ALABAMA FORMS OF ORGANIZATION Maynard Cooper & Gale, P.C. W. Clark Goodwin David H. Humber

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1 Last Updated: August 2012 Table of Contents 1. Nonprofit Corporations 2. For-Profit Corporations 3. Limited Liability Companies 4. Low Profit Limited Liability Companies 5. Joint Ventures 6. Partnerships and Limited Partnerships 7. Sole Proprietorships 8. New Forms of Hybrid Organizations 9. Resources ALABAMA FORMS OF ORGANIZATION Maynard Cooper & Gale, P.C. W. Clark Goodwin David H. Humber The most common legal form of organization utilized by the social sector is a nonprofit corporation although for-profit corporations, limited liability companies (LLCs), joint ventures and various kinds of partnerships, including limited partnerships, are increasingly being used-- typically to accommodate plans to earn revenues or access capital markets. Each of these forms of organization has advantages and disadvantages and sometimes, with the help of experienced counsel, they are used in combination to maximize strengths and minimize weaknesses of a particular form. The Alabama Legislature enacted a new Title 10A to the Alabama Code that governs Alabama businesses and nonprofits and became effective January 1, This summary explains the current law and reflects any changes made in the new legislation. Nonprofit 501(c)(3) Corporation Formation File articles or certificate of incorporation (containing specific info required by IRS) with state and pay filing fee. File application on Form Management and Control Liability Tax Factors Capital and Loans Managed by directors Members, directors, who appoint officers officers and employees to run day-to-day are generally not liable operations as specifiedfor debts and in bylaws. Some obligations of the nonprofit corporationscorporation, including have members (like for unlawful acts of shareholders) who others involved in the Generally exempt from federal and state taxes if receive 501(c)(3) exemption. Liable for tax on unrelated business income, and other taxes such as property Can accept charitable donations and grants. Eligible for program related investments (PRIs) by foundations. Can borrow money and issue debt instruments but cannot raise capital 1

2 For-Profit Corporation B Corp (a forprofit corporation with a social mission that is licensed to use the trade name B Corporation ) Formation Management and Control Liability Tax Factors Capital and Loans 1023 for tax-exempt status unless below gross receipts threshold. Recruit directors, draft bylaws and hold organizational meeting. Take steps to comply with license, tax and employment law/regs. elect directors. affairs of the corporation. They can be held liable for injuries due to their own misconduct but some states provide limited immunity to such persons and also to volunteers. and sales (unless local by issuing stock. and state exemptions apply). Donors can deduct contributions File articles or Managed by Shareholders are A C Corporation is Can raise capital by certificate of directors that are generally not liable for subject to corporate issuing stock (equity) incorporation with elected by debts and obligations tax on net income. If and by borrowing state and pay filing fee. shareholders. of the corporation, net income is paid to money through loans or Decide on board of Directors appoint including for unlawful shareholders as other debt instruments. directors, draft bylaws, officers to run dayto-day acts of others involved dividends, the Corporation may be hold organizational operations as in the business. Unless individual able to accept PRIs meeting and issue specified in bylaws. indemnified by the shareholders are from foundations in the stock. Take steps to corporation, directors, taxed. If a corporation form of loans or equity. comply with license, officers and employees elects to be an S tax and employment can be held liable for corporation and meets laws/regs. injuries caused by their several criteria, it can own acts or failures to receive pass through act. taxation. See for-profit corporation See for-profit corporation. The B Corp license requires the corporation to incorporate specific socially beneficial performance standards into its governing documents and operating principles. See for-profit corporation. See for-profit corporation. See for-profit corporation. A B Corp should be in a better position to attract PRIs from foundations in the form of loans or equity. LLC File articles of organization or certificate of formation with state and pay filing fee. Negotiate and execute operating agreement. Take steps to comply with license, Flexible structure like a partnership with management responsibilities specified in operating agreement (usually management Same as a corporation. Usually not taxed as an entity because most LLCs choose pass through treatment whereby the member/owners report profits and losses on personal tax returns. Can raise capital through contributions by member/owner. Otherwise, same as forprofit corporation. 2

3 L3C (low-profit LLC) Partnership Formation tax and employment law/regs. Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states No filing requirements unless limited partnership (LP) or limited liability partnership (LLP), but partners should sign partnership agreement. Take steps to comply with name, license, tax and employment law/regs. Sole Proprietor No filing requirements. Has no legal existence apart from owner. Take steps to comply with d/b/a name, license, tax and employment law/regs. Management and Control Liability Tax Factors Capital and Loans committee or single Tax-exempt manager). member/owners treat their share of income as exempt or subject to unrelated business taxable income, depending on the character of the income. See LLC Same as a corporation See LLC. Same as for-profit corporation except L3C enabling legislation is written to comply with PRI regs and is thus intended to attract equity or debt investments by foundations. Partners have equal, full control unless otherwise specified in partnership agreement. Owner has full control. Partners are personally liable for the debts and obligations of the partnership, including for unlawful acts of other partners and employees. Risk can be limited by creating an LP or LLP. Owner is liable for all debts and obligations, including for unlawful acts of employees. Generally not taxed as an entity. Partners report profits and losses on personal tax returns. Not taxed as an entity. Owner reports business profits and losses on personal tax return. Can raise capital through contributions by partners and by borrowing money through loans or other debt instruments. Owner provides funds for capital investment and owner can borrow money through loans or other debt instruments. 1. Nonprofit Corporations a. Overview The Alabama Business and Nonprofit Entity Code ( Entities Code ), ALA. CODE 10A , et seq., generally governs the formation and governance of all entities, including nonprofit corporations. The Alabama Nonprofit Corporation Law, ALA. CODE 10A-3-3

