Transcript for:
Overview of Business Law Concepts

hello everybody and welcome to the Cooper Smith review course crash course for bus 202 and that is business law in this course we are going to get into business organizations specifically all the various different types of businesses and we're going to discuss them a little bit we're also going to get into Corporate Finance we're going to get a little bit into mergers and Acquisitions a little bit about Securities rules and finally we're going to look into some employment law as you can see from the course objectives over here we are going to be looking at various types of business formations we're going to be looking at documents we're not going to be focusing so much on the nitty-gritty of preparing the documents but more on having you understand what these documents are we're going to discuss a little bit about Securities markets a little bit about stock Etc our first topic is Sole proprietorships and entrepreneurs sole proprietorships are the majority Believe It or Not of all business forms in the United States and entrepreneurs essentially are is anybody who starts a business an entrepreneur forms and operates a new business by him or herself or with other people you can have an individual that's an entrepreneur you could have a company that's entrepreneurs you could have a group that of entrepreneurs Etc entrepreneurial forms of business in other words how you actually operate as a business can be can include many different types of businesses the first one we are going to discuss is the sole proprietorship then you have a general partnership limited partnership limited liability partnership or the limited partnership and the limited liability company we're going to discuss each of these in turn and we'll discuss the positives and the negatives the one we're going to start with is the sole proprietorship the sole proprietorship is simply where you open up and start operating it's not the sort of thing that you need any that you need any formation in terms of forming a business now if you form us if you have a store or if you have even a lemonade stand or pretty much anything you have you may actually have to get government permission before you actually operate in other words just to if you want to open up a restaurant you know you may need to get permission from the Board of Health or you may need to get a license if you start a real estate brokerage firm you may need to be a licensed real estate broker that's all completely apart from the issue of the business formation but in terms of a business formation a sole proprietorship does not require any actual formalities you just open your doors and you start operating you don't need to go to the government to get a license to operate a business again depending on the type of business you may need a license for that particular type of business but in terms of the formation in terms of your operating how you're operating a sole proprietorship simply means open your doors and start operating if you have a garage sale or if you have a lemonade stand or if you whatever you want to do you this operating is simply a matter of advertising or going out and doing whatever you need to do you are a sole proprietorship if you make any money from royalties or from authorship or whatever and you haven't formed any uh any actual business formation well then you are a sole proprietorship the business is not a legal entity and that's the reason why it's the most common business organization form of business organization in the United States because many people that have very small businesses or only do a little bit of business if you file an income tax return this would be a Schedule C where you report yourself for self-employment income and you may not even think of it necessarily as a business but if you make money congratulations you are a sole proprietorship I would venture to say that most people in their lives at one point or another are a sole proprietorship to at least one extent so it's owned by a single person just open the doors and start operating you can hire people you know just because you're a sole proprietorship doesn't mean you can't have anybody working for you many sole proprietorships do have people working for them and for legal purposes there really is no distinction for between the individual and the business as far as taxes taxation goes and as we go through the various types of business organizations at each step we are going to look at the the important things that distinguish this business type from other business types in terms of how they are taxed in terms of how the owners are liable for various issues that come up Etc now the taxation for a sole proprietorship is easy all profits are considered personal income of the sole proprietor and there's no separate entity of the business itself that means as I said before when you file your income tax return you file a Schedule C which is self-employment income and you report whatever income you made or a loss you know there are some limitations on losses but generally speaking if you lose money you can take that as a deduction so if you make a lemonade stand in your front lawn and people come to you on hot summer days and you give them ice and you give them lemonade maybe give them some Isis whatever you give them and they pay you a couple of dollars well at the end of the year you know you've made uh one thousand dollars and you've had four hundred dollars in expenses so you've made a profit of six hundred dollars well that goes on your schedule C of your 1040 and you don't even have to report it as a separate entity it doesn't have to file its own tax return you may have to describe the business and the on your form 1040 the IRS actually asks you to tell it to put it within one description you can write the uh you know Jane's lemonade stand or whatever whatever you want to call it you have to put it in a particular business category they give you a whole book that that determines what business category you are and that one would probably be food service or you know something to that effect but as far as taxation goes there's really no difference between that and the person who's actually owning it liability on the other hand the problem one problem with the sole proprietorship is the proprietor proprietor is fully liable for all corporate debts which you know makes sense makes Common Sense really uh if somebody chokes on the lemonade or somebody slips on a little bit of a an ice cube that fell down from the lemonade stand and Sue's sues me your ensues my lemonade stand well I am going to be personally 100 liable for whatever debts incurred by the company if I went and signed a contract to a sugar distributor to deliver 100 pounds of sugar to my lemonade stand well again that's me for the same reason there is no legal distinction between the owner and the business the person is simply running a sole proprietorship as we'll see later on in the other business forums have some Advantage when it comes to liability and have some differences when it comes to taxation the advantages of a sole proprietorship are simple you have total control and simplicity of formation doesn't cost a dime to form you just open your doors and that's that you have total control over it you don't have to worry about going to a board of directors or going to a managing partner or anything else you just start operating what are some of the disadvantages of sole proprietorship in other words why do people uh become more complex and more expensive forms of business like the Partnerships or corporations or other things we are going to discuss well number one difficulty in raising Capital if you want to raise money to run your lemonade stand now Lemonade Stand probably is not going to cost that much to run maybe you need a little bit of cardboard to put up your stand and you know some lemons and some water and some sugar and some ice cubes doesn't cost that much to actually run but if you have something more complicated like you want to build a you want to hire a couple of developers to work for a year to build in to build an iPhone app it's going to take it's going to cost you a couple hundred thousand dollars to pay salaries to build or to rent office space or whatever it is you really have to come up with that money on your own you know if you don't have that kind of money in your pocket you can go to the bank and get a loan but you can go get a business loan but again it's not there's no real special shortcut you got to raise the money somehow we'll see with corporations you can sell stock you can uh you can sell parts of the business but raising capital is not that easy when it comes to a sole proprietorship you've also got unlimited liability for the owner and the business debts as I said before if there's a problem and somebody gets sued or there's some level of liability the owner will be 100 liable and there is very low liquidity in the ownership of the business if you want to sell the business just like any other business you can sell it but it's not that easy to chop up the business and sell individual shares and get investors if you do want to do those things which many sole proprietorships do eventually want to do sell shares of the business you're probably going to have to then turn it into some other form of business like a partnership or an LLC or a corporation even and of course by the way you can switch back and forth if you have a sole proprietorship you can turn that into a corporation by just forming a corporation you're not locked into any one of these particular business forms so many businesses start as a sole proprietorship and then after a while they're formed into Partnerships when other people come on and then maybe llc's and then eventually they become corporations that's fine let's take a look at some of the other slides again some of this is a little bit of repetition some advantages of sole proprietorship we discussed low cost of formation the owners can make all the management decisions you can have employees that's fine you know when you're talking about tax rules of course you'll you may have special tax rules as an employer you may have to send your employees W-2s you may have to send them and send independent contractors 1099s and all that other good stuff that's a little bit beyond the scope of this course but that is certainly something you do have to be concerned about but in terms of the profits it just goes on your personal 1040. so proprietorship owns the whole business has the right to receive all the profits you can sell the business if you like without any other anybody's permission I mentioned before it's not that easy to sell shares of it but if you want to sell the whole business all you have to do is make a contract and have somebody agree to buy it and you agree to sell it what are the disadvantages well again as we discussed before access to Capital is limited to the personal funds plus whatever loan that you can contain you're legally responsible for the business and personally liable for any tort that is committed creation of a sole proprietorship is simple there are no formalities there are no federal or state government approval to form a sole proprietorship but again depending on the nature of the business you may require some sort of a license to do business depending on what it is you're actually doing be liability which we briefly touched on before and we'll get into a little bit more now the liability of the business includes number one the risk of loss of the business if the business doesn't do well the business fails well that's 100 your problem it's nobody else's problem as it would be in the corporation the proprietor has unlimited personal liability if somebody wants to sue the business you and you alone the proprietor alone is going to be completely liable and the creditors can recover claims against the business from the sole Proprietors personal assets if they sue the sole proprietor well then the sole Proprietors house and other assets may be in jeopardy and as you can see from this little diagram over here the sole proprietor is really the entire business the sole proprietor will owe debts or obligations to a third party with whom they do business and if the third party owes the sole proprietorship money again the sole proprietor has the personal liability as the per is the person who would bring an action or the person who is owed to the same extent in other words the sole proprietor really the point of the entire first lesson is that the sole proprietor is the entire thing it's the entire business start to finish after the sole proprietorship our next major form of business that we're going to discuss is the general partnership general partnership is a very simple business device business form it's maybe a little bit more complex than the sole proprietorship but not much it's a voluntary Association of two or more people that carry on a business for profit if it's non-profit they would be a different type of business entity it creates rights and responsibilities that we will discuss between the partners and third parties and partners are personally liable for the debts and obligations of the Partnership if the partnership has a problem and gets sued then each partner is personally liable and can have his or her own personal assets seized in some sort of a lawsuit which is one of the disadvantages of this method of business as opposed to some of the ones that we're going to see later on like the limited partnership or the LLC the general partnership has only one type of partner and that is the general partner in this example this chart you've got three General Partners here could be five could be three could be two could be a hundred doesn't really matter that much they make agreements with third parties and the general partners are liable to each other to as we'll see later on to pay back their personal Investments and in case they get sued but they're also liable to any third party if the general partnership makes an agreement with the third party each of the general Partners is liable to that third party if later on there's a lawsuit or some sort of a damage that is caused and the partnership is governed primarily and Most states have not have adopted this Rule and this rule is called The Uniform Partnership Act The Uniform Partnership Act is a model act a model act means a series of rules that is written by an expert in a particular area that they hope that states will take and adopt the rules that they write and I believe Most states have adopted the Uniform Partnership Act and it covers problems from or not necessarily problems but situations or questions that arise from formation operation to solution all those things the general rule is that all of these types of rules that are established by The Uniform Partnership Act can be changed by agreement if the parties agree to Something in terms of how their partnership is governed they can agree to pretty much anything they like the Uniform Partnership Act is generally there to establish default rules as to what happens if there actually is no agreement the theory of partnership in other words a partner of what how Partnerships are viewed is based on the entity Theory which means that the Partnerships are separate legal entities now when it comes to a Corporation as we'll see later on a corporation really is a separate legal person a partnership is not really a separate legal person a partnership really is the sum total of its Partners however from The Uniform Partnership Act perspective it helps to look at it as though it were a separate entity and a partnership has relatively simple requirements you only need a voluntary Association of two or more persons and those could be corporations two corporations can form a partnership that's sometimes known as a joint venture that we're going to discuss a little bit later on in the course briefly when in the chapter on franchising the partner the you could have two corporations that form a partnership they carry on a business as co-owners all Partners have to agree to participation otherwise it's not a partnership they don't necessarily have to be equal Partners but they don't have to be part ownership and it's for profit here's a summary of some of the some of the issues regarding a general partnership again it is a contract so each party of the partnership has to have the capacity to form a binding contract each person has to be competent each person has to have the ability maybe be an adult be mentally stable have the ability to establish a partnership in order for a partnership to be valid because then that's like any other contract a partnership is considered its own entity for some purposes but primarily as I mentioned a few moments ago a partnership is the sum of its ownership Parts which means really the partnership is just a and b as the partners managing the business together partnership agreements can be oral but in most cases and the better suggestion is for them to be in writing and they can even be implied they can even they don't even necessarily have to actually the parties don't necessarily actually have to have agreed to for their be to for there to be a partnership if two people just operate something together they operate a lemonade stand together even though they didn't actually say we're partners for legal purposes they will be considered Partners especially if it comes to being sued if we have a and b that are opening up a lemonade stand and a and b are running the whole show together and somebody gets hurt and wants to sue A and B and B says well I was never this was never a partnership I was just here to watch but if B actually held himself out to the customers as being part of the as being part of the partnership well then a court might say we're going to consider you part of the partnership for purposes of liability and that is sometimes known as partnership by estoppel which is a legal term that essentially means that the somebody is prevented from making an argument in this case b is prevented from making the argument that he's not a partner because he held himself out to the public as somebody who was running this business business as well single taxation unlike a corporation which we'll see later on there's only one level of Taxation when a partnership makes money that money the profits of course you know if their expenses they can be deducted but the profits are considered part profits of the partners and the partners have to put their profits on their own income tax return similar to a sole proprietorship in terms of liquidity and capitalization it's very illiquid hard to sell shares of a partnership you can't really sell shares of a partnership you'd probably if you want to add new partners or take away Partners you might have to un yeah you really have to change the entire structure and make a new partnership agreement and it's very unstable as I mentioned a moment ago if a any partner leaves the partnership the whole partnership dissolves now it can be reformed but it's certainly not the type of entity that you want if you want people to be able to sell them sell their shares of the business relatively easily our next issue here is some of the default rules that are relevant to Partnerships in other words these are things that under the Uniform Partnership Act will apply unless the parties agreed too differently the default rule is that each partner has an equal ownership so if you have three people running a business and you didn't specify otherwise each one will own one-third of the business so if you're in a partnership and you invest more or you want to establish that you are a majority owner you'd better say so if you don't say so you might be prevented from doing so later on that's very important upon the solution when the company goes bankrupt or the company stops operating for whatever reason doesn't have to go bankrupt it could be doing very well but it dissolves for whatever reason first the debts get paid off then the capital Investments get paid back in other words each partner gets back what he or she put into the partnership and then it's left over the leftover is split equally if it's owned equally or if it's not owned equally because they agreed on a different structure of ownership than its split proportion if I own 50 and you own fifty percent then it's 50 50. if I own 40 and two other people own 30 each well then I get 40 percent of the leftovers evidence of a partnership again usually when we're talking about trying to sue one of the partners for debts of the partnership which is where this becomes important there could be prima facie evidence which means evidence on its face clear evidence that you don't really need any interpretation for simply Rasheed of the receipt of the share of a business profits if somebody gets a share of the business profits well it's obvious that person is a partner or even without that you can still prove the existence of a partnership by an agreement to share in the part in the profits and losses and the right to participate in management even if the word partner is not used if the parties if you can show that the parties agreed that they were going to manage it together or that they agree that they were going to split the profits well then you can use that as evidence that there is a partnership those are all cases in which there's not actually a partnership agreement where there is a partnership agreement obviously that controls and that's the sort of thing that could be in writing or it could be oral it's recommended that it's in writing and anything can be put in there if something is not put in there then you would have to look to the Uniform Partnership Act to fill in any gaps that were that did not occur in the agreements and the Uniform Partnership acts and mandates which means says the right to an equal share in the profits and losses again unless the agreements provide otherwise however one little caveat is that if the agreement establishes a different profit sharing Arrangement well then that will be the assumption is that that will apply to losses as well and vice versa so if the normally if there are three Partners a b and c well the Assumption will be that the losses are 33 33 33 and the uh profits are 33 33 33 but what what if there's an agreement that says a has the right to 50 of the profits in b and c 25 each well then the Assumption will be the same thing as losses and then the losses will also be 50 25 25 and the same thing is true the opposite again the theory being that if the division of losses or the division of profits is stated that the that is the Assumption in terms of how much of the partnership each person actually owns in terms of managing the partnership there is also the question of compensation what if one of the partners a let's say goes out and starts the business and goes out and spends a year and spends you know a thousand hours of time working on the partnership business is that person entitled to compensation well the general answer is no unless it is specified in the agreement so if you're going to work on behalf of your Partnership if you have you and a few other people have a partnership and you're going to work your head off trying to get the uh you know get the part get the business going well then make sure that there's an agreement preferably in writing among the partners that you're entitled to reasonable compensation that you're entitled to uh to get something more than just your share of the profits if you don't the Assumption will be that you're doing it out of the goodness of your heart that you're doing it because you're a partner and you're trying to make the whole business do well but that you're not entitled inherently to a salary on the other hand indemnification is automatic so if I spend 500 on legal fees to get the articles of you know partnership written or if I spend two thousand dollars on an agreement if I actually lay out money on the partnership business the assumption is that the partnership will pay me back then there are some other rights that are relevant to partnership there's the right to return of loans in capital which means if a partner lends money to the to the company or if the or if a partner contributes money to the company the assumption is that eventually the company the partnership will have to pay that person back as we just discussed and finally we've got the right to information the right to information means as it sounds is that Partners have the right to true and full information from any partner regarding anything that affects the Partnership if I want to see the Partnerships tax returns or I want to see where the partnership spend its money if I'm a partner I have the right to that information part the other partner the web server partner does know the information or does have the information has a responsibility to provide it and partnership books have to be kept at the Partnerships principal place of business and the partners have the right to inspect or copy the records anytime they so choose okay and the next thing we are going to discuss are responsibilities among the partners after we've finished already discussing their rights okay these can be referred to and this is something that's going to be important with regard to corporations later on pretty much all the same rights that you're going to see here apply to corporate directors and corporate officers as well so keep that in mind as we discuss this that we're talking about it in the partnership section but all this stuff is really going to be relevant to businesses in general to corporations and that is the duty of loyalty the duty of information the duty of care and the duty of obedience which is not quite as harsh or as all encompassing as it sounds but we are going to discuss it in a little bit of detail okay let's first start with the duty of loyalty and the duty of loyalty means a partner owes a responsibility not to act adversely to the interests of the partnership or as we'll see a little bit later on the corporation as well that means really as you can see from the last bullet point over here in the case of a conflict between partnership interest and personal interests the interests of the partnership the interests of the response of the Corporation or the interest of the business come first now that of course doesn't mean that you're not allowed to negotiate for a higher salary with your company because your company would be better off giving you a lower salary doesn't mean any of that of course uh it does have some specific ramifications and those specific ramifications are as follows we've got a partner cannot self-deal with the partnership without permission that means if you are a partner or you are a corporate director and you own an element of the company you cannot make a deal between your own private interests and the company interests for example if you own a house and you say well hold on a second I have an idea why don't I need to sell my house I need to move so why don't I sell the house to the partnership or why don't I sell the house to the come to the corporation that I am a director of or the partnership that of which I am a partner that is called self-dealing and it is a breach of the duty of loyalty unless the rest the other partners and the other corporations the other corporate directors if it's a corporation know of the fact that you're making this self deal you're essentially making a deal with yourself and your own personal capacity with the company and also it doesn't say so on the slide but there also is a fairness requirement there's the idea that the deal has to be fair to the Partnership if I make a deal where I sell my house to the partnership for five hundred thousand dollars and my house is only worth three hundred thousand dollars according actually strike that down that would be considered a breach of my duty of loyalty to the company number two you cannot usurp a corporate or partnership opportunity and that means that if in the course of my doing business for a partnership I am presented with an opportunity I cannot take it for myself I have to give it to the partnership for example if the partnership is buying a building and while I'm working on that deal I find out that the neighboring building is also for sale let's say The Neighbor comes up to me and says uh hi uh you know I know that you're working for Jim and Joe's partnership and working to do this to buy this building well I've got the next door building that's also a good building and how would you like to buy that from me as well and if I say well I don't want to do it on behalf of the partnership I don't want to do it on behalf of Jim and Joe but I would like to do it in my own personal capacity I'll give you the money that is usurping a partnership opportunity that is taking an opportunity that you found out about and that you got in the context of the business that you were doing for the company and you're taking it for yourself that's a breach of the responsibility of loyalty as well compete with the partnership without permission if the partnership for example opens up a bunch of coffee houses and I decided to open up my own coffee house next door or down the block from one of the companies coffee houses I am essentially competing with myself now there's nothing inherently illegal about competing with yourself or competing about anybody else but if you have Partners in one Venture and you have different partners in the other venture or no Partners in the other Venture you're essentially violating the responsibility you have to your first Partners we've got a series of Partners we've got Partners let's say a b and c and I'm a and then I and where we have a coffee shop and then next door I open up my own little coffee shop well then I'm violating my responsibility to be and save because I am essentially competing with BNC unless of course BNC give me permission make secret profits from partnership business very similar to the idea of corporate opportunity but this could be let's say getting Kickbacks or getting gratuities if I steer business for example if I make a deal with a real estate agent well if I steer the business to you you'll pay me a certain amount of money on the side as a referral fee now that of course sidesteps the issue of whether you can do that in the first place let's put it this way getting a kickback in order for steering business towards somebody getting kind of a referral fee can be okay in some circumstances in some circumstances it's illegal uh so then you know you can actually go to jail for doing that in some cases but in many cases it is okay in many cases it's fine for example if a real estate agent wants to give you a little wants to give you a gift in exchange for uh for referring a client or in exchange for using that particular agent to buy a house there's nothing inherently wrong with that but even in cases where it's okay if you were getting money in your own personal capacity when the business you were doing was on behalf of a partnership or on behalf of a corporation that is a breach of your responsibility of loyalty disclosing confidential partnership information if you have information that the partnership ought to stay Secret the partnership in terms of how much money the partnership has in terms of what its plans are for the future if there are things that are not publicly available information if you disclose that information to a third party you are violating the responsibility of loyalty misusing partnership property or other breaches of fiduciary responsibility this word fiduciary is the idea that you owe a responsibility to your partners to act as somebody that is trusted fiduciary really just means that you are you're acting in a way that is helpful to your partners is helpful to the other people uh that are that are in your business and if you act in any other way even though we've already discussed some examples the idea of usurping a corporate opportunity competing without permission making secret profits disclosing information these are all examples of the duty of loyalty but the point is this is not a limitation it's not like these are the only possibilities of breaching the responsibility of loyalty there are other examples where responsibilities of loyalty could be breached and if one of these arises even if maybe it hasn't been thought of if not on this slide it doesn't matter anything that can be construed or can be looked at by a court as being a violation of the responsibility that you have to your partners or to your corporate shareholders as a fiduciary in other words as a trusted member as a trusted representative of them that can also be considered a breach of the duty of loyalty so in other words the overall theme is you owe a responsibility to do things in the best interests of the people with whom your partners then you've got the duty of care duty of care is a responsibility that you owe to your partners in a way that means that in addition to being faithful and loyal you also have to show some level of competence if you're handling your partner's money and you put it in a non-fdic insured account or you invested in something that's reckless and the money is lost well then you may be found to violate the duty to have violated the duty of care and if the partners lose money because you negligently invested their money poorly or you negligently allowed their money to be lost for whatever reason then you could be subjected to a lawsuit for a violation of this duty of care then there's the duty of information the duty of information is a simple one you as a partner or as a managing partner again as a corporate director or corporate officer or anybody who is conducting business on behalf of a partnership or on behalf of a business have a responsibility to share whatever information you possess that's relevant obviously you don't have to share everything but if it's relevant to the business if it's important if it's the sort of thing that the other party ought to know about well then you have a responsibility to share that information with your uh with the people that are are with you or in terms of ownership of the partnership or the corporation there's no particular black letter rule in terms of exactly what information must be shared and what information doesn't have to be shared it's the sort of thing that has to be looked at on a case-by-case basis and if somebody is alleging a violation if somebody's alleging that well you didn't inform me of this information and therefore the therefore you're the person is suing you well then the court the court would have to look at or the jury would have to look at is this information that a partner normally ought to have if it's the sort of thing that a part partner or normally ought to know will then failing to disclose that information could be considered a response a violation of the fiduciary duty that you have to your partners and finally you've got this duty of obedience that duty of obedience doesn't mean you have to listen to everything your partners tell you your partners tell you to do something well you have just as much right to act on behalf of the partnership as your partners do what it does mean is that if there is a provision in the partnership agreement or if it's something that was decided by a duly consulted majority sometimes if there are five Partners