NEW YORK FORMS OF ORGANIZATION Day Pitney LLP Peter Chadwick, Jennifer M. Pagnillo, Elida Salcedo and Emile Buzaid

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1 Last Updated: January 2012 NEW YORK FORMS OF ORGANIZATION Day Pitney LLP Peter Chadwick, Jennifer M. Pagnillo, Elida Salcedo and Emile Buzaid 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 The most common legal form of organization utilized by the social sector is the nonprofit corporation, although for-profit corporations, limited liability companies, 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 following chart provides a high-level overview of various organizational forms that can be used in the social sector. More detailed descriptions of each form follow in the subsequent text.

2 Nonprofit 501(c)(3) Corporation Formation File articles or certificate of incorporation (containing specific information required by IRS) with state and pay filing fee. File Form 1023 to obtain 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/regulations. Management and Control Liability Tax Factors Capital and Loans Generally, managed by Can accept charitable directors who appoint donations and grants. officers to Eligible for program run day-to-day related investments operations as (PRIs) by foundations. specified in bylaws. Can borrow money and Some nonprofit issue debt instruments corporations have but cannot raise capital members (like by issuing stock. shareholders) who elect directors. Members, directors, officers and employees are generally not liable for debts and obligations of the corporation, including for unlawful acts of others involved in the 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. Generally exempt from federal and state taxes if receive federal 501(c)(3) exemption. Liable for tax on unrelated business income, and other taxes such as property and sales taxes (unless local and state exemptions apply). Donors can take an income tax deduction for their contributions to these organizations. For-Profit Corporation File articles or certificate of incorporation with state and pay filing fee. Recruit directors, draft bylaws, hold organizational meeting and issue stock. Take steps to comply with license, tax and employment laws/regulations. Managed by directors that are elected by shareholders. Directors appoint officers to run day-today operations as specified in bylaws. Shareholders are generally not liable for debts and obligations of the corporation, including for unlawful acts of others involved in the business. Unless indemnified by the corporation, directors, officers and employees can be held liable for injuries caused by their own acts or failures to act, as more specifically provided herein. A C Corporation is subject to corporate tax on net income. If net income is paid to shareholders as dividends, the individual shareholders are taxed. If a corporation elects to be a S corporation and meets several criteria, it can receive pass through taxation. Can raise capital by issuing stock (equity) and by borrowing money through loans or other debt instruments. Corporation may be able to accept 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, tax and employment law/regulations. Flexible structure like a partnership with management responsibilities specified in operating agreement (usually management committee or single manager). Members/owners are generally not liable for debts and obligations of the LLC, including for unlawful acts of others involved in the business. Unless indemnified by the LLC, members/owners can be held liable for injuries caused by their own acts or failures to act, as more specifically provided herein Usually not taxed as an entity because most LLCs choose pass through treatment whereby the members/owners report profits and losses on personal tax returns. Taxexempt members/owners treat their share of income as exempt or subject to unrelated business taxable Can raise capital through contributions by members/owners. Otherwise, same as forprofit corporation.

3 L3C (low-profit LLC) Partnership Formation Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states (e.g., VT, IL, MI,UT,ME,WY) 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/regulations. 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/regulations. Management and Control Liability Tax Factors Capital and Loans income, depending on the character of the income. Generally, same as LLC Partners have equal, full control unless otherwise specified in partnership agreement. Owner has full control. Generally, same as LLC. 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. See LLC. 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. Same as for-profit corporation except L3C enabling legislation is written to comply with PRI regulations and is thus intended to attract equity or debt investments by foundations. 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 Not-for-Profit Corporation Law ( N-PCL ) governs the formation, operation and dissolution of nonprofit corporations in New York ( NP Corporations ). A NP Corporation in New York 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 a New York 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 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

4 b. Advantages of Incorporation; pros and cons of nonprofit corporations versus forprofit corporations The principal advantage of incorporation is that it protects the directors 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 are subject to a body of statutes that provide very specific guidance as to their formation and operation. Also, 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 markets, the 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 NP 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 forgo 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. c. Formation A nonprofit corporation attains its separate legal status through the filing with and approval by the New York Department of State ( NY Department of State ) of the certificate of incorporation. The incorporator files the certificate of incorporation with the New York State Department of State, Division of Corporations, One Commerce Plaza, 99 Washington Avenue, Albany, NY One or more natural persons of at least 18 years of age, regardless of the incorporator s residence, may incorporate a nonprofit corporation, with each incorporator required to sign the certificate and deliver it to the NY Department of State. The basic filing fee is $75. The certificate of incorporation for a nonprofit corporation must set forth: - 4 -

