Last Updated: August DELAWARE FORMS OF ORGANIZATION Richards, Layton & Finger P.A. Melissa Stubenberg, Peter Calder and Jennifer Veet Barrett

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1 Last Updated: August 2014 DELAWARE FORMS OF ORGANIZATION Richards, Layton & Finger P.A. Melissa Stubenberg, Peter Calder and Jennifer Veet Barrett Table of Contents 1. Nonprofit Nonstock Corporations 2. For-Profit Corporations 3. Public Benefit Corporations 4. Limited Liability Companies 5. Low Profit Limited Liability Companies 6. Joint Ventures 7. Unincorporated Associations 8. Partnerships and Limited Partnerships 9. Sole Proprietorships 10. New Forms of Hybrid Organizations The most common legal form of organization utilized by the social sector is the nonprofit nonstock 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; sometimes, with the help of experienced counsel, they are used in combination to maximize the strengths and minimize the 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 Nonstock Corporation (a charitable nonstock corporation is a nonprofit nonstock corporation exempt from taxation under 501(c)(3) of the United States Internal Revenue Code) Formation File certificate of incorporation (containing specific info required by IRS in the case of a charitable nonstock corporation) with state and pay filing fee. File application on Form 1023 for tax-exempt status, if desired, unless below gross receipts threshold. Recruit members of the governing body, draft bylaws and hold organizational meeting. Take steps to comply with license, tax and employment laws/regs. Management and Control Liability Tax Factors Capital and Loans Managed by a Can accept charitable governing body donations and grants. elected by members o Eligible for program the corporation. The related investments governing body (PRIs) by foundations. appoints officers to Can borrow money and run day-to-day issue debt instruments operations as but cannot raise capital specified in bylaws. by issuing stock. Members are generally not liable for debts and obligations of the corporation, including for unlawful acts of others involved in the affairs of the corporation. Directors, officers and employees can be held liable in some circumstances for injuries caused by their own acts or failures to act, but they may be indemnified in some situations by the corporation. 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 and sales (unless local and state exemptions apply). Donors can deduct contributions. For-Profit Corporation File certificate of incorporation with state and pay filing fee. Decide on board of directors, draft bylaws, hold organizational meeting, and issue stock. Take steps to comply with license, tax and employment laws/regs. Managed by a board of directors that are elected by shareholders. Directors appoint officers to run dayto-day 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. Directors, officers, and employees can be held liable in some circumstances for injuries caused by their own acts or failures to act, but they may be indemnified in some situations by the corporation. 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 an 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. Public Benefit Corporations See For-Profit See For-Profit Corporation. The Corporation; certificate of Directors have a incorporation must duty to balance the state the public benefits pecuniary interests that the corporation of the stockholders, intends to promote. the interests of those materially affected by the public benefit corporation s conduct, and the public benefits identified in the certificate of See For-Profit Corporation See For-Profit Corporation See For-Profit Corporation 2

3 LLC L3C (low-profit LLC) Partnership Formation File certificate of formation with state and pay filing fee. Negotiate and execute operating agreement. Take steps to comply with license, tax and employment laws/regs. Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states (VT, IL, MI, UT, ME, WY, LA, NC, RI) 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 laws/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 incorporation. Perio dic reports concerning the corporation s efforts to balance these interests must be provided to stockholders. Flexible structure like a partnership with management responsibilities specified in operating agreement (usually management committee or single manager). Same as a corporation but duties and liabilities of members, managers or other persons may be expanded, restricted or eliminated to the fullest extent permitted by law by a provision in the limited liability company agreement. 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. Taxexempt member/owners treat their share of income as exempt or subject to unrelated business taxable income, depending on the character of the income. Can raise capital through contributions by member/owner. Otherwise, same as forprofit corporation. 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. Limited partners in an LP do not participate in the control of business. 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. 3

