This Document Contains Chapters 41 to 45 Chapter 41—Types of Business Organizations TRUE/FALSE 1. A sole proprietor must file a certificate indicating that he or she is commencing operations and pay a single organizational fee. Answer: False 2. A sole proprietorship must pay, at the corporate income tax rate, income taxes based on the net earnings of the sole proprietorship. Answer: False 3. A sole proprietor is subject to unlimited personal liability for the debts of the business. Answer: True 4. A limited liability company is treated like a partnership under federal tax law and has the limited liability feature of corporations. Answer: True 5. Partnership agreements allow individuals to conduct their business without the requirement of a formal organizational structure. Answer: True 6. A partnership is not dissolved by the death of a partner. Answer: False 7. A corporation must have at least two shareholders. Answer: False 8. Business corporations exist to make a profit. Answer: True 9. The major advantage to investors in a corporation stems from the fact that their risk of loss is limited to the amount of their investment. Answer: True 10. In a corporation, a large number of investors may pool their assets to finance a large business enterprise. Answer: True 11. The death of a majority shareholder terminates a corporate enterprise. Answer: False 12. A corporation is a separate legal entity capable of owning property, contracting, and being sued in its own name. Answer: True 13. Corporations are subject to a form of double taxation. Answer: True 14. The process of incorporation involves the expenditure of funds for organizational expenses. Answer: True 15. A joint venture typically relates to the carrying out of a single enterprise or transaction. Answer: True 16. Most courts hold that joint ventures are not subject to the same principles of law as partnerships. Answer: False 17. If there is a joint venture, the fault or negligence of one venturer will not be imputed to the other venturers. Answer: False 18. Unincorporated associations are generally formed to further a common purpose. Answer: True 19. An unincorporated association cannot sue or be sued in its own name. Answer: True 20. A cooperative consists of a group of two (2) or more independent persons or enterprises that cooperate for a common objective or function. Answer: True 21. A franchisor or franchisee could be a sole proprietor, a partnership, a limited liability company, or a corporation. Answer: True 22. Franchise disclosures are not required under federal law. Answer: False 23. A franchisor is the person to whom the franchise is granted. Answer: False 24. A franchise agreement in which the franchisor grants the franchisee authority to manufacture and sell products under the trademark(s) of the franchisor is known as a manufacturing or processing franchise. Answer: True 25. Franchise agreements frequently contain an arbitration provision under which a neutral party is to make a final and binding determination whether there has been a breach of the contract sufficient to justify cancellation of the franchise. Answer: True 26. The relationship between the franchisor and the franchisee is ordinarily an arm’s-length employment relationship. Answer: False 27. The Federal Trade Commission has adopted a franchise disclosure rule that requires franchisors to give prospective franchisees a full disclosure statement thirty (30) days before a franchisee signs a contract or pays any money for a franchise. Answer: False 28. Freedom from liability to third persons dealing with the franchise holder is one of the main reasons that franchisors grant franchises. Answer: True 29. If the negligence of the franchisee causes harm to a third person, the franchisor is not liable because the franchisee is an independent contractor. Answer: True 30. Franchisors may be found liable for the wrongful conduct of their franchisees on an apparent authority theory when the conduct of the franchisor creates an appearance of authority. Answer: True MULTIPLE CHOICE 1. The principal forms of business organization are: A. sole proprietorships, joint ventures, and corporations. B. unincorporated associations, partnerships, and corporations. C. unincorporated associations, limited partnerships, and corporations. D. sole proprietorships, partnerships, and corporations. Answer: D 2. A sole proprietorship is taxed: A. only on a personal. B. only on the corporate level. C. on a personal and a corporate level. D. none of the above. Answer: A 3. A major disadvantage of the sole proprietorship is: A. no organizational fees. B. the sole proprietor obtains all of the profits. C. the sole proprietor is personally liable for the debts of the sole proprietorship. D. the sole proprietor is free to make all business decisions concerning operation of the sole proprietorship. Answer: C 4. A limited liability partnership: A. is taxed like a corporation. B. provides limited liability for all partners. C. shields innocent partners from personal liability beyond their investment. D. All of the above. Answer: C 5. Government grants create: A. sole proprietorships. B. corporations. C. partnerships. D. unincorporated associations. Answer: B 6. The people in a corporation responsible for the management of the business are the: A. partners. B. shareholders. C. board of directors. D. licensees. Answer: C 7. Who serve as agents of the corporation and run the “day-to-day” operations of the business? A. officers B. directors C. shareholders D. employees Answer: A 8. Under which organizational structure would the death of the owner have no legal effect? A. a partnership B. a corporation C. a sole proprietorship D. all of the above Answer: B 9. In the absence of a fixed duration provision, a joint venture will ordinarily terminate: A. upon completion of the project. B. at the will of any participant. C. as specified in the joint venture agreement. D. any of the above. Answer: D 10. In a joint venture, the parties: A. combine their labor or property for a single undertaking and share profits and losses equally. B. combine their labor or property for a continuing business and share profits and losses equally. C. assume no personal liability beyond the risk of losing their initial investment. D. none of the above. Answer: A 11. An unincorporated association: A. cannot sue in its own name. B. cannot be sued in its own name. C. does not have any legal existence apart from the members who compose it. D. all of the above. Answer: D 12. A parents' group in a small town formed an association to run a little league baseball team. Tom and Mary were members of the association, which was never incorporated. Tom was elected president of the association and ordered some uniforms for the team. When the uniforms were not paid for, the baseball supply company sued Tom and Mary for the contract price. Regarding the liability of Mary: A. Mary is liable because she is a member of an unincorporated association. B. Mary is not liable because members of an unincorporated association have no personal liability. C. Mary is liable if she authorized or ratified the purchase. D. Mary is liable but only for 50% of the outstanding debt. Answer: C 13. An arrangement in which the owner of a trademark licenses others, under specified conditions or limitations, to use the trademark in purveying goods or services is a(n): A. corporation. B. limited partnership. C. unincorporated association. D. none of the above. Answer: D 14. Theoretically, the relationship between a franchisor and a franchisee is one of: A. parent and subsidiary. B. an “arm's-length” relationship between two (2) independent contractors. C. an “arm's-length” relationship between two (2) partners. D. an “arm’s-length” relationship between