CHAPTER 3

BUSINESS ENTITIES

Before starting a business an entrepreneur must decide what form of business entity will be utilized. Businesses are generally established in one of four forms: 1. 2. 3. 4. Sole proprietorship Partnerships Corporation Limited Liability Companies and Limited Liability Partnerships

There can be a number of factors to consider when trying to decide what is the best business form to adopt. These factors include, but are not limited to, taxes, liability, transferability of interest, ability to raise money and control. The following material addresses some basic aspects about each business form.

SOLE PROPRIETORSHIP

A sole proprietorship is the simplest form of a business. Although some additional steps may be required, such as acquiring licenses and accounting measures, there is no distinction between the business and the individual. A sole proprietorship may operate under an assumed trade name. John Doe, for example, may operate a business known as "Superior Car Care". The use of a trade name does not change the nature of the sole proprietorship. The owner has absolute control over the business. The owner has full liability for any and all claims, in tort or contract, against the business. The owner is responsible on his individual tax return for all taxes due as a result of the income generated by the business.

PARTNERSHIP

Louisiana recognizes three types of partnerships. partnerships-in-commendam, are discussed in this section.

Two of the types, ordinary and A third type, Limited Liability

Partnerships, is discussed in the section addressing Limited Liability Companies.

93

Any time two or more persons agree to combine their efforts or resources for their common benefit a partnership may exist. The laws pertaining to partnership are found in Louisiana Civil Code Articles 2801, et. seq.

Ordinary Partnership--Articles Of Partnership Written articles of partnership are not always necessary to establish an ordinary partnership. La. Civil Code article 2806 states that if the partnership is to own immovable property in its own name, as opposed to the individual partners, written articles of partnership are required. In order to be effective against third parties the articles of partnership must be filed with the Secretary of State and recorded with the clerk of court in the parish where the property is located. If immovable property is not owned, written articles are not required, but they are recommended. A partnership may exist between or among the parties even though they have never expressly reached such an agreement.

Transfer Of Interest And Control The partnership articles will usually address what is necessary for the sale of a partnership interest, the admission of new partners and how the partnership will be managed. It is possible that one partner could sell or transfer his partnership interest to a third party without the consent of the remaining partners. This transfer may permit the third party to share in the partnership profits, but it would not mean that the third party would become a partner. Partnership articles rarely permit the admission of a new partner without the unanimous or majority consent of the remaining partners. Historically, the death of one partner resulted in the termination of the partnership. This is no longer the rule unless the partnership only has two partners. Management or control of the partnership is generally by unanimous or majority vote of the partners, but may be established in any other manner by the articles.

Taxes With respect to income taxes a partnership has somewhat of a mixed existence. A

partnership must file an income tax return, but the returns are only informational. The partnership pays no income taxes. All income is "passed through" to the partners who report and pay taxes on their individual return based on their percentage of ownership in the partnership.

94

Liability With respect to partnership debts, the partnership, not the partners, is primarily liable. What happens if the partnership is unable to pay the debt? La. C.C. Art. 2817 states that each partner is liable for his " virile share" unless there is an agreement to the contrary in the partnership articles. The meaning of "virile share" is not given in article 2817 and has been the subject of considerable debate. Is the "virile share" owed by the partners calculated by "heads", that is, the number of partners in the partnership? Or, does "virile share" mean the percentage each partner has in the partnership. In Hibernia Bank v. Carner a federal court held that "virile share" meant the liability was calculated by "heads." There is considerable support for this view, however, other courts may still take a different position. Regardless of how "virile share" is interpreted, what happens if one or more partners becomes insolvent or bankrupt?. Is the shortage assumed by the remaining partners or does the creditor suffer the loss? The former will be the probable outcome. Liability for the partnership or the partners generally arises, excluding taxes, in one of two ways, by contract or tort. In many contracts by the partnership the individual partners will be required to personally endorse or guarantee the contract. Generally each partner would become "solidarily" bound with the partnership. "Solidary" or "in solido" liability means that each partner would be liable for the full amount of the debt. That is, if the partnership and one or more of the partners subsequently went bankrupt, the remaining solidary partner(s) could be liable for the full debt. With respect to tort claims, if a partner were to personally commit a tort while engaged in conduct on behalf of the partnership, the partnership and the tortfeasor partner would each be responsible for the entire claim. If the partnership, or the partner who committed the tort, did not pay the debt in full the remaining partners would be liable for their virile share.

Partnership-in-commendam A partnership-in-commendam must have at least one "general" partner and at least one "limited" partner. Articles of partnership must be in writing and filed with the secretary of state. The law requires specific matters as to the name of the partnership. A partnership-in-commendam has mixed characteristics. The limited partners are, with respect to liability, treated like shareholders of a corporation. That is, their liability for the debts of the partnership is limited to their investment or agreed upon contribution. General partners are, however, liable for the full amount of all partnership debt, not just their virile share. Unlike an 95

ordinary partnership, the law requires that management in the partnership-in-commendam be vested solely in the general partner. There are restrictions regarding a limited partner's participation in management of the partnership. A limited partner's involvement in the operation of the partnership could jeopardize the limited partner's status and "limited liability" protection. Partnerships-incommendam were very popular entities for investment purposes several years ago. The limited liability and potential tax advantages for a limited partner were the primary attractions. However, because of restrictions on some tax write-offs and the development of Limited Liability Companies, discussed below, partnership-in-commendams are not as popular today.