5 i) the name of the NP Corporation, with the corporate name such as to distinguish it from the names of corporations of any type or kind, or any other entity registered with the NY Department of State; and contain the word corporation, incorporated or limited or an abbreviation of one of such words unless the corporation is formed for charitable or religious purposes, or for purposes for which the approval of the commissioner of social services or the public health and health planning council is required, or is a bar association; ii) iii) that the NP Corporation is a corporation exclusively formed for a purpose, not for pecuniary profit or financial gain, and no part of the assets, income, or profit of which is distributable to, or inures to the benefit of its members, directors or officers except where allowed by law; the purpose for which the NP Corporation is formed and the type of NP Corporation as described below: Type A. A nonprofit corporation of this type may be formed for any non-business purposes including, but not limited to, non-pecuniary purposes, such as, civic, patriotic, political, social, fraternal, athletic, agricultural, horticultural, animal husbandry, and for a professional, commercial, industrial, trade or service association; Type B. A nonprofit corporation of this type may be formed for any of the following non-business purposes: charitable, educational, religious, scientific, literary, cultural or for the prevention of cruelty to children or animals (this type generally corresponds to Internal Revenue Code section 501(c)(3) charities); Type C. A nonprofit corporation of this type may be formed for the purpose of achieving a lawful public or quasi-public objective (in the case of a Type C corporation, the lawful public or quasi-public objective which each business purpose will achieve must be described in the certificate of incorporation); and Type D. A nonprofit corporation of this type may be formed under New York law when formation is authorized by any other corporate law of New York for any business or non-business purposes specified by such other law; iv) the county within New York in which the office of the NP Corporation is to be located; in the case of a Type A, Type B, or Type C corporation, the names and addresses of the initial directors, and in the case of a Type D corporation, the names and addresses of the initial directors, if any, may but need not be included; the duration of the NP Corporation if other than perpetual; a designation of the Secretary of State as agent of the NP Corporation upon whom process against it may be served and the post office address within or without - 5 -

6 New York to which the Secretary of State shall mail a copy of any process against the NP Corporation; if the NP Corporation is to have a registered agent, the agent s name and address within New York, and a statement that the registered agent is to be the agent upon whom process against the NP Corporation may be served; and the statements, if any, required for special not-for-profit corporations under New York law. A certificate of incorporation which includes among its purposes the formation of a trade or business association requires the consent of the attorney general. In addition, certain activities, such as the operation of cemeteries, hospitals, substance abuse programs, among others, require the consent or approval of certain New York agencies prior to the filing of the certificate of incorporation with the NY Department of State. The corporate existence of the NP Corporation begins upon the filing of the certificate of incorporation with the NY Department of State. Except as otherwise provided in the certificate of incorporation, generally, a NP Corporation shall be managed by its board of directors, and the certificate of incorporation or the bylaws may prescribe qualifications for directors. While the N-PCL sets forth general guidelines for powers of the board of directors, the certificate of incorporation may vest the management of the NP Corporation in persons other than the board. The board must consist of at least three directors. If the nonprofit corporation intends to obtain exemption from federal income taxation, the certificate of incorporation must conform with applicable statutes and regulations. There is no separate application for exemption from New York State income tax. Examples of certificates of incorporation may be found in the following resources: Certificate of Incorporation of the National Association of Engineering Student Councils, Inc., available at Software in the Public Interest, Inc., available at The Clear Fund, available at oration.doc - 6 -