two (2) joint tenants. Answer: B 15. Holders of automobile dealership franchises are protected from bad faith termination of their dealerships by the: A. Sherman Antitrust Act. B. Robinson-Patman Franchise Act. C. Automobile Dealers' Day in Court Act. D. Franchise Holder Protection Act. Answer: C 16. The Petroleum Marketing Practices Act gives gas station __________ the opportunity to continue in business by purchasing the entire premises used in selling motor fuel when the franchisor decides to sell the property and not renew a lease. A. franchisees B. licensors C. joint venturers D. partners Answer: A 17. The FTC franchise disclosure statement must contain: A. the business experience of the franchisor and its brokers. B. any current and past litigation against the franchisor. C. the grounds for termination of the franchise. D. all of the above. Answer: D 18. A rule requiring that a franchisor provide a disclosure statement to all prospective franchisees was adopted by the: A. UCC. B. Franchise Tax Board. C. Securities and Exchange Commission. D. Federal Trade Commission. Answer: D 19. To protect themselves against liability, franchisors often require individual franchisees to: A. take out fraud insurance. B. register with the attorney general. C. publicly disclose their own separate business identities. D. disavow any connection with the franchisor. Answer: C 20. Normally in a franchise operation: A. both the franchiser and the franchisee will be liable to third persons for contracts that are breached by the franchisee. B. only the franchisor will be liable to third persons for contracts that are breached by the franchisee. C. only the franchisee will be liable to third persons for contracts that are breached by the franchisee. D. neither the franchisor nor the franchisee will be liable to third persons for contracts that are breached by the franchisee. Answer: C CASE 1. Sally Gomez is interested in starting a new business. Although Gomez has developed her business plan and is ready to implement her ideas, she lacks the necessary finances to begin her new business. Along with a lack of finances, Gomez worries about the potential liability involved with starting a new business. Gomez would hate to lose all that she has personally accumulated to date in the event of a successful lawsuit against her. She is considering a sole proprietorship, a partnership, or a corporation as the organizing structure of her new venture. Which type of business would best serve Gomez's needs at this given time? Answer: Gomez would like to operate a business enterprise that limits her liability. In a sole proprietorship, there would be no limitation on potential liability, and Gomez's personal assets as well as those invested in the business would be available for recovery in the event of a lawsuit. A partnership would offer her little protection, as the liability exposure is similar to that of a sole proprietorship. The corporate form would simultaneously afford Gomez limited liability and the means to obtain necessary financing. The financing could be obtained through the sale of shares of stock in her corporation. 2. Arnold was the sole shareholder, president, and chief executive officer of Algernon Enterprises, Inc. Acting on behalf of Algernon, Arnold negotiated the credit purchase of inventory from Amax. The contract was signed in the name of Algernon Enterprises. Algernon never paid the sums due on the contract, and Arnold and the corporation were sued. Is Arnold personally liable to Amax? Answer: Arnold has no liability because the business was incorporated and the contract was made by the corporation. Shareholders and officers have no responsibility for corporate debts. 3. Louise Feldspar obtained the exclusive right to sell TastyCrunchy Chicken in a specified area. Under the agreement, Feldspar was permitted to use the TastyCrunchy name and logo for her restaurant and she agreed to comply with TastyCrunchy's restaurant requirements. She purchased her equipment, as well as the chicken she served, from the firm. She agreed to devote a certain percentage of her revenues to promoting the TastyCrunchy operation in local media. The operation was successful from the start, and Feldspar has had no problem meeting the sales quotas imposed by TastyCrunchy. The past year TastyCrunchy informed Feldspar that it intended to open a new restaurant on an interstate highway that had just been completed in her exclusive area of trade. Because her operation would be competition for the new store, Feldspar's right to sell TastyCrunchy products and use the name TastyCrunchy was revoked. What can Louise do? Answer: Feldspar was operating under a franchise agreement that gave her the exclusive right to the area in question. She should immediately examine the terms of the franchise agreement to make sure that she has not committed any violations of the franchise requirements that would justify the cancellation. If no justification for termination exists, Feldspar should take action against TastyCrunchy for bad faith termination of her franchise. Chapter 42—Partnerships TRUE/FALSE 1. The Uniform Partnership Act, a codification of partnership law, has been adopted by 49 states. Answer: True 2. Each partner is an agent of the partnership. Answer: True 3. A partner is considered an employee of the partnership when doing work that would ordinarily be done by an employee. Answer: False 4. A partnership involves partners' contributions of capital, services, or a combination of these. Answer: True 5. A combination of two or more persons for a common nonprofit purpose is commonly an unincorporated association. Answer: True 6. The rights of partners are determined by the partnership agreement. Answer: True 7. In order to satisfy the statute of frauds, all partnership agreements must be in writing. Answer: False 8. A partnership may occur even though the parties did not label their relationship a partnership. Answer: True 9. The burden of proving the existence of a partnership will always fall on one of the partners. Answer: False 10. The sharing of profits and losses is conclusive evidence of partnership. Answer: False 11. Sharing of gross returns, as compared to the sharing of profits, is strong evidence of a partnership. Answer: False 12. All partners must contribute money to be treated as partners. Answer: False 13. When a person who performs continuing services for another receives a fixed payment that does not depend on the existence of profit and is not affected by losses, that person is a partner. Answer: False 14. Persons who are not partners under appropriate circumstances may be held liable to third persons as though they were partners. Answer: True 15. A registration certificate for a partnership's fictitious name contained the names of Barry, Boyd, and Swartz. Cruise extended credit to the firm in reliance in part on the certificate that named Swartz as a partner. Swartz, in fact, had no knowledge of the certificate and never had agreed to be a partner. Because of Cruise's reliance on the certificate and the statement that Swartz was a partner, Swartz has a partner's liability insofar as Cruise is concerned. Answer: False 16. Partnership property is only that property contributed by the partners. Answer: False 17. A creditor of an individual partner cannot proceed against any specific items of partnership property, but can obtain a charging order against that partner's interest in the partnership. Answer: True 18. The assignee of a partner's interest in the partnership becomes a partner only with the consent of the other partners. Answer: True 19. A majority action of partners is not binding if it contravenes the partnership agreement. Answer: True 20. A partner has the authority to do those acts that