CORPORATIONS

A corporation is an artificial person recognized by the law. A state must grant a charter for a corporation to exist. The charter is obtained by filing articles of incorporation with the Secretary of State and the clerk of court in the parish of the corporation's registered office. The formality of creating a corporation is actually quite simple. The basic requirements to create a corporation in Louisiana are found in La. R.S. 12:24, 25 and 101 which are set forth below. See Appendix A for Articles of Incorporation and Initial Report forms. The person who signs and files the articles of incorporation is referred to as the "incorporator". The incorporator does not necessarily have any interest, ownership or control of the corporation. Corporations are owned by its shareholders who elect directors to run the corporation. The directors, in turn, hire officers to run the day-to-day affairs of the company. A corporation may have only one or a large number of shareholders and directors. Technically a corporation should have at least two different people to serve as officers.

R.S. 12:24. A. The articles shall be written in English language, and shall be signed by each incorporator, or by an agent of each incorporator duly authorized by a document attached to the articles. The articles shall be acknowledged, or may instead be executed by authentic act. The articles shall set forth: (1) (2) The name of the corporation; In general terms, the purpose or purposes for which the corporation is to be formed, or that its purpose is to engage in any lawful activity for which corporation may be formed under this Chapter; 96

B.

(3) (4) (5) (6)

The duration of the corporation, if other than perpetual; The aggregate number of shares which the corporation shall have authority to issue; If the shares are to consist of one class only, the par value of each share or a statement that all of the shares are without par value; If the shares are to be divided into classes, the number of shares of each class; the par value of the shares of each class or a statement that such shares are without par value; the designation of each class and, in so far as fixed in the articles, each series of each preferred or special class; a statement of the preferences, limitations and relative rights of the shares of each class and the variations in relative rights and preferences as between series, in so far as the same are fixed in the articles; and a statement of any authority vested in the board of directors to amend the articles to fix the preferences, limitations and relative rights of the shares of any class, and to establish, and fix variations in relative rights as between, series of any preferred or special class; The full name and post office address of each incorporator.

(7) R.S. 12:25. A.

The articles, or a multiple original thereof, shall be filed with the Secretary of State, together with the initial report prescribed by R.S. 12:101. (If the first directors are not named in the initial report, a supplemental report, setting forth their names and addresses and signed by each incorporator or his agent or by any shareholder, shall be filed with the Secretary of State, and filed for record as provided in subsection D of this section, as soon as they have been selected.) The articles and initial report may be delivered to the Secretary of State in advance, for filing as of any specified date (and, if specified upon such deliver, as of any given time on such date) within thirty days after the date of delivery. If the secretary of state finds that the articles and initial report are in compliance with the provisions of this Chapter and after all fees have been paid as required by law, the secretary of state shall record the articles or the multiple original thereof and the initial report in this office, endorse on each the dated and, if requested, the hour of filing thereof with him, and issue a certificate of incorporation that shall show the date and, if endorsed on the articles, the hour of filing of the articles with him. The certificate of incorporation shall be conclusive evidence of the fact that the corporation has been duly incorporated, except that in any proceeding brought by the state to annul, forfeit, or vacate a corporation's franchise, the certificate of incorporation shall be only prima facie evidence of due incorporation. Upon the issuance of the certificate of incorporation, the corporation shall be duly incorporated, and the corporate existence shall begin, as of the time when the articles were filed with the secretary of state, except that, if the articles were so filed within five days (exclusive of legal holidays) after acknowledgment thereof or execution thereof as an authentic act, the corporation shall be duly incorporated, and the corporate existence shall begin, as of the time of such acknowledgment or execution.

B.

C.

97

R.S. 12:101. The initial report to be filed as provided in R.S. 12:25(A), shall be signed by each incorporator, or by his agent duly authorized by a document attached to the report, and shall set forth: (1) (2) The location and municipal address, if any, (not a post office box only) of the corporation's registered office; The full name and municipal address, if any, (not a post office box only) of each of its registered agents; and The names and municipal addresses, if any, (not a post office box only) of the first directors, if they have been selected when the articles are filed with the secretary of state.

(3)

A sample form of articles of incorporation and an initial report are attached at the end of this chapter.

Publicly Held, Closely Held/Small Corporations Many corporations are extremely large. The earnings of some companies are even greater than the GNP of many countries. Large corporations are generally owned by thousands of

shareholders. The shares in these corporations are generally bought and sold on a daily basis through brokers who utilize public stock exchanges. These companies are generally referred to as publicly held companies. The stock is registered with state and federal security authorities.