7 USTAB, Inc., available at Division of Corporations, Department of State of New York, available at d. Management and Control Once the 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 the nonprofit corporation and 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 the NP Corporation consistent with the applicable statutes of New York and the certificate of incorporation. 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. Examples of corporate bylaws may be found in the following resources: Society for Social Work and Research, Inc., available at We the People Congress, Inc., available at Westview Taskforce, Inc., available at National Alliance on Mental Illness, New York State Bylaws, available at e. Liability of Members, Directors and Officers The N-PCL imposes upon directors and officers duties of loyalty, of good faith and of the care an ordinarily prudent person in a like position would exercise under similar circumstances. The factors set forth in the standard of conduct for managing and investing an institutional fund, if relevant, must be considered by a governing board delegating investment management of institutional funds. These factors include general economic conditions, the possible effect of inflation or deflation, the expected tax - 7 -

8 consequences of investment decisions, the role that each investment plays within the overall investment portfolio, the expected total return from income and the appreciation of investments, other resources of the institution, the needs of the institution and the fund to make distributions and to preserve capital, and an asset s special relationship or value to the purposes of the institution. Furthermore, in managing and investing an institutional fund, an institution may incur only costs that are appropriate and reasonable in relation to the assets, purposes, and skills available to the institution, and shall make a reasonable effort to verify facts relevant to the management and investment of the fund. Directors and officers, when acting in good faith, may rely on information, opinions, reports or statements including financial statements and other financial data prepared and presented by certain individuals, such as officers and employees of the corporation, counsel and public accountants of the corporation or a committee of the board of directors. Directors and officers will not be considered to be acting in good faith if they have knowledge concerning the matter in question that would cause such reliance to be unwarranted. Directors and officers who manage the NP Corporation in accordance with their fiduciary duties have no liability by reason of being or having been directors or officers of the NP Corporation. The members of a NP Corporation are not personally liable for the debts, liabilities or obligations of the NP Corporation, and member liability is limited to the extent of any unpaid portion of the initiation fees, membership dues or assessments imposed upon the member by the NP Corporation, or for any other indebtedness owed by the member to the NP Corporation. With certain exceptions, a director or officer serving without compensation is not liable to any person other than the NP Corporation based solely on his or her conduct in the execution of such office, unless the conduct constituted gross negligence or was intended to cause the resulting harm. For this purpose, a director or officer is not considered compensated solely by receiving payments for actual expenses incurred in discharging his or her duties. Such exceptions include any action or proceeding brought by the attorney general, the distribution of the NP Corporation s assets to members, directors or officers other than distributions permitted by the N-PCL, and the making of a loan to directors and officers which contravenes the N-PCL. Additionally, directors who vote for or concur in certain corporate actions, including the unlawful distribution of the NP Corporation s cash or property or unlawful loans to directors and officers, are jointly and severally liable to the NP Corporation for the benefit of its creditors or members or the ultimate beneficiaries of its activities, to the extent of any injury suffered by such persons, respectively, as a result of such action, or, if there are no creditors or members or ultimate beneficiaries so injured, to the NP Corporation, to the extent of any injury suffered by the NP Corporation as a result of such action

9 The N-PCL permits a NP Corporation to indemnify directors and officers in their capacity for amounts paid against judgments and fines, amounts paid in settlement and reasonable expenses, including attorneys fees, for any action brought against such director or officer, if their conduct was undertaken in good faith and in a manner reasonably believed to be in the best interests of the NP Corporation and such director or officer had no reasonable cause to believe that his or her conduct was unlawful. However, New York law does not permit indemnification by a NP Corporation against directors or officers in actions by or in the right of the NP Corporation, if such director or officer has been adjudged to be liable to the corporation, except and only to the extent that the court in which the action was brought, or, if no action was brought, any court of competent jurisdiction, determines the director or officer is fairly and reasonably entitled to indemnity for such portion of the settlement amount and expenses as the court deems proper. Despite the protections afforded by the N-PCL, a New York court may hold a director or member liable for the acts (or failure to act) of a corporation where (i) the corporation is a sham and exists for no other purpose than as a vehicle for fraud, (ii) the members exercise complete domination and control over the corporation, or (iii) the corporate existence is disregarded by the members who essentially treats the assets of the corporation as their own. New York provisions for liability of volunteer directors, officers, or members, are subject to the Federal Volunteer Protection Act of 1997 (42 U.S.C and following). This Federal law generally pre-empts state laws to the contrary and provides that volunteers can plead volunteer immunity as a defense against any claim arising out of their volunteer activities, except for willful or criminal misconduct, gross negligence, reckless misconduct, or a conscious, flagrant indifference to the rights or safety of the individual harmed by the volunteer or harm caused by motor vehicles. Board members concerned about liability should therefore consider serving as volunteers rather than collecting compensation for their activities. f. Mergers, Acquisitions and Dissolution Two or more nonprofit corporations may merge into a single nonprofit corporation. The board of each corporation proposing to participate in the merger must adopt a plan of merger, setting forth: the name of each constituent corporation and the surviving corporation, as to each constituent corporation, a description of the membership and holders of any certificates, if any, the terms and conditions of the proposed merger, and a statement of any amendments or changes in the certificate of incorporation of the surviving corporation to be effected by such merger. Upon approving such plan of merger, the board must submit the plan for member approval if the NP Corporation has any member entitled to vote. After the approval of the merger, a certificate of merger is - 9 -