are customary for a member of a partnership conducting the particular business of that partnership. Answer: True 21. When a partner executes an agreement outside the limitations of that partner’s agreed scope of power, the other partners are always able to set aside the contract. Answer: False 22. Partners have the implied authority to bind the partnership by contracts of surety for any and all purposes. Answer: True 23. A partner cannot make a general assignment of firm property for the benefit of creditors unless authorized by the other partners or unless they have abandoned the business. Answer: True 24. A partner admitted as a partner into an existing partnership has unlimited liability for all obligations of the partnership arising before such admission. Answer: False 25. The vested rights of partners are not extinguished by dissolving the firm, and the existing liabilities remain. Answer: True 26. The habitual drunkenness of a partner is a sufficient cause for judicial dissolution of a partnership. Answer: True 27. Bankruptcy of only one of the partners does not cause dissolution of the firm. Answer: False 28. When the dissolution of a partnership has been caused by operation of law, notice of such dissolution must be given to third persons. Answer: False 29. After the dissolution of a partnership, partners retain the authority to perform any acts necessary to wind up the business. Answer: True 30. Creditors of a firm have first claim on the assets of the partnership. Answer: True MULTIPLE CHOICE 1. In determining the rights of partner Dewey in the firm of Dewey, Cheatham and Howe, the most important reference point is: A. the Uniform Partnership Act. B. the partnership agreement. C. the sworn testimony of Cheatham and Howe. D. the customs and traditions of similar partnerships. Answer: B 2. Persons who are in a partnership are called __________ partners. A. general B. silent C. secret D. nominal Answer: A 3. In determining whether a partnership exists, which of the following factors is not evidence of a partnership? A. Shared profits and losses B. Co-ownership of property C. Equal control of the business D. All of these are evidence of partnership. Answer: B 4. Partnership property may consist of: A. real property only. B. personal property only. C. any and all property acquired by the partnership. D. all property contributed by the partners or acquired for the firm or with its funds. Answer: D 5. Partners hold title to firm property by: A. tenancy in partnership. B. tenancy in common. C. joint tenancy. D. none of the above. Answer: A 6. Regarding partnership property: A. only a managing partner has the right to use firm property for firm business. B. where a three-person partnership owns three autos, each partner owns one of the autos individually. C. on the death of a partner, that partner's share of partnership property vests in his or her next of kin. D. a creditor of a partner cannot proceed against any specific items of partnership property. Answer: D 7. An assignee of a partner's interest does not become a partner without the consent of the other partners and is only entitled to: A. participate in the management of the partnership. B. receive the assignor's share of the profits during the term of the partnership and the assignor's share of capital on dissolution. C. inspect the books of the partnership. D. vote on matters concerning the business of the partnership. Answer: B 8. In a partnership of four physicians, a decision to buy an office copier for the partnership must be approved by: A. all of the partners. B. at least three of the partners. C. at least two of the partners. D. one partner. Answer: B 9. A third person should recognize that a partner has limited or no authority if: A. the partner seeks to act for the partnership concerning a matter not within the usual business of the firm. B. the third person knows that the partnership has been terminated. C. the partner seeks to pay a personal obligation by issuing a promissory note in the name of the firm. D. all of the above. Answer: D 10. Prohibited transactions by a partner without the consent of other partners include: A. a contract that makes it impossible for the firm to conduct its usual business. B. submitting controversies of the firm to arbitration. C. making a general assignment of firm property for the benefit of creditors D. all of the above. Answer: D 11. Each partner has to a right to: A. take an equal part in transacting the business of the firm. B. receive compensation for any work done for the partnership. C. both a. and b. D. neither a. nor b. Answer: A 12. A partner's authority to act for the partnership is similar to the authority of a(n): A. agent to act for a principal. B. independent contractor to act for an employer. C. shareholder to act for a corporation. D. employee to act for another employee. Answer: A 13. Partners are: A. jointly liable on all firm contracts and for all torts committed by one of the partners in the scope of partnership business. B. jointly and severally liable on all firm contracts and for all torts committed by one of the partners in the scope of partnership business. C. jointly and severally liable on all firm contracts and jointly liable for all torts committed by one of the partners in the scope of partnership business. D. jointly liable on all firm contracts and jointly and severally liable for all torts committed by one of the partners in the scope of partnership business. Answer: D 14. Dissolution of a partnership: A. always means that the business has ended. B. increases the authority of the partners. C. both a. and b. D. neither a. nor b. Answer: D 15. Which of the following does not result in dissolution of the partnership by operation of law? A. The expulsion of a partner. B. Bankruptcy of the partnership or of one of the partners. C. The death of a partner. D. All of these will result in dissolution of the partnership by operation of law. Answer: A 16. A partner may withdraw from the partnership without liability: A. unless the withdrawal violates the partnership agreement. B. when the partnership is not for a definite purpose. C. when the partnership is not for a definite time. D. all of the above. Answer: D 17. Which of the following will not result in dissolution of the partnership by court decree? A. A partner becomes incapable of performing the terms of the partnership agreement B. A partner persistently or willfully acts in such a way that it is not reasonably practicable to carry on the partnership business C. The withdrawal of a partner. D. All of the above. Answer: C 18. When a partner disassociates with a partnership: A. the partnership is no longer bound by acts of that partner, whether or not a notice is filed. B. the disassociated partner is prohibited from competing with the partnership for a period of one year. C. the disassociated partner may be liable for damages for breach of contract. D. none of the above. Answer: C 19. When a partnership is dissolved by the act of a partner, notice: A. is not required. B. must be given to the other partners only. C. must be given to third persons only. D. must be given to both other partners and third persons. Answer: D 20. When a partnership is dissolved by a partner’s bankruptcy, notice: A. is not required. B. must be given to the other partners only. C. must be given to third persons only. D. must be given to both other partners and third persons. Answer: B CASE 1. Robertson and Enrickson prepared an agreement to enter into a partnership. Both of the partners realized that outside capital was needed for the firm to begin operations; however, they also realized that their individual and combined credit ratings would not attract sufficient funds. In order to improve the new partnership’s ability to attract investment capital, and with the approval of Enrickson, Robertson added his friend Thompson’s name to the partnership agreement. Thompson, a well-known personality from a family of means, was not asked to be a partner and knew nothing of Robertson's and Enrickson's actions. Upon seeing Thompson's name on the partnership agreement, a local bank readily agreed to advance Robertson and Enrickson the total sum required to begin operations. The partnership has now failed, and the bank would like to hold Thompson, Robertson and Enrickson liable for the amount of the loan. Will the bank recover from Thompson, Robertson and Enrickson? Answer: No. Thompson was not a partner. He did not participate in the preparation of the partnership agreement and was not even aware of the fact that his name was being used. In addition to their civil liability for the bank loan, Robertson and Enrickson might be subject to criminal charges for fraud. 