Corporations which are not publicly traded are often referred to as closely held corporations. Many closely held corporations are large and quite successful, but most closely held corporations are very small. Many small corporations may have no more than one or two shareholders. There are some major practical differences with respect to publicly held and closely held and/or small corporations which are discussed below.

Limited Liability The liability of a shareholder for the debts of the corporation is said to be "limited". This description is due to the fact that if the corporation cannot pay its debt, the shareholder has no liability for the corporation's obligations. The shareholder's loss is limited to his investment, or the price paid for the shares. The "limited liability" feature of a corporation is probably the most attractive aspect of a corporation. Public companies would not be able to obtain the investment funds from shareholders were it not for the "limited liability" protection. A shareholder can 98

purchase shares in a "publicly held" corporation, for example General Motors, and know that no matter what happens financially to the company the shareholder's loss will not exceed the price paid for the shares. The shareholder does not incur any personal liability on behalf of the company. The "limited liability" protection is also the primary reason that people choose a corporate entity for their "closely held" or "small" business. Shareholders of "closely held" companies do not, however, necessarily obtain the full benefit of "limited liability". In many "closely held"

corporations the shareholders, directors, officers and employees are all the same people. The corporation may want to borrow money or obtain goods or services on credit. Creditors will often insist that the shareholders personally guarantee the debt. If a personal guarantee is given by the shareholders, the shareholder would, in the event the company was unable to pay the debt, be responsible for the debt. In this situation the "limited liability" concept would not protect the shareholders. The shareholder of a "closely held" corporation will usually be employed by the business. If the shareholder committed a tort while performing a function on behalf of the company, the corporation and the shareholder would be fully liable for the tort claim. Again, in this situation the "limited liability" feature would not protect the shareholder who committed the tort. The "limited liability" feature can, however, benefit the shareholder in a "closely held" corporation. The corporation may be able to obligate itself on some contracts without the personal guarantee of the shareholders. If so, the shareholders would not be personally liable. Or, a tort may be committed by another employee of the corporation, who may or may not be a shareholder. The shareholders who did not commit the tort would generally not be personally liable for the damages caused by another employee or shareholder. Piercing The Corporate Veil "Piercing the corporate veil" is a phrase used to describe situations in which the court will allow a creditor of the corporation to recover a debt from a shareholder or another individual even if the "limited liability" protection is available. There are a number of factors which are considered by the courts when addressing this issue. Situations in which a shareholder is using the corporate entity to commit fraud, the formalities required by law have not been met or corporate funds being commingled with personal funds are the types of factors that the courts have looked at when a creditor is seeking to recover a corporate debt from a shareholder. The case of Riggins v. Dixie Shoring is presented below. It is a lengthy opinion. However, the Riggins case has an excellent discussion on the theory of "piercing the corporate veil". 99

RIGGINS v. DIXIE SHORING COMPANY, INC. A New Orleans shoring company, founded in 1953, incorporated in 1963, and doing business in New Orleans continuously during that time, contracted with plaintiffs to jack and level their home. Plaintiffs sued for damages after the slab and some of the walls cracked when the house was being jacked. One and one-half years after the lawsuit was filed, the corporation filed for bankruptcy, whereupon plaintiffs amended their petition to add as defendants the two shareholders and the majority shareholders son who helped run the business. The district court rendered judgment for $51,000 against the majority shareholder and his son while dismissing claims against the second shareholder, the separated wife, after "piercing the corporate veil" and finding damages arising out of deficient performance of the contract. The court of appeal exonerated the son because he was neither a director nor shareholder of the corporation, but affirmed judgment against the majority shareholder individually. We granted writs to consider whether the law limiting the liability of corporate shareholders has been properly applied. For the reasons which follow, we determine that it has not. Plaintiff is entitled to judgment against the corporation with which they contracted, but not against the majority shareholder personally. Dixie Shoring was one of the older shoring companies in New Orleans, having been founded by O.P. Bajoie's father, Woodrow Walker, around 1953. From its founding through 1987, the business operated continuously, providing shoring services throughout the city. In May of 1963, the company incorporated in accordance with the corporation laws of Louisiana. The corporation did business under that name for an additional twenty-three years, through 1986, maintained checking accounts at Hibernia And First National Bank of Commerce in the corporate name, had gross receipts in excess of a quarter million dollars in each of the years 1985 and 1986, and filed appropriate tax returns with the Internal Revenue Service, the Louisiana Department of Revenue Service, the Louisiana Department of Revenue and Taxation, and the Louisiana Office of Employment Security. O.P. Bajoie and his son, Reginald, met regularly about the business operations. In November of 1985, William and Patricia Riggins contracted with Dixie Shoring Company, Inc. to have their home jacked and leveled. The south side of the house had sunk slightly, apparently because of ground subsidence in the area. O.P. Bajoie, who represented himself as the owner and president of Dixie Shoring Company, Inc., negotiated and signed the contract for his corporation after several meetings with Riggins. The amount of the contract was $9,100. Work began on the house November 18, 1985. At the time of the first payment, O.P. Bajoie asked that the check be made out to himself personally instead of the Dixie Shoring Company, Inc. In December, O.P. Bajoie's son, Reginald, approached Riggins for the second payment and he also requested that the check be made out to him personally instead of to the company. Although Riggins refused to do this until he had the permission of O.P., he ultimately did make the second check payable to Reginald. Both O.P. and Reginald Bajoie testified that they requested the checks be issued in this manner to enable them more readily to cash the checks and use the money for necessary company expenditures. In January, 1986, after the jacking caused a major crack in the foundation with concomitant cracks in the interior and exterior walls of the house, plaintiffs refused to pay the final installment, and in April of 1986 initiated this suit to recover damages. Initially, the plaintiffs named only Dixie Shoring Company, Inc. as defendant in the action. However, according to the court of appeal (supported by the testimony of plaintiff), it was one and 100