let's say and the partnership agreement says that three out of five can make a decision and three out of the five make a decision to sell a particular piece of property and you don't you decide not to do it because you think it's a bad idea you know you're put in charge of this transaction and you decide to sell it for a different price or sell it to a different buyer even though you were out voted that is a violation of the responsibility of obedience obedience meaning meaning that you have a responsibility to follow whatever is appropriate under the rules of the company if you fail to act in this regard of course that could also subject unfortunately to a lawsuit so let's continue with various other miscellaneous things with regard to Partners and their relationship with the other partners and relationship with the uh with the outside world number one of course there is a right to an accounting accounting means a right for the financial information all right to look over the books and make sure if one partner suspects that one partner has gotten too much or one partner or that person has gotten too little or there have been information that hasn't been properly shared or for really whatever reason each partner has a right to see the books of the company to see the balance sheets to see the income to see the outflow to see whatever money was made to see whatever money was spent Etc they can bring in action each partner can bring in action for an accounting either they can ask to see the books directly or they can literally go to court and ask the court to force the other partners whichever partner is actually taking care of the books and taking care of the money to ask for a former judicial accounting it in which they can review the partner's transactions and award each partner his or her share of the partnership assets if the court believes that one party has not been paid appropriately based on the partnership agreement or based on the default rules the court can order the parties to uh you know to have to get paid what they're supposed to be paid the next issue is this idea of tort liability towards for those of you who may not be familiar means when there's some sort of an injury suffered by someone in this case by a third party the question is who is liable and the answer is everybody's liable when you're talking about a regular general partnership now we're going to discuss a little bit later on how when you're talking about different types of entities there's a limitation on liability but generally speaking when you are talking about liability when you're if the partnership commits it towards in other words if the partnership business is sued let's say the partnership makes uh has a restaurant and somebody chokes on a foreign object that's in the food or there's food poisoning that somebody gets and the person files a lawsuit against the restaurant well everybody is liable everybody all the partners are liable partnership is liable for the tortious which means committing it toward which means damaging acts of a partner employee or an agent in other words somebody who works in the restaurant or in somebody who's hired by the restaurant if they're working within the ordinary course of the partnership business that's a general tort rule that if I own a business and somebody commits a tort somebody commits damage while working on behalf of the business I am liable and that's the general rule when you're talking about a general partnership and that is that the partners are personally liable for whatever happens in the context of the business the way they are liable is sometimes known as joint and several liability joint and several liability means is a concept that says each partner is fully liable for whatever injury there is now of course that doesn't mean that each partner has to pay a hundred percent meaning the person that sued gets 400 percent if there are four Partners a b and c and d and the victim at our restaurant suffers a hundred thousand dollars worth of Damages that of course doesn't mean we each have to pay a hundred thousand dollars and that the plaintiff walks away with four hundred thousand dollars I mean that would be very nice for the plaintiff but that wouldn't make much sense instead what it means is we're each liable for a hundred percent to the extent that if one of us is not around or if one of us has no money then the others have to make up whatever difference there is so if there are four partners and there's a hundred thousand dollar judgment we would each own 25 ho 25 000 however what if Partners b c and d will skip town or they have no money or they can't pay for whatever reason well then partner a would be responsible for the full hundred thousand dollars that is a concept called Joint and several liability and it applies in general whenever you're talking about two or more people that committed toward if you have two people that together beat somebody up or together you know injure somebody through negligence they are joined in severally liable which means they're both liable for a hundred percent of the damages the normal rule would be that they split it and each pay half however if one cannot pay for whatever reason or if one is beyond the jurisdiction of the court if one you know doesn't live in the United States and the court doesn't have jurisdiction over the person for whatever reason then the other person the other person partner who committed the tour or in this case the partner of the business would be fully liable so if you have three people that own a hot dog stand or three people that own a restaurant and the person gets injured and two of them can't pay for whatever reason or two of them skip town two of them there's no jurisdiction over whatever it is the poor a third person is going to have to pay for the entire thing that is the concept of joint and several liability and it applies to a car a partnership then we've got the idea of contract liability well if the business signs an agreement to order supplies or to rent an office or whatever it is well who's liable for that and the answer is all of them are right that's really the same rule with regard to torts we just assessed good discuss that rule with regard to torts and now we're going to discuss the same rule with regard to contracts if the company duly signs a contract company you know the partnership orders an office let's say five thousand feet of workspace for a year for a hundred thousand dollars well then that contract all of the partners are individually liable for it I think you can start to see why it's a good idea to have one of those other business forms that we're going to discuss a little bit later on wherein you have a limitation on liability wherein you have a situation where the partners are not necessarily fully liable each for the uh you know for the company's debts because the default rule is that each partner is joined in severally liable for the entire debts of the company a there is one minor distinction between contract and towards liability the third party has to name all Partners in the lawsuit rather than just suing the company you have to sue the people individually and a successful third party can collect judgment against any or all of the partners so again these are here's here's a chart with some of the slight distinctions but I can tell you in general that the rule is that you can sue any or all the partners and of course the partners can fight amongst themselves to make sure they split any debt equally if there are four partners and there's a hundred thousand dollar judgment well then they have to each pay twenty five thousand dollars let's say BC and D are out of town or b c and d are run away and they they don't pay the money then a has to pay the entire thing but then of course a can turn around and collect his or her what is called indemnification from the other partners and indemnification means well like indemnify like an insurance company they get to get to get their money back in other words partner a can then turn around and Sue Partners b c and d each for twenty five thousand dollars for their individual shares what about an incoming partner when you're talking about debts that already existed before the partner comes in we've got a b c and d our partners and they owe this judgment of a hundred thousand dollars and then they take on Partner e during the lawsuit either partner he doesn't know about the lawsuit or partner he does know about the lawsuit the question is what is partner ease liability is partner e liable for these what are called antecedent debts and antecedent in this case means debts that occurred before ease interest in the partnership was established or not and the general answer I think you probably could figure this out is that the new partner is liable for prospective debts in other words liable for debts to come in the future and of course the partner can lose his or her contribution to the Partnership if the partnership goes under or if the partnership has to pay all of its money for a uh you know for for a lawsuit however the new partner is not personally liable for debts that existed beforehand so for example while the partnership has a hundred thousand dollar debt e comes in and pumps in fifty thousand dollars to the partnership as a new investor well that fifty thousand dollars of course now belongs to the partnership and so that fifty thousand dollars can be used to satisfy whatever debts there are in the partnership however e cannot be sued personally in addition to that you know for ease personal assets for something that happened before E ever even got involved in the partnership which I think is a fairly common sensical if that's a word rule so the new partner is personally liable for debts and obligations incurred by the partnership after becoming a partner but not before becoming a partner and finally with regard to a partnership we are going to look at dissolution which means ending a partnership dissolution occurs when the partnership ends that doesn't necessarily mean the business owned by the partnership ends it just means the partnership relationship as it existed till now is being fundamentally changed or is being ended so for example if there's a restaurant in a b c and d our people are running this uh let's say this barbecue restaurant let's say for argument's sake the restaurant might still exist but the partnership could be dissolved the partnership could be dissolved either because it was only established for a limited time in the first place let's say the partnership was only established for five years well then of course the partnership dissolved after five years even if there's actually business being run by the partnership another example would be if a partner decides to opt out a partner decides to withdraw the general rule is unless established differently by the partnership agreement as soon as one partner withdraws the end partnership is being is considered dissolved or when there's a vote to dissolve sometimes the partnership could could vote to change the structure of the partnership that could be because it's not working out or it could be because it is working out and they want to reform as something else instead of using a general partnership form they want to become an LLC or they want to become a corporation or they want to become some other form of business well the first thing you got to do is you have to end the previous relationship and the general partnership so what happens when you end a general partnership again it could be because of a good reason or it could be because of a bad reason or anything in between doesn't necessarily have to mean that the entire business is coming to a crashing halt well the process by which a partnership is ended is called the winding up this is the process of liquidating the partnership assets and distributing the proceeds to satisfy claiming against the partnership and then settling up essentially among the partners again this doesn't mean that you're necessarily going to distribute the money maybe you're going to take the money and reform it into a new business entity but the stage of winding up occurs whenever a partnership is dissolved which essentially occurs whenever a partner withdraws or whenever the people in the partnership vote to fundamentally change change the uh the structure okay so first thing you do is what do you do with the partnership assets Partnerships got a bank account partnership has a plant it has inventory it has a store it has intellectual property it has whatever property it has what do you do with that money well the first thing you do is if there are creditors they get paid first if there's a bank if they have credit cards uh if they took out a loan whatever it is they get paid first then once you've paid off the creditors assuming that there's money left you pay the partners who are creditors sometimes Partners lend money to the company well they don't have first priority outside creditors have first priority but then they've got next priority once that's done you pay off whatever Capital contributions there were Capital contributions means the amount invested in the partnership by the partners if for example you have a b c and d and a invested a hundred thousand into the partnership and B invested 50 000 and C invested 20 000 and de-invested ten thousand well they might be equal Partners anyway because maybe they have different levels of expertise for whatever reason they're equal Partners still when you're winding up a gets his or her hundred thousand first and B's fifty thousand Etc and then once they all get paid off whatever's left over is now profits whatever's left over the creditors have already been paid loans have already been paid from the other partners Capital contributions have been paid and now it's time to divvy up whatever profits there are as we discussed discussed just because a partnership is dissolved doesn't mean that it's necessarily over that there's no more business necessarily going to be conducted by these people you can continue after the dissolution if you like you can even make a continuation agreement says okay after everything is distributed or after some of the debts are distributed depending on what the partners want to do they can continue as a partnership with either new members or a subset of the previous members Etc or you can have the entire the old partnership dissolved and an entirely new partnership created or a new Corporation created or a new LLC created or anything to that effect if all the creditors are not paid off you know if you're forming a new entity and you just didn't have enough money to pay off the creditors well then the old creditors the banks the credit cards whatever it is become creditors which means people who are owed money by the new uh entity by the new partnership what about outgoing partners and the answer is of course another logical rule just because a partnership is dissolved does not necessarily end the liability that already existed for that partner in terms of previous debts or antecedent debts as we saw before so if a b c and d oh a hundred thousand dollars because there was some lawsuit or because they signed an agreement to lease some space or for whatever reason Dee decides to leave the partnership and therefore the whole thing is dissolved that doesn't get to you off the hook if it did get to you off the hook well then any partner who was in debt would simply dissolve the partnership and that would be it D is still personally liable and that personal liability is in the form of joint and several liability so D theoretically could be on the hook for the entire thing you know if ABC a b and c don't pay their share so just because D is leaving the partnership doesn't absolve D of whatever liability there was again a fairly common sensical rule that is really necessary in order to make sure that people can simply get out of whatever uh of whatever liability they had next issue is okay let's say a partner dies well what happens to his or her share the default rule for a partnership and this could be changed by the agreement is what is called a right of survivorship now there are really two different types of Arrangements in this respect some types of businesses or entities or you know there could be you could write in the agreement that if one partner dies his or her share goes to his or her family that is called an arrangement where there is no right of survivorship right of survivorship means that the remaining account holders or the remaining Partners would get his or her share I mean just to give you another an example of how this would work when you're talking about a bank account if a bank account has right of survivorship so let's say You've Got A and B have a have have a bank account a joint bank account which has a right of survivorship so when a dies B becomes the sole account holder and beholds the entire thing on the other hand if they're holding assets in a way that there's no right of survivorship well then A's share doesn't go to b a share instead go to A's errors a family or whatever A's will says so the default rule unless stated otherwise is that when you're talking about a partnership there is a right of survivorship but they could be changed by the agreement you have to look at the partnership agreement if there is a partnership agreement and if the partnership agreement says there is a right of survivorship well then if the first partner dies it goes to his or her heirs if the agreement says that there's no right of survivorship well then if a partner dies the assets or the partnership interests go to I'm sorry if there is a rate of survivorship that goes to the other partners and if there's no right of survivorship then it goes to the deceased partner's Heirs of course after the death of the last partner well then it would have to go to the deceased partner's legal representative like the executor or the fam really eventually to the family or to The Heirs of the last partner for the simple reason that there's nobody left uh there's nobody left for it to go even if there's a right of survivorship there are no survivors if the last partner dies all right let us take a look before as we end the our discussion of General Partnerships of an example of a winding up of a distribution of okay so let's take a look at an example then we're going to look at the solutions for each of these examples Bart Lisa and Maggie have a partnership with no written agreements so we're going to look at the default rules in other words the ones that we have just discussed in the last few minutes Bart contributed five hundred thousand dollars of the partnership Lisa contributed 300 000 and Maggie one hundred thousand if the partnership dissolves with 1.5 million in the bank and no debts how much will each party receive second one if there's no assets or debts what will happen to the parties or D what if there's 1.2 million dollars and that's what does each have to pay well remember the first thing that gets paid are the debts of the company so in the first and then the second thing after the debts of the company you have to give back the capital contributions and the third thing if the capital contributions are given out and there's still money left then it's split among the partners so let's take a look at each of these in turn let's take a look at number one partnership dissolves with 1.5 million in the bank and no debts how much will each party receive well here's our solution each partner has to get back his or her original capital contribution now Bart contributed 500 000 so he takes the first five hundred thousand Lisa contributed three hundred thousand so she gets the next three hundred thousand Maggie gets her 100 000. now if you subtract that's nine hundred thousand paid out so there's six hundred thousand left that 600 000 left is now profit so that profit gets split three ways 200 to each so if yeah if you have a calculator or you have a pen you could write it out and see if you can figure out the same thing as I say as the way I did it but Bart has seven hundred thousand altogether his original 500 000 contribution plus the two hundred thousand in profits that were split equally Lisa gets 500 000 altogether her original 300 000 and 200 000 of the profits Maggie has 300 000 which is her one hundred thousand dollars Capital contribution plus her two hundred thousand dollar share what about number two if the partnership dissolves with no assets or debts well remember the capital contributions are considered partnership debts so the partners essentially have to contribute enough to pay the debts there is nine hundred thousand dollars in debts here because the BART is owed five hundred thousand lease has owed three hundred thousand and maggies owed one hundred thousand so that's nine hundred thousand dollars in debts so of that nine hundred thousand dollars each party has to contribute essentially three hundred thousand to the pot to the middle so that they can each be paid back so Bart put three hundred thousand in the pot but gets to take five hundred thousand out because he get he's getting his five hundred thousand dollars back Lisa of course breaks even she has to put three hundred thousand into the pot in order to pay everybody but she gets her three hundred thousand dollars back and Maggie of course who only made a one hundred thousand dollar Capital contribution has to pay two hundred thousand because she's got to put three hundred thousand in the pot and only gets 100 000 left the third example on the other hand obviously this partnership hasn't done too well the partnership has no assets and 1.2 million in debts who has to pay what well if you think about it there's really 2.1 million dollars in debts 1.2 and that's to the outside and then 900 000 in debts within the partnership so essentially each person has to put 700 000 in the middle in order to make up that 2.1 million Bart puts in seven hundred thousand and then gets five hundred thousand dollars back because that was his Capital contribution Lisa puts in 700 000 but then gets 300 back for a net payment of four hundred thousand Maggie's net payment is of course six hundred thousand and again if you have trouble understanding what uh you know what this example is I would recommend maybe pausing it go back to the original example see if you can come to the same conclusion I think once you understand that each partner has to pay for debts which include uh which include Capital contributions it should be fairly easy to calculate next we are going to focus on a different type of partnership and that is the limited partnership the major difference between the limited partnership and the general partnership which we just discussed is that some of the partners in the limited partnership namely the limited partners a take no part in the management but as computation for that they are also not liable for partnership debts that's the key about a limited partnership the idea of the limited partnership and the reason why the limited partnership was created in the first place is that it was designed to keep the control Taxation and simplicity benefits of the partnership in other words to not have to actually go to a corporation but eliminate the problem of unlimited liability that plagues or ordinary Partnerships in other words in the old days there was really just two types of businesses there was the partnership or I guess the sole proprietorship if it was one person and then there was the corporation and the corporation had the advantage of unlimited liability whereas the partnership had the advantage in terms excuse me the part the corporation had the benefit of limited liability which meant that the shareholders were not liable for corporate debts whereas the partnership or the sole proprietorship led to only single taxation was only taxed once and had more Simplicity than a regular Corporation so the limited partnership was created to kind of be a little bit of a hybrid today we'll see there's probably a better hybrid called the LLC but the limited partnership was this it does require refilting with the state unlike the general partnership which we saw a little while ago you actually have to file with the state in order to establish a limited partnership and you have in a limited partnership two groups of owners you've got the general Partners these are the people who essentially are comparable to the general Partners or the regular Partners in a general partnership these are the controllers they have unlimited liability but they also manage the company whereas the limited partners partners are more like investors these are people that have no management functions they cannot actually run the business on a day-to-day basis but they have limited liability which means that they are not liable for partnership debts essentially if you have limited liability if you are a limited partner your liability is the maximum extent of what you can lose is what you put in if you put fifty thousand dollars to buy into the partnership you can lose that whole fifty thousand dollars if the partnership goes belly up but on the other hand if the partnership commits a tort if the partnership signs a contract if the partnership gets some sort of a judgment or a debt you are not personally liable so really the most you can lose is what you put in that's the whole idea of limited liability a limited partnership unlike a general partnership is not automatically dissolved by transferring interest to a third party when we talked about a general partnership remember how it dissolved pretty much whenever anything happened when a partner decided to leave when there was a reorganization pretty much anything caused the partnership to dissolve limited partnership is not quite the same thing when you're talking about taxation well taxation has the same as a general partnership taxation if you may recall when we talked about a general partnership occurs on an individual level when you're talking about a partnership in other words each partner has to pay tax on his or her share of the partnership profits the partnership itself does not actually pay any of its own income taxes instead the partners get a a schedule K1 from the partnership which they really the partnership does file its own tax return it's called the form 1065. then the form sent 1065 kind of tells everybody what their income is but the partnership itself doesn't pay its own income tax unlike a corporation a corporation is its own entity and files its own income tax return and pays its own income tax but the income but the partnership on the other hand is only taxed at one level and that's the level of the individual that's the level of the partners themselves capitalization of course which means getting money is easier than in a general partnership because people can invest without working at the business or assuming liability it's a lot easier to get somebody to to invest and become a partner if you can say don't worry you're only going to have limited liability whereas if you have to tell a person you're going to be liable for debts it's going to be much harder to get people to sign on to become Partners so limited partnership has that Advantage it's a little easier to get investors many of the other rules as we're going to see are going to be very similar to The Limited to the general partnership in fact the general partnership rules pretty much all apply to the limited partnership except for the distinctions that we already discussed namely that some partners are only limited partners they're going to have limited liability they're they don't have they don't have management roles in the company and the sale of one person's interest doesn't automatically dissolve the entire thing there is a uniform rule the revised uniform limited partnership act or the ru LPA which is the series of rules that govern the limited partnership which is of course similar to its counterpart for the general partnership which is the UPA The Uniform Partnership Act so these so Capital contributions they can be Capital contributions means the money that you actually put into the business that you invest in the business and just like with the general partnership these become debts of the company the company's got to pay it back eventually upon dissolution so these can be in cash property even Services promissory notes pretty much anything that can be contributed to a company just like with a general partnership there can be a partnership agreement there doesn't necessarily have to be a partnership partnership agreement but there usually is there has to be certificate again unlike a general partnership which you can just start operating without any certificate you do need to file something with the state and that is the certificate so there does have to be a certificate and usually there will also be a document and the document will set forth the rights and duties of the partners the terms and conditions regarding the operation of the business and terms regarding dissolution or termination of the entity there are default rules if some of these things are uncovered then you have to look to the revised uniform limited partnership Act and the rules that we're discussing and that we have discussed so far are generally speaking the default rules but if the parties want to make different rules well they can always they can agree to pretty much anything they like it's their agreement they can do pretty much what they like here are some of the default rules and that is to start with the uniform rule regarding profits and losses and the rule here is very simple it can do whatever the agreement says so if the agreement actually specifies this if there is no agreement regarding the sharing of profits and losses then the uniform limited partnership act provides the profits and losses are shared on the basis of the partner's Capital contribution that's not the same rule as with the general Partnerships but when you're talking about limited Partnerships the idea is that the partners are really based basically investors so if you have a profit from the company then you have to look at how much each person contributed for them to determine how much of the profits they have a right to share the right to information is very similar to the one that we discussed with regard to General Partnerships really it's the same rule but it doesn't hurt to go over upon a reasonable demand for information the limited partnership has to give the information to the demanding partner this Inc they also have to keep the records if they don't keep the records then they will be in violation of the duty of care which as we discussed before is owed by the partners to each other this includes again this is the information that people are entitled to by virtue of their being Partners copies of the certificates and all amendments to the certificate any changes to the certificate names of the partners agreements copies of the tax returns copies of the financial statements these are things that Partners whether they're General Partners or limited partners are inherently entitled to can you add Partners the answer of course is yes if you have the consent of all the partners or unless the agreement specifies otherwise the default rule under the revised uniform limited partnership Act is that all the partners have to agree before you add another partner to the partnership on the other hand if the original agreement said that we can add partners by majority votes or by two-thirds Vote or by you know whatever vote is specified then that controls in other words the agreement can change the default rules to whatever extent the partners agree so new partners can be admitted but under the terms specified in the agreement but if the agreement doesn't specify anything one way or the other well then you need all the partners to agree in order to add a new partner usually this new partner will be an investor the new partner might will probably be a limited partner where the new partner will give certain Capital contributions to the company in exchange for an ownership share of a of the business okay next we're going to move on to a couple of other issues that are relevant to limited Partnerships now the truth is that a lot of these issues are relevant to all types of Partnerships but we're discussing it in this chapter first of all the issue is is something considered foreign or domestic now you may say well who cares whether it's foreign or domestic and the answer is that foreign companies have certain tax requirements and certain reporting requirements and all that so very often it is important to make a determination as to whether an entity is foreign or considered domestic which means of course subject to the laws of the United States while even foreign companies sometimes are subject to the laws of the United States but where is the central location of the company considered and in this context we're talking about both uh inside the United States versus outside the United States and also within various States a Corp a limited partnership that's filed in New York for example might would be considered for this purpose a foreign limited partnership in the state of New Jersey so we're talking about both within the United States versus with outside the United States and States compared to other states and under the uniform limited partnership there is a very simple very logical rule the laws of the state in which your entity is organized governs its organization so if you file in Delaware your limited partnership is subject Delaware laws even though you may never have been to Delaware many people do file in Delaware because Delaware has got favorable rules regarding corporations and regarding limited Partnerships and llc's the fees structure is a little bit different so many people file in Delaware and therefore their their companies are subject to the rules of Delaware even though the business may have nothing to do with Delaware and the certificate of registration would be the thing that's filed in Delaware that makes it subject to Delaware rules and that is that makes it a Delaware partnership for example as we discussed before the key distinction between a general partnership and a limited partnership is based on the idea of liability the general partners even in a limited partnership have unlimited liability these are the people who are comparable to the general part to the partners in a general partnership these are the people who run the company and they have got unlimited liability which means they are personally liable if the company gets sued if the company commits a tort or if the company gets subject to some sort of a judgment The Limited Partnerships the limited partners are only liable up to the amount of their contributions that is the maximum that they can lose but by the same token they give up their right to control and manage the company only the general Partners have the right to share in the management and voting rights in terms of how the company is management how the company is managed what can a limited partnership what can excuse me a limited partner do and not lose his or her limited liability now if you have a limited partner and it turns out that that limited partner is running the show and that limited partner is really acting as a general partner then a court might say this person really is a general partner and lose his or her