4 1. Nonprofit Nonstock Corporations a. Overview The General Corporation Law of the State of Delaware (the DGCL ) (8 Del. C. 101, et seq.) governs the formation, operation and dissolution of nonprofit nonstock corporations in Delaware. The DGCL distinguishes between nonstock corporations (a corporation that is not authorized to issue capital stock), nonprofit nonstock corporations (a nonstock corporation that does not have membership interests) and charitable nonstock corporations (a nonprofit nonstock corporation that is exempt from taxation under Section 501(c)(3) of the United States Internal Revenue Code). A Delaware nonprofit nonstock corporation is managed by a governing body and generally operated by its officers and employees. Instead of shareholders, a nonprofit nonstock corporation has members. A nonprofit nonstock corporation has an existence of its own. It can own real estate, sue, and be sued in its own name. The Delaware attorney general has the power, developed at common law, to pursue derivative suits (a lawsuit brought by a shareholder on behalf of a corporation against a third party) on behalf of the beneficiaries of charitable nonstock corporations. b. Advantages of Incorporation: Pros and Cons of Nonprofit Versus For-Profit The principal advantage of incorporation is that it protects the members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, members of the governing body 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 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 markets, the nonprofit nonstock corporation is the preferred vehicle for pursuing social objectives. Although nonprofit nonstock corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit nonstock corporation 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 nonstock corporations cannot issue capital stock. The directors of a for-profit corporation (that is not a public benefit corporation, as discussed in further detail in Section 3), however, owe strict duties to the shareholders to maximize profits and value. 4

5 Therefore, unless the directors and management can tie the social mission of their forprofit 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 if the company is a public benefit corporation or if all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes, but, in the latter case, 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 nonstock corporation attains its separate legal status through the filing and approval by the Secretary of State of the State of Delaware (the Secretary of State ) of its certificate of incorporation. The DGCL requires that the certificate of incorporation for a nonprofit nonstock corporation include the name of the corporation, the name and address of the corporation s registered agent in Delaware, the nature or purpose of the corporation, that the corporation is not authorized to issue capital stock, the names and mailing addresses of the incorporators, and, if the powers of the incorporators are to terminate upon the filing of the certificate of incorporation, the names and addresses of the initial members of the governing body. Generally, the name of the corporation is required to contain one of the following words or an abbreviation thereof: association, company, corporation, club, foundation, fund, incorporated, institute, society, union, syndicate, or limited. The name must also be distinguishable from other entity names. While the DGCL provides for corporate purposes as general as engaging in any lawful activity for which corporations may be organized, the separate sections of the DGCL provide franchise tax exemptions for certain corporations, including those organized primarily or exclusively for religious or charitable purposes. If the nonprofit nonstock corporation intends to obtain exemption from federal and state income taxation, the certificate of incorporation must conform with applicable statutes and regulations (discussed below in section g). The incorporator(s) of the nonprofit nonstock corporation must execute, acknowledge, and file the certificate of incorporation. The DGCL provides that any person, partnership, association, or corporation, singly or jointly with others, may incorporate or organize a Delaware nonprofit nonstock corporation regardless of the incorporators residence, domicile, or state of incorporation. The incorporator(s) must sign the certificate and acknowledge it in accordance with Section 103(b) of the DGCL. The certificate of incorporation is then filed with the Secretary of State. As of August 12, 2014, the basic filing fee is $89. While the DGCL sets forth general guidelines for powers of the governing body of a 5

6 nonprofit nonstock corporation, it also provides a nonprofit nonstock corporation with the option of removing itself from these guidelines through its certificate of incorporation. The certificate of incorporation of a nonprofit nonstock corporation may provide that the business and affairs of the corporation shall be managed in a manner different from that provided in Section 141 of the DGCL. However, if it is not otherwise provided in the certificate of incorporation, Section 141 applies to nonprofit nonstock corporations, and all references to the board of directors, members thereof, and shareholders are deemed to refer to the governing body of the nonprofit nonstock corporation, members thereof, and members of the nonprofit nonstock corporation, respectively. Generic forms of certificates of incorporation for a Delaware nonstock corporation may be found in Delaware Nonstock Corporations as Practice Tools 3 and 4 referenced in subparagraph i of this section. d. Management and Control Once the nonprofit nonstock corporation has been established, the initial members of the governing body, if named in the certificate of incorporation, should hold an organizational meeting (or execute a written consent in lieu of an organizational meeting), to ratify the acts in connection with the initial formation of the corporation and adopt bylaws. Bylaws may also be adopted by the incorporators if the initial members of the governing body are not named in the certificate of incorporation. The bylaws generally set forth the rules and procedures governing the decision-making process of the governing body and the general operation and management of the corporation consistent with applicable law and the certificate of incorporation. Typically, the bylaws of a nonprofit nonstock corporation contain provisions governing the qualifications, powers, and duties of members of the governing body, officers, and members of the corporation; voting; filling of vacancies in the governing body; meetings; property holding and transfer; indemnification of members of the governing body and officers; committees; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment and dissolution procedures. Generic forms of bylaws and an organizational consent for a Delaware nonstock corporation may be found in Delaware Nonstock Corporations as Practices Tools 5 and 6.. e. Liability of Members, Directors and Officers The fiduciary duties (legal or ethical duties based on confidence or trust) of members of the governing body of a nonprofit nonstock corporation are defined by principles of corporate law. Officers of nonprofit nonstock corporations also stand in a fiduciary 6