10 filed with the NY Department of State. For a merger involving a Type B or Type C corporation, the N-PCL requires an order approving the plan of merger and authorizing the filing of the certificate by the New York Supreme Court, with a certified copy of the order annexed to the certificate of merger. The application for the order may be made in the judicial district in which the principal office of the surviving corporation is to be located, and the application shall be made by all the constituent corporations. In addition, the N-PCL provides that a Type A or Type C NP Corporation may be merged with and into a business corporation. To dissolve a not-for-profit corporation, the board must adopt a plan for the dissolution of the corporation and the distribution of its assets. Upon adopting a plan of dissolution and distribution of assets, the board must submit it to a vote of the members, if any are entitled to vote; the plan of dissolution and distribution of asset must be approved by twothirds vote or via the consent of the members. In the case of a Type B or Type C corporation or one that holds assets restricted to a particular purpose, the plan of dissolution must be approved by a justice of the New York Supreme Court for the district in which the corporation s office is located, although notice to the Attorney General s office alone may be sufficient if the corporation has no assets at the time of its dissolution. If the corporation plans to dispose of all or substantially all of its assets as part of its dissolution, that disposition may be subject to a requirement for a separate Supreme Court approval. It is a good practice, in determining the requirements for dissolution, to consult the Attorney General s office for the district in which the corporation is headquartered prior to beginning the legal process. After dissolution, a corporation shall not commence any new activities, but a dissolved corporation, its directors, officers and members may continue to function for the purpose of winding up the affairs. g. Recordkeeping, State Reports and State Taxes The N-PCL requires each corporation to keep, at the office of the corporation, correct and complete books and records of account and minutes of the proceedings of its members, board and executive committee, if any, and keep at such office or at the office of its transfer agent or registrar in New York, a list or record containing the names and addresses of all members, the class or classes of membership or capital certificates and the number of capital certificates held by each and the dates when they respectively became the holders of record thereof. A corporation may keep its books and records of account in an office of the corporation outside of New York, as specified in its certificate of incorporation. The regular reporting requirements pursuant to New York Estates, Powers & Trusts Law ( EPTL ) Section and Article 7-A of the Executive Law differ depending on corporate purposes, tax exemption type and the amount and type of revenue the

11 corporation raises yearly. Charitable corporations are required to register within six months after any property is held or income is received which must be applied to charitable purposes and to file annual reports. Such corporations include purposes that benefit the community and are charitable, e.g., educational, religious, literary, cultural or the prevention of cruelty to children or animals. Charitable organizations that plan to solicit contributions from the public or from government must register with the attorney general prior to solicitation unless exempt under either Section 172-a of the Executive Law or pursuant to the EPTL. New York exempts charitable organizations from state and local sales taxes. The exemption can be claimed by filing a Form ST-119.2, Application for an Exempt Organization Certificate, with the New York State Tax Department. The form and instructions are available at 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. 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. Proposed New York Legislation The State of New York is considering what may be considered the most significant changes to New York s Not-for-Profit Corporation Law in over forty years. The goal of the proposed legislation is to produce a revised statute that best serves the public interest and the New York non-profit sector. The draft revision compares favorably with comparable laws in other states and, if enacted, it has the potential to streamline nonprofit governance without compromising oversight. The proposed legislation attempts to reduce the administrative burdens associated with the formation and operation of not-forprofit corporations in New York, while maintaining sufficient government oversight and emphasizing the fiduciary responsibilities of directors and officers