limited liability however you can have at least some element of management of a limited partnership and still be considered a limited partner in other words what can you do you can be an agent of the limited partnership if you're a limited partner and the general Partners appoint you as an agent to do something for the company that's okay you can still be a limited partner you can also be an employee you can also be a contractor for the limited partnership and of course you can be a general partner but then if you're a general partner obviously you lose your limited liability I'm going to write that over here but then you lose the idea of limited liability because then you're a general partner not a limited partner and of course you can also be a consultant or advisor just because you're hired by the general Partners you just can't have a voting right in other words you just can't be the person that actually is fundamentally in charge of managing the company if the people that do manage the company in other words the general Partners appoint you as an employee or as an agent that's fine you can act as a surety in other words it's a guarantor for loans that are taken out by the company you can approve or disimprove an amendment to the partnership agreement that's not really considered management of the company and voting on certain specific Partners partnership matters really what you can't do is be somebody who is in charge of the day-to-day operations of the company and is the person that has the final say on these matters and what this means what the result of this is is that limited partners of course the general rule are not individually liable for any debts that are owed or torts that are committed by the partnership there are some exceptions if the formation was defective in other words the proper documents were unfiled well then everybody has unlimited liability because now it is not a valid limited partnership if you participate in the management you can then lose your status as we discussed before as a limited partner and also even if you are a limited partner if you make a personal guarantee on a loan taken out by the partnership let's say well then you'll be personally liable just like if you weren't a partner and you made a personal guarantee you would be liable for the repayment of that amount dissolution of a limited partnership is somewhat similar to a general partnership which we covered before it could be at the end of the life of the limited partnership if the time span is specified in the certificate a partnership can be dissolved with the written consent of all General and limited partners because of the withdrawal of the general partner remember with a general partnership any partner that withdrew dissolved the entire thing a limited partnership on the other hand it has to be a general partner that's withdrawing if it's a limited partner in other words an investor that's withdrawing that does not automatically cause the entire partnership to dissolve and finally if there's a decree of judicial dissolution in other words the judge orders it to be dissolved for whatever reason either because one of the partners brought an action or for some other reason a judge can order the partnership dissolved when you wind up a limited partnership the default rules are pretty similar to what we discussed before regarding a general partnership you have to wind up upon the solution file a certificate of cancellation with the Secretary of State in other words when you when you established the partnership originally you had to file a certificate with the state to establish that you had a limited partnership maybe pay a fee so the same thing is true when it ends you have to file a certificate of cancellation a general partnership doesn't have to do this because a general partnership doesn't have to file a certificate in the first place but a limited partnership does and as far as Distributing the assets these after these well there if there are assets then they have to be distributed and the revised uniform limited partnership act provides the this preference order first you have the creditors then the partners with respect to unpaid distributions in other words if there was supposed to be a distribution and the and one partner never got his or her distribution that becomes the first thing paid out then Capital contributions then the remainder of the proceeds essentially these are the same rules as we discussed when we discussed the general Partnerships our next business form is the limited liability company or more simply known as the LLC the LLC is designed to be a hybrid between the corporation and a partnership really would an LLC and a little bit more detailed explanation is really supposed to improve on the limited partnership as you recall the limited partnership has some limited partners and some general Partners the limited partners have limited liability the general Partners have unlimited liability and that was designed to take advantage of the limited liability feature of the general Corporation and the Simplicity feature or the taxation benefits of the partnership and so at some point somebody woke up in one state I don't know which state which state started it probably Delaware one of those and woke up and said I have an idea why don't we do something that is similar to a limited partnership except nobody has unlimited liability everybody has limited liability in other words we'll make the whole thing just like a corporation when it comes to liability but just like a partnership when it comes to Taxation and the other aspects and so they formed and the LLC was born so they all see in terms of its formation very similar to a limited partnership but it has that one big advantage that nobody has to be a general partner there's a managing member of an LLC but the managing member's liability is limited as well in other words even the managing members are not personally liable for debts of the LLC so forming an LLC is very similar to forming a limited partnership you file Articles of Incorporation or articles of organization and the shareholders are called members and then there are managing members who are the people that actually run the company you've got limited liability for all members you've got no double taxation you've got easy transferability of shares in other words you can transfer interest just like a corporation you can sell parts of an LLC you can give shares of an LLC you can transfer shares of an LLC and that way it's a lot better than a partnership remember in a partnership when a general partner or any partner in a general partner ship leaves then the whole thing automatically becomes dissolved that is not true with an LLC with an LLC you can transfer shares you can transfer ownership interests you can transfer interests in the LLC and the thing does not get dissolved so therefore you've got good capitalization potential no cap on the number of members we'll see in the S corporation is a different what type of Corporation has a limited uh limited number of members LLC has no limit on the number of members who can sell shares you can buy shares you can get investors and in terms of control of the LLC the members don't inherently get rights to vote and that was one of the problems with the partnership that everybody has an equal stake in the management well that's not necessarily true with an LLC with an LLC you can have a managing member and the managing member is the person that actually runs the show see the LLC as you can see is really a very good business form it's better than it has a lot of features that are a lot better than all the others that we've discussed so far and in fact it's probably the single most common business form of new businesses when they start assuming they're not a sole proprietorship in other words if you're going to go actually and form one and go to the state and pay the fee in a file you're probably going to end up forming an LLC there are still Limited Partnerships around there's still corporations around but the LLC generally speaking is a very strong form of business and a very popular form of business and another great thing about the LLC interestingly enough is that uh over as you can see over here an LLC can elect to be taxed as a partnership but it doesn't even necessarily have to do that the IRS and for far as the tax code goes there's really no such thing as an LLC because an LLC is something that is created by state law the IRS doesn't even really recognize an LLC because an LLC can choose to be taxed as a corporation or to be taxed as a partnership so as an LLC you can actually choose from year to year based on which is a better idea for your particular company at that particular time usually LLCs will be will be will choose to be taxed as a partnership but if for whatever reason they want to be treated as a corporation for tax purposes they can choose to do that as well the owners can manage the business and of course all owners even the managing members have limited liability these are created by state law I mean really all of the business forms we've discussed are a matter of state law you go if you find a form of Corporation or you want to form a limited partnership you have to file something with your secretary of state not with the federal government but as I mentioned before the corporation has special rules with regard to Federal taxation for example they have to file their own Form 1120 which is a corporate tax return a partnership has to file a form 1065 and LLC can kind of choose because the federal federal law doesn't even really make a provision for an LLC although it does specifically allow llc's to choose whether they want to be taxed as a corporation or to be taxed as a partnership and just like you have the Uniform Partnership Act and the human uniform limited partnership act that usually defines how Partnerships are run and what their default rules are you've got limited liability company codes the limited liability company Act and the revised uniform limited liability company act Etc that determine how llc's are run the LLC is a separate legal entity in that way it's well like a corporation LLC can own property and LLC can sue and be sued can enter into contracts and can even be found guilty or civilly liable and can be punished can be fine can even be shut down by the government in this way an LLC is very much like a corporation a corporation it has a status of a separate legal person and the LLC also has a status of a separate legal person and the LLC assuming the articles of organization don't specify otherwise is governed by the uniform rules that are covered by the uniform limited liability company act or the ullca which of course is the llc's version of the Uniform Partnership Acts or the uniform limited partnership acts that we discussed a little bit earlier now all of these rules are only applicable if they are adopted by the state basically what a uniform rule is I didn't mention this earlier but really what a unit uniform rule is it's a series of rules that are written by experts in the field not by any particular government employee but by experts in the field and then the states if they want to can adopt these rules as their own State's rules now some of these have been adopted some of these uniform rules have been adopted by every state like the Uniform Commercial Code then there are some that have been adopted by some states and not others like the uniform probate code there are some there are some uniform rules that haven't been adopted by any states like the model Penal Code but I'm not going to worry about that too much right now that's not really the key thing is the key thing is that the ullc if there are rules that govern a particular case they're not necessarily binding on a particular state or in a particular LLC unless that particular state has adopted the ullc as its own States rules and again just like a corporation an LLC has powers to do things like an independent legal person it can own mortgage or transfer property it can do the same for personal property real property and personal property it could enter into contracts it can make guarantees they can borrow money it can issue notes issue bonds like uh like corporations can can borrow money and borrow money from shareholders and of course can sue and be sued it is an independent legal person just like a corporation and the members have limited liability the limited liability applies to members of the LLC and that means that members of the LLC are only liable to the extent of their Capital contributions which means you can lose what you invested but you cannot lose more than that of course one little caveat to that and this is always true whether you're talking about a corporation or an LLC or a limited partnership if the person actually commits the tour in other words if I own the LLC and I'm running a restaurant and I negligently you know give somebody food poisoning well I can be sued personally even though it's an LLC that doesn't protect me if I personally committed a tour if I personally damage somebody I can still be liable but the point is that a debt strictly of the company does not transfer as my own personal debt and this is a chart that kind of illustrates this concept of liability and that is you have the members who invest in the LLC and the LLC can owe money to the third party so the third party can collect money from the limited liability company can sue the LLC and collect whatever money is in there but cannot directly get money from the members so that's why the investment is limited to a capital contribution and there's no personal liability I think we've covered this concept in many different ways so far in this course and just like any other business the LLC is liable for loss or injury caused by an action of a member manager employer agent in the ordinary course of business this is really a tort Rule and the rule is something called respond yet Superior which means the boss literally means the boss has to respond or the boss has to answer so if you have a business and somebody who is representing the business somebody who works for the business signs a contract with a vendor or commits a tour in the ordinary course of business then the company is going to be liable just like you're talking just like any other business okay as far as the LLC goes in terms of How It's formed initially well we've got the formation of an LLC and the formation of an LLC is simply it's well as similar to the formation of a limited partnership an LLC can be organized to operate businesses real estate developments Etc certain professional groups may have to form their own special type of LLC there's some states have a pllc which is a professional LLC things like law firms and uh doctors offices dentists offices other professional offices may have their own special type of company that they have to organize but virtually all businesses can establish and run as an LLC an LLC can be organized in only one state even though it can conduct business in all other states you can go form a Delaware LLC and it may go and then do business in multiple states that are separate again that's true with corporations in general the way the LLC forms is by establishing an art or by filing by drawing up and filing In Articles of organization the LLC is formed by delivering the articles of organization which is a series of initial rules that set up the LLC to the Secretary of State for or for for filing and that has to include certain very basic information this is very similar to The Articles of Incorporation for a corporation it has to include basic things like the name the addresser or of the office name and address of the agents and organizers the type of LLC being formed it also specifies what it's organized for but it can be very vague for example it can specify that it's being established in order to do any lawful business or to make money or something like that so that's it can be very vague and very often it is very vague they're a duration an LLC could be Perpetual or it could be limited to a specific period of time most LLCs that are formed are simply Perpetual which means they exist until they're dissolved a capital contribution to an LLC is very similar to a capital contribution to a partnership anything can be contributed to a an LLC which again includes Services includes promissory notes other agreements money tangible intangible and not excused by death or disability which means that just like when you're talking about a partnership this becomes something that is owed to the partners or to the LLC members if the LLC member dies well then as we'll see a little bit later on there's no right of survivorship necessarily when you're talking about an LLC because when an LLC member dies his or her Shares are like shares of a corporation it goes to the person's family it goes under the person's will just like if a person dies and owns stock in Google that Google wouldn't go to the other shareholders of Google that stock and Google would go to the person's heirs well the same thing is true when you're talking about an LLC you may have noticed so far there's a kind of a theme going on here and then as an LLC is very similar to a corporation the only major difference between the corporation and an LLC being the issue of Taxation whereas a corporation pays its own income tax the LLC taxation is if it elects to be treated as a partnership is taxed directly to the partners an LLC gives out certificate of interests which are certificates that illustrate how much stock or how much ownership interest each person has similar to a stock certificate when you're talking about a corporation you know today's day and age you might not have paper certificates they could be done electronically or they could be just done in the books but uh but in other words you have the same structure just like instead of stock they call it interest instead of stockholder or shareholder you're called a member but it's the same basic idea and an LLC can have an operating agreement an operating agreement is an agreement among the members that governs the Affairs and business of the LLC and the relationship among the members men and managers of the LLC and it can be amended which means to be changed by the members either by a majority vote or by unanimous vote again depending on what the original document said just like corporations have bylaws and LLC can have an operating agreement which specifies virtually everything about how the business is going to be run and how this document itself can be amended later on if at all according to the uniform limited liability company act each member has the right to an equal share of profits and losses that's the default rule when we were talking about Partnerships and that's the default rule when we're talking about LLCs of course if there is an operating agreement the operating agreement can specify something else then you have the distributional interest the distributional interest requires the members to receive distributions of money and property from the LLC this is like having stock this is like having the ability to get profits from the LLC you have by having a distributional interest you have the right to be distributed along with the other members your share of the profits now an LLC can be member managed or it can be manager managed it can be member managed which means in a member managed LLC all members of the LLC can bind the company by agreeing to contracts with outside vendors or outside parties and in such a case equal each member would have equal rights to membership regardless of their Capital contribution and any matter would be set to a majority vote that's one possibility and again how is this determined this is determined by the operating agreement otherwise the operating agreement can specify that a manager is only a manager or only a group of managers are entitled to bind the LLC are entitled to do business on behalf of the LLC that those people would be called the managing members almost always those are people that are actually members and they're chosen from among the members to manage the to manage the LLC so the members and non-members who are designated managers control the control the management they don't have to be members for example if you want to hire an outside manager like you know a chairman of the board when you're talking about a corporation that person doesn't have to be a member usually the manager is a member but if you want to hire a financial professional to run the LLC who's not a member but gets a yearly salary instead or something that's perfectly fine again whatever the operating agreement says will control in this case the members who are not managers have no rights to manage the LLC unless otherwise provided in the operating agreement of course a non-manager member is not entitled to compensation when the LLC is being winding down or winded up they're entitled to get their share of the ownership interest but they're not entitled to let's say a salary on the other hand people who are managers of the LLC unless specified otherwise in the operating agreement are entitled to be paid compensation and whatever other normal benefits there are when you're talking about managing an LLC again but again these things really should be specified in the agreement itself in terms of what the salary is or it can specify that they'll pay a reasonable salary and of course you know you can hire managing members you can negotiate with managing members just like you can negotiate with people who run a business you can negotiate with managing members to make a determination of their salary and LLC is obligated to reimburse members for payments made on behalf of the LLC again that's you know fairly common sense now who has who does who can bind the LLC in other words who which member of the LLC can sign a contract on behalf of the LLC and the LLC has to listen is it any member or is it just a manager well here are the rules again fairly intuitive any member if the if it's a member managed LLC remember in the member managed LLC everybody had voting Authority every member had the ability to manage or the right to vote and the right to manage the LLC well in such an LLC any one of them can go sign a contract with a third party with a vendor and the LLC is bound by it when you're talking about a manager managed LLC where you only have some members or managing members well then it's only them that have the authority to actually sign a contract on behalf of the LLC and then if they do of course the LLC is liable LLC had LLC managers have the same similar fiduciary responsibilities as we discussed when we were talking about Partnerships there's the duty of loyalty and again the duty of loyalty this is going to be a little bit of a review the duty of the duty owed by a member of a member managed LLC or a manager of a manager a managed LLC basically if you are a manager then you have a fiduciary responsibility to the company you have to be honest in dealings with the LLC don't act adversely to the interests of the LLC you can't usurp a corporate opportunity you serve an opportunity make secret profits secretly dealing secretly competing representing any interest adverse to the LLC all the same rules we discussed before when we were talking about a partnership and there's also a duty of care a duty of care means that if you are handling LLC assets or LLC business you are not allowed to engage in conduct that negligently puts the puts the interests of the other members at risk such as by knowingly violating the law intentional conduct that could cause damage to the company Reckless conduct or even negligent conduct and so ordinary negligence or negligence that causes a that causes the LLC to suffer some sort of a debt or to suffer or to be sued let's say for example I'm managing an LLC that owns a restaurant and I negligently uh you know leave the food out and somebody gets food poisoning because of that well then that person can sue the LLC under the doctrine of responding it's Superior that we discussed before and the LLC can then turn around and sue me for a violation of the duty of care because I messed up with the with with the company business I negligently messed up with the company business and therefore caused them to be liable there is no none there is no fiduciary duty as we discussed before owned by a non-manager member because the non-manager member doesn't have any role in the managing or the running of the company anyway so that person doesn't have any duty of loyalty if I only own a share if I'm only an investor let's say so I own a share of an LLC but I don't manage it and I want to open up a competing business or I want to you know do business with the LLC that's fine I can do both of those things and the reason is because I don't owe a fiduciary responsibility to the company as far as an LLC goes again it can expire only by dissolution if its time runs out or something to that effect not by simply one member leaving if an LLC is about to expire members can vote to continue the LLC or it can be continued as a quote unquote at will llc at will LLC means Perpetual means it can be continued after its term expires if the if there is a vote for it when you're talking about winding up an llc's business at the end well the process of preserving and selling an LLC and distributing the property of and to creditors and members is the winding up process and the same basic rules apply here again as we as we discussed when we were talking about a partnership creditors pay are paid first and then including Capital contributions and then after all of that Surplus amounts are distributed to the members in equal amounts that is the default if the operating agreement changes that then of course whatever that says controls and just like when we were talking about the limited partnership to end an LLC you do need to file articles of termination which end the llc's business with the same organization same Department of State that you use when you file the original articles of organization our next form of business is the corporation and we're going to start with the corporation with a discussion of how you actually form a corporation or the discussion of corporate formation well a corporation in general similar to the LLC that we just discussed is a fictitious legal entity that's created according to statutory requirements in other words it's created under state law and the state law will really determine how it's governed and what the requirements are now there are two basic type of Corporation there's the open Corporation and the close corporation or the closed Corporation now the open Corporation is something that is available on the open market something like Microsoft or Google something that can be traded in the stock market is an open Corporation whereas most corporations when they are originally formed or certainly many mature corporations to this day that are not traded on the open market are called close corporations or closed corporations where the shares are not accessible directly if I want to buy somebody else's Corporation I can't automatically buy it whereas if I want to buy a share of Google all I have to do is go on to my brokerage account and do it that way so a close corporation or a closed Corporation is controlled only by a few people now the advantage of course of a close corporation is that it's easier to make decisions you don't have to go to the public to the to the you don't have to have these massive elections in Mass of meetings of the public to make a determination as to whether something can be done there's also limited accountability to shareholders you don't have to worry about the shareholders because usually the people who are running the company are the shareholders for a close corporation you're usually talking about a family business or a relatively small business you don't have to worry about appeasing the market or appeasing the public because there is no market and there is no public and they're not as heavily regulated the SEC for example doesn't really apply to the SEC regulations don't really apply to close corporations they generally only apply to publicly traded corporations so why do people have open corporations well there are two real reasons number one it makes it much easier to make to raise money and number two it's easier to resell the shares both of them are really the same idea if you're Facebook and you're already they were already worth a couple of billion dollars before they even hit the open market but the ability to allow the public to buy shares it makes it a lot easier to raise money and Facebook became you know went from a company worth a couple of billion dollars to a company worth tens of billions of dollars and that's how what happens with many of these companies companies are doing well but then they go out on the open market and allow anybody to buy their shares at any time and then all of a sudden their valuation increases by 10 times or their valuation increases dramatically they do an IPO and again people do it even though there are handicaps in terms of control and in terms of Regulation because of the fact that you can make so much more money when you're talking about an open corporation that is traded on a public exchange okay how do you actually form a corporation now a corporation is a creature of state law which means that it's created by this it's created under the rules of whatever state you happen to be in so it's not really a federal issue necessarily there are some federal legislation there are some federal rules that govern corporations there are securities rules there are General business rules that apply but when you're talking about forming a corporation originally you're really talking about an issue of state law and Corporation requires the formation of a corporation requires three steps people paper and act I'm sorry the ACT is kind of cut off at the bottom of the slide over there but we're going to discuss each in turn first of all let's discuss the people that are necessary to find a corporation well there has to be to start with and incorporate it an incorporator is somebody who goes to the state and says I would like to form this Corporation it doesn't necessarily even need to be a shareholder it doesn't necessarily that need to be anybody that's involved in the company but the incorporator needs to be the person who's actually going to the state and filing it very often that could be an attorney or a paralegal who works for the firm or a secretary who works for the firm that's that's helping the business or it could be the Principal him or herself or it can be an agent you know you can go online and go to you know incorporate our websites or incorporator services and they'll form a corporation for you they know what to do they know where to mail it they know how to do a name search they know how to do whatever it needs to be done to form a corporation and that person can be the incorporator there's really no specific rule about who can be the incorporator except they have to be 18 years old it's not clear whether another entity can be an incorporator but it's really easy to do because pretty much anybody can be an incorporator so this is not usually a major problem for anybody then there are the people who run the company and own the company the people who own the company are called the shareholders the people who manage the company the people who run the company are called the directors they are the people that have the ultimate say as to what happens and then you have the officers the officers like the president and the CEO are people that run the day-to-day operations of the company of course one person or one group of people can play multiple roles the president can also be a shareholder the president can also be a director a director can also be a shareholder if there's a single person that owns a whole Corporation well then that person is the sole shareholder the sole director and the sole officer there's nothing inherently wrong with people taking two or more of these roles but these are the three basic roles when it comes to owning and managing a corporation next we have the paper elements and the paper elements are the filing of the Articles of Incorporation similar to The Articles of an organization for an LLC and the articles are a contract between the shareholder the incorporators and the states the Articles of Incorporation are a relatively simple documents usually only a couple of pages long and it contains certain basic information about what's being filed this you're going to file with the state and so it only needs to contain some very basic information the company's name and address the name and address of any of the incorporators could be one incorporator could be multiple incorporator the purposes of the corporation now this can be very broad as we discussed before very often they'll say something like the purpose of the corporation is to engage in any lawful business authorized stock issuance if the corporation is being authorized to issue stock initially the Articles of Incorporation will say so now this can be changed later on just because you don't give stock issue stock originally issues stock meaning meaning shares of ownership of the corporation to new people stock is like a percentage if there are 100 shares of the company well then each share represents one percent of the entire ownership of the corporation duration of the corporation's existence doesn't have to be there if it doesn't then the assumption is that it goes on perpetually or until it's dissolved really forever and some states require corporations to designate an agent for service of process for example if you're going to be sued well where can they send the lawsuits very often you will have to name the Secretary of State of that state as the agent for service and process so if I want to sue a company I don't actually have to go down track down the company itself I can simply mail the lawsuit or send the serve the lawsuits on the Secretary of State's office so that is the paper requirements there's also the corporate bylaws now corporate bylaws are not necessarily required but corporations do have them at some point they don't have to be originally they don't have to be set up at the time of the Articles of Incorporation but they're set up later on usually they're adopted by the board of directors after the articles are filed and the corporate bylaws are kind of like a Constitution under which the corporation operates there are templates that people can use and just kind of use generic corporate bylaws but they can also be modified they can say things like you know when is the annual meeting what can the kind of Corporation can the business do what kind of votes are required uh who can serve as officers who can serve as directors how do you transfer Shares are there restrictions on share transfers these are all things that will be taken care of by the corporate bylaws which are usually much more complex and much longer than something like a corporate In Articles of Incorporation which is filed originally the corporation must also issue stock certificates where they want to give out stock and there's also requirements sometimes that an out-of-state company register before doing business in the state if I'm registered in Delaware and I want to do business in New