7 relationship to the corporation and its members. In addition to the conventional duties of due care, loyalty, and candor, members of the governing body of a nonprofit nonstock corporation also owe a special duty of obedience: a duty to advance its charitable goals and protect its assets. These duties are clearly owed to the corporation and its members and, in some cases, may be owed to the beneficiaries or creditors of the corporation. Delaware courts have broad discretion in fashioning an appropriate remedy for a breach of fiduciary duty, including holding members of the governing body personally liable for monetary damages. A nonprofit nonstock corporation may limit the liability of its governing body members through its certificate of incorporation. Members of a nonprofit nonstock corporation are generally not personally liable for the corporation s debts. The certificate of incorporation may include a provision imposing liability on the members of the corporation, but otherwise the default rule is that members of a corporation shall not be personally liable for the corporation s debts except by reason of their own conduct. Section 145 of the DGCL permits a corporation to indemnify its directors, officers, employees, and agents for attorneys fees and other expenses incurred in their capacity as such (if their conduct was undertaken in good faith and in a manner reasonably believed to be in the best interests of the corporation) and for judgments, fines, and amounts paid in settlement of civil cases in third-party actions. Delaware law does not, however, permit indemnification by a Delaware corporation for judgments rendered against its directors, officers, employees, or agents in actions brought by or in the right of the corporation (i.e., derivative actions) or for amounts paid in settlement of such actions. Section 145 of the DGCL applies to nonprofit nonstock corporations by virtue of the translator provisions in Section 114(a) of the DGCL. Since the courts have held that actions for breach of fiduciary duty must generally be asserted derivatively, indemnification may not be available to directors or officers for judgments rendered against them for breach of their fiduciary duties or amounts paid in settlement of actions making such allegations. f. Mergers, Acquisitions and Dissolution The DGCL has several provisions that are specifically applicable to charitable nonstock corporations, which are defined under the DGCL as nonprofit nonstock corporations that are exempt from taxation under Section 501(c)(3) of the United States Internal Revenue Code. Sections 253, 254, 255, 256, 257, 258, 263, and 264 of the DGCL all contain provisions prohibiting mergers that would cause the charitable status of charitable nonstock corporations to be lost or impaired. In addition, Section 266 of the DGCL prohibits the conversion of a charitable nonstock corporation into another entity if the charitable status of such charitable nonstock corporation would thereby be lost or 7

8 impaired. Section 255 of the DGCL provides for the merger of two or more Delaware nonstock corporations (including nonprofit nonstock corporations) into a single corporation. It requires, first, that the governing body of each nonstock corporation adopt a resolution approving an agreement of merger or consolidation and second, that the agreement be submitted to the members of each constituent nonstock corporation who have the right to vote for the election of the members of the governing body of their corporation and to each other member who is entitled to vote on the merger under the certificate of incorporation or bylaws of such corporation (this second requirement does not apply if the only members with the right to vote for the election of governing body members or on the merger are the members of the governing body themselves). Sections 253(f) and (g) of the DGCL allows nonstock corporations (including nonprofit nonstock corporations) to take advantage of Delaware s short-form merger procedure, subject to three key conditions. First, the nonstock corporation must be the parent corporation. Second, the nonstock corporation must be the surviving corporation in the merger. Third, no charitable nonstock corporation may effect a short-form merger if its charitable status would thereby be lost or impaired by virtue of the merger. Dissolution of a nonstock corporation (including a nonprofit nonstock corporation) is effected under Section 276 of the DGCL. Section 276 provides that the governing body of a nonstock corporation shall perform all acts necessary for dissolution as required by Section 275 of the DGCL. If the members of the nonstock corporation are entitled to vote for the election of governing body members or are entitled to vote for dissolution under the certificate of incorporation or the bylaws, they are given notice and the opportunity to vote, similar to the shareholders under Section 275. If there are no members entitled to vote on the dissolution, the dissolution may be effected by the vote of a majority of the members of the governing body then in office. Once the dissolution is properly authorized, the certificate of dissolution shall be executed, acknowledged, and filed with the Secretary of State. g. Recordkeeping, State Reports and State Taxes All corporations incorporated in the State of Delaware are required to file an annual report (also referred to as the annual franchise tax report) with the Secretary of State in conjunction with paying annual franchise taxes. Nonprofit nonstock corporations that are exempt corporations, as that term is defined in Section 501(b) of the DGCL, are exempt from the corporate franchise tax but must file an annual report with the Secretary of State. The annual report filing fee is $50 for nonstock nonprofit corporations (and $25 for exempt corporations), and the franchise tax applicable to nonstock nonprofit 8