2. Rundles, Kreiger, and Larson formed a partnership to breed and show horses. Rundles and Kreiger each contributed $25,000 to the partnership. Larson contributed four (4) horses valued at $25,000. The partnership agreement provided that the partners would share profits equally. When the horses failed to perform as expected, Rundles and Kreiger decided to reduce Larson's share of the profits. Larson claims that this decision must be unanimous to be binding. How will the case be decided? Answer: Judgment will be for Larson. Although a decision by the majority of the partners in a partnership will control in matters concerning the ordinary operations of the firm business, such a decision is not binding if it contravenes the partnership agreement. In this case, the agreement provided that the partners would share profits equally. The decision by Rundles and Kreiger is therefore not effective, since is not based on the unanimous consent of all partners. 3. Theo, a member of TGI partnership, withdrew from the partnership and duly notified the other members. The firm was an at-will partnership and the parties parted amicably, posting a notice in the local newspaper of the dissolution of their firm. Cosmo, a customer who had conducted business with Theo several times, did not see the newspaper notice and was not informed of the dissolution. Later, Theo approached Cosmo concerning a transaction similar to those Cosmo had engaged in before with Theo acting on behalf of TGI. Cosmo placed an order, gave a substantial down payment to Theo, and received a receipt on TGI stationery from him. Theo thereafter absconded with the down payment, and TGI failed to honor the contract. Cosmo sued the other members of TGI partnership. Discuss their potential liability. Answer: The other members of TGI partnership are liable for the deposit and breach of contract because they failed to notify the former customer, Cosmo, of the dissolution. Cosmo relied on the appearance of Theo being a partner who was making a usual contract. Cosmo was entitled to actual notice that Theo was no longer with the firm. Chapter 43—LPs, LLCs, and LLPs TRUE/FALSE 1. Even limited partners are completely liable for debts of the business. Answer: False 2. Limited liability is not a feature of general partnership law. Answer: True 3. While most states have adopted limited liability company statutes, few states have created statutes allowing the formation of limited liability partnerships. Answer: False 4. It is impossible to form a business in a manner that allows for single taxation and limited liability. Answer: False 5. The names of limited partners and investors must be included on the certificate of limited partnership. Answer: False 6. A limited partner can never lose money. Answer: False 7. Every limited partnership must have at least one general partner. Answer: True 8. Both general partnerships and limited partnerships are created only through the process of executing a certificate. Answer: False 9. If a limited partnership certificate is never filed, all partners are treated as limited partners. Answer: False 10. Courts tend to resolve ambiguities in limited partnership agreements against the general partners. Answer: True 11. Limited partners may contribute cash or property as their capital contributions. Answer: True 12. Under the Revised Uniform Limited Partnership Act, limited partners may engage in certain “safe harbor” activities without losing their protection from liability. These activities include being a contractor for, or an agent or employee of, the limited partnership or of a general partner. Answer: True 13. In a limited partnership, general partners are not responsible for the debts of the firm. Answer: False 14. It is possible for a limited partner to be subject to the debts of the firm if the limited partner participates in the control of the business. Answer: True 15. A limited partner may receive a share of the profits. Answer: True 16. A limited partner may never sue the business. Answer: False 17. A general partner within a limited partnership may be a corporation. Answer: True 18. The dissolution of a limited partnership is governed by unique rules quite different from those applicable to the dissolution of a general partnership. Answer: False 19. A limited liability company pays federal income tax. Answer: False 20. The limited liability company combines the tax advantage of the partnership with the limited liability feature of the corporate form of business organization. Answer: True 21. Limited liability companies may be formed without filing formal articles of organization with the secretary of state. Answer: False 22. An LLC is a legal entity with the authority to conduct business in its own name. Answer: True 23. All owners of a limited liability company are known as officers. Answer: False 24. A limited liability company may be managed directly by the owners. Answer: True 25. The operating agreement of an LLC must be in writing to be valid. Answer: False 26. Managers of an LLC have the same fiduciary duties to the entity as corporate officers have to a corporation. Answer: True 27. A limited liability company may hold property in its own name. Answer: True 28. A limited liability company is identical to a Subchapter S corporation. Answer: False 29. A limited liability partnership protects partners from liability for the wrongful acts of those whom they directly supervise and control. Answer: False 30. Limited liability partnership statues are designed to permit the conversion of existing general partnerships into limited liability partnerships. Answer: True MULTIPLE CHOICE 1. The spread of limited liability corporation statutes resulted from: A. a United States Supreme Court decision. B. an Internal Revenue Service ruling. C. a Wyoming Supreme Court decision. D. a Securities and Exchange Commission ruling. Answer: B 2. A limited partnership can be formed by one (1) or more __________ partners and one (1) or more __________ partners. A. unreserved; reserved B. active; silent C. licensed; unlicensed D. general; limited Answer: D 3. The partners who manage the limited partnership and are personally liable for the firm debts are __________ partners. A. general B. active C. licensed D. unreserved Answer: A 4. When no limited partnership certificate is filed, what is the result? A. Only limited partners are fully liable. B. Only general partners are fully liable. C. Limited partners retain their limited liability. D. Both general and limited partners are fully liable. Answer: D 5. Under the Revised Uniform Limited Partnership Act, a limited partner may contribute: A. cash only. B. property only. C. services only. D. cash, property, and services. Answer: D 6. Which of the following statements regarding limited partnerships is true? A. The words