4 1.01, et seq., specifically governs the formation, operation and dissolution of nonprofit corporations in Alabama (the Nonprofit Law ). A nonprofit corporation in Alabama is managed by its board of directors and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may, but is not required to, have members. Nonprofit corporations, of course, are specifically organized to not earn profits. No part of the income or surplus of an Alabama nonprofit corporation may be distributed to its members, directors or officers; however, reasonable compensation may be paid for services rendered. A nonprofit corporation has an existence of its own, independent of the terms of office or employment of members, directors or officers. It can sue or be sued in its own name and can own real estate in its own name. b. Advantages of Incorporation; Pros and Cons of Nonprofit vs. For-profit The principal advantage of incorporation is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, directors and staff acting on its behalf. In addition, incorporation establishes continuity; corporations (both nonprofit and for-profit) are subject to a body of statutes that provide very specific guidance as to their formation and operation; and incorporation brings stature to the organization and implies stability. Where profit is not a goal and the enterprise can be funded without the need for access to capital, a nonprofit corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit are duty-bound to devote primary attention to the promotion of the social mission of the corporation rather than the production of net income. On the other hand, if access to capital markets is needed, a for-profit corporation (or limited liability company, discussed below) is likely to be the preferred option because nonprofit corporations cannot issue capital stock. The directors of a for-profit corporation, however, owe strict duties to the shareholders to maximize profits and value. Therefore, unless the directors and managers can tie the social mission of their for-profit corporation directly to its business purpose, they can be sued for breach of their duties to shareholders and for misuse of corporate assets if they focus too much on the social mission and forego profits. This problem can be avoided where all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes but such agreements may be temporary because a change in control or a drop in earnings can lead to amendment or abrogation of shareholder agreements. 4

5 c. Formation A nonprofit corporation attains its separate legal status through the filing and approval by Alabama of its certificate of formation (the term certificate of formation is synonymous with the term articles of incorporation ). This document is in essence a contract between the state and a nonprofit corporation in which Alabama grants individual legal status to the corporation in exchange for the corporation s commitment to follow its rules. In order to form a nonprofit corporation, a person must first reserve the corporate name by delivering an application to the Secretary of State for filing. The application must be signed by the applicant and state the name and address of the applicant and the name proposed to be reserved. The fee for a name reservation is $10, or $25 to expedite the process to less than 24 hours. One or more persons, partnerships, domestic corporations or foreign corporations, whether for-profit or not for profit, may act as incorporator or incorporators of a nonprofit corporation by signing the certificate of formation and delivering the same to the probate judge of the county in which the nonprofit corporation is to have its initial registered office. The filing fee for filing the certificate of formation with the State of Alabama is $ and the fee for the probate judge filing is $50. Corporate existence begins upon the filing of this document. The certificate of formation shall set forth: (i) the name of the entity being formed; (ii) the type of entity being formed; (iii) the purpose or purposes for which the entity is formed; (iv) the period of duration, if the entity is not formed to exist perpetually (v) the location and mailing address of its initial registered office, and the name of its initial registered agent at such address; and (vi) the name and address of each organizer. In addition to these general requirements that apply to all filing entities, a certificate of formation for a nonprofit corporation must also include: (i);if the corporation is to have no members, a statement to that effect; (ii) any provisions, not inconsistent with law, for the regulation of the internal affairs of a nonprofit corporation, including any provision for distribution of assets on dissolution or final liquidation; and (iii) the number of directors constituting the initial board of directors, and the names and addresses of the persons who are to serve as the initial directors. Each nonprofit corporation shall have and continuously maintain in Alabama a registered office which may be, but need not be, the same as its principal office. Each nonprofit corporation also shall have and continuously maintain in Alabama a registered agent, which agent may be either an individual resident in Alabama whose business office is identical with such registered office, or a domestic corporation, whether for-profit or nonprofit, or a foreign corporation, whether for-profit or nonprofit, authorized to transact business or conduct affairs in Alabama, having an office identical with such registered office. 5