9 corporations (except exempt corporations) is $175 as of August 12, In general, a corporation that is incorporated under Delaware law but otherwise has no contact with Delaware will generally not be subject to other Delaware taxes. However, even to the extent that a nonprofit nonstock corporation has assets or activities in Delaware, such nonprofit nonstock corporation may be exempt from corporate income taxes, property taxes, and certain business licensing fees. Corporations organized for religious, charitable, scientific, or educational purposes or for the prevention of cruelty to children or animals are exempt from state-imposed corporate income taxes. Corporations created for charitable purposes are also exempt from property taxes imposed by counties. Nonprofit nonstock corporations that are exempt under federal income tax law are also exempt from various business licensing fees. h. Insurance Nearly every type of activity by a nonprofit nonstock 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., governing body members, 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 governing body members or officers of the corporation, many nonprofit nonstock corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit nonstock corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation s offices, at sponsored meetings, and the like. Section 145(g) of the DGCL specifically allows a Delaware corporation to purchase liability insurance on behalf of its directors, officers, employees, or agents and to insure against potential liability of such directors, officers, employees, or agents regardless of whether the corporation has the power to indemnify the particular litigant. Thus, Section 145(g) theoretically permits the corporation to insure its directors, officers, employees, or agents against judgments or amounts paid in settlement of derivative suits and against expenses incurred by a director, officer, employee, or agent even in circumstances in which such person has been found to have acted unlawfully or in bad faith. As noted above, Section 145 of the DGCL applies to nonprofit nonstock corporations by virtue of the translator provisions in Section 114(a) of the DGCL. Liability insurance for nonprofit nonstock 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. 9

10 i. Resources John Mark Zeberkiewicz and Blake Rohrbacher, Delaware Nonstock Corporations, 98 Corporate Practice Series (BNA 2014). John Mark Zeberkiewicz and Blake Rohrbacher, New Day for Nonstock Corporations: The 2010 Amendments to Delaware s General Corporation Law, 66 Bus. Law. 271 (Feb. 2011). Oleck and Stewart, Nonprofit Corporations, Organizations & Associations (Prentice- Hall, 6 th ed. 1994, Cum. Supp. 2002). Jacobs, Jerald A., Association Law Handbook (ASAE & The Center for Association Leadership 5 th ed., 2012). 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 3d ed., 2012). Nonprofit Organizations: Forms for Creation, Operation and Dissolution (Marcia Clifford, et al. ed., Callaghan & Company) (1987). Takagi, Gene, Nonprofit Bylaws - Common Issues Nonprofit Law Blog (Sept. 2009), 2. For-Profit Corporations a. Using For-Profit Corporations to Pursue Social Objectives The for-profit form of organization can be 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 a profit for the benefit of their shareholders, a for-profit corporation may be formed to further a social mission by including its social objectives in the purpose clause of the certificate of incorporation. The purpose clause should be carefully drafted to require the corporation to pursue social objectives if that is the aim of 10

