put before a meeting of stockholders (shareholders) or the directors of a firm for discussion, approval or adoption. Resolutions are of four common types: (1) Elective (see elective resolution), (2) Extraordinary (see extraordinary resolution), (3) Ordinary (see ordinary resolution), and (4) Special (see special resolution).

Reverse Piercing

Reverse piercing the corporate veil is the act holding a shareholder personally liable for the debts of the corporation and then (when taking his assets as damages) reaching into the assets of other corporations to which he is a shareholder.

Rule 10b-5

- one of the most important rules targeting securities fraud by the SEC.

- prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security.

Sarbanes-Oxley Act of 2002

- set new or enhanced standards for all U.S. public company boards, management and public accounting firms..

- enacted as a reaction to a number of major corporate and accounting scandals, including Enron.

- sections of the bill cover responsibilities of a public corporation's board of directors, adds criminal penalties for certain misconduct, and required the SEC to create regulations to define how public corporations are to comply with the law.


refers to intent or knowledge of wrongdoing. This means that an offending party has knowledge of the "wrongness" of an act or event prior to committing it.

Securities Offering

a discrete round of investment, by which a business or other enterprise raises money to fund operations, expansion, a capital project, an acquisition, or some other business purpose.

Securities Regulation

Exchange acts ensure that trading on the exchanges is conducted in a proper manner. Most prominent the pricing process, execution and settlement of trades, direct and efficient trade monitoring. Trading acts demands that listed companies publish regular financial reports, ad hoc notifications or directors' dealings. Banking acts lays down rules for banks which they have to observe when they are being established and when they are carrying on their business.


A situation where a trustee or another foundation member abuses his or her position of power in order to benefit him or herself, as opposed to the trust's beneficiaries.

Share Transfer Restrictions

Vehicle for closely held corporations to restrict the sale of shares to strangers without their approval. Laws require private companies to impose restrictions on the transfer of shares by incorporating such restrictions in their articles.

Shareholders Agreement

Agreement amongst the shareholders, contract beyond the scope of the constitutional documents of the company, that outline the private agreements made by the shareholders regarding the operations and payouts of the company.

Social Entity Theory


Subsidiary vs. Division

Subsidiary: An enterprise controlled by another (called the parent) through the ownership of greater than 50 percent of its voting stock. See also affiliate.

Division: logical element or segment of a company (such as accounting, production, marketing) representing a specific business function, and a definite place on the organizational chart, under the domain of a manager. Also called department, division, or a functional area.

Successor Liability

Successor liability is a state law doctrine that allows a creditor to seek recovery from the purchaser of assets even when the purchaser did not expressly assume such liabilities as part of the purchase. In corporate successor liability law, the traditional corporate law rule does not impose the liabilities of the selling predecessor upon the buying successor company unless

1. the successor expressly or impliedly assumes obligations of the predecessor,
2. the transaction is a de facto merger,
3. the successor is a mere continuation of the predecessor, or
4. the transaction is a ruse to defraud the creditors and avoid liabilities of the predecessor.

Supermajority Independent Board


Tag-along rights

assures that if the majority shareholder sells his stake, minority holdershave the right to join the deal and sell their stake at the same terms and conditions as would apply to the majority shareholder.

Tools at hand

Delaware courts suggest shareholders using the "tools at hand", i.e. inspect the books, the right they have under state laws, to bolster their claims for a derivative action.


Situation where a business does not have sufficient stockholders' funds for its size of operations. An undercapitalized firm does not have enough cash to carryout its functions and usually does not qualify for bank or other loans due to its unacceptably high loan-to-equity ratio. Under capitalization is one of the major causes of business startup failures.


Directors have a duty not to waste corporate assets by overpaying for property or employment services. Thus the definition of waste is an exchange so one-sided that no business person of ordinary, sound judgment could conclude the corporation has received adequate consideration. This is difficult to prove in a court of law.