6 By statute, a nonprofit corporation shall not have or issue shares of stock. In addition, no dividend shall be paid and no part of the income or profit of a nonprofit corporation shall be distributed to its members, directors or officers. These are two of the distinguishing features of a nonprofit corporation. If a nonprofit corporation intends to obtain exemption from federal and state income taxation, the certificate of formation must conform with applicable statutes and regulations (discussed in the Recordkeeping, State Reports, and State Taxes section below.) A sample article of incorporation document for use in the State of Alabama can be found at the following link: d. Management and Control The nonprofit corporation will be run by the directors and managed on a daily basis by the officers. By law, the directors shall be natural persons but need not be residents of Alabama (unless the governing documents certificate of formation and bylaws so require). The number of directors shall be set at first by the certificate of formation and then by the bylaws but shall not be less than three (3). If the governing documents so provide, the board of directors, by resolution adopted by a majority of the directors in office, may designate and appoint one or more committees each of which shall consist of two or more directors. Such committees, to the extent provided in such resolution or in the governing documents of a nonprofit corporation, shall have and exercise all the authority of the board of directors, except in making major decisions which require full board approval. The officers shall consist of a president, one or more vice-presidents, a secretary, a treasurer and such other officers and assistant officers as may be deemed necessary, each of whom shall be elected or appointed at such time, in such manner and for such terms not exceeding three (3) years as may be prescribed in the governing documents. It should be noted that no loans shall be made by a nonprofit corporation to its directors or officers. As mentioned earlier, a nonprofit corporation may have one or more classes of members or may have no members. If a nonprofit corporation has one or more classes of members, the designation of such class or classes, the manner of election or appointment and the qualifications and rights of the members of each class shall be set forth in the governing documents. If a nonprofit corporation has no members, that fact shall be set forth in the certificate of formation. Once a nonprofit corporation has been established, the initial board of directors should meet (in person/by consent) to ratify the acts in connection with the initial formation of a 6

7 nonprofit corporation and to adopt bylaws which set forth the rules and procedures governing the decision-making process of the board of directors and the general operation and management of a nonprofit corporation consistent with the applicable statutes of Alabama and the certificate of formation. Typically, the bylaws of a nonprofit corporation contain provisions governing member, director and officer qualifications, powers, and duties; voting; filling of vacancies; meetings; property holding and transfer; indemnification of directors and officers; committees; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment and dissolution procedures. Pursuant to ALA. CODE 10A , any action required to be taken at a meeting of the members or directors of a nonprofit corporation or any action which may be taken at a meeting of the members or directors or of a committee of directors may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by all of the members entitled to vote with respect to the subject matter thereof, all of the directors or all of the members of the committee of directors, as the case may be. e. Liability of Members, Directors and Officers As stated earlier, the limited liability protection of the corporate structure is one of the most important reasons to incorporate. In Alabama, this protection is expressly codified. According to ALA. CODE 10A (b), the members of a nonprofit corporation shall not be liable for obligations of a nonprofit corporation. Similarly, according to ALA. CODE 10A (b), the directors of a nonprofit corporation shall not be liable for obligations of a nonprofit corporation. Finally, according to ALA. CODE 10A (d), the officers and employees of a nonprofit corporation shall not be liable for obligations of a nonprofit corporation. However, all of these limits on personal liability are subject to piercing of the corporate veil in instances in which the corporate formalities are not respected by the individuals. f. Mergers, Acquisitions and Dissolution As with for-profit corporations, Alabama nonprofit corporations have the power to engage in mergers or acquisitions and to dissolve. Under the new Nonprofit Law, nonprofit corporations may also participate in cross-entity mergers. Pursuant to ALA. CODE 10A , any two or more domestic nonprofit corporations may merge into one of the corporations pursuant to a plan of merger provided that each nonprofit corporation shall adopt the plan of merger. The plan of merger must be authorized by the members, if such power is vested in the membership, or the board of directors, if not a power reserved for the members. Upon such approval, a certificate of merger (the term certificate of merger is synonymous with the term articles of merger ) or articles of consolidation shall be executed for each corporation by its 7