11 the stockholders. Drafters should keep in mind that a corporation will have the power and authority to conduct only such activities as are within the scope of its purpose clause. A shareholders agreement is another way to ensure that a corporation is pursuing its social objectives. 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. 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 may change via sale, gift or inheritance. Moreover, a tightly drafted shareholders agreement that makes it difficult to respond to business changes over time may render the for-profit corporation much less attractive to investors (potential new shareholders). b. Formation The DGCL governs the formation, operation, and dissolution of nonprofit and for-profit corporations in Delaware. Section 101(a) of the DGCL authorizes [a]ny person, partnership, association or corporation, singly or jointly with others, and without regard to such person s or entity s residence, domicile or state of incorporation to incorporate or organize a corporation under the DGCL by filing a certificate of incorporation with the Delaware Division of Corporations in the Department of State. The certificate of incorporation must set forth: (i) the name of the corporation, which must include a word designating that such entity is a corporation (e.g., company, corporation or abbreviations thereof) and be distinguishable on the Secretary of State s records from the names of each other corporation, partnership, limited partnership, limited liability company, or statutory trust; (ii) the address of the registered office of the corporation in the State of Delaware and the name of the corporation s registered agent at such address; (iii) the nature of the business or purposes to conducted or promoted (also know as the purpose clause ); (iv) capitalization of the corporation, including the total number of shares of stock (including the number of shares of each class of stock, if applicable) that the corporation shall have authority to issue and the par value of each of such shares; (v) the name and mailing address of the incorporator or incorporators; and (vi) if the powers of the incorporator or incorporators are to terminate upon the filing of the certificate of incorporation, the names and mailing addresses of the persons who are to serve as the initial directors of the corporation. Section 102(b) of the DGCL sets forth additional provisions that may be included in the certificate of incorporation. The certificate of incorporation must be executed, acknowledged and filed by the incorporator or incorporators in accordance with Section 103 of the DGCL. As of August 12, 2014, the cost of filing a certificate of incorporation with the Delaware 11

12 Division of Corporations includes a $89 filing fee and an organizational tax, which is due at the time of filing the initial certificate of incorporation. The organizational tax is computed based on the authorized shares of capital stock. Contact the Delaware Division of Corporations ( for more information regarding the computation of fees due upon filing the initial certificate of incorporation. A generic form of certificate of incorporation may be found in The Delaware Law of Corporations & Business Organizations as Form 1.5. c. Management and Control The business and affairs of a Delaware corporation are managed by or under the direction of a board of directors. The board of directors shall consist of one or more members. The DGCL does not specify qualifications for directors other than that they be natural persons. Each director holds office until his or her successor is elected and qualified or until such director s earlier resignation or removal. Generally, directors are elected each year at the annual meeting of shareholders, but their terms may be staggered so that only a portion of the directors are elected each year. The board of directors is permitted to delegate managerial duties to officers of the corporation, except to the extent that the corporation s certificate of incorporation or bylaws limit or prohibit such a delegation. The DGCL permits the bylaws or the board of directors to determine the titles, duties and number of corporate officers so long as the corporation has such officers as may be necessary to enable the corporation to sign stock certificates and instruments filed with the Secretary of State. By virtue of the procedure for signing stock certificates set forth in Section 158 of the DGCL, Delaware corporations having certificated shares of stock are required to have at least two officers designated by the titles specified in Section 158. The DGCL permits any number of offices to be held by the same person. Officers of a Delaware corporation are chosen in the manner, and hold their offices for a term, prescribed by the bylaws or determined by the board of directors. The powers and duties of the officers are fixed by the bylaws or by resolution of the board of directors, except that the DGCL requires one officer to have the duty to record the proceedings of the meetings of the shareholders and directors in a book kept for that purpose. After filing the certificate of incorporation, the incorporator or incorporators, or the board of directors if the initial directors were named in the certificate of incorporation, may hold an organizational meeting to adopt bylaws, elect directors (if the meeting is of incorporators) to serve or hold office until the first annual meeting of shareholders, elect officers (if the meeting is of directors), do any other acts to perfect the organization of the corporation, and transact such other business as may come before the meeting. 12

13 Alternatively, in lieu of an organizational meeting, the incorporator(s) or the director(s), as the case may be, may execute a written consent setting forth the actions so taken. Section 109(b) of the DGCL provides that the bylaws of a corporation may include any provision that is not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its shareholders, directors, officers, or employees. In general, the bylaws of a typical Delaware for-profit corporation contain provisions governing shareholder meetings, the board of directors and committees thereof, officers, and the indemnification of directors and officers. A generic form of bylaws may be found in The Delaware Law of Corporations & Business Organizations as Form While Delaware corporations are managed by and under the direction of a board of directors, the DGCL requires a shareholder vote on major corporate events including the election of directors, certain mergers, a sale of all or substantially all of the corporation s assets, and a voluntary dissolution of the corporation. d. Liability of Directors, Officers, and Shareholders In fulfilling their managerial responsibilities, directors are charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of the corporation s shareholders. In recognition of the managerial prerogatives granted to directors of Delaware corporations under the DGCL, Delaware law generally presumes that, in making business decisions, the directors of a corporation are disinterested and act on an informed basis, in good faith, with due care, and in the honest belief that the action taken is in the best interests of the corporation and its shareholders. Under the business judgment rule, a court will not second-guess the business decisions of the board, nor impose liability on directors for decisions that in hindsight appear to have been wrong, if the decision was made in good faith for a rational business purpose. This presumption will be rebutted, however, if the directors are shown to have breached their fiduciary duty of loyalty or their fiduciary duty of due care, and in such an event, the directors will bear the burden of demonstrating that their decisions were entirely fair to the corporation and its shareholders. The duty of care essentially requires that the corporate fiduciary be attentive and inform himself of all material facts regarding a decision before taking action. The duty of loyalty generally requires that the corporate fiduciary s actions be motivated solely by the best interests of the corporation and its shareholders. For directors to fulfill their fiduciary duties they must also act in good faith. Directors are also charged with a duty of disclosure to the shareholders and to other directors, as well as a duty to maintain the confidentiality of corporate information. Officers also owe fiduciary duties of care and loyalty to the corporation and its 13