limited partnership or simply LP must appear in the firm’s name. B. General partners cannot avoid personal liability by incorporating. C. Limited partners can lose their liability limitation if they participate in the control of the business. D. All of the statements are true. Answer: C 7. Under the Revised Uniform Limited Partnership Act, a limited partner probably will not lose the protection of limited liability when the limited partner: A. becomes a contractor for, or an agent or employee of, the limited partnership or of a general partner. B. consults with and advises a general partner regarding the partnership business. C. votes on partnership matters, such as dissolving and winding up the limited partnership or removing a general partner. D. all of the above. Answer: D 8. The dissolution and winding up of a limited partnership is governed by the same principles applicable to a __________. A. “Subchapter S” corporation. B. limited liability company. C. general partnership. D. none of the above. Answer: C 9. Each limited partner in a limited partnership is entitled to which of the following? A. A share of the profits. B. The right to sue the general partner to protect the limited partners’ interest. C. Both a. and b. D. Neither a. nor b. Answer: C 10. Management of an LLC is vested in its: A. members B. partners C. shareholders D. managers Answer: A 11. A limited liability company’s operating agreement: A. is equivalent to the bylaws of a corporation. B. must be in writing. C. does not cover member compensation.. D. all of the above. Answer: A 12. A limited liability company: A. is the same type of business entity as a “Subchapter S” corporation. B. has no restriction on the number of owners. C. is taxed in a manner similar to that of a corporation. D. has unlimited life regardless of what happens with any individual member. Answer: B 13. The owners of a limited liability company are known as: A. members. B. partners. C. contributors. D. electors. Answer: A 14. Members of a limited liability company share profits: A. according to their status (general or limited) in the firm. B. in proportion to their contribution of services. C. in proportion to their capital contribution. D. according to the terms of the operating agreement. Answer: D 15. Most limited liability company statutes provide that a LLC will dissolve: A. by the consent of the members. B. upon the death of a member. C. upon the expulsion of a member. D. all of the above. Answer: D 16. A limited liability company may be classified as a partnership for tax purposes if: A. such an election is made by “checking the box” for partnership tax treatment on the appropriate Internal Revenue Service form. B. such an election is made in the operating agreement. C. such an election is made in the articles of incorporation. D. a majority of its members petition the Internal Revenue Service for partnership tax treatment. Answer: A 17. A limited liability company: A. must have at least one member that is subject to unlimited liability. B. member may actively participate in control of the business without losing limited liability status. C. both a. and b. D. neither a. nor b. Answer: B 18. It is expected that in the future, the limited liability company will in many instances replace which of the following forms of business ownership? A. the general partnership B. the limited partnership C. the close corporation D. all of the above Answer: D 19. Which form of business entity was created primarily to shield innocent owners, particularly those in professions, from malpractice liability generated from other owners in the firm? A. the limited partnership B. the limited liability partnership C. the limited liability company D. none of the above Answer: B 20. A limited liability partnership must include which of the following terms in its name? A. LLP B. limited liability partnership C. either a. or b. D. neither a. nor b. Answer: C CASE 1. Alice, Betty, and Cathy are interested in forming a business venture. Alice is quite wealthy and is ready to contribute money to the venture. Betty has a degree in business from an excellent university, worked for five years as a manager in a major corporation, and currently is a leadership/management consultant. Cathy is a scientist who has developed a process that will, according to her, “revolutionize cancer treatment throughout the world.” Alice, Betty, and Cathy believe it is in their best interest to form a general partnership. Do you agree? Is there a more appropriate form of business you might recommend? Answer: The general partnership form is not appropriate because each owner would be liable for all debts of the organization. In light of her wealth, Alice might be particularly troubled with the liability exposure of a general partnership. The limited partnership form is arguably a preferable choice in this situation. Should the parties choose a limited partnership, Betty (with her business acumen) might be best positioned to serve as the general partner, and Alice and Cathy could be limited partners. Under the Revised Uniform Limited Partnership Act, it is possible that both Alice and Cathy could contribute to the effective management of the firm (by consulting with and advising Betty, the general partner, regarding the partnership business) without losing their limited liability status. 2. You are asked to provide two friends who are in business together with advice regarding what they need to do to legally in order to form a limited liability company. Although your friends like the general notion of limited liability in the operation of their business, they are totally unfamiliar with the legal processes for forming a LLC, so you need to provide them with the basic requirements for LLC creation. What specific advice would you give them? Answer: A limited liability company comes into existence only after articles of incorporation have been filed with the secretary of state. The articles must state the name, purpose, duration, registered agent, and principal office of the business. The name of the entity must include “LLC” or the words “limited liability company.” Chapter 44—Corporate Formation TRUE/FALSE 1. A corporation is an artificial person that is created by governmental action. Answer: True 2. Debts of a corporation are not the debts of the persons running the corporation or owning shares of stock in it. Answer: True 3. Shareholders ordinarily cannot be sued for corporate liabilities. Answer: True 4. A California corporation is a foreign corporation with respect to the remaining forty-nine (49) states of the United States. Answer: True 5. The shares of a close corporation are always held by a single individual. Answer: False 6. Subchapter S corporations have the benefits of limited liability as in partnerships and are taxed as corporations. Answer: False 7. A quasi-public corporation is one that is organized for charitable or benevolent purposes. Answer: False 8. Most states have a general corporation code, and anyone who satisfies code requirements and files the necessary papers with the government may automatically become a corporation. Answer: True 9. A corporation is considered a person for purposes of the due process clause of the United States Constitution. Answer: True 10. Subject to constitutional limitations, corporations may be regulated by statutes. Answer: True 11. For the purpose of determining the right to bring a lawsuit in federal court, a corporation is a citizen of any state in which it has been incorporated and of the state where it has its principal place of business. Answer: True 12. The corporate form of business continues regardless of changes in stock ownership. Answer: True 13. A corporation may properly exist without a name. Answer: False 14. A corporate