Jersey I might have to go to the New Jersey Secretary of State and register the reason why states make you do that is again for this designation of a service of process representative they don't if the if somebody wants to sue you they want the Secretary of State to be able to receive process and finally you've got the acts these are things that have to be done in order for the corporation to to start operating you need the signatures of all the incorporators who need filing you need to go to the state and file the Articles of Incorporation pay a whatever fee there is and then the are the incorporators or the shareholders usually the same people meet and elect an initial board of directors and adopt initial bylaws the voting at the very beginning the Voting is really based on the shareholders so if there's only one shareholder that person makes all the decisions if there are three shareholders well then they they have a vote on things like electing a board of directors once they elect the board of directors the board of directors is really going to manage the company okay so now let's look over some of the other aspects of a corporation and a lot of things with a lot of these things we've already covered but these are all important aspects of a corporation Corporation is a legal person which means a corporation is a separate legal entity is really distinct from its shareholders and distinct from its directors a corporation can sue or be sued can enter into and enforce contracts can sue to enforce contracts and can be sued to enforce contracts against them hold title 2 and transfer property real estate can be in the name of a person real estate can be in the name of a company and it can even be found civilly and criminally liable can even be prosecuted a corporation also has certain certain characteristics it has limited liability of shareholders that's really the key to the corporation in other words the shareholders are not liable personally just because they're shareholders if a corporation has a debt really if you invest in a company you invest in a corporation the most you can lose is the amount you put in you can transfer shares freely unless specified otherwise in the corporate bylaws they can exist forever and they have centralized management which means there are a group of people namely the directors who are elected by the shareholders and they have control over the company limited liability as we discussed before that shareholders are only liable to the extent of their Capital contributions to the extent of their Investments they're not liable for debts of the company beyond what their investment is the worst they can do is lose what they put in and are not personally liable for debts of the company now if transferability means that corporate shares can be transferred by a shareholder one shareholder can sell or give away the shares that he or she owns shareholders of course Also may agree amongst themselves regarding limitations on this kind of transferability but free transferability without these kinds of limitations is kind of a Hallmark of the default rule for a corporation and a corporation can last forever it can be voluntarily terminated by the shareholders or it can be involuntarily terminated by the creditors if the corporation owes money and is not paying a corporation can be liquidated by a court upon lawsuit by the creditors so that its assets can be divided up among the creditors to pay their debts centralized management means a direct the board of directors makes the policy decisions now there are actually some decisions that are made by the shareholders mainly whether to dissolve which directors to elect whether to merge with another company in some cases but most decisions are really the directors of the ones who are in charge although the board of directors themselves are elected by the shareholders and again here you're talking about state law that will govern these default rules because there's no General Federal corporate law except to the extent of Securities and other federal regulations that govern the marketplace there can be corporations that are for-profits and there can be corporations that are non-for-profit for-profit Corporation is most corporations a a company that can conduct business for a profit and distributes profits in the form of dividends that's how shareholders get their money get their profits from a corporation if a corporation makes money well then they can turn around and take that money and distribute it to the shareholders of course the shareholders and directors may be the same people and so they make the determination to give it to themselves and that's fine obviously people there are there are tax implications of that that we'll discuss a little bit later on but the general rule is that corporations if a corporation makes profits that profit can but doesn't necessarily have to be distributed to the shareholders the difference between that and a non-profit Corporation is a non-profit Corporation can't give out dividends a nonprofit corporation is not supposed to make a profit now it may make a profit one year because it does business but then that money has to be kept in the company and used towards the other company's goals the reason why you want to make a non-profit Corporation is because a non-profit Corporation can be eligible for tax-exempt status could be a charitable Corporation could be religious Corporation could be a school that's owned by a non-profit Corporation these things may be eligible for tax-exempt status assuming they meet the other requirements of the Internal Revenue code but it has to be non-profit a for-profit corporation can never get tax-exempt status and of course there are also some other state and federal rules that make it a little bit more favorable to be a non-profit but again the trade-off is that you're not going to be able to get a dividend if the company does make a profit for whatever reason then it has to keep that within the organization then you've got as we discussed before the distinction between a publicly held and a closely held company a publicly held Corporation has many shareholders and the shares are available on the open market this is sometimes called a security Securities and exchanges commission regulates it and then you've got closely held companies where you have only owned by a few shareholders and shares are not traded on the open market now the next question is okay where do you go to incorporate you can only incorporate in one state now it doesn't mean that you can only do business in one state there are certainly many big corporations that do business in all 50 states but you can only incorporate initially in one state very often people do this in order to minimize the fees that they pay you in order to have more friendly corporate laws Delaware for example is a very common incorporation State and the reason is Delaware charge is less fees from in terms of in terms of incorporating and it also has some rules that are favorable to corporations that some other states might not have so a corporation can be domestic in the state in which it's Incorporated it could be foreign which means it's from another States or it could be alien which means it's Incorporated some in some other country all of these are legitimate all of these can do business in the United States there may be certain restrictions or certain limitations or certain differentiations based on taxes and based on fees based on certain other things but it's important to know that if you form a corporation in Delaware and then do all your business in Michigan well then you're going to be a foreign corporation in Michigan not necessarily a terrible thing but it is something that you need to be aware of a promoter is somebody who's not the incorporator or necessarily even a shareholder of a company a promoter of a corporation is somebody who organizes the start of the corporation and negotiates to enter into the contract that the corporation will need to do business now of course the promoter could be a future shareholder of a company and very often is but a promoter essentially is somebody who acts before the corporation exists on its behalf sometimes the promoter will find the initial investors of the company now really the question is are the promoters liable for the debts of the company that will arise because the whole idea of the promoter is to organize contracts on behalf of the company but when the company actually starts doing business and starts to exist the theory is that the company would take over its own debts and the promoter would no longer be liable however the promoter does retain certain liability and again here for example we're talking about a case where a promoter might know that that later on the promoter and a few friends are starting a restaurant and so therefore the promoter goes and organizes agreement saying you know we're forming ABC Corp to establish restaurants and we'd like to order a thousand pounds of meat to be delivered uh you know scattered over the course of the next three months at these intervals and this is the amount we'll pay Etc and the person might organize uh the a deal on behalf of the future company so if the corporation never comes into existence there's some sort of a problem and it never starts well then of course the promoters have liability on the contract if they make an agreement and they actually sign an agreement on behalf of this company with the supplier and the supplier uh you know obviously needs to get paid so if the company never exists the only person that's really left to be liable is the promoter or the promoters if the company does come into existence well then the understanding assuming the vendor the other party knew that they it was just being entered into on behalf of a company the understanding is that it will be the company that will retain the ultimate liability and therefore the promoter is no longer personally liable unless the contract itself said the promoter retains liability so if Joe negotiates a contract with the vendor on behalf of ABC Corp before it's even formed and then ABC Corp is being formed the assumption is that ABC Corp will be liable and nacho personally on the other hand if the contract with the supplier says that Joe has to retain personal liability maybe that's the only way the the other party would sign as if Joe guaranteed personal liability or for whatever reason if Joe agreed to remain personally liable then of course Joe does remain personally liable the promoter remains liable on the contract unless the parties again in the second case if the promoter agreed to remain liable well then the promoter doesn't remain personally liable even aside from the liability of the corporation unless the parties enter enter into a Novation innovate Nation essentially is an agreement between parties that changes the parties to a contract so if they later on agree that instead of Joe being liable ABC Corp will be liable then that's binding otherwise if Joe agreed to be liable well then Joe retains liability well pretty self-explanatory and fairly intuitive the Articles of Incorporation as we discussed before are the basic governing documents of a corporation they have to be filed with the secretary of state and contain basic information okay what happens if you need to change the Articles of Incorporation well then you can establish an amendment you can amend the Articles of Incorporation to include pretty much any change it has to show that the board adopted the board of directors adopted a resolution recommending an amendment and then the shareholders are the ones that actually make this decision if it's mended to change for example the number of shares that could be distributed the purpose of the company or pretty much anything else that's in the Articles can be amended in order to be amended the board of directors have to recommend it and then the shareholders have to approve it by majority votes in terms of the of the status of a corporation well here we have reference to the rmbca which is the revised model business Corporation act and that's one of these model rules similar to The Uniform Partnership Act or the Uniform Commercial Code or the uniform limited liability company act like we discussed before and that provides that corporate existence begins within the Articles of Incorporation they're filed that of course is important in terms of liability who is going to be liable when can this company actually Sue or be sued when can this company enter into a contract when can this company be liable in other words if the employee of the corporation commits a tort well the tort could be sued but that only applies if the company actually existed at the time the tort was committed if the Articles hadn't been filed yet well then the individual who committed the tour the individual who caused to the damage could be personally sued but the corporation can't be sued because the corporation didn't exist at the time that the tort was committed so the filing of the Articles of the incorporation is proof that the corporation exists as of the time they were filed as of that only the state can stay a challenge the status of the corporation in other words it is presumed that this Corporation now exists as a separate legal entity the purpose of a corporation as we discussed before can be pretty much anything and most articles or many articles of incorporation contain a general purpose clause which says that the corporation can engage in pretty much any legal activity a registered agent is a is an agent that can receive a lawsuit or can act on behalf of the company that should be article identified in the Articles of Incorporation and as we discussed before many states actually require that you appoint the Secretary of State of the State to be a registered agent for purposes of receiving lawsuits on behalf of the company corporate bylaws are established by the board of directors and they contain the ways in which the corporation is allowed to act essentially the series of rules upon which the corporation is governed and the board of directors can amend the corporate bylaws every corporation can also have a corporate seal a corporate seal is a design containing the name of the corporation in the date and it can be imprinted on legal documents the I obviously the significance of a corporate sale is that that is evidence that the corporation agreed to enter into a particular agreement or execute a particular document in organizational meeting is held by the board of directors after the certificate is filed then the initial board of directors which may only be the shareholder at that point or it could be additional directors who are named in the Articles of Incorporation and they will have the initial corporate meeting and the initial corporate meeting will adopt bylaws elect officers transact business and do pretty much whatever is necessary to get this particular business off the ground and finally with regard to corporate formation I want to briefly discuss this idea of the subchapter S corporation a regular Corporation or a C corporation is to when it makes income it's taxed essentially twice when the company makes money when the C corporation when a regular Corporation makes money it has to file its own Form 1120 which is a corporate tax return and it has to pay income to income to X and then when it takes its profits and distributes its profits to the shareholders as dividends well then the shareholder has to pay a dividend tax which is really just a form of an income tax if there is a small corporation that doesn't want to have to have double corporate double tax federal law allows you to instead elect to be treated as what is called a subchapter S corporation and this avoids this double taxation so there are certain requirements of a sub chapter S corporation only individuals can be shareholders there cannot be more than 100 shareholders all the shareholders have to be United States residents and not foreign foreign citizens so there are certain requirements to be a corporation essentially if you're a really big business or if you're traded on the open market you cannot be elected to be considered an S corporation Microsoft can't be elect can't elect to be considered an S corporation but a smaller company that meets the requirements of the Internal Revenue code can elect to be treated as an S corporation when in the way you do it is by filing an IRS form 2553 which is a document that says that you want to be let you want to elect to be treated as a as an S corporation if you do that well then the corporation doesn't pay tax on the federal level what happens is or in the state level really what happens is whatever money is earned by the company is automatically considered income distributed among the shareholders and the individual shareholders pay their own income tax kind of like it generally happens when you're talking about a partnership or an LLC as we discussed before this kind of eliminates the double taxation which is a negative of of a C corporation our next discussion involves Corporate Finance Corporate Finance is really just a discussion of how corporations can get money well of course they can earn money but how can it get money to begin with how can it get loans and get startup Capital that is necessary to start doing the business for the company in the first place well there are a few different methods by which companies can establish money yes or make money or you make money in order to be used on behalf of the company and we'll discuss their pros and cons and why they might not be such a good idea in some cases and why they might be good ideas in other cases first one is operating funds in other words just use the money it has whatever com money the corporation has just go ahead and use it well obviously if you can do that that's fantastic because you don't have to actually borrow any money and you don't have to go into debt the problem is the company has to have sufficient profits to meet operating expenses and salaries in order to grow and you can't use that money for dividend ends in other words if all you're going to do as a business is just simply use the money that you have well then it's very hard to grow it's very hard to make new plans and then buy new uh make new Investments buy new things that can help you make more money in the long run and also these shareholders might get annoyed if you're making profits and not giving them the shares not giving them the profits because the shareholders want dividends they want to get their share of the corporate profits the second possibility of getting money again here we're still talking about relatively small companies is taking out loans from the bank that can be a certainly an efficient way to get money to be able to uh to get startup Capital to do new Investments and new procedures the problem is first of all you have to have good credit to get a get a big loan you may not have the kind of Capital Bank especially if you don't have the kind of history may not be that easy to get this kind of a loan and second of all too much debt on the corporate balance sheet is not a good idea they can make investors especially on the open market more wary about buying shares of your company if your company has too much debt number three you can issue shares of the company in other words you can sell equity in the company you can sell components of the company if you're publicly traded it means floating shares on the open market even if you're a close corporation you can simply sell shares of the company to private individuals either by advertising or by getting a broker or just by Just By Word of Mouth of course the pro of the pros of making money or raising money by Distributing shares is that there's no debt if a company sells a billion dollars worth of shares in the open market that's not a debt of the company of course the downside is that it dilutes the value of the shares held by the current shareholders if I own 50 of the company and then I sell 20 of the company well now I only own 30 percent again seems pretty obvious and if you're going to sell Securities especially if you do so in the open market there are strict SEC regulations Securities and exchanges commission regulations just going public for example just doing an IPO and putting your stock out on the open market like the New York Stock Exchange is probably going to cost tens of millions of dollars in legal fees and Investment Banking fees because it takes a tremendous amount of effort to put together all the documents that are necessary to actually be allowed to sell your shares in the open markets another thing you can do is you can issue corporate bonds now a bond is a loan that you're soliciting from a from from an individual and about you're paying back interest for example you can say I'll give you a thousand dollar Bond you give me a thousand dollars and I'll pay you three percent interest for the next five years and then you know I'll pay you back the thousand dollars whatever there are many different types of bonds there are other courses that that can cover uh exactly what bonds are and how they operate I'm not going to get into that in too much detail right now but it is important to mention just that corporate bonds are loans that you solicit from people out there in the market they could be from private individuals it could be mutual funds it could be pretty much anybody that buys your bonds now the advantage of that is of course you can raise a lot of money and you don't have to dilute your shares you don't have to give people Equity you don't have to give people control of the company however again you have sec regulations when you're floating bonds and just like taking out a loan from A bank it adds to the company debt if I sell a bond well then I owe that person money and that adds to the corporate debt which could make investors a little wary of it and of course it also means it got to pay it back sooner or later these two types of distribution you are called Equity Securities are stocks shares or thus what an equity security is because you're getting equity in The Firm which means a percentage of ownership and then there is a debt security and debt security is another word for a bond this establishes a debtor creditor relationship in which the corporation borrows money from the investor to whom the debt security is issued again a bond is really the best example of a debt security Equity Securities can be in the form of common stock which means common stock means regular plain old stock a certain percentage of the company if there are a million shares outstanding and I own a thousand shares that means I own one one thousandth of the company there are no preferences with regard to common stock in other words if there are dividends or if there are if the company dissolves or whatever it is I get treated in the same way as other common stockholders if there's not enough money to pay everybody well then everybody gets paid proportionally based on what the company has corporations May issue different classes of common stock there could be preferred stock there could be stock for example that gets dividends first there could be stock that gets dissolution money first and of course common shareholders have limited liability if I own a share of Google that doesn't mean that somebody can sue me personally if there was a problem with something that Google did then there's preferred stock preferred stock as we discussed before eight is a type of equity security that has is given certain preferences they can be based on classes you know you could classes of shares that are being distributed different series of shares you know series a has these rules in series B has have these rules and preferred shareholders just like all other shareholders also have limited liability here are some examples of things that can Define uh can Define stock it can be a right to get a dividend a defined preferred stock excuse me right to get dividends ahead of other types of shares right if the company liquidates in other words goes out of business a right to get the money before other other classes maybe a cumulative dividend right in other words the right to get a certain percentage a certain amount of dividends before anybody else gets dividends the right to convert to different types of shares if you have uh maybe the right to uh convert maybe and buy and buy more shares for a certain price and the rate of participate in the profits these are just some examples of some of the things that can characterize preferred stock as opposed to common stock there are different types of debt Securities debt Securities meaning loans that the company takes from a from the investor you have the debt insurance the bond which essentially mean the same thing it's just a question of whether it's secured or not a Devonshire is unsecured which means there's no collateral there's nothing that can be collected uh can be held can if the if the stock isn't if the bond isn't paid a bond is a long-term debt security that's secured by some form of collateral but they both mean when the investor gives the company a certain amount of money and that entitles the investor to a certain amount of Interest a note is a debt security with maturity of five years or less again that's just terminology and the indenture agreement has the terms of the debt but these are all examples of loans that companies can take out from investors next let's discuss what the power of the what the what the corporation can do and the answer basically is that a corporation can do pretty much anything that a person can do a corporation is a legal person and the Express Powers of a Corporation can be found or can be implied from I mean there's a little bit of a misnomer you don't really have a clause uh you know in U.S Constitution saying what corporations can do but their implication and freedoms that Corp that apply to corporations for example in a major U.S Supreme Court decision a few years ago the U.S Supreme Court said that a corporation has freedom of speech that was the famous Citizens United versus the Federal Election Commission ruling and you have various state and federal rules that discuss what a corporation can do but also it's governed by its own governing documents including the Articles of Incorporation it's owned bylaws and resolutions that are taken by the board of directors what can a corporation do well again pretty much anything purchase only sell real property make contracts or personal property incur liabilities issue bonds notes promissory notes things like that invest funds Sue and be sued and in general pretty much whatever a legal person can do a corporation can also do things beyond what is specifically laid out in the bylaws or in the Articles of Incorporation if those are necessary to allow it to do its normal business so for example a corporation even if the bylaws don't say that the corporation is allowed to open a bank account a corporation is inherently considered able to open a bank account because that may be necessary for it to carry out its business also to reimburse its employees for expenses these are things that even if they're not specifically laid out in the bylaws the implication is that corporations are allowed to do these basic things the question really is what happens if a corporation does something that it's not authorized to do you know if the if the bylaws specifically say or if the Articles of Incorporation specifically says that this Corporation is only allowed to operate a restaurant and instead of operating a restaurant that goes out and operates a farm well that is considered an ultra virus act an ultra viries act as something that is beyond the authority of a company to do and act on be enact by a corporation that is beyond its Express or implied powers remedies there are several remedies in other words one of the the corporate shareholders consume they can sue for an injunction they can sue the officers or directors who caused the act for damages in other words they can if the company lost money because of an ultra virus act that the directors did something that was beyond the scope of the corporation's Authority and because of that the shareholders lost money they can successfully sue for those things and they can also bring an action to enjoin the act and join means to stop the ACT to get an injunction against the act or if it's flagrant enough even to dissolve the corporation okay so the next issue is how does a corporation dissolve in other words how does a corporation actually end it could be done by a judge it could be there could be administrative distribution we'll see the solution we'll see what that is in a minute or even voluntary dissolution when the company simply decides to stop operating voluntary is the easiest one to discuss because voluntary dissolution simply means that uh they the company the shareholders vote to end the company if the company hasn't actually commenced any business well then you could simply dissolve it by a majority vote of the incorporators or the board if there already is business that has been started by the company well then just like some of the other major changes that we saw before board of directors has to recommend that the company dissolve and a majority of the shareholders have to actually vote to dissolve the company it's a fundamental change and therefore it's something that the board of directors cannot do by themselves and then you have to file articles of dissolution with the secretary of state in order to tell the state that you're winding up the business then there is Administrative dissolution wherein the comp the Secretary of States in other words the state says this Corporation is not following the formalities of a corporation and therefore we no longer consider it an independent person for legal purposes failing to file an annual report failing to maintain a registered agent which many states require as we discussed before failing to file a change of a registered agent not paying a fee you know they're not going to they're usually not going to do this right away usually they'll send a warning letter to the company saying you know you haven't paid your fee or yeah you don't have a registered agent or whatever it is and give them some time to fix it but in other words if a company does not the whole idea of establishing a corporation as an independent legal person is a privilege in in terms of it's something that makes it easier to do business and makes limited liability So based on that the state can say listen if you refuse to to follow the formalities if you refuse to follow the rules regarding the operation of the company well then the state the state can say we're not recognizing you anymore as this independent legal entity and again then in that case rather than the company issuing a certificate of dissolution the secretary of state would do so then you could have this then you could have judicial dissolution where the courts can order a company shut down sometimes they refer to this as the corporate death penalty it doesn't happen very often but if they if the Articles were fraudulent or they exceeded they exceeded their Authority in other words some basis in a lawsuit where a court thinks that the only remedy to a particular harm is to dissolve the company when a company does dissolve or when a corporation does dissolve they have to wind up just like the partnership winding up include period that we saw a little bit earlier when we were talking about Partnerships and LLCs very similar the first thing the company assets have to be liquidated and creditors have to be paid off if they're paid if there are no creditors or the creditors are already paid then the shareholders would get the rest of the money if any and then the company is terminated the ending of the corporation is determination which occurs only after the winding up of all the corporations Affairs the liquidation of it and the distribution of proceeds to anybody who has a claim our next discussion is about franchises franchises is a method by which a larger Corporation has many different branches or many different operations or many different franchises that run a business that's really part of the larger organization but also has some Independence franchising as you can see over here is an important method of Distributing goods and services to the public one example if there's a major chain restaurant like Starbucks or McDonald's or something like that there is a central central office that runs the show for the entire group for the entire Starbucks for all Starbucks but the individual Starbucks is are run by franchisors it's run by franchises and they own each individual business now they have an agreement they have a management agreement with their parent Corporation but fundamentally they run their own businesses within of course certain contractual responsibilities that both sides have a franchise is established when the franchisor namely Starbucks let's say licenses the franchisee which is the owner of the individual Starbucks to use the franchise nor's trade name trademarks commercial symbols patents copyrights other types of property individual Starbucks if I decides to open up a Starbucks in the mall and I get permission from Starbucks the central agent well now I can use the Starbucks name I can use the Starbucks logo I can use the star Edition Starbucks trademark colors I can use their recipes I can use pretty much everything I can call my drinks the caramel frappo whatever Frappuccino whatever I can call anything because now I have permission to use essentially all of the Starbucks intellectual property so the franchisor and the franchisee are usually established as separate businesses separate corporations there is the big Starbucks and then there's me who is just running the individual Starbucks with my own business the advantages there are many advantages of franchising and that is the franchisor can reach lucrative new markets the franchisor in other words Starbucks can rather than having to go set up shop and then in far-flung places if they want to open up a Starbucks if they want to be able to tap the Nova Scotia Market or the Bogota Market or the Moscow Market or whatever it is it might not be that easy for them to go set up shop there they might not know the the local people they might not really know what to do in that area but if you get a local person to do it for you then it becomes a lot easier the franchisee namely the person who owns the local Starbucks has access to the franchisor's knowledge and resources and the franchisee runs an independent business and the consumers are in short of uniform product quality because you have the same standards that are applied Starbucks central office makes sure that will that its General quality control is applied in all uh for in all individual franchises of course it might not work 100 like that but at least that's the theory and of course the central business can advertise and this advertising now helps all of the franchisees you've got really a franchise starts with a franchise agreement and the franchise agreement has two parties you've got the franchisor who's the licensor in other words the person giving the license Starbucks the central component the central agency in our case gives me the person who's running the Starbucks franchise the license to use