one-half years after plaintiffs filed suit that the corporation filed for bankruptcy, and shortly thereafter that plaintiffs amended their petition to bring in O.P. and Reginald Bajoie as individual defendants. Later, they filed a second supplemental and amending petition naming as another defendant Julie Bajoie the former wife of O.P. Bajoie and allegedly a shareholder of the company at the time the contract was executed. After a trial on the merits, the district court dismissed the plaintiffs' claims against Julie Bajoie. Additionally, the court "pierced the corporate veil" of Dixie Shoring Company, Inc. found both O.P. Bajoie and Reginald Bajoie personally liable, and awarded plaintiffs $51,000 in damages for the negligent and improper leveling of their house. The judgment is silent concerning the corporation. However, the plaintiffs' claims, and prayer for monetary relief against Dixie Shoring Company, Inc., was not eliminated in their supplemental petitions adding the three defendants. In its reasons for judgment, the district court found that several factors supported ignoring the corporate existence: 1) employees being paid in cash with no records maintained of this; 2) checks from customers of the business that were made out to O.P. and Reginald Bajoie individually instead of to the corporation; 3) no corporate minutes kept; 4) property belonging to O.P. Bajoie individually was used by the corporation without compensation to O.P.; 5) over $100,000 disappeared without explanation between the end of 1986 and the filing of the bankruptcy petition; 6) some of the same equipment used by the corporation is now being used by the successor business, including a truck titled in the name of the former corporation; 7) disbursements made to employees without complete documentation; 8) failure to show that the cash received by cashing the checks made out to the Bajoies individually was deposited into the corporate accounts; and 9) inexact testimony by O.P. and Reginald about how cash was handled. The district court also found facts which suggested that the corporate veil should not be pierced: 1) for many years the corporation operated under the corporate name; 2) the corporation maintained checking accounts and filed the appropriate tax returns under the corporate name; 3) the corporation showed profits and paid federal income taxes; 4) the plaintiff testified that he understood that he was dealing with the corporate entity and not O.P. and Reginald individually; 5) O.P. held informal meetings with Reginald about business operations which amounted to a form of Board of Directors meetings; 6) the corporation was properly incorporated under the laws of Louisiana; 7) the corporation had gross receipts of $280,403 in 1985 and $251,963 in 1986; 8) corporate checking accounts were maintained from which significant corporate disbursements were made; and 9) substantial sums of money were maintained in the corporate checking accounts during the time that work was being performed on plaintiff's house. Furthermore, the district court found that Reginald acted "beyond a mere employee of [the corporation] and acted personally and periodically as [its] alter ego." The court also found that both O.P. and Reginald Bajoie converted corporate funds to their own use. The only possible support in this record for that conclusion is the evidence regarding the two checks made payable to O.P. and Reginald Bajoie and cashed by them. The district court concluded that "[t]he totality of the testimony, documentary evidence and pleadings" established that the corporate veil should be pierced. It awarded plaintiffs $51,000 in damages and held both O.P. and Reginald Bajoie personally liable for deficient performance under the contract. The court found that the jacking was negligently performed, in violation of the 'implied warranty" inherent in all contracts. The court noted that the 5th and 6th factors given for ignoring the corporate existence were the most damaging (the trial judge said they "tipped the scales") and resulted in the imposition of liability upon O.P. Bajoie and Reginald Bajoie individually. Factors 5 and 6 are: "(5) In excess of $100,00 of corporate ... assets disappeared ... prior to bankruptcy" and "(6) ... equipment formerly used in [the corporation's] business is now used by [the successor business]." The court of appeal affirmed the district court's ruling that Dixie Shoring Company, Inc. was simply the alter ego of its major shareholder, O.P. Bajoie. However, the court of appeal reversed the portion of the district court's judgment holding the son, Reginald, individually liable because he 101