seal is required in order for the corporation to enter into a binding contract. Answer: False 15. Bylaws are typically adopted by the managers of a corporation. Answer: False 16. A corporation may exercise its power to borrow money by issuing bonds. Answer: True 17. Stock that is reacquired by the corporation that issued it is commonly called “boomerang” stock. Answer: False 18. When a corporation acts in excess of or beyond the scope of its powers, the corporation’s act is described as “ultra vires.” Answer: True 19. Because nonprofit corporations have a more restricted range of powers than business corporations, actions not authorized by the charters of nonprofit corporations are more likely to be found ultra vires. Answer: True 20. Corporations come into existence as the result of the activities of one or more persons known as promoters. Answer: True 21. A corporation may be an incorporator of another corporation. Answer: True 22. Under the Revised Model Business Corporation Act (RMBCA), corporate existence begins when the articles of incorporation are filed with the secretary of state. Answer: True 23. A de facto corporation is not accorded legal recognition due to some recognized defect in its incorporation. Answer: False 24. A corporation may be judicially dissolved when its management is deadlocked and the deadlock cannot be broken by the shareholders. Answer: True 25. If two firms consolidate, the new corporation usually succeeds to the rights, powers and immunities of its component parts. Answer: True 26. A holder of a single share of stock who objects to a merger has the power to stop the merger. Answer: False 27. “Conglomerate” describes the relationship of equal companies engaged in similar fields of business activity. Answer: False 28. A merger is subject to antitrust law, while a consolidation is not. Answer: False 29. In a merger or consolidation, the surviving corporation generally succeeds to all the rights and property of the predecessor. Answer: True 30. Corporations may avoid liability for the obligations of a predecessor corporation by treating a consolidation or merger as a sale of assets. Answer: False MULTIPLE CHOICE 1. A public corporation is: A. also know as a public utility. B. organized for charitable and benevolent purposes or for purposes of finance, industry, and commerce. C. established for governmental purposes and for the administration of public affairs. D. all of the above. Answer: C 2. A corporation that does business in the state in which it was created is called a(n): A. domestic corporation. B. foreign corporation. C. alien corporation. D. home corporation. Answer: A 3. Nonprofit corporations: A. are also known as a eleemosynary corporations. B. are organized for charitable or benevolent purposes. C. include hospitals and universities. D. all of the above. Answer: D 4. A corporation must have: A. a name. B. more than one shareholder. C. a corporate seal. D. all of the above. Answer: A 5. Which of the following will affect the perpetual life of a corporation? A. a change in stock ownership B. the death of a shareholder C. both a. and b. D. neither a. nor b. Answer: D 6. The rules and regulations enacted by a corporation to govern the affairs of the corporation and its shareholders, directors and officers are called: A. articles of incorporation. B. corporate management agreements. C. bylaws. D. articles of organization. Answer: C 7. What is not a correct statement concerning promoters? A. Promoters are generally active before the corporation is formed. B. Two (2) or more promoters are required to form a corporation. C. Promoters are fiduciaries with respect to the corporation and its shareholders. D. Promoters are liable for any torts that they commit while promoting the corporation. Answer: B 8. Which of the following is a correct statement concerning the incorporation process? A. Each application for incorporation is reviewed by the appropriate state legislature. B. The incorporation process is essentially a matter of filing the correct papers and fees with the designated government official. C. Most applications for incorporation are rejected. D. Incorporator(s) are never required to give public notice of the intent to form a corporation. Answer: B 9. Under recent statutes, the articles of incorporation must contain all of the following except the: A. name of the corporation. B. name and address of each incorporator. C. purpose for which the corporation is organized. D. number of shares the corporation is authorized to issue. Answer: C 10. The Revised Model Business Corporation Act: A. has eliminated the certificate of incorporation. B. has made the process of incorporation more difficult. C. states that corporate existence begins when the secretary of state issues a certificate of incorporation. D. has eliminated the need for articles of incorporation. Answer: A 11. Where a corporation is properly formed, it is called a corporation: A. di giorno. B. de facto. C. de jure. D. by estoppel. Answer: C 12. In states that have adopted the Revised Model Business Corporation Act, the secretary of state may commence proceedings to administratively dissolve a corporation under all but which of the following circumstances? A. the corporation adopts more than one business purpose. B. the corporation does not pay franchise taxes within sixty (60) days after they are due C. the corporation does not file its annual report within sixty (60) days after it is due. D. the corporation is without a registered agent or registered office for sixty (60) days or more. Answer: A 13. After a corporate charter has been forfeited, the owners and officers of the dissolved corporation are __________ shielded from personal liability by using the corporate name when making contracts. A. still B. conditionally C. not D. retroactively Answer: C 14. _________ of a corporation may occur when management is deadlocked and the deadlock cannot be broken by the shareholders. A. Bankruptcy B. Consolidation C. Reinstatement D. Judicial dissolution Answer: D 15. If there is a consolidation of corporations A, B, and C: A. corporations B and C are absorbed into corporation A, and corporation A continues to exist. B. all of the corporations continue to exist. C. all corporations continue to exist, but corporation A owns all of the stock of corporations B and C. D. corporations A, B, and C cease to exist, and a new corporation with the property and assets of the old corporations comes into being. Answer: D 16. When two corporations merge: A. their separate existences cease, and a new corporation is formed. B. one of the corporations absorbs the other. C. each corporation’s stockholders keep their original shares of stock D. a new charter is needed. Answer: B 17. In a merger situation, what is the right of a dissenting shareholder? A. to block the merger until satisfied regarding its terms. B. to have their shares appraised and purchased by the corporation. C. to enforce a consolidation instead of a merger. D. dissenting shareholders have no rights with respect to a merger. Answer: B 18. If a wire manufacturing company owned a mill to produce the metal used in making the wire, this relationship between the companies would be best be described as: A. a conglomerate. B. a holding company. C. an integrated industry. D. a merger. Answer: C 19. An enterprise that conducts business following a merger or consolidation succeeds to: A. all of the rights of the predecessor. B. all of the property of the predecessor. C. all of the debts and liabilities of the predecessor. D. all of the above. Answer: D 20. A successor enterprise is not subject to the contract obligations of the former business if: A. one corporation is absorbed by another through merger. B. a corporation merely purchases