trademarks service marks Trade Secrets and of course more than just that other things like patents copyrights whatever else whatever other type of intellectual property maybe may be applicable and there are many different types of franchises one type of franchise is the distributorship franchise where the franchisor manufactures a product and life licenses somebody to distribute the product to the public the example they give over here Ford motor company manufactures Automobiles and franchises in other words individual dealerships are independently owned dealers and they sell them to the public there are many examples of food distributorship franchises where you have a pretzel manufacturer in Pennsylvania that may make uh different different pretzel bags and then but then you have different distributors some some people some actually might sell the exact same pretzel as UTS whereas another distributor might sell the same product as hers just based on who is the distributor the distributor just gets permission from the central office to distribute these particular food products so a distributorship franchise is simply where the central component makes it and then the distributor has the ability to uh to sell it sell it down down in the Stream of Commerce you've got the processing plan franchise where the franchisor provides a secret formula or secret process secret recipes and then the individual franchisee actually manufactures it it's one more step removed than the distributorship from the distributorship the parent company makes everything whereas in the processing plant it's the parent company that just gives the recipe or gives the secret or gives the process to the franchise and the franchise then goes ahead and manage it makes the product one example of course is that Coca-Cola they license Regional bottling companies to manufacture and distribute Coke they give the central Coke in Atlanta may give some other battling company in Connecticut or California or wherever the secret recipe whatever that might be and then they go ahead and use the secret recipe to maybe they give them even some ingredients or whatever it is but the franchisor or in other words the processing plant takes the recipe manufactures the products and then goes ahead and distributes it or sells it themselves now then we've got a chain style franchise where a franchisor licenses the franchisee to make and sell its products from a retail outlet serving in exclusive territory here is the example of the restaurant franchise Pizza Hut is the example they give over here the one I was discussing before Starbucks same idea where it's not that the central Starbucks agency is actually making the coffee they're not taking you know in Seattle the essential they're not in that huge Starbucks building in Seattle they're not sitting there and making uh three million gallons of coffee every day and then shipping it around the country what they're doing is is everybody is making the coffee all the Starbucks are making their coffee in-house with their own machines but Starbucks is just giving them the right to uh to use the Starbucks intellectual property maybe some recipes logos trademarks whatever it is and they they also might give them a a an exclusivity within a particular area they might say okay you know in this city you you have you're the only one that has the right now of course if you've ever walked through New York City or some other big cities you'll know that Starbucks doesn't have a very big exclusivity range some very often you'll have Starbucks that are right across the street from each other or within a couple of blocks of each other but again that's up to the individual franchisor and franchisee agreement there could be an exclusive territory but there doesn't necessarily have to to be in exclusive territory then there is the area franchise where the franchisee is granted the authority to sell its own franchises sometimes called a sub-franchisor a franchise for example a rat let's say Starbucks decides they don't want to have to control all the thousands and thousands of Starbucks that appear appear across the country so Starbucks will say okay we're going to sell our the right to run all the Texas Starbucks's to Texas Starbucks Incorporated and then Texas Starbucks Incorporated will go ahead and hire or distribute to to other franchises around the state so in other words you're giving the people right not only to sell but you're giving somebody the right to actually create and manage sub-franchises so that's what franchises are now let's take a look at some of the rules that govern franchises many states have enacted statutes that require franchisors to make specific disclosures to the franchisees you obviously want to make sure that the franchisees the people who are going to be investing and actually building the restaurants or building the plant or building whatever the case may be you want to make sure that they understand what they're doing and the series of rules that applies to these is called the uniform franchise offering circular or the ufoc the FTC the Federal Trade Commission also has rules those are talking about State rules State rules that the union the uniform rule something gets enacted by various States then rules that apply to franchises and the FTC is the Federal Trade Commission which of course the federal administrative agency and they require franchisors also to make pre-sale disclosures so in other words there are State rules and there are federal rules that require that the franchisee the person establishing the franchise will actually be able to understand what he or she is getting into the franchisor has to disclose assumptions underlying any estimates in hypothetical data for example if I'm deciding whether to open up a Starbucks and Starbucks tells me well you know you're going to probably make a hundred thousand dollars a year for the first five years and then when you really get rolling you'll make 200 000 well you know how do they know that so they have to give them the the explanation for why they're making that assumption and how they know that that assumption is accurate if projections are actually are based on actual past data then the franchisor has to disclose that data where did they get that data how do they collect that data and the franchisor has to provide a mandatory precautionary statement explaining that things aren't guaranteed and what the possible risks are and what franchises are fundamentally about is intellectual property so I'm going to discuss a little bit about intellectual property and the various types of intellectual property that exist and that are relevant to franchises intellectual property generally means property that is not physical you've got physical property which is real property real estate you've got personal property which is movable property and then you've got intellectual property which is something where you own an idea or you own a process or you own something that may not be able to be held the three major examples of intellectual property are patents copyrights and trademarks patents is a process an invention something like that copyright is a written work or a musical work or something to that effect then you've got trademark which is something that indicates or is is associated with an organization you know the Nike Swoosh or the McDonald's M or you know the baseball teams uh you know the New York Yankees interlocking NY why something like that things things that are recognizable to the public or to the people that that symbolize a particular product so a franchisor licenses the use of the trademarks in the franchise agreement anyone who uses the mark without authorization and that's talking about people who are not franchisees or even that are franchisees but don't have the right to use something under a particular agreement can be sued for trademark infringement and the franchisor can recover damages or what is called an injunction which is a court order for the other person to stop doing this wrongful infringement in other words a franchise agreement should say what the person has the right to use does the person have the right to use all the company logos does the person have the right to use some of the company logos and exactly to what extent though do you have to do that and then there's something similar to a trademark called a trade secret a trade secret is something that that is not public knowledge the classic example here would be the recipe for Coca-Cola Coca-Cola It's Almost Famous that Coca-Cola has the secret ingredient that they won't tell anybody and blah blah blah but the franchises obviously the distrib the distribution franchises are not the distribution the manufacturing franchises the people the franchisees the people who are who are bottling and making the new the coke obviously they have to know this ingredient otherwise they wouldn't be able to to manufacture it so what if they go ahead and take the secret ingredient they disclose it and they they release it to the public well that is a misappropriation of trade secret and that would subject them to being sued the franchisor can recover damages and obtain an injunction again which is a court order for them to stop doing it if anybody releases any trade secrets in any franchise agreement um sorry in any franchise relationship first thing you have is a franchise agreement an agreement is between the franchisor and the franchisee that sets forth the conditions of the franchise now it can cover pretty much anything if I want to open up a Starbucks the agreement between Starbucks and I can cover pretty much anything usually it has some sort of a fee that I I pay to open up I pay you know a hundred thousand dollar one-time fee and I get certain maybe I pay a yearly fee also and in exchange I get Starbucks intellectual property it may also contain things like quality control standards Starbucks doesn't want just anybody to have their to have a Starbucks you know if uh if the franchisees do a bad job well then the parent company is going to get a bad reputation if I if I have a bad experience with the uh you know with the Pizza Hut in in Dallas well then I might be less likely to go to the Pizza Hut in Houston so there may be terms in the contract that require a certain level of quality control same thing with training requirements a covenant not to compete in other words the idea is if you have a Starbucks franchise well then you're not going to go turn around afterwards and open up your own coffee shop and use all the secrets that you learned as a Starbucks owner and therefore compete with other Starbucks in arbitration clause which is a very common contract clause in general which says that in the event that there is a dispute rather than going to court you will agree to go to arbitration use of the franchisor is trade name logo and trademark and conditions for termination of the franchise if that happens they will the franchisee will typically have to pay a franchise fee a franchise fee is established in the agreement this may include an initial license fee to start a royalty fee which is a a fee to use the intellectual property as you move along an assessment fee cost of supplies lease fee these are all different types of fees that a franchisee might have to pay in order to run a in an individual franchise now let's get to the end of a franchise relationship how can a franchise be terminated well it could be terminated for cause which means for a good reason it could be terminated at will if the contract allows it to be terminated it will which means where either side can just end it right away without giving any explanation and underlying both is the possibility of wrongful termination which is when one side ends it illegally or against their agreement and that might cause a lawsuit termination for cause means some good reason that the franchisor has for ending the relationship this could be non-payment of a franchise fee this could be continued failure to meet quality control standards really it could be any violation of the franchise agreement these are just two very common examples then there's termination at will and even if the agreement between the franchisor and the franchisee gives the franchisor the right to end the relationship at will many state and federal laws prohibit terminating the franchise at will because you don't want to allow the franchise or to take advantage of the franchising if I go and work you know work very hard to run run a wonderful Starbucks in this area for five years then all of a sudden they shut me down and say you can't use the Starbucks logo anymore but thank you so much for giving us all that free advertising and cultivating all these great Starbucks relationships in your town you know we're going to open up a Starbucks next door that's not really fair to me so there are certainly federal regulations that apply to that wrongful termination occurs when there is no just cause for termination now of course if the contract expires that's a different story if the if the franchise was only established initially for a 10-year period Then 10 years expires well then of course then then the franchise ends but if the franchise agreement was perpetual and there's no good reason a franchisor cannot simply cut off the ability of the franchisee to operate and if the if it does happen if Starbucks shuts down my rest my coffee shop for no good reason then I can recover damages based on this wrongful termination and by suing in terms of the relationship between the franchisor and the franchisee the franchisee is an independent contractor which means that the independent the franchisee is not an employee or an agent and is not liable for the and the franchisor is not liable for the franchisees contracts and torts if I am a franchisee and I own a Starbucks in New York let's say first of all they don't pay me a salary I earn my own salary I may pay franchise fees but the point is they don't have to send me a W-2 or any kind of tax form because I make my own money and I pay my own income taxes I'm not an agent of Starbucks I can I'm an agent of my own branch of my own uh franchise of my own venue but I can't make contracts on behalf of Starbucks in general if I make a contract with a coffee bean Farm in in Colombia to supply Starbucks in general with 100 tons of coffee beans per month well I may be liable for that but Starbucks the main Starbucks headquarters in Seattle is not liable for that because I don't have the authority to speak on behalf of the franchise and the same thing is true with the contracts or torts that I commit if I if my store if I'm negligent and somebody ends up with a uh with a jagged piece of metal in their coffee and files a lawsuit against me well of course they consume me they consume my franchise but they cannot sue the parent company they cannot Sue Starbucks in general because I am not an agent of the of the Starbucks name I am simply a franchise that has the right to Market under their logo of course each one of them franchisors and franchisees are liable for their own torts and their own contracts but not necessarily of each other of course I'm not liable for a Starbucks as torts if Starbucks gets sued for false advertising or something for putting on commercials on the radio that were inaccurate well then just because I have a franchise doesn't mean that I'm personally liable neither of us are liable for the torts the damages caused by the other licensing is really an element of franchising Licensing in general is a business Arrangement that occurs where the owner of an intellectual property very often a trademark or a patent could even be a copyright contracts to permit another party to use that intellectual property you can see why it's relevant to franchising because if I have a Starbucks I have the right to use the all the intellectual property that goes along with that other types of agreements might be where I have the right to manufacture something with a patented process because I made an agreement the licensing agreement with the owner of the patent with the person who filed for and secured the patent that would be a licensing agreement another type of similar business Arrangement is a joint venture a joint venture is simply where two or more businesses combined combine to pursue a single project or transaction now for purposes of everything we've discussed so far in these courses they're really considered Partners they have fiduciary duties to respond to each other they have to manage the business together they're joined in severally liable one example I think 18t and Bell South I think it was back on 10 15 years ago combined and formed a joint venture called Singular Wireless LLC now now I think it's no such thing now I think Singular Wireless might have become a t Mobility or something I forget offhand but the point is that they two big companies ATT and Bell South were two major companies and they got together to try to join the join the cell phone market join the wireless markets and that was a joint venture where they're not really becoming a single company but they're working together on a particular Project based on some sort of agreement and a joint venture as we discussed before operates as a partnership each join each joint venturer Bell South and and uh ATT and the example I just gave is considered a partner and therefore they're each liable for the debts and operations of the joint venture partnership just like any other partnership just like we discussed before when you're talking about a general partnership each partner is liable when you're talking about a joint venture the same thing applies something that is not quite a joint venture and certainly not a franchise agreement is something that is called a strategic Alliance a strategic Alliance is an arrangement between two or more companies in the same industry to achieve a particular objective again it's not that they're forming a partnership or doing anything together specifically they're just agreeing to work together on some particular facet lesson 8 is about corporate management in other words okay we've got a corporation now what are some of the rules that governing manage that govern its management from day to day well we've got three basic components of us in the power structure of a corporation we've got the shareholders who own the company you've got the directors and you've got the officers now of course both can be both one person can play both roles and we've discussed all this before but now we're going to go into in a little bit more detail about the roles of the various of these three different groups let's start with the board of directors the board of directors are really in charge of the corporation except some major decisions that are made by the shareholders of things that the directors do they hold annual meetings States actually require these annual meetings they could be done live they could be done by phone they could be done by teleconference but they do have to be done they can call special meetings when there's something important that's going down in the company they can create committees regarding particular issues that are important study particular issues they can hire and fire officers the officers of the company the executive officers are really any officers of the company serve at the pleasure of the board of directors the board of directors can hire a president and the board of directors can fire a president and they can make recommendations to shareholders on major issues like whether to dissolve whether to merge that sort of thing board action is accomplished by a majority vote but in a subcommittee if you have nine members of the board and they say three people will study this particular issue well those three people cannot act on behalf of the board because you need a majority of the whole board corporate officers on the other hand are people that manage the day-to-day Corporation examples of course the CEO the chief executive officer the CFO president vice president and House Council these are all people that are at the head of managing the company they're not the directors they don't make the over the major decisions but they make the day-to-day operating decisions officers one thing that distinguishes an officer from a another employee obviously the officers are employees of the company just like people who work on the assembly line or the custodian or whatever everybody else who works for the company is also working for the company but there are some distinctions between officers and directors excuse me officers and regular employees first of all officers have authority to bind the company an officer can sign a contract and make an agreement on behalf of a company whereas a regular employee a lower level employee cannot officer has speaking Authority for the company if an officer makes a statement that is considered a representation of the company the company could get in trouble for misleading or false advertising if the if an officer makes a statement that later turns out to be not true and officers have an obligation to report to the board as the shareholders regarding the status of the firm and the nature of this is governed by its Securities rules the Securities and exchanges commission rules lower level employees may work for the company they may get a salary but they don't have a duty to report and they don't have the authority to bind the company with a statement that they made some other responsibilities are the fiduciary responsibilities now these are owed both by directors and by shareholders and we've discussed all of these before when we discussed Partnerships so some of this is going to be a little bit of review this requires that officers and directors act with reasonable care and diligence you have the duty of loyalty and the duty of care and now we are discussing the duty of care a breach of the duty of care which means a breach of the responsibility to act appropriately can be misfeasance in other words taking actions that are harmful to the company taking actions that are unreasonable buying things that are bad or objectively bad Investments not just bad judgments but making decisions that are bad for the company and then there's non-feasons which means failing to take action that a reasonable person would take this season's for example if I owned if I was in the board of directors of a coffee manufacturing company and I decided to buy a line of cars or a car dealership that I knew nothing about but because I thought it was a good idea that might be misfeasons whereas non-feasons would be let's say failing to file the tax return for the corporation on time that I was supposed to do and because of that the company got hit with a fine or the company got hit with some some bad consequence these responsibilities are objective which means every corporate officer and director is expected to adhere to the standard that a reasonable person would normally be expected to adhere to in other words a person an officer and director is expected to have a reasonable level of competence in be in acting on behalf of the company and and it also takes into account the person's experience and training obviously if a corporation hires an executive officer and pays that person a lot of money because the person has a PHD or the person has 20 years of experience managing companies well that's part of the reason why the person was hired and because of that that person now has a responsibility that is commensurate with the person's experience if I'm a 20-year CEO and I make a bad decision well that might not necessarily have been such a bad decision if I were a rookie but I'm not a rookie and that's why I got paid the big bucks CEOs very often have big companies get paid huge amounts of money tens of millions of dollars a year sometimes even hundreds of millions and they and they get paid for that part of the reason is because they have this big responsibility and if they mess up and they cost the shareholders hundreds of millions of dollars they can get sued for hundreds of millions of dollars because the director officer will be liable to the corporation for harm suffered as a result of this breach of care however there is one major caveat to that and that is the business judgment rule the business judgment rule says and it protects both directors and officers it says that if the company makes a good faith decision that was based on due care that was based on reasonable research that was based on reasonable behavior on the part of the decision maker and it turns out to go bad just turns out to be a bad decision that does not mean that there will be liability it says if the director or corporate um makes a corporate decision in good faith the court won't second guess that decision it would not be a good system whereby everything that turns out bad causes the corporate officer or corporate director to be sued for tens of millions of dollars because the shareholders lost that kind of money based on the stock going down if that were the case well then no corporate director or corporate officer would take any risks they would just be extremely conservative because they don't want to be sued so the business judgment rule kind of encourages corporate directors and officers to not be Reckless but to be bold in their actions and therefore just because a decision turns out to be a bad decision does not inherently mean the duty is breached so the business judgment rule applies in all cases a corporate just because you make a bad decision doesn't mean you're liable except in some of these circumstances number one where you haven't been reasonably prudent if you haven't done your research if you haven't done your quote-unquote due diligence well then you're not protected by the business judgment rule or if you haven't adequately researched the transaction that also is a reason why the business judgment would not protect you again if a business judgment rule that doesn't protect you well then you can be liable as a corporate director or officer if the corporate shareholders lose money which usually happens when you're talking about a bad decision on behalf of a corporation it also doesn't apply when the officer director acts in bad faith in other words knows it's a bad decision or takes bribery or something to that effect certainly a business judgment rule would not protect the officer director the officer director has breached the duty of loyalty or has a stake in the transaction either of these cases duty of loyalty like when the we saw earlier when you usurp a corporate opportunity There's an opportunity that comes to your attention by virtue of the fact that you're an officer in the company and instead you take it for yourself the business judgment rule doesn't protect you when you have a stake in the transaction if you personally if I'm the director of a company and I personally am selling a house to the company well then the business judgment rule doesn't protect me there's a conflict of interest there and the deal better be fair in order for me to avoid liability next we move to the next set of players in our business drama and that is the shareholders the shareholders have many rights of course because really they own the company anybody can be a shareholder it could be an individual investor so we believe if you're listening to this you very well may be a shareholder of various companies you could have private Pension funds State Pension funds you know 401ks things like that mutual funds which essentially are professional companies that invest in various companies with many investors money instead of investing yourself you invest with a mutual fund and the mutual fund manager decides which stocks to put all the money in there could be other companies could be employees of the company who are very often given stock or options in the company these different investors of course each have their own unique set of concerns however the overall goal is of course to do what's best for the company in terms of the bottom line in terms of the profits they have to assert their individual voices to make their goals uh to make their goals to have the best chance of being met now of course well shareholders get to vote on some key decisions including electing the directors and deciding whether to merge that sort of thing so the shareholders inside from the aside from what they do they also have rights they elect single directors that can be done in a single slate of directory sometimes which means they're let's say there are nine directors they could all be elected in a single year or there could be a staggered board for example you could have nine members on the board but three elected each year every three years almost like United States senators they also approve or disapprove of fundamental changes if the company wants to merge or the company wants to dissolve the shareholders have to approve that and they also have the right to vote at annual meetings on these sorts of questions on these fundamental questions and they are based on the record date for example if the annual meeting is on June 1st well in order to decrease confusion let's say they'll say the record date is March 5th May 15th so two weeks early if you're a shareholder on May 15th you get to vote otherwise you don't it would just be too complicated if you got your shares on May 31st and then to vote on June 1st it would be virtually impossible to keep track of who has the ability to actually vote now of course a shareholder can actually come to the meeting can come to the annual meeting and vote physically while there but most shareholders in a publicly held company are not actually going to come to the meeting many like if if I'm a shareholder of Google I'm not going to fly out to San Francisco or mountaindale or whatever it is and uh and vote in the in the Google annual meeting I just don't have time and most shareholders are the same way so instead what shareholders can do is they can give somebody the authority to vote their shares and that is called a proxy so a proxy is an authorization given by the shareholders to a third party to vote that shareholders place the person who's being appointed is also sometimes known as a proxy in other words I give a proxy to my proxy and the proxy can then go ahead and vote whatever my Shares are very often you'll have proxy solicitations you'll get things in the mail and the mail will say you know we'd like to vote this particular director if you if you agree then send in this form and the form is is a proxy form it gives somebody the authority to vote your shares in a particular way a proxy has the name of the shareholder what the authorized vote is it could be yes or no to an issue or it could be unlimited discretion in other words you can give somebody the proxy saying you can vote whatever you like or you with my shares or you can give somebody a proxy saying you can vote but only if it's yes to question C proxies are usual okay sorry the default rules that the proxies are good for 11 months to cover only one annual meeting although they don't have to be that way it could be longer or shorter depending on what it says proxies are usually fully revocable which means if you change your mind if you give your proxy to somebody the meeting is on June 1st and you give your proxy to somebody on May 1st and now it's May 15th and you change your mind you can revoke your proxy there are a couple of exceptions number one if they're coupled with an interest which means there's consideration I gave my right to vote in exchange somebody paid me for my right to vote well if somebody pays me for my right to vote then it's a contract then a contract can't Simply Be can simply be withdrawn just like that also there could be a voting contract that can be specifically enforced there also could be a voting trust where a bunch of people rather than having to worry about proxies and rather than having to worry about voting individually they all pull their shares so now they've got a block of let's say a hundred thousand shares that they can vote and this way this is a way to become to gain more influence rather than having if one person with 10 shares which just doesn't doesn't matter that much well but all of a sudden if this voting trust controls a hundred thousand shares then all of a sudden its vote could mean a lot bigger it could make a much bigger difference okay what do shareholders why do shareholders own money well the reason of course I'm sorry why do they own shares of the company and the answer is because they want money they want their they want to get money from their from the company and how do they get money from the company well the first and most common way they do so is by getting dividends the board of directors declares how much will be given on a per share basis for example if there are a million shares and the company makes two million dollars of profits well the board can say okay we're taking that two million dollars and giving it out to our shareholders and therefore every person gets two dollars per share or they can say you know we made two million dollars we're going to keep one million in the company for future projects but we're gonna take the other million and give it out to our shareholders and then the shareholders get one dollar per share so in other words the board of directors decides when and how much to give as dividends to the shareholders of course the board of direct who wants to give more money to the shareholders because well it's the shareholders money but also because the shareholders will like them and more likely to vote for them on the other hand the board of directors might want to keep the money and for a rainy day or keep the money in case they in case they need it for whatever reason or to start new projects and so therefore the and of course the board of directors don't get to keep it personally it would be in the corporate bank accounts so this is just one of the decisions that directors have to make shareholders can also get money through a share repurchase plan which give up gives options to shareholders to sell their shares back to the company they don't have to have one of these but sometimes companies want to consolidate a little bit decrease the number of shares that are floating so they might announce saying anybody that wants to sell sell the stock back to the company you know will pay you 50 per share and if they do that and stockholders do that well then of course they give up their shares and they get the money there can also be a dissolution dividend which means if the company goes out of business and there's money sitting there that's left after all the creditors are paid well then that money whatever is left over is given to the shareholders because the shareholders are the ones that actually own the company and finally you have distribution of corporate property if the company has you know if it's a small company usually this is relevant to and the company goes out of business or the company stops operating for whatever reason and it's got the desk and it's got file cabinets and it's got physical plan inventory whatever it is that's distributed proportionally among the shareholders as well shareholders also have some rights in the company including the right of appraisal the right of appraisal essentially is where shareholders have a right to ask a court to make sure that a transaction