12 There are several key changes advanced by the proposed legislation. For example, notfor-profit corporations in New York, which are required to obtain regulatory approvals before incorporating, such as child day care centers, are currently not allowed to incorporate until regulatory approvals are obtained. The proposed legislation would relax this requirement by permitting such corporations to incorporate before obtaining regulatory approvals, provided that no regulated activity occurs until the required approvals and licenses are obtained. Some other changes include the elimination of the various types of not-for-profit corporations; the creation of additional circumstances in which director liability may be eliminated; the expansion of judicial authority to intervene in all types of not-for-profit corporations in circumstances involving misappropriation of corporate funds; the expansion of the set of possible organizational names to be used in the full name of a not-for-profit corporation; the clarification of procedures for member meetings, meeting notices, rights of inspection, voting on bylaw amendments, and other decision making by the board or members; the ability of one person to hold all or any combination of the offices of president, secretary, or treasurer in a one-member not-for-profit corporation; the ability to use funds for a new corporate purpose when those funds were acquired prior to the associated amendment of purpose; the ability to merge with a non-profit corporation in another state; and the application to all types of charitable corporations of the requirement to obtain the Supreme Court s approval prior to dissolution of the corporation. j. Resources 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) Forming a Not-For-Profit Corporation in New York State, Division of Corporations, NY Department of State, available at Takagi, Gene. Nonprofit Bylaws - Common Issues Nonprofit Law Blog

13 2. For-Profit corporations a. Using For-Profit Corporations to Pursue Social Objectives The for-profit form of organization can and frequently is used as a vehicle for conducting a business that also has a social mission or objective. Although for-profit corporations are usually formed for the purpose of making money and distributing it to managers and shareholders, there is no reason why a for-profit corporation cannot include a social mission in the purposes clause of its certificate of incorporation. While such a provision would authorize the corporation to pursue social objectives, it would not require the corporation to do so only the shareholders have this power. And unless all shareholders agree to pursue social aims, dissenters could sue the corporation s directors and managers for failing to operate the corporation in the best economic interests of the shareholders. A shareholders agreement is probably the best way to address this problem. Such an agreement, entered into by all shareholders and the corporation, would require the 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 for-profit corporations. But 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 which makes it difficult to respond to business changes over time would tend to render the for-profit corporation much less attractive to investors (potential new shareholders). b. Formation The New York Business Corporation Law ( BCL ) governs the formation, operation and dissolution of for-profit corporations in New York. One or more natural persons of the age of 18 years or over may incorporate a corporation. Unless the certificate of incorporation sets forth a future effective date, not exceeding 90 days after the filing date, the certificate of incorporation becomes effective upon the filing of the certificate with the NY Department of State. A business corporation may be formed for any lawful business purpose and a corporation formed for the purpose of establishing a child day care center must submit a certified copy of the certificate of incorporation to the Office of Children and Family Services

14 The certificate shall be signed by each incorporator, with his or her name and address, and filed with the New York State Department of State, Division of Corporations, State Records and Uniform Commercial Code, One Commerce Plaza, 99 Washington Avenue, Albany, NY The filing fee for incorporation is $125. The certificate shall include: i) the name of the corporation; ii) iii) iv) the purpose, which may include a social mission or purpose; the county in which the office of the corporation is to be located; the aggregate number of shares which the corporation shall have the authority to issue, including the number of each class of shares, if applicable, and the par value or a statement that the shares are without par value; v) if the shares are to be divided into classes, the designation of each class and a statement of the relative rights, preferences and limitations of the shares of each class; vi) vii) viii) ix) a designation of the Secretary of State as agent of the corporation upon whom process against it may be served and the post office address within or without New York which the Secretary of State is to mail a copy of any process against it served upon him or her; if the corporation is to have a registered agent, the name and address within New York; if the shares of any preferred class are to be issued in series, the designation of each series and a statement of the relative rights, preferences, and limitations, a statement of any authority to be vested in the board to establish and designate series and to fix the variations in the relative rights, preferences, and limitations, and a statement of any limit on the authority of the board of directors to change the number of shares of any series of preferred shares; and the duration of the corporation if other than perpetual. A for-profit corporation must have one or more directors. The corporate name must be such as to distinguish it from the names of corporations of any type or kind, or any other entity registered with the NY Department of State; the name must include word corporation, incorporated or limited, or an abbreviation of one of such words. Examples of certificates of incorporation may be found in the following resources: Certificate of Incorporation of IBM, available at