the assets of another business. C. two or more corporations consolidate. D. none of the above. Answer: B CASE 1. The Miller family, who operates a musical instrument manufacturing concern, has decided to incorporate. The three (3) members of the Miller family, Mary, Mark and Sue, would like to become a corporation and obtain limited liability; however, taxation at the corporate level would be very costly for them. If possible, Mary Miller would rather be taxed as a partnership. Mark Miller is worried about the additional paperwork and meetings that incorporation would surely bring. Sue Miller does not want a large board of directors to be formed. Sue fears that the board would somehow detract from the family goals and orientation the business has always enjoyed. In light of these concerns, is there a corporate form that would better suit the Miller family? Answer: Yes. When a small family company decides to incorporate, the form often selected is that of a close corporation. In a close corporation, the shares are held by one shareholder or a closely-knit group of shareholders. The stock would not be publicly traded. Statutes are quite liberal toward the formation of close corporations. The board of directors could consist of one individual, and the requirement of formal meetings would be eliminated. A close corporation could also seek the status of a "Subchapter S” corporation. In a Subchapter S corporation, the business would be afforded limited liability and yet would be taxed as a partnership. The combination of a close and a Subchapter S corporate form would satisfy the needs and concerns of the Miller family. 2. Osvaldo was attempting to promote a corporation to be named Xavier, Inc. In that capacity, Osvaldo signed a lease in the name of Xavier and ordered furniture in the company’s name. The corporation was in fact formed and the board of directors, knowing of the actions of Osvaldo, moved into the space Osvaldo had leased. Upon delivery and inspection of the furniture Osvaldo ordered, numerous defects were discovered, and the furniture was accordingly rejected and returned to the seller. The corporation was not successful, and as a result, the rent was not paid. Osvaldo was sued for the unpaid rent and for breach of contract concerning the furniture. The corporation was sued on the same grounds. Decide the cases against Osvaldo and Xavier, Inc. Answer: Osvaldo is liable for the lease because a promoter is personally liable for contracts made on behalf of the corporation before its existence, unless the agreement or the circumstances clearly indicate that the promoter should not be liable. Although Osvaldo would be personally liable for the furniture had the other party adequately performed, Osvaldo is not liable on the contract since the other party breached (This answer assumes that the seller has no right to “cure” the defective delivery under the provisions of the Uniform Commercial Code; for example, the time period for delivery has expired, and the furniture seller cannot establish that he made the defective delivery with the reasonable assumption that it would be acceptable to the buyer.) The corporation, Xavier, is liable on the space rental because the actions of the board of directors clearly demonstrate that they adopted the lease contract. There is no corporate liability for the furniture because that contract was expressly and rightfully rejected. Chapter 45—Shareholder Rights in Corporations TRUE/FALSE 1. The two most common instruments used to provide the capital structure of a corporation are stocks and bonds. Answer: True 2. Each shareholder owns a proportionate share of the property of the corporation. Answer: False 3. An interest in a corporation is based on the ownership of one or more shares of stock of the corporation. Answer: True 4. Shares of stock that have been issued to stockholders in a corporation are said to be outstanding. Answer: True 5. All shares must have a par value of at least one dollar per share. Answer: False 6. Another term for par value is book value. Answer: False 7. Preferred stock cannot have priority over common stock with respect to dividends. Answer: False 8. Preferred stock is ordinarily nonvoting stock. Answer: True 9. Shares can exist for only as long as the shareholder is alive. Answer: False 10. Shares of stock may be acquired through subscription or through a transfer of existing shares from a shareholder or from the corporation. Answer: True 11. A contract for the sale of shares must be evidenced in writing. Answer: True 12. No writing is required for a contract by which a broker agrees with a customer to buy or sell securities for the customer. Answer: True 13. A pre-incorporation subscription to stock is generally treated as an offer to the corporation to buy the stock when the corporation is formed and the stock is thereafter issued. Answer: True 14. Under the RMBCA, a pre-incorporation subscription agreement is irrevocable for three (3) months unless the subscription agreement provides a longer or shorter period, or all of the subscribers agree to revocation. Answer: False 15. Upon acceptance of a subscription after incorporation, the subscriber immediately attains the rights, privileges, and liabilities of a shareholder, even though the subscriber has not paid any of the purchase price. Answer: True 16. Restrictions on the transfer of stock are valid if they are not unreasonable. Answer: True 17. A provision giving a corporation the right to purchase a shareholder's shares on the death of the shareholder is invalid. Answer: False 18. A shareholder may make an absolute transfer of stock or may transfer it merely as collateral to secure the payment of a debt. Answer: True 19. To correctly transfer shares of stock, a delivery from the owner of the shares directly to the transferee is required. Answer: False 20. Corporate securities evidenced by a certificate are negotiable. Answer: True 21. A bona fide purchaser of stock is shielded from the claim that the transfer was made in violation of a transfer restriction that was unknown to the purchaser and that was not noted conspicuously on the certificate. Answer: True 22. If a shareholder borrows money and delivers stock as collateral security, the creditor has a perfected security interest in the stock without any filing by the creditor. Answer: True 23. Until a transfer is recorded on its books, a corporation is entitled to treat the person whose name is on its books as the owner of its stock. Answer: True 24. If a share certificate is lost, destroyed, or stolen, the ownership of the shareholder is destroyed. Answer: False 25. Shareholders exercise direct control over their corporation. Answer: False 26. Ordinarily, each shareholder is entitled to one vote for each voting share. Answer: True 27. A shareholder can give a proxy to vote shares only to another shareholder. Answer: False 28. Voting trusts are usually illegal. Answer: False 29. As an owner of the corporation, a shareholder always has the right to inspect the books of the corporation for any purpose, regardless of whether the inspection is related to the shareholder's interest as a shareholder. Answer: False 30. Statutes sometimes provide that shareholders shall have unlimited liability for the wage claims of corporate employees. Answer: True MULTIPLE CHOICE 1. When an individual owns a share of stock in a corporation, that individual: A. has an ownership interest in the corporation. B. is a creditor of the corporation. C. generally has no voting rights. D. is in possession of a debt security. Answer: A 2. A shareholder does not: A. qualify as a member of the corporation. B. own any specific property of the corporation. C. have a fractional interest in the total property of the corporation. D. all