8 president or a vice president, and by its secretary or an assistant secretary, and verified by one of the officers signing such articles. Likewise, pursuant to ALA. CODE 10A , one or more foreign corporations and one or more domestic corporations may be merged or consolidated, so long as such merger or consolidation is permitted by the laws of the state under which each such foreign corporation is organized. According to ALA. CODE 10A , a nonprofit corporation may dissolve and wind up its affairs in the following manner. If there are members entitled to vote thereon, the board of directors shall adopt a resolution recommending that a nonprofit corporation be dissolved, and directing that the question of such dissolution be submitted to a vote at a meeting of members entitled to vote thereon, which may be either an annual or a special meeting. If there are no members, or no members entitled to vote thereon, the dissolution of a nonprofit corporation shall be authorized at a meeting of the board of directors upon the adoption of a resolution to dissolve by the vote of a majority of the directors in office. Upon the adoption of such resolution by the members, or by the board of directors if there are no members or no members entitled to vote thereon, a statement of intent to dissolve shall be executed for a nonprofit corporation by its president or a vice president, and by its secretary or an assistant secretary, and verified by one of the officers signing such statement. The assets of a nonprofit corporation in the process of dissolution shall be applied and distributed as follows. First, all liabilities and obligations of the corporation shall be paid and discharged. Second, assets held by the corporation upon condition requiring return, transfer or conveyance, which condition occurs by reason of the dissolution, shall be returned, transferred or conveyed in accordance with such requirements. Third, assets received and held by the corporation subject to limitations permitting their use only for charitable, religious, eleemosynary, benevolent, educational or similar purposes, but not held upon a condition requiring return, transfer or conveyance by reason of the dissolution, shall be transferred or conveyed to one or more domestic or foreign corporations, societies or organizations engaged in activities substantially similar to those of the dissolving corporation, pursuant to a plan of distribution. Fourth, other assets, if any, shall be distributed in accordance with the provisions of the governing documents. Lastly, any remaining assets may be distributed to such persons, societies, organizations or domestic or foreign corporations, whether for-profit or nonprofit, as may be specified in the plan of distribution. If voluntary dissolution proceedings have not been revoked, then when all debts, liabilities and obligations of a nonprofit corporation shall have been paid and discharged, or adequate provision shall have been made therefore, and all of the remaining property and assets of a nonprofit corporation shall have been transferred, conveyed or distributed in accordance with the provisions of this chapter, a certificate of termination (the term 8

9 certificate of termination is synonymous with the term articles of dissolution ) shall be executed for a nonprofit corporation by its president or a vice president, and by its secretary or an assistant secretary, and verified by one of the officers signing such articles. g. Recordkeeping, State Reports and State Taxes Pursuant to ALA. CODE 10A , each nonprofit corporation shall keep correct and complete books and records of account and shall keep minutes of the proceedings of its members, board of directors and committees having any of the authority of the board of directors; and shall keep at its registered office or principal office in Alabama a record of the names and addresses of its members entitled to vote, directors and officers. All books and records of a corporation may be inspected by any member, director or officer, or his agent or attorney, for any proper purpose at any reasonable time. As to be expected, corporations exempt from federal income tax are also exempt from state income tax pursuant to ALA. CODE In addition, all property, real and personal, used exclusively for religious worship, for schools or for purposes purely charitable are exempt from Alabama ad valorem taxes (i.e., property tax) under ALA. CODE (1). However, property used for non-exempt purposes is taxable. Likewise, according to Alabama Department of Revenue regulation , charitable and nonprofit organizations and institutions have no special exemption from the sales and use taxes imposed locally or by the State of Alabama. Further, such organizations are required to comply with all the provisions of these sales and use tax laws, relating to the filing of returns, making payments of taxes required to be collected, etc., with the exception of those entities specifically listed by the Department of Revenue as exempt from payment of all sales and use taxes by special acts of the Legislature. Lastly, nonprofit corporations in Alabama are also subject to employment taxes, such as payroll taxes, and must follow withholding obligations. h. Insurance Nearly every type of activity by a nonprofit corporation can become the target of some kind of a claim by a firm or an individual that alleges damage or injury by the corporation or individuals responsible for it (i.e., directors, officers or employees). Even if the claim is without merit, the costs of defending against the claim can be very substantial. To encourage qualified individuals to accept positions as directors and officers, many nonprofit corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation s offices, at sponsored meetings and the like. 9

10 Liability insurance for nonprofit corporations is often a very complicated matter. Consultation with an experienced and knowledgeable agent or consultant is essential in order to obtain the right coverage at the lowest premium. i. Resources Alabama Business and Nonprofit Entity Code, ALA. CODE 10A , et. seq. Alabama Nonprofit Corporation Law, ALA. CODE 10A , et seq. Oleck and Stewart, Nonprofit Corporations, Organizations & Associations (Prentice- Hall, 1994, Cum. Supp. 2002). Jacobs, Jerald A., Association Law Handbook (ASAE & The Center for Association Leadership 4 th ed., 2007). Nonprofit Governance and Management (American Bar Association and American Society of Corporate Secretaries, 2002). Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley (American Bar Association Section of Business Law, 2005). Guidebook for Directors of Nonprofit Corporations (American Bar Association Section of Business Law 2d ed., 2002). 2. For-profit Corporations a. Using For-profit Corporations to Pursue Social Objectives The for-profit form of organization (hereinafter, business corporation ) can and frequently is used as a vehicle for conducting a business that also has a social mission or objective. Although business corporations are usually formed for the purpose of making money and distributing it to managers and shareholders, there is no reason why a business corporation cannot include a social mission in the purposes clause of its certificate of formation (the term certificate of formation is synonymous with the term articles of incorporation ). While such a provision would authorize the business corporation to pursue social objectives, it would not require the business corporation to do so only the shareholder/owners have this power. Unless all shareholders agree to pursue social aims, dissenting shareholders could sue the business corporation s directors and managers for failing to operate the business corporation in the best economic interests of the shareholders. 10