that was done with their shares or their company really was fair and made sense so this applies whenever a corporation is dissolving or selling out to another company it's like merging being acquired declaring bankruptcy dissolving in other words something major even changing a class of stock that affects your voting rights you have a right to bring an action in court for the court to look over and make sure that you are not being treated unfairly the shareholder you have to have dissented from the action in other words if you voted in favor of the dissolution or if you voted in favor of the merger you can't then turn around later on and ask a court to make sure it's there because well you know you voted for it so you don't have the right to challenge it but so if you do that and you can bring an action in court if the court agrees with you that it's not fair the court can actually order the company to change whatever policy was being challenged how does a company make that how does a court make that determination how does a company make a determination as to whether a particular transaction is fair and of course the right of appraisal will be to try to make this determination as to whether something is fair value well you have to look at a whole bunch of things again here we're talking about a merger we're talking about selling to another company we're really talking about a whole a whole variety of different types of of actions that could be ripe for appraisal you have to look at the public price of a stock at the time of the transaction and during you know during the preceding time if the company was being sold out for fifty dollars a share and the company's share prices now 48 but it's been 60 or 70 for the last three or four years well then a court might say that this price that was being sold at Now is really too low you have to look at the price of the stock as paid by the purchasing company any competing bids before the company sells out and merges uh you know was there a better option that the company should have taken advantage of a professional evaluation of the value of the company and it shares value of the assets transferred in other words if the company was being bought and let's say it's an airline and there's value in the airplanes in the airport slots that has to be included in this appraisal as to whether it's fair the value of any shares that was being transferred the overall economic health of the firm in other words a court will look into all of these things before making a determination as to whether a proposed transaction was fair okay so next thing is we discussed many times that there is a limited liability when you're talking about a shareholder a shareholder is not liable personally for corporate debts there are some exceptions to that and that's what I want to discuss now and that is sometimes known as piercing the corporate veil piercing the corporate veil is when the court says even though it's a corporation you are still personally liable for the company debts now that's not the normal case the normal case is that there is limited liability but piercing the corporate veil can happen when a court says that shareholders are personally liable for corporate debts here are a couple of examples of when that happens number one is the alter ego rule the alter ego rule is when the court thinks that this Corporation is really just a sham and the corporation really is just the shareholder now this is not going to be relevant in a publicly held company but if you have a private company with only one or two shareholders and the one or two shareholders don't you know really observe the corporate formalities and they do everything behind the company and they just you think that the only reason why they they they formed the cut they formed the corporation is to limit their liability then a court can eliminate or ignore the corporation uh really if the entire driving force behind the corporation was a single or small group of people and the purpose of forming the corporation was just to limit liability and there was some sort of illegal or wrongful conduct if the conduct was legitimate then you're probably not going to have the alter ego be be implied but also you know was there co-mingling of Assets in other words did the person use One bank account for his own assets in One bank account for the corporations assets well that's more of a reason to keep the corporation on the other hand if everything was just commingled into one person's bank account the court might say this was really a joke the corporate formalities were not respected generally speaking if you want the liability shield and you run a comp Corporation keep the formalities you know make sure you have meetings of the annual minutes of the annual meetings make sure that you do everything by the book make sure you issue shares properly make sure you keep separate bank accounts make sure you keep separate books pretty much make sure you do everything separately from yourself also incorporation can be ignored if the corporation is used to hide room collectivity if you have a crime or fraud committed by an officer director or shareholder in the name of the company for his or her own benefit the court can say you are personally liable for the results of that and eliminate the corporate liability Shield then there are a couple of other scenarios in which the core the shareholder can be liable again 99.9 of the time the corporate shareholder is not going to be liable for corporate debts but here are some examples if it's a close corporation in other words if it's not publicly held there are some states there are some rules saying that they that the shareholders the owners are liable for employees wages in other words if the company didn't pay the employees wages then the individual shareholders have to this is a rule to try to make sure that the employees get paid it's not fair if they if the employees work and then they don't get paid then the shareholders say well you know yeah it's it's a debt of the corporation but the corporation is going out of business and you know nobody has to pay it so some states say the shareholders in a close corporation are personally responsible for the debts that are owed to employees also or if there's an interested or fraudulent transaction interested means when the corporation and the director do business with each other directly again as we discussed before that's a breach of the responsibility of loyalty as well there is also um if for an open Corporation in other words for a corporation that's publicly held then the liability of the shareholder would be to give back a dividend that was given improperly a dividend can only be of corporate profits if the company has no profits the company's insolvent the company doesn't have money it's not allowed to give out a dividend and if it does give out a dividend then the shareholder has to pay it back and finally this is an idea of watered stock what are stock means if a person receives stock from the corporation for less than its fair value because the directors wants to give the person a gift or there was some kind of a kickback going on or whatever it is then it has to repay the company for the reasonable value of the discount that it got because a publicly publicly traded company is not allowed to play favorites a publicly traded company is not allowed to give certain people one price and other people other prices the Securities rules say you pretty much have to treat everybody equally and if you don't you're going to have this watered stock concept now we turn to the idea of what can a corporate shareholder do if there's a problem with the way that the corporation is being operated by the shareholders or by the directors or officers and the answer is they can bring what is called a shareholder derivative action there's actually a special section in the federal rules of civil procedure rule 23.1 that discussed this idea of the shareholder derivative action and the shareholder derivative action is brought by the shareholders when they want to hold directors responsible for actions that hurt the corporation now the problem with suing the directors is that the corporation can't really sue the directors because the directors are the people that make the decision as to whether the corporation sues so if the corporation wants to sue the directors in essence they would be suing themselves which doesn't really make any sense so therefore the shareholders can sue on behalf of the corporation the shareholders on behalf of the corporation file a lawsuit against the directors and the corporation so really the corporation is both the plaintiff and the defendant which is kind of weird and that's why they had to make a special rule to establish this unique circumstance so there are there is a procedure in this respect when you're talking about a general derivative action first the plaintiff has to Clinton has to make a claim make a complaint to the board give them time to fix it if there are disinterested directors in other words directors that are not being sued there could be nine directors on the board and only two of them are being sued well then the other seven will study the merits of the lawsuit to see whether that's a good idea to to allow it to go forward uh if the if the rest of the directors think that the suit should go forward against these bad directors against these Rogue directors well then they can adopt the lawsuit on behalf of the company otherwise it could simply be this you can just let the shareholders continue to press forward the action on behalf of the company So eventually it will go to court and the court will make a determination as to whether there is Merit in the cause of action and if there is then the court will compensate the shareholders who brought the suit in the first place and order whatever helpful action is necessary then we have this fiduciary duty of loyalty we already discussed this so I'm not going to discuss it in too much detail just like with the partnership just like with an LLC this Duty requires the officers and directors to put the interests of the corporation above their own Financial interests and the way you go against that and we've discussed this many times so again I'm not going to discuss it in too much detail take a corporate opportunity for yourself as one way to violate the breach of Duty of loyalty to start a competing Venture in other words go into competition with your own company and engaging in an interested director transaction which means something between you and the company and if there is a breach of the duty of loyalty a court can set aside a transaction undo a transaction establish a constructive trust in other words take the profits and hold those profits that were made by this wrongful transaction for the rest of the shareholders and can even hold the director officer liable for damages if the company was damaged lesson nine is mergers Acquisitions and hostile takeovers this is where two companies merge into one company one company takes over another company whether voluntarily or believe it or not involuntarily so a merger is simply two or more corporations combining into form into one single Corporation when AOL and Time Warner merged and became AOL Time Warner that was a merger where in acquisition is when one company buys out another company so that only one company now exists when Facebook purchased WhatsApp well the whole thing became part of Facebook although the app is still called WhatsApp but still that was an acquisition the difference is really just formality the only one major difference is that when you're talking about a merger in other words both of them essentially don't survive become one hybrid company the shareholders of both companies have to approve before the merger is actually done whereas in an acquisition when one company is taking over another company the buying company doesn't need to put it to a shareholder vote but the recipient company the selling Company the company that is going to no longer exist does need to put it to a shareholder vote in order for it to be allowed a short form merger on the other hand which doesn't require the approval of either company in terms of its shareholders obviously the management has to consent to it is when one company that already owns a lot of another company that already owned let's say 80 or 90 percent of the subsidiary company just takes it over entirely that is called a short form merger in these cases and when whether we're talking this is a short form merger or a merger or an acquisition the company that is surviving whichever company that is the purchasing company the new company and a merger the parents company in a short form merger the parent company takes all the debts rights and responsibilities and obligations of both companies in other words if there's a merger then whatever contracts each company had now become the sole responsibility of the surviving company other important things regarding corporations include something like a share exchange a share exchange is a method by which companies are very often paid for if Facebook wants to buy WhatsApp for example for 19 billion dollars well people don't usually have 19 billion dollars in cash even companies even major companies don't usually have 19 billion dollars in cash Apple might be one exception but uh virtually all companies in the world don't have that kind of cash when there's a merger and a company needs billions of dollars it doesn't usually go to the bank and or write a check or anything like that instead the way it pays for the new company is it gives the old shareholders the shareholders of The Old Company stock in the new company for example if WhatsApp was let's say they were was being what for 19 billion dollars what Facebook did I'm sure is it gave the owners of WhatsApp 19 billion dollars worth of Facebook stock they didn't actually give 19 billion dollars in cash if they're both publicly held companies if you know when American Airlines and U.S air emerged or when two other big companies merge rather than the the individual shareholders of each company getting cash for whatever stock is being purchased by the parent company instead they get stock in the new company people who own stock and U.S Airways instead just got American Airline shares that were worth the amount of whatever the purchase was dissolution on the other hand is when a company simply stops operating if the company does start operate any kind of a company publicly held or not does stop operating so whatever is left whatever assets there are that could be inventory it could be Goodwill it could be intellectual property it could be pretty much anything is used to pay whatever creditors and the rest if there are and it'll if there is any money left over then those are used as dividends as the solution dividends the solution Dividends are dividends that are paid off to the shareholders after the company stops operating a consolidation very similar to a merger occurs when two or more common corporations combine to form an entirely new Corporation and in this case the Articles of Incorporation of the new Corporation replace the Articles of Incorporation of the two old corporations essentially a merger in a consolidation are pretty much the same thing and as we discussed before an ordinary merger or a share exchange requires the vote of both sets of shareholders it requires originally the recommendation of the board of directors of each company because any major company any major undertaking of a company first is going to be decided by the board of directors and the board of directors will make a recommendation to the shareholders to up to adopt it but the shareholders have to vote by majority vote and usually this is done through a process of of proxy proxy system where you know voters don't actually come and vote particularly but they give they give people their proxies to vote to you know to uphold to uh approve the merger let's say and when that happens then the acquisition or the merger the consolidation whatever it is can take place so you need an affirmative the affirmative vote Yes vote in other words of the majority of the shares of the new of the new Corporation if the merger is approved or if the consolidation is approved so the articles of merger or the share exchange are filed with the secretary of state and now instead of two corporations of that state it is now one Corporation of that states there's also the purchase of all assets the purchase of all assets occurs when a company instead of merging and buying the company instead of actually purchasing the company itself it simply purchases the company's assets purchase the company's inventory if I want to buy an airline for example I can buy the airline or I can buy all the airlines airplanes and all of the Airlines pilot contracts and all the airplanes airport slots and whatever other assets there are instead of actually buying the company now the advantage of this is that you don't have to take on the contracts if there's an error airline that has all sorts of debts well if I buy the airline I'm going to take on those debts but on the other hand if I just buy the airplanes and I just buy the or by the airport support slots or the fuel or the hangers or whatever else the airline owes well that I'm not buying the whole company and therefore I'm not buying the debt as well now a court can look at a transaction and say this was really a merger and you're just phrasing it as a purchase of assets in order to avoid taking on the debts and in that case the court can actually say this is more like a merger and we're going to hold you liable for debts but that's that doesn't always happen sometimes if you have a company that has a lot of debts or has bad contracts you may just want to buy their assets rather than buying the entire company the next subject is of course relevant to mergers and Acquisitions and that is the Hostile takeover now owing to the nature of a publicly traded business it is possible to take over a company even though the board of directors doesn't want you to of course that's not possible when you're talking about a private company when you're talking about a private company unless the government steps in and requires it for some reason you can't buy the company unless the owners are willing to sell but because of the fact that when you're talking about a public company it's not really owned by the directors the directors are just kind of in charge of it it is possible to take over a company without the consent of the board of directors and that is called a hostile takeover so this occurs when a person or group wants to take over a company without the consent of the board of the target Corporation now there will be many different possibilities as to when that might happen one possibility is the company isn't doing is isn't doing that well the company has more inherent value but the stock price is low because of mismanagement and so other companies look at it and say hmm you know if we buy that cheap if we buy that for you know not as much money because it's not doing so well maybe we'll turn it around and we'll be able to to you know buy it for cheap and then then make more money also corporations with lock Style with large stockpiles of cash are attractive takeover can take over targets sometimes companies want to invest but they don't have the money now they don't have the cash now one thing they could do is they could sell you know they could float more shares they could take out loans they could issue bonds but these are all complex and they might not want to so that but they also might look around for other companies with cash a company might be worth a hundred billion dollars and see another company worth only 10 billion and say yeah but that company with 10 that's worth 10 billion dollars has 2 billion in the bank so let's go take over that company and then we'll take that two billion dollars and be able to use it towards our infrastructure projects whereas we even though we're worth 100 billion might not have 2 billion in cash assets so those are different reasons why there might be a hostile Takeover in the first place now in terms of terms of a policy reason to allow hostile takeovers why doesn't the government just say this is not fair and then we shouldn't allow hostile takeovers well there are a few good reasons number one the threat of a takeover leads keeps Management in line if the directors know that if they don't do a good job with the company other companies are going to take them over and probably once there's a hostile takeover they're going to get rid of the board of directors and get a new a new board and they're and they're going to lose income that that's a that's a good reason for them to try to keep their company competitive also for the and by the same token a hostile takeover and a merger causes a little bit more efficiency maybe they'll uh you know decrease the number of higher management because now there's less to manage so those are the pros but that of course is the other side of the coin is the people the managers who are you those managers or some Managers from may lose their job because if you have two companies and they merge into one there's a lot of duplication that they might be able to get rid of so it can lead to layoffs the battle can be costly in terms of the Hostile takeover battle that we'll discuss shortly it's often executed by greedy corporate Raiders who don't care that much about the company's business but they just want to make a profit basically corporate Raiders people who make money doing this can buy companies and then turn around and sell the stock for more especially if they know how to manipulate the market there were some movies like Wall Street that were you know based on corporate Raiders and they were real life corporate Raiders too and they also this idea of green mail green mail essentially is when a corporate Raider starts to take over a company and buys up some stock and starts the process of a hostile takeover and then the board of directors is so desperate to get rid of them and keep their jobs that they agree to pay the corporate reader more value than than the you know and in order just in order to make the have the corporator go away like for example if the corporator buys a million dollars worth of stock and is threatening a hostile takeover they might pay the corporate Raider two million dollars just reader will stop they call that green mail nothing inherently illegal about it but it's just not really the most efficient thing for a company to have to spend its operating money on on getting rid of of corporate Raiders so how do you go about doing this how do you go about in enacting a hostile takeover against the company doesn't want to be taken over well one thing you can do is you can just simply buy the company buy a controlling block it could you know it could be 51 percent of the company certainly is a controlling luck but even without 51 you can buy enough to effectively be able to control the company remember not everybody actually votes in these things so you don't actually need 51 percent of the company to control it you may be 30 or 35 percent so the point is you need a lot and this makes it not the most efficient way to enact a hostile takeover if the company's a very big company it takes a lot of money and also it requires all sorts of sort of SEC filings when you're buying so much stock of a single company and which means that when you're while you're doing this the directors will know what's going on and they may try to stop the Hostile takeover the other two possibilities number one is a proxy contest a proxy contest is probably the most common type then the proxy contest is where you go directly to the company shareholders you don't even deal with the board of directors necessarily you go to the company's shareholders and you use your advertising or whatever it is to try to convince them to uh to elect new a new board of directors that is friendly to you and then once your the board of directors is friendly to you once you become the board of directors then you can pretty much do what you want for the company it's much less expensive but also you don't have as much control it's not like you can just throw cash at it do you have to convince the shareholders to vote for you and they might or might not do so you can also do what's called a bear hug a bear hug is when you just offer so much money you know you make them an offer they can't refuse you of course if the stock is worth thirty dollars and you offer fifty dollars the offer might be so high that the board of directors might feel under tremendous pressure to accept it because if they don't accept it the shareholders may get very upset at them for not uh you know for for for costing them money by not taking it not taking a higher offer again the advantage of that is that it's not as contentious you don't have to you don't have to fight SEC filings you don't have to have a media campaign but on the other hand it's the most expensive you're going to end up paying more than you do if you try a proxy contest or or buying up the company yourself you're going to end up paying more per share part of that is what is called a tender off where a tender offer could be either one a tender offer is really part of the bear hug strategy of a hostile takeover it doesn't even have to be hostile a tender offer is an offer offer that's made uh to to acquire the target Corporation and you go directly to the shareholders essentially then this would have to be done through an advertising campaign where you tell the shareholders okay uh we're making this particular this this particular offer and I mean this is the basically the way it works in terms of a diagram the target Corporation is the one that you're trying to take over so rather than going to their board of directors and asking them to accept or asking them to recommend a merger instead you just go directly to the shareholders and see if the shareholders will sell you their shares of the company now these are regulated these are very heavily regulated by The Williams Act 1968 which is an amendment to the SEC acts and it requires certain disclosure requirements in other words if you're going to go directly to the shareholders you need to explain to them certain things about what the consequences of the merger will be because the fear is obviously that you'll just say well you're going to make all this money and the shareholders don't really fully understand and you know don't if you go to a board of directors well the board of directors are professional and they'll hire people that will do a due diligence and try to make sure that it's a good idea but on the other hand the shield if the shareholders might not be that sophisticated and so therefore there are more heavily regulated rules that apply to Tender offers than they do when then then there are when you go directly to the board of directors and there are some specific rules there's the fair price rule which well you can probably figure out what that says a rule that says any increase in price paid for uh paid for shares must be offered to all shareholders even if you previously even if like for example if you if you make a tender offer and then 10 of the shareholders sell to you and then you make another tender offer and you get another 10 percent uh if you increase the price between the two tender offers then the first series of recipients the first series of shareholders that sold out have to get the same price as the second the idea is he can't uh it wouldn't be fair to pay people just because they're more gullible to get them on the first because you get them on the first tender offers they they should lose out there's also the pro rata rule which says that shares must be purchased on a pro rata basis if they're tendered you can't buy just from some some shareholders if a person owns a thousand shareholders shares and another person owns 10 000 shares you have to buy them proportionally you can't uh a tender offer which goes again this it's not that you're not talking about buying individual shareholders that you can do without a tender offer that has something to do with it a tender offer is something that's open to all shareholders of a company so it has to be proportional it has to be fair and there are also anti-fraud Provisions that are relevant to Tender offers it prohibits fraudulent deceptive and manipulative practices and of course violations and it's beyond the scope of the course to go through the specifics of those kinds of rules but the point is there's very heavy regulation with regard to Tender offers and with regard to dealing directly with shareholders uh when you're talking about trying to take over a corporation now what can a board of directors that realizes or thinks it's about to be subject to a hostile takeover attempt too again we're talking about a bear hug we're talking about a proxy contest we're talking about a tender offer we're talking about the company trying to buy up shares these are all different methods of a hostile takeover and so what can the management of the board of directors of the target company do to try to prevent this because again you have to realize if once there is a merger they're probably going to lose their jobs and even if they don't it won't be their company anymore so one thing they can do is they can propose a plan of their own if it's a tender offer or if it's a proxy contest they can explain to the shareholders why the shareholders are better off leaving them in charge you know we're going to turn around the company doing XYZ they can also try to find a white knight which is an alternative buyer if they're worried about the corporate Raider or the purchaser being somebody that's bad for the company well they can try to find somebody else to step in that's more friendly to this board of directors and by the company instead that's a simple alternative to being taken over you instead of being taken over by somebody that's hostile you try to get somebody who's less hostile to take over to buy your company in the first place also stagger the board which many companies do instead of having every let's say there are nine directors instead of having them all nine elected every year say have three of them elected every every year so that it's harder to let's say for example get a proxy contest when you have to when you have to convince shareholders to vote for you in three different elections it's much harder to do that obviously than it is to do it all Do It All in One Direction in one election one other thing you can do is you can adopt what is called a poison pill a poison pill is kind of a strange mechanism somebody is if there's not there's no law about a poison fell some smart director thought of it at one point and what a poison pill essentially says as as the name indicates is that if you take over the company the company is going to be worthless and the way it does this is it says something like this it says if we get taken over then every shareholder has the right to buy shares at one cent each can buy you know a million shares at one cent each now if that actually comes to fruition and the the provision actually goes into effect well then the company's going to get destroyed because now the companies are the company's Shares are going to be worth one cent if the company shares were worth eighty dollars but there's a provision saying that if they get taken over now all of a sudden they can buy shares from the company worth for one cent well then the market value of those shares become one cent and once the market value of the shares is worth one cent the whole the whole thing becomes a joke and the company will fall apart so the the idea of that is to try to make sure that people don't is that is that they may you make sure that the corporate Raider or whoever is trying to enact the Hostile takeover doesn't actually commit the Takeover doesn't actually do the Takeover because if they do they're going to be destroying the company that they purchased very often this is done as leverage you know you don't want to do it you don't want to you don't want to be stuck with a poison you don't want to if you're if you're worried that somebody's going to take over your company you don't simply always want to resort to this tactic because then the shareholders will know that you're incompetent and you have to resort to these kinds of tactics in order to prevent a takeover and you don't want to do a good job managing the company uh so they'll probably vote you out of office and people won't invest in you if they if they think that you lack self-confidence to the extent that you have to do a poison pill so instead very often this will be kind of a negotiating tactic company will adopt a poison Bill a provision that says that if we get taken over all these rights Provisions kick in that are going to destroy the company but they can negotiate with the company trying to do a hostile takeover and if they come to an agreement well they can always rescind it just like a board of directors can adopt one of these shareholder rights Provisions that essentially is a poison bill it can also cancel it one time the the Dead Hand poison fill which courts which courts have not allowed uh is when the it was when a board of directors tried to enact a poison pill that only they could undo and the court said that's that's too much of a restriction so again it's a little beyond the scope of the course the course to go through in detail but the poison pill is a strategy by which you try to prevent a hostile takeover by causing the Takeover to trigger a shareholder rights provision that would make the company worthless if it actually establishes and here are some uh some other examples in terms of fighting a tender offer or fighting a hostile takeover I think some of this so you can try to persuade the shareholders that you're right you can file lawsuits for you can try to find ways to file lawsuits and tie the thing up in court you can sell a crown jewel in other words sell a good part of the company to make the company less valuable to make the person trying the Hostile takeover take pause you can adopt a poison pill we as we discussed you can find a white knight you can do a reverse tender offer where you try to buy the buy the remaining shares from the from the shareholders uh yourself rather than letting the the corporate Raider do it you can issue additional stock you can create an employee stock ownership plan and various other things you can pay off pay off the uh the the Hostile takeover wannabe and these are some of the things that we've discussed in terms of how you can fight a hostile takeover attempt next chapter is about Securities and securities regulation security essentially means something that is publicly traded in the open market usually a stock but it could also be something like a bond until 1929 Securities were pretty much unregulated which means pretty much anybody could sell any stock they wanted on the open market and there wasn't much in the way of government regulation and all that kind of led to the stock market crash of 1929 which led to the Great Depression uh until 1929 the stock market was doing very well throughout the 1920s the 20s were cold sometimes the Roaring Twenties because the economy was doing so well but a lot