of the above. Answer: B 3. The net assets of a corporation may be referred to as: A. debentures. B. stock. C. capital. D. bonds. Answer: C 4. Which of the following statements is not true of common stock? A. It is ordinary stock that has no preferences. B. It entitles the holder to share in corporate profits in the form of dividends. C. It entitles the holder to participate in the distribution of capital upon dissolution. D. It is ordinarily nonvoting. Answer: D 5. A bond: A. that is unsecured is called a debenture bond. B. is a negotiable security C. generally has a life of five years or longer. D. all of the above. Answer: D 6. A contract or agreement to purchase a specific number and kind of shares of stock when it is issued is called a stock: A. guaranty. B. subscription C. request. D. warranty. Answer: B 7. Which of the following is an effective means of notice to purchasers of shares that there are restrictions on the sale? A. notation in the bylaws B. resolution of the shareholders at a shareholders' meeting C. notation on the stock certificate D. resolution of the directors at a directors' meeting Answer: C 8. Ownership of shares of stock may be transferred by any of the following methods except: A. delivery of the stock endorsed by its owner in blank. B. delivery of a notice of intent to transfer. C. delivery of the stock endorsed by its owner to a specified person. D. delivery of the certificate and a separate power of attorney executed by the owner. Answer: B 9. Delivering stock to a creditor as security for a debt owed by the shareholder: A. transfers ownership rights. B. gives rise to a perfected security interest. C. makes the creditor a perfected party after filing. D. makes the debtor a perfected party after filing. Answer: B 10. Straight voting: A. increases the voting power of minority shareholders. B. is the normal method for shareholder voting on corporate matters. C. restricts each shareholder to one vote, regardless of the number of shares owned. D. all of the above. Answer: B 11. Cumulative voting: A. decreases the voting power of minority shareholders. B. is the normal method for shareholder voting on corporate matters. C. generally is required or allowed in the election of corporate directors. D. is a right given to participating preferred shareholders. Answer: C 12. An individual who has been authorized to vote the share of another stockholder is said to be voting by: A. trust. B. proxy. C. estoppel. D. agency. Answer: B 13. The RMBCA provides that shareholders: A. have no preemptive rights unless the articles of incorporation so provide. B. have preemptive rights regardless of what the articles of incorporation provide. C. cannot have preemptive rights. D. only have preemptive rights with respect to the transfer of a block of stock as consideration. Answer: A 14. A shareholder has a right to inspect the books of the shareholder's corporation if: A. the request is made in good faith. B. the request is made with proper motives. C. the inspection takes place at a reasonable time and place. D. all of the above. Answer: D 15. A shareholder has: A. an absolute right to dividends. B. a right to dividends when declared. C. a right to insist that dividends be declared. D. to share equally all dividends with fellow shareholders. Answer: B 16. Dividends are payable in: A. money. B. products manufactured by the corporation. C. shares of other corporations held by the corporation. D. all of the above. Answer: D 17. When the corporation has the right to sue its directors, officers, or third persons for damages caused by them to the corporation or for breach of contract, one (1) or more shareholders may bring such action if the corporation refuses to do so. This is known as a __________ action. A. primary B. derivative C. deferential D. preemptive Answer: B 18. Which of the following is not a factor that may lead to “piercing the corporate veil” and imposing liability on corporate owners (shareholders)? A. grossly inadequate capitalization of the corporation B. formation of the corporation to avoid personal liability for business obligations C. formation of the corporation to perpetuate a fraud or conceal illegality D. shareholder diversion of corporate funds or assets Answer: B 19. Pursuant to the __________ theory, when a corporation is so dominated and controlled by shareholders, officers, and/or directors that the separate personalities of the individuals and the corporation no longer exist and there is a wrongful use of that control, the courts will disregard the corporate entity so as not to sanction a fraud or injustice. A. alter ego B. altered states C. puppeteer D. invisible hand Answer: A 20. The liability of a shareholder in a professional corporation for the malpractice of an associate: A. varies from state to state. B. is sometimes determined in court. C. both a. and b. D. neither a. not b. Answer: C CASE 1. The Toy Corporation issued 200 shares of stock with no par value. The articles of incorporation provided that the board of directors had the right to fix the value of the stock. Through subscription agreements between the directors and two subscribers, 101 shares were issued to Maria Perez for $5,000, and 99 shares were issued to Ken Pilar for $15,000. Toy is now insolvent and is unable to pay the $6,000 it owes to Pine, its major supplier. Pine has brought suit against Perez, claiming that the subscription agreement was invalid. How will the case be decided? Answer: Judgment will be for Perez. The subscription agreement was not invalid as to the creditors of the corporation. As provided in the articles of incorporation, the directors had the right to fix the consideration for the sale of the no-par stock. If the shares had been par-value shares for which Perez had not fully paid, she might have been liable for the unpaid balance. 2. Donna called her stockbroker Henry and told him to purchase 300 shares of Royex Corporation shares at $15 per share, the current market price. Henry agreed to do so, but became distracted and failed to do so. The price of the shares rose $3 in price that day. In the evening, Donna in a telephone conversation agreed to sell 300 shares of Royex to Sid. Assuming Henry and Donna dispute the validity of the contracts, which of the contracts are enforceable in court? Answer: A contract for the sale of corporate securities must be evidenced in writing or it cannot be enforced, so the contract between Donna and Sid is unenforceable. No writing is required for a contract by which a broker agrees to buy securities; this is not a contract for the sale of securities but an agency contract in which an agent agrees to perform a duty for a fee. 3. Manis owns 100 shares of stock of the Linquist Corporation. She sells her stock to Sosnik and delivers to him: (1) her stock certificate for 100 shares and (2) a written, signed assignment of the 100 shares to Sosnik. The assignment form printed on the back of the share certificate is left blank and is not signed. Sosnik refuses to take the certificate and the assignment on the ground that Manis must fill in and sign the assignment form on the stock certificate to make the transfer of stock effective. Is he correct? Answer: No. Manis could have made the transfer in the manner requested by Sosnik, but she was not required to do so, and the transfer is just as effective when made in the manner followed by her. It makes no difference to the corporation or the transferee which method of making the transfer is followed. Therefore, Sosnik cannot object to Manis' choice of method. Test Bank for Business Law: Principles for Today's Commercial Environment David P. Twomey, Marianne M. Jennings 9781133588245, 9781305575158, 9780324786699
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