Zone of Insolvency

D’s & O’s are supposed to stop incurring ANY liability after knowingly having entered this Zone of Insolvency. This means, no further payroll, contract or vendor costs are to be incurred. This could mean furloughing employees, or simply laying them off. It could mean notifying creditors that you are in this zone, and you agree to not incur further liability without having a solid plan to leave this zone.

Does a C Corp get a tax deduction for paying dividends to its shareholders?


With a pass-through entity, do profits and losses both pass to the owners?


If a business entity has only one owner, what are its possible tax classifications under check the box regulation?

- S or C corp

- Partnership

- Disregarded entity

Disregarded Entity

Disregarded entity is a type of business that is regarded as separate from the owner for liability purposes, but same as the owner for tax purposes. Such a business pays income through the owner's personal income tax return. If a disregarded entity is owned by an individual, it is treated as a sole proprietor. If the disregarded entity is owned by any other entity, it is treated as a branch or division of its owner. The advantage of being considered a disregarded entity is protection of personal assets from business bankruptcy or lawsuits

Domestic Eligible Entity

a business entity formed under US law, but not under a special corporate statute, that is not required to be a corp for fed tax purposes. (assume also for exam no foreign entities or owners)

Appreciated Property

Property with a fair market value in excess of the owner's adjusted tax basis in the property.

- AKA built-in tax gain = if the owner sold or exchanged the prop for $ or equal value prop, he would realize a gain as the amount realized would exceed the owner's adjusted tax basis.

If an owner of appreciated property exchanges it for an equity interest in an entity, will that trigger recognition of the built-in gain?

Generally no, if he gets only partnership interest or stock in a corp (unless he is getting non qualified preferred stock, which exempts him from the non-recognition) (for exam assume entity does not have to recognize any loss or gain on land contributed)

If an owner of appreciated property exchanges it for an interest in an entity that otherwise qualifies for non-recognition treatment, but the entity assumes liabilities in excess of the owner's adjusted tax basis in the contributed property, will the owner have to recognize a tax gain?

Partnership - maybe depends on the share of such liability that the owner still owns because of his share in the partnership

S or C corp - yes. Example: Owner owns land w/ FMV of 100k, land has mortar. of 50k, so owner's adjusted tax basis is 25k. If he exchanges the land for stock and corp assumes mortar., he will have to recognize 25k gain bc of debt in excess of basis. BC 50k liability assumed by the corp exceeds owner's adjusted tax basis of 25k.

If the appreciated property is exchanged for equity in the entity and successfully results in non-recognition of the built-in gain, who bears the tax responsibility if the entity subsequently sells that land?

Owner owns land worth 100k. His adjusted tax basis is 25k, exchange w/ non-recon. happens. 3 yrs later entity sells the land for 100k.

- C corp = corp recog 75k gain (lowers all stocks)

- S corp = corp recog 75k gain (Sh subject to tax on the gain)

- Part. = recall 75k gain, under IRS 704c, the gain is allocated to the partner who contributed the land initially, or his heir)

What if the entity exchanges equity for services instead of property?

Corps = contributor of services recall tax gain in the amount of FMV of stocks received. (corp does not see gain here)

Part = depends on whether the equity received includes a capital interest, or is just a mere profits interest, good chance of avoidance on gain (part could pay gain under proposed regs)

Direct Action

SH seeking to enforce a claim based on ownership of shares. EX:

- Trying to compel dividend payments

- Access to corporate records,

- right to vote their shares,

- stop oppressive actions by controlling SH trying to harm minority SH

- class actions for securities fraud by corp.

Derivative Action

One or more SH bring action on behalf of corp where there corp has been directly injured. Most states, incl MO, SH must have held shares at time of trans in question (contemporaneous ownership rule, designed to stop selling of lawsuits by selling shares).

Nominal defendant / Nominal plaintiff

Corp is the nominal defendant in a derivative action, even though the nominal plaintiff (SH bringing suit) would actually have damages paid to the corp. Actual defendants are the wrongdoers.