14 shareholders and will presumably be protected by the business judgment rule when they have made business decisions on a fully informed basis, are not burdened by conflicting self-interests, and have acted in good faith for the interests of the corporation and its shareholders. Delaware law permits a corporation to make available to its directors and officers three separate levels of protection against possible exposure to liability for breach of fiduciary duty. Delaware law permits a corporation to (i) indemnify its directors and officers for attorneys fees and other expenses incurred in defending such actions (and, in the case of third-party actions, for judgments and amounts paid in settlement); (ii) advance litigation expenses (including attorneys fees) incurred by directors and officers; and (iii) provide insurance to directors and officers against those expenses incurred by them in their capacity as directors and officers of the corporation, including those expenses that may not otherwise be subject to indemnification. In addition, Delaware law permits a corporation to include in its certificate of incorporation a provision eliminating or limiting the personal liability of a director to the corporation and its shareholders for monetary damages for breach of fiduciary duty as a director. Such provision shall not, however, eliminate or limit the liability of a director: (i) for any breach of the director s duty of loyalty to the corporation or its shareholders; (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; (iii) under Section 174 of the DGCL; or (iv) for any transaction from which the director derived an improper personal benefit. Because a Delaware corporation is generally considered to be a distinct legal entity that is separate and apart from its shareholders, the shareholders of a Delaware corporation are generally not personally liable for the actions, liabilities, or obligations of the corporation. In fact, the DGCL specifically contemplates that the shareholders of a corporation are not personally liable for the debts of the corporation unless such liability specifically is imposed by a provision of the corporation s certificate of incorporation. However, there are instances where a Delaware court 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). A Delaware court may hold a shareholder 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 shareholder is exercising complete domination and control over the corporation; or (iii) the corporate existence is disregarded by a controlling shareholder who essentially treats the assets of the corporation as his, hers, or its own. e. Raising Capital For-profit corporations offer a great deal of flexibility in raising capital, ranging from 14

15 various kinds of equity (e.g., common stock, preferred stock, options, warrants) to numerous types of debt instruments (e.g., convertible notes, subordinated notes, bonds, commercial paper). f. Recordkeeping and State Reports All corporations incorporated in the State of Delaware are required to file an Annual Franchise Tax Report (the Annual Report ) with the Secretary of State in conjunction with paying annual franchise taxes. As of August 12, 2014, the annual report filing fee for for-profit corporations is $50 plus the franchise taxes due upon filing of the Annual Report. The Taxation section below discusses the computation of a Delaware corporation s annual franchise taxes. The Annual Report and franchise taxes are to be received no later than March 1st of each year. g. Taxation Delaware corporations that do not conduct business in the State of Delaware are not subject to Delaware corporate income taxation. If the corporation does not conduct business in Delaware, the only tax paid to Delaware is the annual franchise tax, which must be received no later than March 1 st of each year. There are two methods for calculating the amount of franchise tax owed by a Delaware corporation the total authorized shares method and the alternative method based on the gross assets of the corporation. A corporation can use whichever method produces the less amount payable, but in no case shall the franchise tax on any corporation for a full taxable year be less than $175 or more than $180,000. Delaware corporations doing business in the State of Delaware are subject to Delaware corporate income tax. Unlike sole proprietorships and partnerships, income earned by Delaware 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. h. Resources Delaware Division of Corporations 15