11 A shareholders agreement is probably the best way to address this problem. Such an agreement, entered into by all shareholders and the business corporation, would require the business corporation to be managed and operated so as to pursue specified social objectives, thereby overriding fiduciary duties and similar legal principles that govern normal behavior of business corporations. However, even the most skillfully drafted shareholders agreement is not a perfect solution because agreements can always be abrogated and amended, and the owners of the shares can change via sale, gift or inheritance. Moreover, a tightly-drafted shareholders agreement that makes it difficult for the business corporation to respond to business changes over time would tend to render the business corporation much less attractive to investors (and/or potential new shareholders). b. Formation The Entities Code generally governs the formation and governance of business corporations. The Alabama Business Corporation Law ( ABCL ), ALA. CODE 10A , et seq., specifically governs for-profit corporations, referred to as business corporations. In order to form a business corporation in Alabama, a person must first reserve a corporate name by delivering an application to the Alabama Secretary of State along with the appropriate filing fee: $25 for expedited, and $10 for more than 24 hours. In order to form a business corporation under the registered name, a certificate of formation must be filed with the probate judge of the county in which the business corporation is to have its initial registered office for filing. The incorporators must submit a copy of the certificate of formation and the probate judge will mail such to the Alabama Secretary of State. For the filing of the certificate of formation, the current filing fee is $150.00, which must be paid separately: $50 to the probate judge, and $100 to the Secretary of State. In addition to the general requirements of a certificate of formation provided in ALA. CODE 10A (and as described above for nonprofit corporations), the certificate of formation must also set forth the following: (i) a corporate name for the business corporation that contains the word corporation or incorporated, or an abbreviation of one of such words, and shall not contain language stating or implying that the business corporation is organized for a purpose other than that permitted by its certificate of formation; (ii) the number of shares the business corporation is authorized to issue; (iii) the street address of the business corporation s initial registered office and the name of its initial registered agent at that office; (iv) the name and address of each incorporator; (v) the names and addresses of the individuals who are to serve as the initial directors; and (v) the purpose or purposes for which the corporation is organized, which may be stated to be or to include the transaction of any or all lawful business for which business corporations may be incorporated under the ABCL. 11

12 Further, the certificate of formation may, but is not required to, set forth provisions not inconsistent with the law regarding: (i) reservation to the shareholders of the right to adopt initial bylaws of the business corporation; (ii) managing the business and regulating the affairs of the business corporation; (iii) defining, limiting and regulating the powers of the business corporation, its board of directors and its shareholders; or (iv) a par value for authorized shares or classes of shares. The certificate of formation also may set forth any provision that under the Entities Code or the ABCL is required or permitted to be set forth in the bylaws. In addition, the certificate of formation may set forth a provision eliminating or limiting the liability of a director to the business corporation or its shareholders for money damages for any action taken, or any failure to take action, as a director, except liability for: (i) the amount of a financial benefit received by a director to which he or she is not entitled; (ii) an intentional infliction of harm on the business corporation or the shareholders; (iii) a violation of the statute prohibiting unlawful distributions; (iv) an intentional violation of criminal law; or (v) a breach of the director s duty of loyalty to the business corporation or its shareholders. Finally, the certificate of formation need not set forth any of the corporate powers enumerated in Sections 10A , 10A , or 10A of the Entities Code. A form of a domestic business corporation certificate of formation for the State of Alabama can be found at c. Management and Control A business corporation has a hierarchical control structure. It is managed by or under the direction of a board of directors and its officers, although its shareholders vote on important corporate issues, such as the election of directors, mergers, sale of all assets and dissolution. Similar to a nonprofit corporation, once the business corporation has been established, the initial board of directors meets (in person or by written consent), ratifies the acts taken in connection with the initial formation of the business corporation and adopts bylaws which set forth the rules and procedures governing the operation and management of the business corporation consistent with the applicable statutes of Alabama and the certificate of formation. In general, the bylaws of a business corporation contain provisions governing director and officer qualifications, powers and duties; voting; meetings of shareholders, directors and officers; filling of vacancies; committees; property holding and transfer; indemnification of directors and officers; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment, merger and dissolution procedures. 12