was neither a director nor shareholder of the corporation. They affirmed the damage award of $51,000 against O.P. Bajoie for deficient performance under the contract. The general rule that corporations are distinct legal entitles, separate from the individuals who comprise them, and that the shareholders are not liable for the debts of the corporation, is statutory in origin and well supported by the jurisprudence. The economic purpose underlying this framework of limited liability was expressed by the First Circuit over a quarter century ago: "Protection from individual liability encourages and promotes business ... and industry ....". Additionally, this shareholder liability shield encourages business investments in high-risk areas by enabling investors who utilize the corporate form to make capital contributions to corporations while insulating their personal wealth from the risks inherent in business. No matter the size of the business, incorporation is an optional form for conducting business in Louisiana. In fact, the 1968 revision to the corporation laws now allow a single individual to incorporate. LSA-R.S. 12:21. Because of the beneficial role of the corporate concept, the limited liability attendant to corporate ownership should be disregarded only in exceptional circumstances. Moreover, if the plaintiffs do not allege shareholder fraud, they bear a heavy burden of proving that the shareholders disregarded the corporate entity to such an extent that it ceased to become distinguishable from themselves. There are limited exceptions to the rule of non-liability of shareholders for the debts of a corporation, where the court may ignore the corporate fiction and hold the individual shareholders liable. Generally, that is done where the corporation is found to be simply the "alter ego" of the shareholder. It usually involves situations where fraud or deceit has been practiced by the shareholder acting through the corporation. Another basis for piercing the corporate veil is when the shareholders disregard the requisite corporate formalities to the extent that the corporation ceases to be distinguishable from its shareholders. Some of the factors courts consider when determining whether to apply the alter ego doctrine include, but are not limited to: 1) commingling of corporate and shareholder funds; 2) failure to follow statutory formalities for incorporating and transacting corporate affairs; 3) under capitalization; 4) failure to provide separate bank accounts and bookkeeping records; and 5) failure to hold regular shareholder and director meetings. The fact that one individual owns a majority of stock in the corporation does not in itself make that individual liable for corporate debts. This is particularly true in the case of a closely held corporation where often corporate business is conducted by the majority, or sole, stockholder. Louisiana courts are reluctant to hold a shareholder, officer, or director of a corporation personally liable for corporate obligations, in the absence of fraud, malfeasance, or criminal wrongdoing. Generally, unless the directors or officers of a corporation purport to bind themselves individually, they do not incur personal liability for debts of the corporation. Furthermore, corporate agents are generally not liable for corporate debts and the burden of establishing the contrary is on the corporate creditor. When a party seeks to pierce the corporate veil, the totality of the circumstances is determinative. In order properly to disregard the corporate entity, one of the primary components which justifies piercing the veil is often present: to prevent the use of the corporate form in the defrauding of creditors. There is no evidence that Bajoie used the corporate form to perpetrate fraud. Indeed, the plaintiffs have not asserted fraud in their pleadings. Possibly that is because, among other reasons, Bajoie had been operating this shoring business for at least twenty-three years, using the corporate form consistently. Although some of the corporate formalities were not strictly followed, such as formal Board of Director's meeting, the Bajoies did follow most of the essential corporate 102

formalities for the twenty-three years of the corporation's existence, such as having corporate bank accounts and filing corporate tax returns, etc. Moreover, in the cases where they did not strictly follow certain formalities, as in the example above concerning the lack of formal Board meetings, O.P. and Reginald still ran the corporation basically on a corporate footing; for example, they regularly met informally about business operations which, especially given that this was a small, closely held corporation, sufficed to satisfy the spirit of the requirement. They routinely contracted in the name of the corporation (indeed, their contracts bear the corporate name) and did so with plaintiffs who understood and believed that they were doing business with the corporation. Riggins even filed suit initially against the corporation alone, and did not include the Bajoies individually until the corporation filed for bankruptcy. In support of the piercing the corporate veil in order to allow casting O.P. Bajoie individually, the district court relied heavily on an alleged diversion of corporate assets prior to the filing of the petition in bankruptcy. Said the court (and quoted by the court of appeal): In excess of $100,000.00 of corporate ... assets disappeared without explanation by OPB and RB between the end of [the corporation's] last fiscal year for tax purposes (1986) prior to bankruptcy and the date of the filing of the [corporation's] petition for bankruptcy. But the record does not support these conclusions, either that the corporation had over $100,000 in assets at the end of 1986, or that these assets disappeared from the corporation prior to filing for bankruptcy. The only record evidence regarding the existence of these assets is the listing of an "equipment" asset of $112,864 which appears on the corporation's December 31, 1986 balance sheet, is confirmed in a 12/31/86 general ledger and included in a 1986 federal tax return. That entry in each pertinent exhibit, however, is immediately followed by a debit entry for depreciation of $103,057.50, and a concluding entry, for the difference, of total fixed assets of $9,806.50. Similarly, a fixed asset entry of $800 (truck) is immediately followed by a corresponding $800 debit for depreciation. This, the machinery and equipment entry, no doubt corresponding to their undepreciated basis for tax purposes, at the end of 1986, on the balance sheet and the tax return, was $9,806. The equipment was thus depreciated just short of 90%, and indication that it was old equipment (probably accumulated over the twenty-three years of the corporation's existence). The cost, or other basis, at no doubt much earlier acquisition dated (dates are not shown in plaintiffs' exhibits), was presumably $112,864. The property may have been worth $9,906, or less, or maybe more. The only specific evidence of value, however, was $1,800, which was placed on this asset in the bankruptcy schedule by the bankrupt corporation. There is no other evidence in the record of value of this machinery and equipment. This $112,864 of equipment must necessarily be the "over $100,000" of corporate assets which the trial court found disappeared, or was illegally diverted, for there is no other evidence of this sort in the record. We have already, in the preceding paragraph, discussed the proof of value of the equipment. Regarding disappearance, the contrary seems evident from the scant evidence presented in the record. Over a year after plaintiff sued the Dixie Shoring Company, Inc. the latter filed for bankruptcy. Notably, they listed in a schedule of assets at that time not only $19,000 in deposits (i.e., bank balances) and over $40,000 in contingent and unliquidated claims, but machinery and equipment, which the debtor valued at $1,800, and a vehicle which was valued at $700. Furthermore, that some of the same equipment purportedly is being used by a successor business entity, including a truck titled in the name of the corporation, is not proof of any illegal diversion. Proper bankruptcy processes often result in a trustee's dispossessing himself of a bankrupt debtor's property. 103