15 Certificate of Incorporation of The New York Times Company, available at Business Corporation Filings, Division of Corporations, Department of State of New York, available at c. Management and Control A for-profit 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 election of directors, mergers, sale of all assets and dissolution. Similar to a nonprofit corporation, once the for-profit corporation has been established, the initial board of directors meets (in person or by consent), ratifies the acts in connection with initial formation of the corporation and adopts bylaws which set forth the rules and procedures governing the operation and management of the corporation consistent with the applicable statutes of New York and the certificate of incorporation. In general, the bylaws of a for-profit 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. Examples of bylaws of for-profit corporations may be found in the following resources: Bylaws of IBM, available at The New York Times Company By-Laws, available at d. Liability of Shareholders, Directors and Officers A director must perform his duties as a director in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances. In performing his or her duties, a director is entitled to rely on information, opinions, reports or statements including financial statements and other financial data, in each case prepared or presented by officers or employees of the corporation, a committee of the board, or the corporation s counsel or public accountants. Directors also owe the corporation and its shareholders a duty of loyalty. A director may not use his or her position within the corporation for self-dealing at the expense of the corporation or

16 exploit for personal benefit a business opportunity that should be utilized by the corporation. In certain cases, such as in the unlawful distribution of dividends, directors of a corporation who vote for or concur in corporate actions are to be jointly and severally liable to the corporation for the benefit of its creditors or shareholders, to the extent of any injury suffered by such persons, respectively. The certificate of incorporation may set forth a provision limiting the personal liability of directors to the corporation or its shareholders for damages for any breach of duty, provided that no such provision can limit the liability of any director for: the approval of unlawful dividends, distributions, loans and purchase of shares; acts or omissions taken in bad faith or which involved intentional misconduct or a knowing violation of law; or gaining a financial profit or other advantage to which he or she was not legally entitled. A corporation may indemnify any director or officer made, or threatened to be made, a party to an action or proceeding because he or she was a director or officer of the corporation, against judgments, fines, amounts paid in settlement and reasonable expenses, if their conduct was undertaken in good faith and in a manner reasonably believed to be in the best interests of the corporation and such director or officer had no reasonable cause to believe that his or her conduct was unlawful. However, New York law does not permit indemnification by a corporation against directors or officers in actions by or in the right of the corporation, if such director or officer has been adjudged to be liable to the corporation, unless and only to the extent that the court in which the action was brought, or, if no action was brought, any court of competent jurisdiction, determines that the director or officer is fairly and reasonably entitled to indemnity for such portion of the settlement amount and expenses as the court deems proper. A New York for-profit corporation is generally considered to be a distinct legal entity separate from its shareholders. Accordingly, the shareholders of a New York for-profit corporation are generally not personally liable for the actions, liabilities or obligations of the corporation. Shareholders, however, are liable for the purchase price of their shares. The BCL also provides that the ten largest shareholders, as determined by the fair value as of the beginning of the period during which the unpaid services are performed, of every corporation, except for public corporations, are jointly and severally personally liable for all debts, wages or salaries due and owing to any of its laborers, servants or employees except contractors, for services performed by them for such corporation