16 Phone: (302) Delaware Division of Revenue - Services for the Business Taxpayer: IRS publication discussing general tax laws that apply to ordinary domestic corporations: IRS publication discussing Subchapter S corporations: R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations (3d ed supp). David A. Drexler et al., Delaware Corporation Law & Practice (2013). 3. Public Benefit Corporations Effective August 1, 2013, legislation permits for-profit Delaware corporations to focus on creating societal benefits by incorporating as, or converting into, public benefit corporations. A public benefit corporation is a for-profit corporation that is intended to produce a public benefit and to operate in a responsible and sustainable manner, and that specifies in its certificate of incorporation particular public benefits to be served. Public benefits are generally defined as positive effects (or the minimization of negative effects) on persons, entities, communities, or interests, including those of an artistic, charitable, cultural, economic, educational, literary, medical, religious, scientific, or technological nature. In order for an existing corporation to convert into a public benefit corporation, the conversion must be approved by 90% of the corporation s stockholders. Except as otherwise provided in the legislation, the same principles that govern the management and operation of other for-profit corporations apply to the governance of public benefit corporations. The key difference, however, is that in managing the business and affairs of the public benefit corporation, the directors have a duty to balance the pecuniary interests of the stockholders, the interests of those materially affected by the corporation s conduct, and the public benefits identified in the corporation's certificate of incorporation. The corporation must make periodic reports to the shareholders concerning its efforts to balance these factors. 16

17 Directors do not have any duty to any person solely on account of any interest in the public benefit. Directors who perform the balancing of interests described above are deemed to have satisfied their fiduciary duties to the stockholders and the corporation if their decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve. Stockholders holding at least 2% of the public benefit corporation s outstanding shares are able to maintain a derivative lawsuit to enforce the promotion of the public benefits identified in the corporation's certificate of incorporation. 4. Limited Liability Companies (LLCs) a. Using LLCs to Pursue Social Change Combining certain characteristics of both partnerships and corporations, LLCs are 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, similar to 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 at the entity (company) level. Members of LLCs may be individual investors as well as for-profit corporations, taxexempt nonprofit corporations, or other legal entities. For this reason and also because of pass-through taxation that 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 generally preferred over for-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 in a limited liability company or operating agreement (an LLC Agreement ). As with the shareholders of corporations, the members of an LLC may be divided into classes, each with its own economic or voting rights, and members have limited personal liability (discussed below). The Delaware Limited Liability Company Act, 6 Del. C , et seq. (the DLLC Act ) governs the formation, operation, and dissolution of LLCs in Delaware. At least two states, including Tennessee and Kentucky, specifically authorize the 17

18 formation of nonprofit limited liability companies (nonprofit LLCs). The statutes of numerous states, including California, have language that permits nonprofit LLCs to exist. Delaware does not have such a provision. Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) of the United States Internal Revenue Code if it elects to be treated as a separate legal entity for tax purposes, 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 To form and organize an LLC (a DLLC ) under the DLLC Act, a certificate of formation must be filed with the Secretary of State, and an LLC Agreement shall be entered into by the member or members. A certificate of formation is only required to set forth: (i) the name of the LLC, which must contain the words Limited Liability Company or the abbreviation L.L.C. or the designation LLC, and (ii) the address of the registered office of the LLC in the State of Delaware and the name and address of the registered agent for service of process on the LLC in the State of Delaware. A certificate of formation is executed and filed by one or more authorized persons. Any legally competent individual or entity may be designated as an authorized person for this purpose in the LLC Agreement, and the DLLC Act does not require that an authorized person be a resident of Delaware. The DLLC Act requires that the DLLC have a registered office, which need not be a place of its business, in the State of Delaware and a registered agent at such registered office for service of process on the DLLC. Section (a)(3) of the DLLC Act sets forth the filing fees for filing a certificate of formation with the Secretary of State. As of August 15, 2014, such filing fee was $70 (and an additional $50 fee is charged for certified copies of the filing). The filings may processed on an expedited basis by the Secretary for an additional fee (processing the filings on a same day, 24 hour, 2 hour, 1 hour or 30 minute basis each faster processing time costing significantly more in fees). Unless the certificate of formation provides for a future effective date or time, a certificate of formation is effective at the time of the filing of the certificate of formation with the office of the Delaware Secretary of State. A certificate of formation may be filed with the office of the Delaware Secretary of State prior to the entering into of an LLC Agreement. Section (d) of the DLLC Act provides that an LLC Agreement shall be entered into or otherwise existing either before, after, or at the time of the filing of the certificate of formation, and may be made effective upon the filing of the certificate of formation of the DLLC or at such other time or date as provided in or reflected by the LLC Agreement. 18