Corporations may invoke bankruptcy under Chapter 7 or Chapter 11. The implication in this case (again, the record evidence is scant) is that Dixie Shoring Company, Inc. filed under Chapter 7 because, from the testimony at trial, the Dixie Shoring Company, Inc. did not continue in operation. Pertinent to plaintiffs' contention (essentially a surmise) that assets were illegally diverted are some principles to be found in the bankruptcy law. Unlike individuals, corporations (which are allowed Chapter 7 relief) may not be discharged from their obligations through bankruptcy. 11 U.S.C.A. Sec. 727(a)(1). Also, the bankruptcy of this corporation may or may not be closed, or have been closed when this case was tried. The bankruptcy court must close the case after full administration, but the case may be reopened to administer assets, to accord relief to the debtor, or for other reasons. 11 U.S.C.A. Sec. 350. The trustee may abandon any property of the debtor that is burdensome or inconsequential to an estate. 11 U.S.C.A. Sec. 554(a). Additionally, unless the court orders otherwise, any property not administered at the point where the case is closed is abandoned to the debtor. Accordingly, any number of possibilities exist regarding the transition in ownership and/or control of the bankrupt's machinery and equipment. On the record presented in this case, including a Summary schedule which lists machinery and equipment, it is at least more likely than not that there has not been a diversion of these assets pre-bankruptcy or an illegal diversion post-bankruptcy, and certainly no disappearance of the machinery and equipment. If the trustee did abandon the machinery and equipment in this case, those movables likely remain with the bankrupt, Dixie Shoring Company, Inc. where they are still subject to seizure in execution of any judgment against that corporation. In the event that the trustee has not disposed of this property, or that the bankruptcy is still open, the assets of the debtor corporation remain titled in trust with the trustee. In any event, the bankruptcy summary scheduled reflects that the machinery and equipment were declared in the bankruptcy proceedings, a fact which argues against the conclusion that they were illegally diverted. In fact, it is not at all evident, although possible, that the bankruptcy was initiated to escape payment of a prospective judgment in this case. The corporation did not file for bankruptcy until one and one-half years after plaintiffs' suit was filed and their declared assets ($67,000) were overshadowed by debts and claims of over a half million dollars. Another factor that the district court pointed to in deciding to pierce the corporate veil was the uncompensated use by the old corporation of certain land and tools owned by O.P. Bajoie personally. In his testimony, O.P. Bajoie admitted letting the corporation use some personallyowned land and tools without compensation. These practices do not warrant a conclusion that the identities of the shoring corporation and Bajoie were merged when balanced against the Bajoies' other practices of operating this family business within the corporate form for twenty-three years. In a case with some facts similar to those in the instant case, Ceco Corp. v. R & M Indus., Inc., the court held that the president's decision to forego a salary or to make an interest-free loan to the corporation were not grounds for piercing the corporate veil. Similarly, the use of Bajoie's land and tools by the corporation without compensation is essentially an interest-free loan which does not constitute sufficient grounds for disregarding the corporate entity. The other infractions cited by the trial judge as ones which militated in favor of piercing the corporate shield are also less significant; for example, the failure to keep corporate minutes or maintain a cash journal. Although these facts indicate less than precise handling of corporate affairs, they do not thwart the basic requirement of maintaining a separate existence between the shareholders and the corporation when viewing the entire circumstances. In fact, the district court listed the same number of factors which it considered weighed against piercing the corporate veil as it listed in support of piercing. Some of these constitute essential corporate requirements, such as: proper incorporation; substantial profits; separate checking, accounting, and filing of tax returns; 104