17 There are other instances where New York courts may disregard the separate legal existence of a corporation and hold the corporation s shareholders (rather than the corporation itself) liable for the corporation s actions (i.e., piercing the corporate veil). Piercing the corporate veil requires a showing that the shareholder exercised complete domination of the corporation in respect to a questioned transaction; and that such domination was used to commit a fraud or wrong which resulted in injury. Indicia of a situation warranting veil-piercing include: the absence of the formalities and paraphernalia that are part and parcel of the corporate existence, i.e., issuance of stock, election of directors, keeping of corporate records and the like; inadequate capitalization; whether funds are put in and taken out of the corporation for personal rather than corporate purposes; overlap in ownership, officers, directors, and personnel; common office space, address and telephone numbers of corporate entities; the amount of business discretion displayed by the allegedly dominated corporation; whether the related corporations deal with the dominated corporation at arms length; whether the corporations are treated as independent profit centers; the payment or guarantee of debts of the dominated corporation by other corporations in the group; and whether the corporation in question had property that was used by other of the corporations as if it were its own. The concept is equitable in nature, and the decision whether to pierce the corporate veil in a given instance will depend on the facts and circumstances. e. Raising Capital For-profit 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 In addition to filing the certificate of incorporation, each corporation must file a signed statement, biennially, setting forth: the name and business address of its chief executive officer, street address of its principal executive office, and the post office address where the Secretary of the State is to mail a copy of any process against it served upon him or her. The BCL requires each corporation to keep correct and complete books and records of account and keep minutes of the proceedings of its shareholders, board and executive committee, if any, and keep at the office of the corporation in New York or at the office of its transfer agent or registrar in New York, a record containing the names and addresses of all shareholders, the number and class of shares held by each and the dates when they respectively became the owners of record thereof

18 g. Taxation New York corporations doing business in New York are subject to New York corporate income tax. Unlike sole proprietorships and partnerships, income earned by New York for-profit corporations doing business in the state may be subject to double taxation. That is, the corporation pays federal and state taxes on the income it earns and the shareholders are taxed at their personal income tax rate on any profits that are distributed to them by the corporation as dividends. A corporation may, however, elect to be governed by Subchapter S of the Internal Revenue Code to avoid double taxation. Subchapter S corporations are not taxed at the corporation level. Rather, the income and losses of a Subchapter S corporation are passed through to the shareholders in relation to their ownership interests. To be eligible for this tax treatment, S corporations must meet certain requirements including, but not limited to, having only one class of stock and no more than 100 shareholders. New York requires a corporation to file franchise tax reports and pay franchise taxes annually even if the corporation does not conduct business or loses money. Franchise tax requirements begin the date the corporate existence begins. Tax responsibilities continue until the corporation is legally dissolved by the Secretary of State. Generally, the corporation must compute four distinct taxes and pay the tax that results in the largest amount owed. It is recommended for the corporation to seek tax advice to determine its franchise tax. h. Resources N.Y. BUS. CORP. LAW 101, et seq. Forming a Business Corporation in New York State, Division of Corporations, NY Department of State, available at Corporate Practice Library: New York Tax Considerations, available at fcn=2&wsn= &fn= &split=0. Internal Revenue Service: Tax Information for Business Corporations, available at 3. Limited Liability Companies ( LLCs ) a. Using LLCs to Pursue Social Change The New York Limited Liability Company Law (the NY LLC Law ) governs the formation, operation and dissolution of LLCs in the State of New York

19 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 entity level and again when it is included in the owner s income), LLCs are preferred over for-profit corporations as vehicles for social enterprise, especially for joint ventures between a taxexempt 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

20 b. Formation To form and organize an LLC under the NY LLC Law (a NY LLC or LLC ), articles of organization must be filed with the NY Department of State at the address set for the below. Department of State Division of Corporations, State Records and Uniform Commercial Code One Commerce Plaza 99 Washington Avenue Albany, NY The NY LLC Law also requires for the member or members of the NY LLC to enter into an operating agreement, a document that is not filed with the NY Department of State but that determines the rights, duties and obligations of the members. (See Section 3(c) below for further discussion.) The articles of organization must set forth the following information: i) the name of the NY LLC, which must contain the words Limited Liability Company or the abbreviation L.L.C. or the designation LLC ; ii) iii) iv) the county within the State of New York in which the office of the LLC is to be located; if the LLC is to have a specific date of dissolution, the latest date on which the LLC is to be dissolved; a designation of the Secretary of the State of New York as agent of the LLC upon whom service of process against the LLC may be served; v) the address within or without the State of New York to which the Secretary of State is to mail a copy of any service of process against the LLC; vi) vii) if the NY LLC is to have a registered agent, the registered agent s name and address within the State of New York, and a statement that the registered agent is to be the agent of the LLC upon whom process against it may be served; and if all or specified members are to be liable in their capacity as members for all or specified debts, obligations or liabilities of the LLC, a statement to such effect. The articles of organization are executed and filed by one or more organizers. Any legally competent individual or entity may organize a NY LLC and such individual or entity is not required to be a New York resident. The NY LLC Law permits the