13 d. Liability of Shareholders, Directors and Officers ALA. CODE 10A sets forth the general standards for directors when discharging his or her duties as a corporate director. A director must act in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director believes to be in the best interests of the business corporation. Alabama follows the business judgment rule and a director is not liable for any action taken as a director, or any failure to take any action, if the director performed the duties of his or her office in compliance with this section. Alabama s guidelines regarding indemnification are set forth in ALA. CODE 10A A business corporation may indemnify an individual made a party to a proceeding because he or she is or was a director against liability incurred in the proceeding if the individual conducted himself or herself in good faith and the individual reasonably believed that the conduct was in the business corporation s best interests or was at least not opposed to its best interests, depending on the situation. A business corporation may not indemnify a director in connection with a proceeding by or in the right of the business corporation in which the director is found liable to the business corporation or in which the director was found liable on the basis that personal benefit was improperly received by him or her. A business corporation must indemnify a director who was successful in the defense of any proceeding where he or she was a party because he or she is or was a director of the business corporation. A business corporation may pay for or reimburse the reasonable expenses incurred by a director who is a party to a proceeding in advance of final disposition of the proceeding if: (i) the director furnishes the business corporation a written affirmation of good faith belief that he or she has met the applicable standard of conduct; (ii) the director furnishes the business corporation a written undertaking to repay the advance if it is ultimately determined that the director did not meet the standard of conduct or is not otherwise entitled to indemnification; and (iii) a determination is made that the facts then known would not preclude indemnification. In order for a business corporation to indemnify a director, a determination must be made that the director has met the standard of conduct required in ALA. CODE 10A The determination must be made by the board of directors by majority vote of a quorum or a designated committee, by special legal counsel, or by the shareholders by majority vote of the shares that are entitled to vote on the transaction by virtue of not being owned or under the control of such directors. As in most jurisdictions, an Alabama business corporation is a legal entity separate from its shareholders, so the shareholders are generally not personally liable for the actions, liabilities or obligations of the business corporation. There are specific instances, 13

14 however, when an Alabama court may disregard the separate legal existence of a business corporation and hold the business corporation s shareholders liable for the business corporation s actions, known as piercing the corporation veil. e. Raising Capital Business corporations (and LLCs) offer the most flexibility in raising capital, ranging from various kinds of equity (common stock, preferred stock, options, warrants) to numerous types of debt instruments (convertible notes, subordinated notes, bonds, commercial paper). f. Recordkeeping and State Reports ALA. CODE 10A requires that a business corporation keep as permanent records minutes of all meetings of its shareholders and board of directors, a record of all actions taken by the shareholders or board of directors without a meeting, and a record of all actions taken by a committee of the board of directors in place of the board of directors on behalf of the business corporation. A business corporation also must maintain appropriate accounting records and a list of its shareholders in alphabetical order by class or shares. This section also requires that a business corporation keep a copy of the following records at its principal office: (i) its certificate of formation or restated certificate of formation and all amendments; (ii) its bylaws or restated bylaws and all amendments; (iii) resolutions adopted by the board of directors creating one or more classes or series of shares and fixing their relative rights and limitations; (iv) the minutes of all shareholders meetings and records of all actions taken by shareholders without a meeting, for the past three (3) years; (v) written communications to shareholders within the past three (3) years, including the financial statements furnished for the past three (3) years; (vi) a list of the names and business addresses of its current directors and officers; and (vii) its most recent annual report delivered to the Secretary of State (described below). ALA. CODE 10A requires that a business corporation deliver to the Secretary of State for filing an annual report that sets forth the following: (i) the name of the business corporation and the state or jurisdiction under whose law it is incorporated; (ii) the address of its registered office and the name of its registered agent at that office in Alabama; (iii) the address of its principal office; (iv) the names and respective addresses of its president and secretary; and (v) a brief statement of the character of business in which the business corporation is actually engaged in Alabama. The annual report must be filed with the Secretary of State between January 1 and March 15 of each calendar year. 14

15 g. Taxation Business corporations in Alabama are subject to double taxation in the sense that the business corporation must pay both federal and state taxes on the income it earns and then the business corporation s shareholders must also pay federal and state income taxes on the dividends distributed by the business corporation. S corporations, however, are not subject to double taxation because the business corporation s income is not taxed at the corporate level; instead, the income and losses of the S corporation are passed through to the shareholders. The election to be taxed as an S corporation is made with the IRS, and there are certain restrictions on eligibility. h. Resources Alabama Business and Nonprofit Entity Code, ALA. CODE 10A , et. seq. Alabama Business Corporation Law, ALA. CODE 10A , et. seq. Thigpen, Richard A., Alabama Corporation Law, 3d (Alabama Practice Series) (Thomson West). 3. Limited Liability Companies (LLCs) a. Using LLCs to Pursue Social Change The Entities Code generally governs the formation and governance of Limited Liability Companies (LLCs). The Alabama Limited Liability Company Law, ALA. CODE 10A , et seq., specifically governs the formation, operation and dissolution of LLCs in Alabama (the LLC Law ). Combining certain characteristics of both partnerships and corporations, LLCs are privately owned legal entities that can be formed for the purpose of earning profits, pursuing a social mission, or both, although some states require an LLC to be formed only for a business purpose. LLCs differ from for-profit corporations because they are formed and owned by members rather than shareholders; however, like S corporations and partnerships, LLCs are eligible for pass-through income tax treatment. This means that income and expenses are reported as though the members incurred them directly, and profits or losses are taxed at the ownership (member) level, rather than the entity (company) level. Members of LLCs can be individual investors as well as for-profit corporations and taxexempt nonprofit corporations. For this reason and also because of pass-through taxation which eliminates double taxation (the effect of taxing income at the corporate level and again when it is included in the shareholder s income), LLCs are preferred over for- 15