of that was based on a mirage a lot of that was based on the idea that these stocks were overvalued and people didn't realize how the underlying companies really were weren't worth as much because the companies didn't really have to provide any information and that all changed with the Securities rules that were passed in 1933 and 1934. these were called the SEC acts they created the Securities and exchanges commission the SEC and also provided a bunch of rules regarding how you can sell Securities in the open market how you can sell stocks the goal of the security rules is really about disclosure and accuracy disclosure in making sure potential investors including Banks mutual funds and individual investors know a lot about the information know a lot about the stock know a lot about the company before they actually decide to invest and number two that the information that is put out by the company is accurate the goals are to assure accuracy and completeness of information given to the public organize a system where there should be full disclosure of accounting information companies profits companies losses companies expenditures and to regulate forms in which Securities are exchanged in other words to try to avoid companies being worth more than they're actually worth because of bad information that is given to the public or because of a lack of information that's given to the public and these are administered by the SEC the SEC was first created in these acts of 1933 and 1934 and of course exists to this very day the SEC the Securities and Exchange Commission is a federal administrative agency run by the executive branch of the government that what it does is isn't it it excuse me enforces and administers Federal Securities rules it can adopt rules and regulations to interpret and Implement Federal Securities laws Federal Securities laws are fairly complex but the Securities that they govern in the entire stock market is almost infinitely more complex and so therefore the SEC has to make judgments on the Fly and pass regulations as many administrative agencies do to make sure that the goals of the Securities the Securities rules and to make sure that the uh enforcement is up to standard it can investigate Securities violations it can bring enforcement actions in other words it could bring actions against people who allegedly violated the Securities rules and it can also regulate activities of Securities Brokers and advisors so let's take a look a little bit more in terms of what securities are and a little bit in terms of details of the Securities rules we could spend whole courses on security so obviously we're not going to discuss in too much detail but we'll discuss kind of a brief overview a little bit of a survey of some of the Securities rules first of all in order for the Securities and exchanges commission act or the SEC act to apply it has to be a security that's the first thing so I guess the first thing you have to do is to find what a security is a security is any interest or instrument that is a common stock preferred stock a bond debenger or a warrant we discuss what bonds and debentures were those are debts of the company that are being sold to individuals when basically the an individual is lending money to the company a stock common stock or preferred stock is a share of the company's ownership and a warrant is really a right to buy a stock at a certain price within a certain period of time kind of like an option but well a little different uh we don't have to go into that in too much detail but the point is something like well you may have heard warrant in terms of a search warrant this is an entirely different type of Warrant a warrant may be a right to buy a particular stock at ten dollars anytime over the next year or something to that in fact very often they come with stocks when you buy a stock you may also buy a warrant depending on the company but that's essentially what a warrant is it can also be an interest or instrument that is expressly mentioned in the Securities act or it's an investment contract these are all examples of Securities that are regulated by the SEC acts and the SEC so the Securities Act of 1933 regulates the issuance of these securities and what it says is that when you're going to issue a security in other words when you're going to start selling things in an open market you don't have to worry about the SEC you don't have to worry about the Securities rules feared as a private company you have to worry about other rules of course but you don't have to worry about Securities rules because you're not being sold on the open market if I on the other hand have a private company and I want to start issuing these shares to the public and and they the issuing these Securities to the public well then I have to start worrying about Securities rules that's because Section 5 of the ACT says that Securities that are offered to the public through use of males or any facility in interstate commerce which of course in today's day and age includes computers and includes the internet includes pretty much anything you can think of Because the Internet does go in interstate commerce when the Act of 1933 uh was originally passed as hopefully you can understand there was no internet so they couldn't really discuss the internet in 1933 but the point is you do have to register with the SEC before you issue any of these Securities to the public and the way you do that is through a registration statement a registration statement is filed with the SEC it contains information about the Securities to be issued and what the SEC is looking for is not whether it's a good stock it's not whether people should buy it or anything to that effect that's the sort of thing that the individuals will decide so that's not the sort of thing the SEC really worries about what the SEC does worry about is whether the this whether the issuer has met the disclosure requirements in other words that the issuer the seller has to establish that the that the securities disclosure requirements statements that are required to be made to the public are actually done then you have what is called the offering process sometimes referred to as the IPO process or initial public offering process and the way this is if I have a company and I want to start issuing shares in public like Facebook did a few years ago like many of the big companies have done they are originally private companies that are held by a couple of few individuals and now all of a sudden they want to start selling stock on the open market in order to make a lot of money and very often these companies do make a lot of money hundreds of millions or even billions of dollars by selling stock so there's a process now it's a complicated process it may cost you know 10 million dollars in legal fees and in the fees of investment Banks who actually set up the offering process but if you're going to make a 200 million dollars or a billion dollars then it may be worth it to spend 10 10 million dollars to uh you know to law firms and investment Banks to help set up this process so the process is first of all disclosure which is a full and complete disclosure of all sorts of information to the SEC and to the public of the company's finances business prospects in the future and the organization of the business it requires that the company get its books in order and make sure the account thing is up to date through a whole series of complex rules that govern Securities and once do so it does so it can go public and it has to issue what is called a prospectus the initial public offering is the process by which the stock or the security is originally offered to the public and they have to create a prospectus now if you've ever invested or ever seen a company that was invested you may have heard of this prospectus if prospectus is usually a long document and the document gives all the disclosures sometimes these companies will say read the perspectives carefully before you invest now most people don't actually read the perspectives carefully before they invest but the point is this information is there and it's one thing if you're going to invest a couple of thousand dollars you're probably not going to bother to spend five hours reading the prospectus but if you're a mutual fund manager and you're thinking of investing you know 25 million dollars in the company well then there's more of a reason to read the perspectives carefully before they invest and this contains all of the information that is necessary it has to be looked at it has to first of all it has disclosures explains how the company is organized gives investors information it has to be approved read and approved by the SEC the SEC hires people that sits there sit there and read prospectuses to try to make sure everything is appropriate and everything is disclosed and everything is discussed and in perspect this is a disclosure a prospectus is not an advertisement it's not trying to it's not to try to condition the market the ideas of prospectus is too much of an advertisement if it's trying to be an infomercial if you're trying to sell the company in the prospectus well the SEC might say you know re-rewrite this paragraph uh don't write about how great you are that's not the purpose of a perspective so if you want to run a commercial or if you want to advertise you know you can go ahead and do that but that's not the place of the prospectus the place of the prospectus is to explain to the public what is going on there is one section called the Management's discussion analysis where the management is allowed to speculate a little bit as to the prospects of the future but it can't be too much like an advertisement or the SEC is going to make you rewrite that paragraph so let's go and continue with our discussion of the IPO you got the issuance this is once the SEC sees the prospectus and sees your plan for an issuance and it gives the approval the corporation or its Investment Bank that's when Investment Bank is very often that's the service they provide if if you're a company you probably don't have the ability to Market things to the public because you just don't have the mechanism by which you're going to be able to sell things to the public so you go to an investment Bank it might be Solomon Brothers or you know Merrill Lynch or something like you know Goldman Sachs something to that effect and they take care of it for you they will I don't know if they'll help you write the perspectives I think that's really the job of the law firm that you hire to comply with the SEC rules but once the prospectus is written and everything is ready to go the investment bank will then set the initial price and start selling things to the public and then we've got the next stage next stage you start with the pre-filing period Then you have to wait forever for the approvals and then the post-effective period let's look at these one at a time you've got the pre-filing period this is when the issuer contemplates Securities offering Securities and ends when the registration statement is filed with the SEC now this is really the initial stage you're still kind of looking into it you're talking to the lawyers you might not even be dealing with the investment Banks yet you know you might be considering hiring them but yet the lawyers are probably drafting up the prospectus and making a determination of whether it's worth it to sell these things on the open markets during this period you can't sell because you haven't gotten approval from the SEC yet you cannot condition the market you can't in other words tell everybody in the market that this great new stock is coming because the SEC hasn't given you permission to sell this thing or to advertise this thing and so to start advertising it would be jumping the gun and would be premature and would be the sort of thing the SEC would frown upon because it's against the law and you can't even engage in a public relations campaign to pump the value of the stock then you've got the waiting period this is when the registration papers have actually been filed with the SEC and now it's kind of a matter of time before everything is it gets final approval to actually issue these things in the open market at this time you can start advertising you can condition the market you can distribute the prospectus and then finally when you're ready to go this is when the the post-effective period this is when the registration actually becomes effective and the Securities can now be traded on the open market during this time of course and you can run ads you can see this term over here Tombstone now that just you know generally means a relatively simple newspaper or magazine ad you can run other types of ads too you can edit pretty much you can write in you can advertise however you like as long as you don't say false things and as long as the prospectus itself doesn't condition the market your other advertising can of course I mean whenever you're trying to sell something whenever you're trying to say this security is a great security well you can advertise and you can build up and you can try to condition the market all you like because now you're actually selling the stock and selling stock that should have been registered with the SEC and was not was that is actually a crime there's criminal penalties and any investors in other words if you float this stock to the to the public without getting security without getting permission of the SEC without filing the appropriate documents then not only can the investors sue for their money back the person who did it can be subjected to criminal penalties somebody who does and this this applies pretty much for other Securities regulations as well if there is a violation of the SEC Act of 1933 that imposes civil liability which means somebody that was victimized by this failure who purchased the stock or who lost the money in a transaction they can file lawsuits and this applies whether they actually bought stock that shouldn't have been issued or whether the stock should have been issued and was issued properly but there was material information that was missing from the prospectus any of these circumstances allows a lawsuit allows a cause cause of action the SEC itself can also enforce Securities rules as we discussed before it can issue a consent order in other words it can order a company to Rectify certain Behavior adding things to the prospectus stopping to sell certain securities whatever remedy they want now the SEC in and of itself cannot actually force a company to do something because the SEC is not a court it's an administrative agency but what it can do it can order somebody to stop and then if they don't they can bring an action for an injunction or they can ask for other relief and like I said before the Department of Justice which is also a federal and federal uh agency can bring criminal prosecution against people who violate Securities rules and now I want to focus a little bit more on some of the minutia of the Securities rules that was kind of an overview and let's take a look at some of the most important and some of the most commonly discussed types of Securities rules first of all over here we've got rule 144a which is trying to increase the liquidity which means the ability to buy and sell easily of registered Securities and this permits qualified institutional investors to buy even unregistered Securities without the holding period necessary based on the idea assuming these Securities will eventually be allowed to so to be sold to the public some institutional investors don't necessarily need the same kinds of protections as ordinary investors would they go in there with their eyes open much more and so therefore the rules are a little bit more relaxed regarding some of them some Securities are exempt from registration and don't have to go through this long onerous and expensive process this includes securities issued by any government in the United States such as state bonds Federal bonds things like that short-term notes that have a majority of a maturity that doesn't exceed nine months in other words if I want to sell short-term Deb insurance or short-term bonds that are only three months long I don't have to go through the whole process securities issued by non-profit issuers like Charities organizations if they want to sell a uh a certain security or like usually bonds or Securities of financial institutions that are regulated by the appropriate banking Authorities on the idea that you know let's say A bank's stock they are regulated anyway so there's no need to increase the second level of Regulation regarding the securities other examples include securities issued by Common carriers these include certain things like railroads and utilities and the reason for this is that they are in any case regulated by the Interstate Commerce Commission so again for the same reason regarding issues of the bank Securities the we don't want the SEC to overly burden a particular industry so if they're already being regulated by another industry by another Watchdog group anyway there's no point in doubling the regulation insurance and annuity contracts by insurance companies again they're also very heavily regulated by insurance laws stock dividends and stock splits and securities issued where One Security is exchanged for another security these things were already seven and eight were already covered by the SEC they were when they were originally sold to the open market they had to go through the entire IPO process so again just because they split their stock and split stock usually means they they divide off one stock into two stocks and they're worth less or they do a reverse split where two stocks are are combined into one stock and they're very various price reasons why they do that that we don't really need to get into right now basically if they get too expensive the stock goes too high very often they'll split if it gets too low very often they'll do a reverse split but either way you don't have to go through the whole process again the first part of the lesson dealt with the SEC Act of 1933 which was mainly about the offering process in other words how companies were able to actually start offering their Securities and the Open Market in the first place now we're going to shift gears a little bit and move to the Securities and exchanges Act of 1934 which regulates the actual trading of the Securities it regulates the Securities exchanges themselves Brokers and dealers who sell and buy insecurities and of course it calls for civil and or criminal liability for anybody who violates these SEC rules and we're going to discuss a few of these selected rules and the first one probably the most all-encompassing one is Rule 10B of the Securities and exchanges Act of 1934 which prohibits the use of dis manipulative and deceptive devices in the purchase and sale of Securities and contravention of the rules and regulations this is extremely complex it may seem pretty simple that you're not allowed to be manipulative you're not allowed to be deceptive but those terms are extremely vague and extremely Broad and there are tons there's Reams and reams of regulations SEC opinions in case law on exactly what it means to be a manipulative and deceptive advice and we're going to discuss some specific underlying rules that are passed based on this rule 10B remember rule 10B is a statute it's part of the SEC Act of 1934 that is currently in the United States code and then there are regulations regulations under the secx which are passed by the Securities and exchanges commissions which are packed by passed by the SEC since it has the authority to pass regulations under the Securities rules and we're going to discuss some of those and specifically we're going to look at rule 10b5 rule 10 B5 is a regulation not a statute in other words it was actually written by the SEC but it is completely enforceable nonetheless and what it does what the rule can be what 10b5 does is it prohibits insider trading insider trading is well it's prove it's more than insider trading but let's focus on insider trading for a minute insider trading means when an Insider makes a profit by personally purchasing the shares of a corporation prior to the release of favorable information or by selling shares of the corporation prior to disclosure of unfavorable information a the proper price for a security would be it wouldn't be fair essentially for somebody with Insider knowledge of what's going on with the company to leverage that inside knowledge in order to make trades ahead of the open market if I work for a big company and the company's stock value is trading in fifty dollars a share and I know that we're about to announce a major acquisition that's going to cause the stock price to go up and I turn around and buy the stock beforehand well then I'm getting an unfair leg up on the market I'm getting an unfair advantage over other people who would be considering investing in the security because I have an information I have Insider information which allows me to know information that the General market doesn't so that's considered not fair and that is considered insider trading under rule 10 B5 of the regulations that are passed under rule 10B of the Securities rules first of all what is an Insider well an Insider is somebody who essentially works for the company an officer director or employee of the company a lawyer accountant or consultant or somebody who is hired by the company to work for the company and therefore gets this information and or somebody who owes a fiduciary duty to the company somebody who maybe is an independent contractor working with the company and auditor for the company somebody who had by virtue of their relationship to the company has some sort of inside knowledge that the open market does not have access to yet and this can also lead to two quote unquote Tipper and Tippy liability a tip is in this context an illegal piece of information that is given from by somebody that has Insider knowledge to somebody else the Tipper is the person who discloses material non-public information and the tippee is someone who receives material non-public information a while back many years ago but but still a while back Martha Stewart who was famous for having these cooking shows on TV and whatnot she actually got arrested and she actually spent some time in prison for insider trading she was a tippee the allegation which which eventually was proven then she was convicted was that somebody gave her somebody with Insider knowledge gave her information because of that a company called inclone which she held stock in was going to announce something negative and because of that she got out ahead of the market and sold sold her stock it wasn't for that much I mean it was for I think about forty thousand dollars which is a lot of money but to Martha Stewart who's a multi-multi-millionaire it's really not as much money but still regardless of how much money you have you're still not allowed to make a profit based on inside information and because she was able to sell because she got a tip this was considered insider trading and she was actually sent to jail for a few months because of it if somebody does violate the SEC Act of 1934 and we discussed insider trading but there are many other rules that are also prohibited many other actions that are also prohibited by the X by the SEC Act of 1934 there are various remedies that are possible there are private actions in other words people other investors or people who were hurt by this person who used Insider information or used manipulative or fraudulent tactics can file a lawsuit for whatever damages they suffered and there are all sorts of other remedies a court can enforce the SEC can enforce with a consent order as we discussed before they can order somebody to do something they can get an injunction which is a court ordering somebody to let's say not make a trade seek a court order insider trading sanctions or even criminal penalties and there are also these treble damages three times profits which are really separate from Criminal penalties so I'm going to separate them over here but treble damages is something that people can be liable for if they violate the SEC Act of 1934 which essentially means they have to pay three times the value it's a special penalty that's established based on that there's also criminal liability as we discussed before and under a much more recent rule called the sarbanus-oxley ACT this was passed in I believe 2002 individuals can be fined up to five billion dollars and imprisoned by up to 25 years where corporations can be fined as well for violations that constitute violations of the SEC Act of 1934. now sarbanus Oxley or Starbucks as it's called expanded government regulation of Securities but one of the things it did is it provided for these sorts of criminal penalties a similar rule to insider trading really a rule that's made to back up the insider trading rule is Rule 16a which is the short swing profit rule the short swing profit rule is something that essentially allows the governments to deny somebody profits who may have had Insider information even if it cannot actually be proven that they did so this this rule 16a defines any person whose executive officer or director or 10 shareholder as an Insider and what it says is that if one of these insiders makes a transaction of the company stock within six months of a uh of some something that causes a fluctuation in the stock then essentially they have to give back their profits to the company this is one of those things where even if you can't prove that they actually knew any information the suspicion you know if they they made some sort of a major deal uh and the company stock goes up and an Insider had bought shares three months ago and then they turn around and sell them well then they basically have to give back their profits to the company it's a mechanism by which you don't sometimes you just simply can't prove that they had Insider information you can't prove that they engage in insider trading but in order to prevent that possibility the law says that you can't even we're not even going to allow you to make profits within the short term because the suspicion is too high that you may have secretly had information that caused you to profit on the expense of the other investors there are even States Securities rules State Securities rules have uh are not as comprehensive as Federal Securities rules but they can increase the requirements of various companies in terms of the disclosures that they give to the investing public but again generally speaking because the Securities markets are traded in interstate commerce and are very comprehensively involved in interstate commerce you're mostly talking about federal law when you talk about Securities regulations and finally I want to quickly go over the Securities markets now a company that is traded in public doesn't necessarily have to be traded on the market could be traded over the counter which is done privately and without an exchange but what an exchange is it is a place or an online place that facilitates the easy transfer of shares these Securities exchanges are very heavily regulated by the SEC and have to be proven by the SEC to allow people to exchange and to trade in their markets some examples include the New York Stock Exchange the American Stock Exchange the NASDAQ or the National Association of Securities dealers automated quotation these are all things that in the old days were actually done physically at least not not the NASDAQ but the New York Stock Exchange in the old days if you wanted I guess in the old old days if you wanted to have if you had 100 shares of Coca-Cola that you wanted to sell you'd go down you'd have to tell a broker or somebody who had a seat on the New York Stock Exchange would come out onto the floor and say I have 100 shares of Coca-Cola anybody want to buy it and then somebody from across the room would say yeah I want to buy it and that's basically the way it would work now today everything is more automated you don't have to I don't I don't I guess people they still do yell on the on the floor of the stock exchange if you go for a tour you can actually look down on the floor of the stock exchange during the day and people are still yelling I don't know exactly what they're yelling about since everything can be done by computer but I guess they figure out a way to yell anyway reason to yell anyway but the point is these are methods by which these which which stocks are traded Now Stocks can be traded without it without an exchange but it's a lot easier in the market is much uh you know it's much more comprehensive when you're trading on an exchange than when you're trading over the counter and the end of our course the last couple of lessons is a foray into a new area of employment rules obviously employment rules are very heavily related to Business Law And even though it doesn't really necessarily it's not really necessarily about business organizations as we've been discussing until now uh because of the fact that people who are in business and people who are practicing business law have to deal with employment law a lot we figured we'd append it to the end of this course and make it a component of this course and we're going to discuss employment law in two basic chapters two basic lessons the first one will briefly go over some of the basics of employment and then we'll discuss some of the concepts of employee benefits of what employees get in exchange for their work and then we are going to discuss employment discrimination a little bit later on first of all we've got the concept of an at-will employee in many states an employee unless stated otherwise unless the employee has a contract is inherently considered an at-will employee which means the person is only there as long as the company wants to once the person hired an employer in a net will state or you know if there's no if there's no contract that says otherwise can fire an employee at any moment really for any reason so this is an employee an at will employee somebody who does not have an employment contract and that person can generally be fired however there are some times or some reasons that you are not allowed to fire somebody and we'll discuss that more when we discuss discrimination but there are discriminatory reasons you're not allowed to fire somebody there are reasons for example you can't fire someone because they went and joined a labor union you can't fire someone because they're a whistleblower there are many rules that will briefly cover a little bit later on in the next lesson that are relevant to why an important employee cannot be fired however the default Rule and the thing that's important to realize is that a person can be fired at any time for pretty much any reason as long as that reason is not contrary to law you don't necessarily have to have established that somebody did a bad job although it always helps if the person sues you for discrimination than having evidence the person did a bad job is certainly something that may help help with that there are some exceptions there are statutory exceptions in other words there are laws that say that you can't be fired for reason XYZ there are contract exception exceptions in other words you might have made an agreement with the company to be there for a certain number of years or to be there for a certain number of months or that you wouldn't be fired without cause there could be toward exceptions where the employer is doing something to damage you and there could be public policy exceptions where a court can say we think that in for the good of the public policy we really ought to prevent people from being fired based on this particular reason okay let's switch gears a little bit over here and now I want to discuss some things regarding employee benefits and the first employee benefit I want to discuss is workers compensation workers compensation Acts were based on the idea back in the old days back in the late 1800s early 1900s if somebody got injured on the job they were in the factory and they worked 12 hours a day and they they took home enough for their family to survive and then one day they got injured by a machine at work and then they can't couldn't work and then they were home and their family starved well when they started to make labor laws they realized that wasn't a very good system so states have established workers compensation routines networkers compensation is a state issue so it does vary from state to state the state you're in will may be very different from somebody else's state in terms of its workers compensation plan but all states have at least some element that protects people to protect people who get hurt on the job so and these people are the people who get hurt on the job are paid according to preset limits established by the state statutes or by regulation of a state administrative agency the way workers compensation Works fundamentally is that states require employers to pay for Workers Compensation Insurance now that may vary obviously if uh if you're a skydiver you're probably going to have to pay more for premiums and Workers Compensation Insurance than if you're a desk clerk because skydiving is a little bit more dangerous than sitting there at a desk and and answering telephone calls but uh P employers are required to purchase workers compensation from an appropriate agency that uh you know that will pay out if the employer gets into the employee gets injured so the then the employee if the employee gets hurt then the employee will be able to collect Workers Compensation Insurance money so to recover the Workers Compensation Insurance the workers injuries have to have been employment related and stress and you know just because it doesn't mean that a brick has to fall in your head something like stress carpal tunnel syndrome even migraine headaches or things like that that are caused based on the fact that people are sitting there are keyboards and staring at their screen for nine hours a day could be considered valid reasons for Workers Compensation Insurance to kick in once that happens then of course the insurance company has to pay premiums to the to the worker for when the worker can't work ERS compensation however is an exclusive remedy which means if the worker gets injured migraine headache carpal tunnel syndrome a brick fell on the worker's head whatever it is they can't sue their employer separately because if they could sue their employer separately essentially they would be double dipping their workers compensation rules let's say if you get injured you get this amount of salary for the amount of time that you can't work because you're hurt because you're on the Shelf you get you get paid still but you can't sue separately except where the employer intentionally injures the employee when you're talking about an intentional tort will workers compensation insurance doesn't cover that Workers Compensation Insurance is meant to be innocent injuries even even negligent injuries perhaps but it's not really a matter of Fault by the way it doesn't if the if it's the employer's fault or the employees for the employees full it doesn't really matter that much in most cases when you're talking about Workers Compensation Insurance it's like automobile insurance now the premiums