and a separate enough identity that customers, including the Riggins, knew that they were dealing with the corporate entity. Therefore, examining the totality of the circumstances before us, we conclude that the lower courts erred in piercing this corporation's shield. By disregarding the corporate form, the district judge essentially merged the entities of the corporation and the individuals. Then, having concluded that there should be individual responsibility for what it found to be a defectively performed job which resulted in damage, the district court neither rendered judgment for or against the corporation. We have found to the contrary by determining that the corporation was indeed a separate entity from the shareholders and by exonerating O.P. Bajoie from personal liability. It is only because of this court's determination that the entities are indeed separate that it becomes necessary to consider plaintiffs' claims against the corporation itself. We could remand to the district court to render judgment consistent with this opinion on plaintiffs' claims against the corporation. However, that would be an unnecessary and useless exercise. Inasmuch as the plaintiffs' claims were neither withdrawn nor dismissed, which asserted liability and sought relief in its prayer against the corporation, we will, on this record, render judgment in favor of the plaintiffs against Dixie Shoring Company, Inc. **********

Transfer Of Interest And Control In principle, control and the transfer of interest of a "publicly held" and "closely held" or "small" corporation are the same. In reality they are quite different. In a "publicly held" company there is always a market for the sale, although it may be at a loss, of the shares in the company. The stock can be sold through a securities dealer or broker on a daily basis. The average shareholder, as a part owner of the company, will be able to vote with respect to the election of directors and possibly other matters. But, actual control of the board of directors, and the company, is generally in the hands of a small number of individuals or other entities who hold a substantial amount of the company's stock. The shareholders with the controlling interests will decide who serves as directors and how the company will be managed. The typical small investor has little say in how a "publicly held" corporation is managed. In a "closely held" or "small" corporation the shares of the corporation are usually not easily transferred. The original shareholders generally want to keep the ownership in the company "closely held" among themselves. The stock is usually issued with restrictions on the sale. These restrictions are usually set forth in "buy-sell" agreements executed by the shareholders. The purpose of the restrictions is to allow the shareholders to prevent the stock from being transferred to someone other than the original shareholders. The "buy-sell' agreements are usually triggered when an original shareholder dies, divorces or desires to sell the stock. Another major impediment to the sale of stock in a "closely held" company is that in many cases there is not much of a market for the stock. Generally there are not many people who are interested in obtaining shares in a such a 105

company, especially a minority interest. Security laws also place major limits on the sale of stock which are not publicly registered. Unlike the "publicly held" companies, each shareholder in a "closely held" business will normally have a significant influence on the management of the business. Minority shareholder are given specific rights by law with respect to the corporate affairs. It must be stressed, however, that the majority interest will control the corporation. Consider for example a shareholder, X, who owns a one-third (1/3) interest in a highly profitable "closely held" corporation. This one-third (1/3) interest is substantial. But, if X is on the "outs" with Y, who owns two-thirds (2/3) interest in the company, the value of X's investment may be drastically reduced. Y will be able to make all major decisions of the corporation, including, but not limited to, who will be employed, at what salary, and what, if any, dividends will be paid. X may learn that he is no longer employed by the company or her salary has been substantially reduced. The company is not paying dividends. X's only option to generate value from the shares she owns would be to sell the stock. But, what value does the stock have to an investor even if the company is profitable? Anyone who purchased this stock would be at the mercy of Y, as was X. The only person interested in buying X's shares will probably be Y. In all probability Y will have the upper hand with respect to the price which will be paid. Double Taxation Corporations pay income taxes at the federal and state level just like individuals, although the rates differ. A negative aspect of investing in a corporation is the existence of "double taxation". This phrase describes the situation in which corporate profits are, in effect, taxed twice at the same federal and state level. "Double taxation" occurs when a corporation pays federal and state income taxes on its profits, (tax 1). The corporation then pays dividends to its shareholders. The

shareholder must then pay federal and state income taxes on the dividends received, (tax 2). Therefore the same profits of the corporation are taxed twice, at the corporate level and again with the individual shareholder. "Double taxation" does not necessarily occur with a small corporation. Usually, the owners of a small corporation are also its employees. The shareholders/employees receive income from the company in the form of salaries, not dividends. The former is deducted from the corporate profits, before taxes are calculated. The profits are only taxed once, at the individual income level.

106

S Corporation Even if shareholders of a "small" corporation are not employed by the company, the effects of "double taxation" are usually avoided. Shareholders of a small corporation can elect to be treated as an "S" corporation with the IRS. An "S" corporation election is simple. IRS form 2553 must be completed and submitted to the IRS. The submission must be made within the first 2 1/2 months of the tax year. In order to qualify the "S" corporation must have 75 or fewer shareholders. The shareholders must be individuals, not other business entities. An "S" corporation is treated like a partnership with respect to income taxes. That is, an informational tax return is filed. The income and losses of the company, however, are passed on to the shareholders for income tax purposes. The "S" corporation does not pay federal income tax and therefore "double taxation" does not occur.