16 profit corporations as vehicles for social enterprise, especially for joint ventures between a tax-exempt nonprofit with a social change mission and a for-profit business. LLCs are akin to partnerships because the members have broad discretion to allocate profit and loss and management powers among themselves (via an operating agreement ). On the other hand, as with the shareholders of corporations, the members of an LLC can be divided into classes, each with its own economic rights, and members have limited personal liability (discussed below). Two states, Tennessee and Kentucky, specifically authorize the formation of nonprofit limited liability companies (nonprofit LLCs). The statutes of numerous states, including California, have language that permits nonprofit LLCs to exist. Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) if it elects to be treated as a separate legal entity for tax purposes and its operating agreement includes the language mandated by the organizational test (purposes, distribution of assets upon dissolution, etc.) and it meets numerous requirements largely designed to guard against inurement and private benefit. These conditions will be discussed in the Nonprofit Taxation section. b. Formation One or more persons may form a limited liability company by filing the certificate of formation (the term certificate of formation is synonymous with the term articles of organization ) for the LLC with the probate judge of the county in which the initial registered office of the limited liability company is located. A person may reserve the exclusive use of a name for the LLC by filing an application with the Secretary of State stating the name and address of the applicant as well as the proposed name for the LLC. The filing fee for a name reservation is $10, or $25 for an expedited process, lasting less than 24 hours. The certificate of formation must state (i) the name of the filing entity being formed; (ii) the type of the filing entity being formed; (iii) the purpose or purposes for which the filing entity is formed, which may be stated to be or include any lawful purpose for that type of entity; (iv) the period of duration, if the entity is not formed to exist perpetually; (v) the street address and, if different, the mailing address of the initial registered office of the filing entity and the name of the initial registered agent of the filing entity at the office; (vi) the name and address of the organizer for the filing entity, unless the entity is formed under a plan of conversion or merger; (vii) the right, if given, of the member or members to admit additional members, and the terms and conditions of the admission; (viii) the circumstances, if any, under which the cessation of membership of one or more members will result in dissolution of the LLC; and (ix) if the LLC is to be managed by one or more managers, the certificate of formation shall so state and shall set out the names and the mailing addresses of the manager(s) who are to serve as managers until their successors are elected and begin serving. 16

17 The certificate of formation shall be signed by one or more members named therein or an organizer. A sample certificate of formation for use in Alabama can be found at the following link: c. Management and Control Typically, an LLC operating agreement entered into among the members governs the management of an LLC. The operating agreement which is like the certificate of formation, bylaws and a shareholder agreement all in a single document may contain provisions requiring adherence to a social purpose, and such purpose and the values it embodies may be interwoven throughout the operating agreement. Unless otherwise stated in the certificate of formation, the management of the LLC is vested in its members. Subject to any provisions in the operating agreement or the LLC Law of Alabama, the members shall have the right and authority to manage the business or affairs of the LLC and to make all decisions with respect thereto. If the certificate of formation vests management of the LLC in one or more managers, then the managers shall have the power to manage the business affairs of the LLC as provided in the operating agreement. Except as otherwise provided in the operating agreement, the managers shall be designated, appointed, elected, removed or replaced by a vote, approval or consent of more than one-half the number of members; need not be members of the LLC or natural persons; and shall hold office until their successors have been elected and qualified. The certificate of formation for a LLC may provide for classes or groups of members or managers having such relative rights, powers, and duties as so provided, and may make provision for the future creation of additional classes or groups of members or managers having such relative rights, powers and duties as may be created in the certificate of formation. The certificate of formation may provide for taking action, including the amendment of the certificate of formation or operating agreement, without the vote or approval of one or more members or classes or groups of members or managers, including an action to create one or more classes of interests in the company that were not previously outstanding, but are authorized under the certificate of formation. The certificate of formation may grant to all or certain identified members or managers or a specified class or group of members or managers the right to vote separately or with all or any class or group of members or managers on any matter. Voting by members or managers may be on a per capita, number, financial interest, class, group, or any other basis. The certificate of formation or operating agreement may, with respect to any rights to vote, set forth provisions relating to notice of the time, place, or purpose of any meeting at which any matter is to be voted on by any members or managers or class or group of members or managers; waiver of such notice; action by consent without a 17