Demand Excused cases

(Delaware Approach)

If Lit Comm says corp should NOT sue, ct checks:

  • if Lit Comm was indp and free from conflicts
  • if decision meets business judgment rule req's
  • ct can also substitute it's indp bus judgment

Demand Required cases

(Delaware Approach)

  • If plaintiff doesn't make demand on the board 1st, the case is dismissed for not exhausting all remedies properly.
  • Making a demand waves claim that it was demand excused.
  • If demand made & rejected, P can get review only by alleging facts that the decision was not protected by the bus judgment rule
  • DE does not allow Ps discovery to help in determining whether to make a demand or appeal from a rejected demand. ---> Follows tools at hand approach = statutory right of SH to inspect corp docs

Proxy Soliciation Regulation

(for publicly-held companies)

Sec. 14 of 34 Act

  • Broad authority to solicit any proxy, consent or authorization
  • Info provided to SEC & SHs in advance of mtgs, even w/o proxies
  • info to SEC & SHs when majority of directors apptd/replaced w/o a mtg of SHs

Merit Review

State blue sky laws tend to involve merit review of securities offerings, in which state regulators may insist on deal changes if the promoters are found to be taking undue advantage of offers in the state.

*Federal law often preempts state laws and precludes such merit review

Howey Test

(does not apply to corp stock, only unincorporated investment contract)

Used to define investment contract per 33 Act:

1) Investment of $ - has not be interpreted literally, so property and services can satisfy this

2) Common Enterprise - may mean vertical commonality (investor's prospects for financial gain are interwoven with promoter's prospects for such gain) or horizontal commonality (same investment opportunity is offered to 2 or more investors)

3) Profits solely from the efforts of others - acts have not interpreted solely literally, instead look to see if the most significant efforts to make profits came from ppl other than investor

Rebuttable Presumptions for Howey Test:

Not a security:

  • interest as a partner in regular partnership
  • int as a partner in an LLP
  • int as a gen partner in an LP
  • int as a gen partner in an LLLP
  • int as a member in a member-mngd LLC

​IS a security:

  • int as limited partner in LP or LLLP
  • int as non-manager member in a manager-managed LLC

What makes the rebuttable presumptions rebuttable?

1) If there are several partners in a regular gen partnership or LLP who agree to vest all material decision making in 1 or a small subset of the partners.

2) If a limited partner in a LP or an LLLP has under the partnership agreement the right to approve a lot of partnership management decisions and is sophisticated enough to exercise that right.

What types of exemptions from registration are available under the 33 Act?

  • Ralston Purina case = private offering exemption, if offers are ppl able to fend for them selves
  • Safe harbor exceptions:
  • intrastate offerings
  • Rule 504 and 505 exemptions for offerings that don't exceed $5million
  • Rule 506 safe harbor private offering and has no $ limit
  • generally, these 3 turn on a # of factors and usually prohibit advertising of the offering

How does a co become a reporting company?

1) By having its securities registered for trading on a national exchange.

2) under the JOBS Act, having more than $10million in total assets and either (a) 2000 + total owners of record of one class of stock or (b) 500 + non-accredited owner of record of one class of stock

3) By filing a registration statement under the 33 Act

Alter ego

Legal doctrine that lifts or pierces the 'corporate veil' (limited personal liability of the stockholders in a limited liability firm) and holds the directors and stockholders personally liable for the firm's debts. It is applicable generally where it can be shown that the firm is merely a conduit or front for the personal dealings of certain individual(s). And that, in effect, the firm does not exist as a separate and independent entity envisaged in the corporate legislation.

6 Factors listed in Baatz v. Arrow Bar for corporate veil piercing

1) Fraudulent representation by corp dir's

2) Undercapitalization

3) Failure to observe corporate formalities

4) Absence of corp records

5) Payment by the corp of indv. obligations

6) Use of the corp to promote fraud, injustice, or illegalities.

MO Tripartite Test for Corporate Veil Piercing

(Radaszewski v. Telecom Corp)

1) Total control of the running of the corp;

2) D used such control to commit fraud or wrong;

3) That control and breach of duty proximately caused the injury or unjust loss complained of.