19 A DLLC may engage in any type of lawful business, purpose, or activity with the exception of the business of banking, whether or not for profit. A DLLC shall possess and exercise all of the powers and privileges granted by the DLLC Act or by an other law or by its LLC Agreement, together with any powers incidental thereto, including such powers and privileges as are necessary or convenient to the conduct, promotion, or attainment of the business, purposes or activities of the LLC. The purposes and powers of an LLC may be restricted by provisions in the LLC Agreement if desired. A generic form of certificate of formation for a Delaware limited liability company may be found in Section of the Transactional Lawyer s Deskbook: Advising Business Entities referenced in subparagraph i. of this section. c. Management and Control Typically, an LLC Agreement agreed to by the members governs the management of an LLC. The LLC Agreement which is like the certificate of incorporation, bylaws and a shareholder agreement for a corporation 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 LLC Agreement. A DLLC is governed by the terms of its LLC Agreement. The DLLC Act permits oral LLC Agreements, but it is always recommended to have a written LLC agreement that defines the rights, duties, and liabilities of the members, and managers if applicable, of the LLC. The DLLC Act permits the formation of DLLCs that have only one member. The DLLC itself is not required to sign the LLC Agreement, even if the DLLC has only one member. The DLLC Act was drafted in a way that provides flexibility in establishing the management and structure of a DLLC. In most cases, the rules set forth in the DLLC Act are default rules that may be modified in the LLC Agreement and are otherwise only applicable when the LLC Agreement is silent on the issue. The DLLC Act provides that it is the policy of the DLLC Act to give the maximum effect to the principle of freedom of contract and the enforceability of LLC Agreements. Unless the DLLC's operating agreement provides otherwise, managers and controlling members of a DLLC owe fiduciary duties of loyalty and care similar to the fiduciary duties of directors of corporations. But unlike corporations, DLLCs have tremendous flexibility to modify those duties. Delaware's LLC Act allows a DLLC's operating agreement to expand, restrict, or even eliminate fiduciary duties. The agreement may not, however, eliminate the implied contractual covenant of good faith and fair dealing. (This covenant becomes relevant when issues arise that the DLLC s operating agreement does not specifically address.) 19

20 Virtually any natural person, legal entity, association, government, or representative may be a member of a DLLC. In connection with the formation of a DLLC, a person is admitted as a member of the DLLC upon the later to occur of (i) the formation of the DLLC or (ii) the time provided in and upon compliance with the LLC Agreement, or if the LLC Agreement does not so provide, when the person s admission is reflected in the records of the DLLC. Once a DLLC has been formed, a person may be admitted as a member pursuant to the terms of the LLC Agreement. A person may be admitted as a member of a DLLC without making a contribution to the DLLC or being obligated to make a contribution to the DLLC. A DLLC may have an LLC Agreement that provides for classes or groups of members having such relative rights, powers and duties as such LLC Agreement may provide. The LLC Agreement may grant to all or certain identified members or classes or groups of members the right to vote, separately or with all or any other class or group of the members or managers, on any matter. The LLC Agreement may also provide for the taking of any action without the vote or approval of any member or class or group of members. The DLLC Act is drafted in a way to permit members to have broad discretion in determining the internal governance of the DLLC in the LLC Agreement. Unless otherwise provided in the LLC Agreement, the management of a DLLC is vested in its members in proportion to their percentage interests in the profits of the LLC, and, unless otherwise provided by the LLC Agreement, the decision of members owning more than 50 percent of such interests shall control. Instead of the foregoing, an LLC Agreement may provide for the management, in whole or in part, of the DLLC by one or more managers or a board or any other management structure that the members desire and reflect in the LLC Agreement. Under the DLLC Act, an interest in a DLLC is freely assignable, in whole or in part, except as otherwise provided by the LLC Agreement. An assignee of an interest in a DLLC shall not be admitted as a member or have any right to participate in the management of the business and affairs of the DLLC except upon either the approval of all members of the DLLC other than the assignor or the compliance with any procedure provided for in the LLC Agreement. Unless an LLC Agreement provides otherwise, a member may not resign from a DLLC prior to the dissolution and winding up of the DLLC. The DLLC Act provides certain default rules regarding allocations of profits and losses and distributions of assets, but members are free to contract with respect to such economic rights in the LLC Agreement. Absent a provision in the LLC Agreement, the 20