18 meeting; establishment of a record date; quorum requirements; voting in person or by proxy; or any other matter with respect to the exercise of any such right to vote. The profits and losses, income, deductions, and credits, and items of income, deduction, and credits of the limited liability company shall be allocated among the members in the manner provided in the operating agreement. If the operating agreement does not so provide, profits and losses, income, deductions, and credits, and items of income, deductions, and credits shall be allocated on the basis of the pro rata value of the contributions made by each member to the extent they have been made and not returned. d. Limited Liability of Members and Managers According to ALA. CODE 10A , a member of a limited liability company is not liable under a judgment, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company, whether arising in contract, tort, or otherwise, or for the acts or omissions of any other member, manager, agent, or employee of the limited liability company. A member may be liable to creditors of the limited liability company for a written agreement to make a contribution to the limited liability company. A member of a limited liability company may become liable by reason of the member s own acts or conduct. e. Merger, Dissolution and Term of Existence A limited liability company is dissolved and its affairs shall be wound up upon occurrence of the first of the following events: (1) events specified in the governing documents (certificate of formation or operating agreement); (2) written consent of all members to dissolve; (3) when there is no remaining member, unless either of the following applies: (a) the holders of all the financial rights in the limited liability company agree in writing, within 90 days after the cessation of membership of the last member, to continue the legal existence and business of the limited liability company and to appoint one or more new members, or (b) the legal existence and business of the limited liability company is continued and one or more new members are appointed in the manner stated in the governing documents; (4) when the limited liability company is not the successor limited liability company in the merger or consolidation with one or more limited liability companies or other entities; or (5) entry of a decree of judicial dissolution under ALA. CODE 10A On application by or for a member, the circuit court for the county in which the certificate of formation is filed may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the governing documents. Except as otherwise provided in the governing documents, the members who have not wrongfully dissolved a limited liability company may wind up 18

19 the limited liability company s business and affairs. A person winding up a limited liability company s business may do any of the following: preserve the company business or property as a going concern for a reasonable time; prosecute and defend actions and proceedings, whether civil, criminal, or administrative; settle and close the limited liability company s business; dispose of and transfer property; discharge the limited liability company s liabilities; distribute the assets of the limited liability company pursuant to ALA. CODE 10A ; and perform other necessary and appropriate acts. After the dissolution of the limited liability company pursuant to ALA. CODE 10A , the limited liability company shall file a certificate of termination (the term certificate of termination is synonymous with the term articles of dissolution ) in the office of the probate judge of the county in which the certificate of formation was filed. Pursuant to any agreement, a domestic limited liability company may merge or consolidate with or into one or more limited liability companies or other business entities formed or organized under the laws of this state, any other state, the United States, or any foreign jurisdiction, with the domestic limited liability company or the other business entity being the surviving or resulting domestic limited liability company or other business entity. Except as otherwise specifically provided for in the operating agreement, a merger shall be approved by each domestic limited liability company which is to merge by all the members at the time approval of the merger is voted on. Notwithstanding prior approval, an agreement of merger may be terminated prior to filing a certificate of merger (the term certificate of merger is synonymous with the term articles of merger ) with the Secretary of State or amended pursuant to a provision for the termination or amendment contained in the agreement of merger. f. Raising Capital An LLC offers the same flexibility in raising capital as a for-profit corporation. g. Recordkeeping and State Reports According to ALA. CODE 10A , each LLC must keep the following at the registered office: a current list of the full name and last known business or residence street address of each member, and each manager, if any; a copy of the filed certificate of formation and all amendments thereto; copies of the LLC s federal, state and local income tax returns and reports, for the three (3) most recent years; copies of any then effective operating agreements including amendments thereto, together with any executed copies of any powers of attorney pursuant to which any documents have been executed; and copies of any financial statement of the LLC for the three (3) most recent years. For domestic LLCs, there is a $100 filing fee that must be paid to the Secretary of State and a $50 filing fee that must be paid to the probate judge. 19

20 h. Taxation Unless it elects to be treated for federal and state purposes as a corporation, an LLC is generally not subject to separate entity-level taxation of its income under state and federal tax laws, although it is required to file an informational return. A domestic or foreign limited liability company in Alabama shall be treated as a partnership unless it is classified otherwise for federal income tax purposes, in which case it shall be classified in the same manner as it is for federal income tax purposes. Unless a member is exempt from income taxation, usually its distributive share of membership income and loss is treated as income or loss to the member and reported on his/her/its return, regardless of whether the member actually receives the income. LLCs that have one owner are generally disregarded as entities separate from their owners. i. Resources Alabama Business and Nonprofit Entity Code, ALA. CODE 10A , et. seq. Limited Liability Company Law, ALA. CODE 10A , et seq. Humphreys, Thomas, Limited Liability Companies and Limited Liability Partnerships (Incisive Media, 2009). Alabama Practice Series, Alabama Corporation Law, 3d Edition, Richard A. Thigpen, Sections 1:15-1: Low-profit Limited Liability Companies (L3Cs) a. Overview The L3C, or Low-Profit Limited Liability Company, is a new type of corporate entity that is a cross between a nonprofit and a for-profit corporation. L3Cs are not eligible for tax exempt treatment by the IRS. Rather, they are intended to be profit-generating entities with charitable and educational (including positive social change) missions as their primary objectives. Building upon the LLC structure, the L3C has thus far been enacted in Vermont (May 2008), Michigan (January 2009), Utah (March 2009), Wyoming (July 2009) and Illinois (Jan 2010), North Carolina (August 2010), and Maine (effective July 2011), as well as the Crow Indian Nation and the Oglala. L3C legislation is also being considered in other states, including Georgia, Louisiana, Missouri, Arkansas, Colorado, Kentucky, Maryland, Massachusetts, Montana, New York, North Dakota, Tennessee, and Virginia. For more information about the status of L3C legislation please visit: 20