might go up if it's your fault whatever it is but automobile insurance where you get paid for by your insurance company if you get into an accident even if it was your fault because that's the whole purpose of it it's statutorily mandated and it's designed to protect everybody whether it's their fault or not so now let's look at some of the other employee benefits and these are usually passed by federal law sometimes by state law but there are a whole bunch of them again at the turn of the 20th century in the early 1900s people were working for very little and children were working for very little and people had virtually no benefits no protection if they got hurt no negotiating leverage with the with with employees it was pretty much laissez-faire and if people were happy to have a job and there was really no power they had and no no law that protected them so employment laws have been you know passed constantly almost and many of these help improve a lot of the workers one example was Osha Osha is the occupational self and safety and health act excuse me and this was enacted to promote safety in the workplace and it established the occupational safety and health administration another federal administrative agency called OSHA and it requires certain workplace safety standards it applies to private employers government employers are exempt although they may have their own rules based on the state's rules but what OSHA does is it imposes record keeping and recorded reporting requirements regarding safety and safety conditions requires employers are required to post notices informing employees of their rights if you if you work and if you go to your work you might see if you look around carefully like in the break room or whatever it is you'll probably see all sorts of notifications posted regarding your rights these are required by the by OSHA and they're empowered to administer the act and to pass regulations just like we saw before when you talking about the Securities and exchanges commission where they were required to where they were allowed to pass regulations to enforce the Securities rules well OSHA is allowed to pass and enforce regulations to protect workplace safety there and these require safety standards on the part of employee employers so there's a specific Duty standard which addresses the safety problem of a specific Duty nature so in other words that there are particular industries that face certain hardships or say face certain dangers and they can make regulations saying a company that does uh that works with jackhammers has to give everybody goggles and and has to Train everybody for seven hours before they actually go ahead and do it whatever the case may be and then there are General general duty standards which say that the employer has to provide a work environment that's free from recognized hazards that are causing or likely to cause death or serious physical harm and of course it's a lot more complex than that but those are just some of the basics of OSHA now let's continue with various other employee benefits rules let's start with the fair labor standards Act passed as part of the New Deal back in the 1930s under President Franklin Delano Roosevelt the fair labor standards Act was designed to increase working conditions help people in general decrease some of the abuses in the employment World it prohibits child labor to some extent and the children can still children under 18 can still get working papers and can still work part-time whatever it is but it prohibits the the kind of child labor that existed beforehand where little children you know seven-year-olds eight-year-olds nine-year-olds were sitting there working 12 hours a day in factories that sort of thing is prohibited it establishes minimum wage requirements which exist to this day although there's a lot of controversy about whether the minimum wage is high enough and it establishes overtime pay requirements to many companies in many fields as far as child labor law goes well the flsa federal labor standards act prohibits the use of oppressive child labor and it's also unlawful lawful to ship goods produced by businesses that use oppressive child labor even overseas and the Department of Labor has a whole series that defines the standards again within certain limitations children can work but those are strictly prescribed if anybody's had any experience when they were younger of trying to work when they were teenagers you had to go get working papers and once he did you're only allowed to work a certain number of hours during the school year you had to work fewer hours during the summer you were allowed to work a few more hours but there were very strictly enforced child labor laws this also includes overtime pay which if you work more than a certain number of hours per week which again can vary by industry but some of the rules require certain level of overtime pay managers and administrative people are very often exempt that's why CEOs can work uh 60 70 80 hours a week and not necessarily be subject to overtime requirements maybe they're probably getting paid enough that they don't have to worry about those sorts of things anyway but other types of administrative works like attorneys who work for law firms are not subject to the overtime rules and but the overtime rules essentially say is that employees are employers are required to pay more than a certain percentage more than the normal wage for overtime employers are also required to pay workers at least the minimum wage for regular work hours the minimum wage is set by Congress and can be changed employers are permitted to pay for students there are actually some Industries like the service industry waiters can get paid less than minimum wage because the idea is they get tips which make up for that and there are certain you know maybe apprentices people who are students interns can actually not get paid at all sometimes but generally speaking unless you fall under one of these exceptions you have to be paid more than the federal minimum wage right now I believe that's seven dollars and 25 cents an hour there's a lot of proposal to increase that but the other thing is is that states can have their own minimum wages there are some states which have minimum wages in some areas as high as fifteen dollars an hour uh so the federal minimum wage is the minimum for the entire country but then states can increase that a little bit and many states have some states have actually made rules that say it depends on where you are in the state Oregon has a minimum wage wage uh scheme I think that they were looking to pass that if you're in Portland you have won a minimum wage but if you're out in the country where things are less expensive in general you actually have a lower minimum wage an employer can reduce minimum wage by an amount that's equal to the reasonable cost of food and lodging if you put a company if you put an employee up or you give the employee lunch you can subtract the normal amount the the value of that based on the idea that this is a benefit that's being provided for the employee overtime pay as we discussed is that an employer cannot require non-exempt employees again there are a lot of employees administrative people white collar professionals who are not who are exempt but you cannot expect them to work more than 40 hours a week unless they're paid one and a half times their regular pay for work for work in excess of 40 hours so if you have an assembly line worker who's getting paid twenty dollars an hour if they work 50 hours a week well the first fifth 40 hours can be paid at twenty dollars an hour but the last 10 hours in the given week has to be paid at thirty dollars an hour and each week is treated separately so just because an employee only works 30 hours one week that doesn't mean you can give the employee 50 hours the next week without overtime pay and regardless of how many hours the employee works in the other weeks every every time the employee Works more than 40 hours in a given week you have to get one and a half times the normal rate some other employee benefits include the FMLA or the Family Medical Leave Act and this doesn't apply to all companies but it applies to big companies and applies to employers with 50 or more workers Federal and State local governments as well and it also requires that an employee has to have worked for at least a year and have had worked at least 1250 hours in the previous 12-month period generally speaking assuming a 40-hour week and 50 weeks a year you're talking about about 2 000 hours of work being approximately the standard full-time job so 1250 is not exactly full-time but it's pretty close somebody works more than 1250 hours is considered at least for these purposes for FMLA purposes to be considered a full-time employee and the rule is regarding full regarding FMLA covered employees is that based on a medical leave or based on one of these events the employer has to give the employee at least three months to 12 weeks which is essentially a little less than three months unpaid leave of course the employer is free to give paid leave is free to give paid leave if the employer wants to but that's not what's required a federal law what's required a federal law is unpaid leave and this includes things like birth of a child and this applies both for the mother and the father a placement of a child for adoption or foster care serious health condition or for care of a spouse child parent with a serious health with serious health condition so if an employee has no more sick or vacation time and needs to take up to 12 weeks for maternity paternity or a serious medical condition or whatever it is the employer has to allow up to 12 weeks of unpaid leave again the employer can pay it but the employer doesn't necessarily have to pay it but the you do have to allow the person up to three months of unpaid leave for one of these situations after the person comes back then the person has to be restored to the same or equivalent position has to be given equal pay of seniority but doesn't have to be given seniority in other words if the person was had been working for three years uh that and then then they don't you don't have the employer doesn't have to start the person's fourth year for seniority purposes until the person comes back but the point is the person cannot be punished or penalized for going out for up to three months more than three months the employer could say listen to them sorry I can't have you work here anymore if you're going to be taking off six months or seven months I have to get somebody else to replace you and your job might not be here two more quick uh discussions of employee benefits we've got Cobra which was passed as really part of the Consolidated Omnibus budget reconciliation act it sounds like a mouthful uh this is really they're now in cobra with the most famous parts of of Cobra is regarding health insurance health insurance says that the employee has to be given offered the opportunity to continue a group health program after the person leaves the company and the admin the employee actually pays it but it also has to be a part of something that is run by the company and it's it's fairly complex in terms of how cold brew works but the point is when a person leaves a company a person has to have the ability to continue health coverage now Cobra itself the idea can the the words Consolidated Omnibus budget reconciliation Act is just a budget Bill Omnibus means like a you know very big and comprehensive budget bill every once in a while Converse passes these budget reconciliation X where you know to establish or update the federal budget and one of the things that that one of these budgets did was it established this requirements and finally we've got erisa which is the employer retirement uh retirement income securities act which establishes record keeping and disclosure requirements for investing and percentages of assets that can be invested in employers Securities when I when I say employer Securities I mean employers stock this thing regulates when you're talking about company retirement plans 401K plans pensions things like that there are certain requirements that the that the employer has to establish in order to have this be a a complying retirement plan for the employees there are disclosure requirements there are record keeping requirements the requirements for investing basically investing is is a mechanism by which a company can say you can only participate or get benefits from the company's retirement plan if you've been with the company for a certain period of time or you mean certain other requirements and there are limitations on what an employer can do to avoid making it too or too unfair on the employee and it's the last thing over here a company can't for example we're going to say we're going to tie a hundred percent of your pension to the company's stock it's just too risky uh some of these were updated after the Enron situation where an end run which went out of business I think in like 2001 or so or 2000 uh was a huge company and many of the employees had hundreds of thousands of dollars in Enron stock that comprise their retirement plan and unfortunately when the company went bankrupt these people lost their entire retirement plans risa's is a very complex set of rules there are I know actually happened to know an attorney who basically does nothing but erisa works for a big firm and the firm makes a lot of money on on helping employers comply with erisa but Arisa erisa again is a federal statute that establishes the sorts of rules that govern employees pension and retirement accounts and our final lesson is employment discrimination obviously also relevant to employment law and here are federal legislation and maybe some State legislation as well that prevents employers from discriminating against people for a variety of different reasons think the origin of all this was the Civil Rights Act of 1964 which we're going to look at before then it was pretty much there was no Federal Regulation against employment discrimination and there was a lot of employment discrimination out there discrimination based on race discrimination based on religion and federal law and many state laws have been trying to do whatever is possible to try to minimize that although it probably can never be completely eliminated the equal equal opportunity in employment is the concept of the right of all employees and job applicants to be treated without discrimination and to be able to sue Employers in the event that there is discrimination this is enforced by the EEOC or the equal employment opportunity commission this is a federal administrative agency that's responsible for enforcing employment discrimination laws they can conduct in term investigations do their own interpretations encourage conciliation and bring a lawsuit the EEOC cannot actually punish employers the EEOC cannot actually bring a judgment because they're not a court they can however investigate complaints try to convince the employers to come to a settlement or if that fails or if they don't think a settlement is a good idea in this case they can file lawsuits to try to enforce the Equal Opportunity laws against employers these equal opportunity laws are based on many statutes but the grandfather statute so to speak was the Civil Rights Act of 1964 Title VII prohibited job discrimination in five protected classes race color religion gender or national origin before that there was really no law differentiating based on these things now this doesn't apply to every single employer it really only applies to fairly a little bit larger employers employers with 15 or more employees it also applies to employment agencies labor unions state and local governments and most federal government employment as well so most medium or large companies are governed by the Civil Rights Act of 1964 and title VI which prohibits employment discrimination what it does is it applies to any term condition or privilege of in of employment and says that you can't discriminate based on those categories race religion color gender national origin you can't discriminate in any of those things in terms of hiring and firing can fire people or hire people more because they're of a particular race or a particular gender whatever it is a work rules promotions compensation job training all of these things are subject to the Civil Rights rules and a Title VII employment discrimination action can be based on disparate treatment or disparate impact disparate treatment is when an employer intentionally treats people differently based on one of those criteria so this is where you're talking about an individual and disparate impact occurs when employer discriminates an entire protected class even if the law does not specifically intend or specifically state that it is that it applies to a particular class for example as we'll see a little bit later on let's say you have a test that that you give to all employees and say well every employee has to take the test in order to get a job and it turns out that this differentiates by eliminating a much larger component of One race than another race now as we'll see a little bit later on if it's directly related to the job that's one thing but if it has nothing to do with the job if you for example write a test that you know that uh 80 of white people are going to pass and only fifty percent of black people are going to pass for whatever reason and that has nothing to do with your job you're you know you're hiring people to manage your food store and the test that you give them is on you know complex mathematical algorithms or whatever it is one thing there's nothing to do with the other that could be considered a disparic and disparate impact discrimination although of course if there is a direct relationship between the test and and the uh and the job then even if it has a disparate impact there may be a justification for enforcing it in order to bring in action under Title VII through the EEOC there are some steps that in a an alleged aggrieved employee has to take first a private complaintant would file with the EEOC you file a complaint with the equal employment opportunity commission then the EEOC is given the opportunity to sue on behalf of the of the complainants for example the EEOC can take a look at this and say okay well uh you know you we we agree with you we think you were discriminated against and we're going to file a lawsuit and of course if that happens well then the EOC will will pay for the lawsuit and has a lot of resources so obviously that's probably the best scenario for the employee if the employee unless well except for the case being settled where the employer gives in to the employees demands I guess that's the best case scenario but the next best case scenario is where the EEOC says yes we agree with you and we're going to file a lawsuit against your employer on your behalf the EOC might not think it's maybe it doesn't have the resources maybe it's busy with other things maybe it doesn't think that the cause of action is meritorious maybe it doesn't think there's any evidence of discrimination so if the EEOC for whatever reason chooses not to bring the lawsuit it will issue a right to sue letter to the complainant in other words hey complainant person making the complaint we're not going to file a lawsuit on your behalf so now if you want to you can bring your own lawsuit in federal court or even in State Court depending on the circumstances and then the employee can either Sue and go to court and see what happens or you know not to or try to settle whatever the case may be if there is a judgment against the employer for discriminating on one of these bases well then a successful plaintiff can recover back pay and reasonable attorneys fees so let us now cross over to the idea of okay what is considered discrimination first we've got race color and national origin discrimination I'll call it race discrimination for short but of course it refers to all of these title IV the main reason why it was passed it was part of the civil rights legislation part of the Civil Rights Act of 1964 and it was intended to prohibit employment discrimination the base of race color and national origin race refers to categories of of individuals based on Mega's physical characteristics color obviously refers to the person the color of a person's skin national origin is the person's ancestry or the person's cultural characteristics now once the law was being passed then the government figured all right listen once we're discriminating once we're trying to prevent discrimination on the basis of race and color in national origin we might as well extend it a little bit and so therefore they all they also prohibited discrimination on the basis of gender and this applies equally to men and women and is very often used so men can use it if only women are being hired women can use it only if men are being hired or not even a matter of only if a company if it can be established by a pattern or even by an individual incident or by somebody who you know by by if they get if they get a Smoking Gun you know they get somebody in an email saying I don't want any women for this job or I don't want any men for this job or whatever it is they can bring an action for discrimination based on title Title VII of the Civil Rights Act and then the last category is religion where title IV also prohibits employment discrimination based on a person's religion or religious practices now that doesn't mean necessarily that an employer has to allow a religious person unlimited flexibility if a person's religion for example says well you know I'm not allowed to work during the daytime and so therefore I'm not coming to work anytime for the next uh you know when as long as I'm with the company well obviously you can't expect an employer to be able to run a run a business like that but an employer does have not only not it's not only not allowed to discriminate based on this based on religion the employer also has to reasonably accommodate an employee's religious religious practices and observance if it doesn't cause an undue hardship on the employer for example if a person can't work on Saturdays and the company's normally open well then the employer would probably have to allow the worker to work a different day instead maybe work different and work Sundays instead or something to that effect on the other hand if uh you know if the job is is a college full announcer where the games are all on Saturdays well then the employer doesn't have to make that kind of accommodation because it just simply doesn't make any sense the whole the whole business would be the whole effectiveness of the employee would be wasted if because of the the employees religious uh beliefs or religious practices take a look at the opposite side of the coin the defenses to a uh to a title to a title to a title seven action and there are a few others that we're going to discuss but Merit means where you say well it wasn't because you were a particular race or religion or gender that you got fired or didn't get a raise it was because you didn't deserve it or you did deserve to get fired or whatever it is seniority you you are allowed to run your business based on seniority give people who are there longer longer the better treatment regardless of what their race or gender is and finally you've got the old bfoq or bona fide occupational qualification a bona fide occupational qualification means okay yes we're discriminating based on gender yes we're discriminating based on race yes we're discriminating based on religion but that's because a particular race or religion is necessary or a particular gender is necessary for this kind of job so it's lawful if it's job related and it's a business necessity if you're for example hiring a you know a Christian Pastor well I think it's you know pretty much common sense that you need somebody who's Christian to be a Christian Pastor so it's the sort of thing where if the you know if you're hiring a model for women's clothing well then you need women to model women's clothing so it that's that's the idea where you're saying yes I'm discriminating but I have a reason why I need to discriminate and that's called the Bonafide occupational qualification okay so now let's turn to some of the overarching principles and some of the rules regarding employment discrimination that have been passed separately from the Civil Rights Act and some of these things will have be part of the Civil Rights Act first of all we've got the Equal Pay Act which was actually recently just a few years ago there was a separate uh this Equal Pay Act the Lily Ledbetter Equal Pay Act and what this does is it protects both genders both sexes from this from Paid discrimination based on gender uh this what this says is that if you have jobs that have equal skill that require equal effort equal responsibility with similar working conditions then the end you have male and female employees that are doing these the same things that are similar you have to give them equal wages now it's hard to enforce these things obviously because it's hard to prove equality but there can be cases and have been cases brought to enforce that why would you be able to justify a difference in wage if you have men and women for whatever reason getting different or people of different races getting different treatment well as we discussed before you've got seniority or Merit just like with race discrimination quantity or quality of the product produced if one person is better at producing then that person can be can obviously get a different wage in any Factor other than gender can be used to justify a difference in wages but the employer Bears the burden of proving these defenses so for example if you establish that that that the other people you know the people that men are getting one wage and when we're getting another wage the employer's got to figure out a way to prove a justification for that distinction there's also the ADEA the atea is the age discrimination in Employment Act and the age discrimination Employment Act is similar to the race-based employment laws and what this does it is it prohibits age discrimination in employment decisions including hiring promotion payment of compensation other terms of employment and what this was based on the idea that there is discrimination sometimes where people want younger workers because people are worried that older people are not going to be as energetic or they're going to retire sooner or they're not going to be able to work as much whatever it is and these are base and this is what the age discrimination in Employment Act is based on it only applies to employees who are 40 years of age or older if you're 38 or 39 or 21 for example you can't do if it's if you're too young that's not a good enough uh reason to sue if you say well I'm 19 and therefore I'm getting discriminating against discriminated against too bad you're not protected by the age discrimination and Employment Act unless you're over 40. it covers employers who cannot establish mandatory retirement ages covered employers excuse me can't establish mandatory retirement ages you cannot say unless again unless there's a really good reason unless there's a bfoq which we discussed before unless there's a bona fide occupational qualification that requires that people of a certain age can't do a job for whatever reason you cannot establish minimum retirement ages and it's also administered by the Equal Opportunity Employment equal employment opportunity commission establishing mandatory retirement ages would be unfair because just because a person is 66 or 67 or even 70 years old doesn't inherently mean they can't do most jobs now if the person is simply not able to do it anymore for whatever reason it requires physical strength and now a 75 year old just doesn't have the physical strength well then of course you can fire that person you can lay off that person simply because the person can't do the work anymore that's not what age-based discrimination means age-based discrimination means discriminating against someone based solely on their age another very important statute that's relevant to employment discrimination is the Americans with Disabilities Act or the Ada and this imposes on employers and not just employers also providers of public transportation public accommodations to accommodate people in individuals with disabilities that's one reason why you see ramps and elevators handicapped parking spots in in most public buildings that were built after a certain certain dates basically I mean their older buildings are grandfathered they don't have to be knocked down and rebuilt but newer buildings even even buildings that are not owned by the public you know buildings that are that are that are Office Buildings are required to have certain disability accommodations and title one of the Ada prohibits employment discrimination against people who are qualified but have disabilities and it also just like with religion Title 1 requires an employer to make reasonable accommodations that do not cause undue hardship to the employer installation of an elevator install relation of a ramp installation of a special workstation if it doesn't cause a huge huge undue burden to the employer then the employer has to make the accommodation reasonable accommodations may include making facilities readily accessible modifying work schedules you know maybe somebody with uh with some sort of a problem can't sit at a desk for eight hours so maybe the person will be given an accommodation where they can work in four hour shifts instead of eight hour shifts acquiring equipment or devices modifying examination or training materials and the schools very often are asked to do this give people with certain disabilities extra time or a person a person to uh you know to read them to read them the work etc also these limitations are are limited I'm sorry these requirements are limited when the qual to win the qualified individual with a disability is qualified to do the job if the person is not qualified to do the job well then of course you don't have to make an accommodation you don't have to allow the person to work for you if the person is going not going to be able to do the job how do you determine whether somebody has a disability remember not everybody is covered by the Ada you're only covered by the Ada you can only Sue based on the Ada and get an accommodation based on the Ada if you have a disability a disability is someone who has a medical a physical or mental impairment that substantially limits one or your one or more of his or her major life activities has a record and is regarding of having such impairments physical impairment like um being blind or being wheelchair bound or something like that obviously is a disability there was actually a case a number of years back about what if you have a disease that doesn't show up but you have to make certain Lifestyle Changes uh based on that disease um you just that you can't do certain things that because you have a disease but it doesn't impact you at all on a day-to-day basis and I believe the courts basically rule that that's not considered as a disability because it doesn't bother you on a day-to-day basis what about so what is the requirement of an employee regarding the Americans with Disabilities Act regarding disabled people well first of all employers are forbidden from asking about the existence or severity of a disability I can't ask you know are you wheelchair-bound are you can you can you walk normally now again there's that bfoq exception if it's something if if the if the uh job is an Olympic sprinter and somebody's wheelchair abound well you know I don't know if there's such thing as a jobs the job of a wheelchair um a sprinter but if a person is you know if the job is a is a lifeguard and the person because of a disability can't swim I mean it's it's common sense that the Ada doesn't protect that person but um also but you cannot discriminate if it is if a person can't the person for example is wheelchair abound but it's a desk job it doesn't require uh somebody to actually walk around well then you can't even ask about that when you're hiring the person in the first place uh free employment medical examinations are also forbidden before a job offer is established you have to essentially give the person a job offer and once you do that once the person starts working for you then you can give the person a medical uh evaluation but if the person does have a disability you have to give a reasonable accommodation okay two last points for the course first of all we've got this idea of affirmative action now affirmative action is a policy that private companies can pick up government policies or government jobs or schools again can enact these policies but they don't necessarily have to and that is a policy that certain job preferences or let's say School admission preferences will be given to minority or protected class applicants when an employer makes an employment decision now that is allowed in certain cases but it's certainly not required basically that what this is is when let's say for example you have a government contractor and they realize that you know 95 percent of their employees are white and that's because in the past there had been discrimination and because of that they have this huge hugely white Workforce and very few minorities on their Workforce well they might say okay you know from now on for a while we're going to start giving some preferences in hiring to minority applicants so that we will a reverse the the effect of past discrimination and second of all we will kind of make sure that our Workforce is kind of a little bit more in line with the general population ratios and that's that can be done there are certain circumstances in which the Supreme Court has disallowed it for example when a school said you know we're going to set aside 15 students 15 seats in every incoming class for people or minorities Supreme Court said you know that's going a little too far you can set aside a certain number of seats but you can give race-based preferences that of course gives rise to the question of reverse discrimination because the idea the whole title seven the whole employment discrimination rules they apply to people who are part of the majority class just as much as they apply to the minority class it protects black people from discrimination but it also protects white people from discrimination it protects Jews and Muslims from discrimination but it also protects Christians from discrimination it protects women from discrimination but it also protects men from discrimination so affirmative action plans the actions that we discussed have been allowed based on these criteria because they're needed to reverse past discrimination and to normalize the workforce but affirmative action plans may not have pre-established numbers of quotas as I mentioned and finally a majority class members just like minority class members who are being discriminated against can recover damages or get other remedies and those are all the material that's all the material we have for this course I want to thank everybody for listening I hope you've gained some insight uh into the course materials based on this video thank you very much have a wonderful day