SECURITIES LAW

A brief discussion must be made about "securities law". Another chapter in this material is entitled "Security Devices". Security devices refers to the laws that provide "security" to creditors and is not to be confused with "securities" in the present context. An accurate definition of "securities" is difficult and would take half a page. A simplified explanation of a "security" is an investment of money, property, or other consideration made in the expectation of earning a profit solely from the efforts of others. Securities are highly regulated at the federal and state level. The issuance, sale and resale of publicly traded corporate stock falls within this regulation. This area of the law is extremely complex. The Securities Act of 1933 and Securities Exchange Act of 1934 are the primary laws regulating security registration, trading, markets and brokers. The Securities Exchange

Commission (SEC) is the government agency that oversees securities activities and it has the authority to implement new rules and regulations as the market changes. The 1933 and 1934 Acts and the SEC try to insure that both investors and the public are informed about securities and protected from fraud. Louisianas law pertaining to security registration is found at La. R.S. 51:701 et seq. The Securities Act of 1933 mainly governs the registration of securities with the SEC. The Act defines which class of securities are governed by the Act and which classes are exempt 107

from the rules of registration. It also states the information required for registration, the penalties and remedies for violations of the Act. The Securities Act of 1934 empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate and oversee brokerage firms, transfer agents and clearing agencies as well as the nations securities Self Regulatory Organizations (SROs). The New York Stock Exchange and the American Stock Exchange are examples of SROs. The SEC also requires periodic financial reporting of information by companies with publicly traded securities, prohibits certain types of conduct in the market and has disciplinary powers over regulated entities and persons associated with them. Companies offering securities to the public for investment must tell the truth about their businesses, the securities they are selling and the risk involved in investing. People who sell and trade securities must treat investors fairly and honestly, putting investors interest first. The primary means of accomplishing the above goals is disclosure of important financial information through the registration of securities. This information enables investors, not the government, to make informed judgments about whether to purchase a companys security. While the SEC requires that the information provided be accurate, it does not guarantee it. Investors who purchase securities and suffer loss have recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information. In general, securities sold in the United States must be registered. The registration forms companies file provide essential facts. These forms describe the companies properties and business, describe the security to be offered for sale, information about the management of the company and financial statements certified by independent accountants. Registration statements and prospectuses become public shortly after filing with the SEC. Not all offerings of securities must be registered with the SEC. Some exemptions from the registration requirement include: 1. 2. 3. 4. private offerings to a limited number of persons or institutions; intrastate offerings; offerings of limited size; securities of municipal, state and federal governments.

Initial Public Offering (IPO) A company considering going public with an Initial Public Offering (IPO) has stringent guidelines that must be followed. One of the most important tasks is the development of the prospectus, which explains all aspects of a companys business, its competitors and growth 108

strategy, financial results for the last five years, the management team and risk factors. All relevant information to investing in the company must be disclosed. After the prospectus is filed with the SEC it is reviewed by securities organizations such as the National Association of Securities Dealers (NASD) for any possible problems. The company can amend the prospectus if necessary. A group of investment banks will then be formed to help sell and market the IPO. Generally the companys management takes a road show by going to different large cities to attract and meet with potential investors for their business. The tour is critical to the success of the IPO since the commitment of several large investors is generally needed. The invitation to road shows are sent to institutional investors only. The companys prospectus is discussed so investors can make a decision about participating in the IPO. The price of the investment is based on the projected demand and market condition as determined by the investment bankers. One of the investment bankers will be considered the lead underwriter and is responsible for smooth trading of the stock for the first few critical days of trading. This underwriter can legally control the price of a new stock issued by buying shares in the market or selling them. The completion of an IPO generally occurs approximately seven days after its initial market introduction. It is possible for an IPO to be canceled after trading starts at which time all money is returned to investors and stock transactions are canceled.

LIMITED LIABILITY COMPANIES

In 1992 Louisiana passed legislation authorizing the creation of Limited Liability Companies, (LLC), and Limited Liability Partnerships, (LLP). The statutes are found in La. R.S. 12:1301 et. seq. This discussion will focus on LLCs, but the same rules are applicable to LLPs. To form an LLC "articles of organization", are filed with the Secretary of State. The "articles" are very similar to a corporation's articles. An LLC basically has the organization and taxation of an ordinary partnership and the limited liability feature of a corporation. LLCs do not

have shareholders, but have members. You may have a 1-member LLC. See Appendix B for an example of an LLC form. An LLC can be managed by its members or the members can designate one or more managers in its Articles of Organization and Operating Agreement. In a member managed LLC, each member is a mandatory of the LLC similar to the partners in a partnership. In a manager managed LLC, the authority of the members to bind the LLC can be limited by a statement to that 109

effect in the Articles of Organization. In addition to these two general concepts the parties are free to custom design their system of management as they see fit. Members of an LLC should also form an Operating Agreement. The Operating Agreement should state exactly what the owners' initial capital contribution to the company will be. The Operating Agreement should address whether the owners are obligated to make additional contributions in the future. Other matters that should be addressed in an Operating Agreement is what happens in the event of the death, insanity or bankruptcy of an owner and what is required with respect to the transfer of ownership.

********************

110