NEW JERSEY FORMS OF ORGANIZATION Day Pitney LLP Lori J. Braender

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1 Last Updated: January 2012 NEW JERSEY FORMS OF ORGANIZATION Day Pitney LLP Lori J. Braender Table of Contents 1. Nonprofit Corporations 2. For-Profit Corporations 3. Limited Liability Companies 4. Low Profit Limited Liability Companies (L3C) 5. Joint Ventures 6. Partnerships and Limited Partnerships 7. Sole Proprietorships 8. New Forms of Hybrid Organizations 9. Resources The most common legal form of organization utilized by the social sector is the nonprofit corporation, although for-profit corporations, limited liability companies (LLCs), joint ventures and various kinds of partnerships, including limited partnerships, are increasingly being used - typically to accommodate plans to earn revenues or access capital markets. Each of these forms of organization has advantages and disadvantages and sometimes, with the help of experienced counsel, they are used in combination to maximize strengths and minimize weaknesses of a particular form. The 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. 1

2 Nonprofit 501(c)(3) Corporation For-Profit Corporation Formation Management and Control Liability Tax Factors Capital and Loans File articles or Managed by directors Members, directors, Generally exempt from Can accept charitable certificate of who appoint officers officers and federal and state taxes donations and grants. incorporation to run day-to-day employees are if receiving 501(c)(3) Eligible for program (containing specific operations as generally not liable for exemption. Liable for related investments info required by IRS) specified in bylaws. debts and obligations tax on unrelated (PRIs) by foundations. with state and pay Some nonprofit of the corporation, business income, and Can borrow money filing fee. File corporations have including for unlawful other taxes such as and issue debt application on Form members (similar in acts of others involved property and sales instruments but cannot 1023 with IRS for function to in the affairs of the (unless local and state raise capital by federal and state taxexempt shareholders) who corporation. They can exemptions apply). issuing stock. status unless elect directors. be held liable for Donors can deduct below gross receipts injuries due to their contributions. threshold. Recruit own misconduct but directors, draft bylaws some states provide and hold limited immunity to organizational such persons and also meeting. Take steps to to volunteers. comply with license, tax and employment laws/regs. File articles or Managed by Shareholders are A C Corporation is Can raise capital by certificate of directors that are generally not liable for subject to corporate tax issuing stock (equity) incorporation with elected by debts and obligations on net income. If net and by borrowing state and pay filing shareholders. of the corporation, income is paid to money through loans fee. Decide on board Directors appoint including for unlawful shareholders as or other debt of directors, draft officers to run dayto-day acts of others involved dividends, the instruments. bylaws, hold operations as in the business. individual shareholders Corporation may be organizational meeting specified in bylaws. Unless indemnified by are taxed. If a able to accept PRIs and issue stock. Take the corporation, corporation elects to be from foundations in steps to comply with directors, officers and a S corporation and the form of loans or license, tax and employees can be held meets several criteria, equity. employment personally liable for it can receive pass laws/regs. injuries caused by through taxation. their own acts or failures to act. 2

3 B Corp (a forprofit corporation with a social mission that is licensed to use the name Benefit Corporation ) LLC L3C (low-profit LLC) Formation See for-profit corporation 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 laws/regs. Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states (e.g., IL, LA, MI, ME, NC, UT, VT, WY) Management and Control Liability Tax Factors Capital and Loans See for-profit See for-profit See for-profit See for-profit corporation. The B corporation. Directors corporation. corporation. A B Corp Corp designation of B Corps cannot be should be in a better requires the held personally liable position to attract corporation to for failing to create PRIs from foundations incorporate specific public benefits. in the form of loans or socially beneficial equity. performance standards into its governing documents and operating principles, and designate a benefit director. Flexible structure like a partnership with management responsibilities specified in operating agreement (usually management committee or single manager). Same as a corporation. 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. Tax-exempt member/owners treat their share of income as exempt or subject to unrelated business taxable income, depending on the character of the income. See LLC. Same as a corporation See LLC. Less tax regulation due to social goals. Can raise capital through contributions by member/owner. Otherwise, same as for-profit corporation. 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. 3

4 Formation Management and Control Liability Tax Factors Capital and Loans Partnership No filing requirements unless limited Partners have equal, full control unless Partners are personally Generally not taxed as liable for the debts and an entity. Partners Can raise capital through contributions partnership (LP) or limited liability partnership (LLP), but partners should sign otherwise specified in partnership agreement. obligations of the partnership, including for unlawful acts of other partners and report profits and losses on personal tax returns. by partners and by borrowing money through loans or other debt instruments. partnership agreement. Take steps to comply with name, license, tax and employment laws/regs. employees. Risk can be limited by creating an LP or LLP. 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 laws/regs. Owner has full control. Owner is liable for all debts and obligations, including for unlawful acts of employees. Not taxed as an entity. Owner reports business profits and losses on personal tax return. Owner provides funds for capital investment and owner can borrow money through loans or other debt instruments. 1. Nonprofit Corporations a. Overview The New Jersey Nonprofit Corporation Act (the NPCA ) governs the formation, operation and dissolution of nonprofit corporations in New Jersey. A nonprofit corporation is managed by its board of trustees and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may but is not required to have members, which are similar in role to that of shareholders, but without an equity interest in the nonprofit corporation. NP corporations, of course, are specifically organized to not earn profits. No part of the income or surplus of a NP Corporation may be distributed to its members, trustees or officers; however, reasonable compensation may be paid for services rendered. A nonprofit corporation has an existence of its own, independent of employment of members, directors or officers. It can sue or be sued in its own name and can own real estate in its own name. b. Advantages of Incorporation; Pros and Cons of Nonprofit versus For-profit The principal advantage of incorporation is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including 4

5 unlawful actions of officers, trustees and staff acting on its behalf. In addition, incorporation establishes continuity: corporations (both nonprofit and for-profit) are subject to a body of statutes that provide very specific guidance as to their formation and operation. 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 NP Corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities or generating net income, the trustees of a nonprofit corporation are duty-bound to devote primary attention to the promotion of the social mission of the nonprofit corporation rather than the production of income. On the other hand, if access to capital markets is needed, a for-profit corporation (or limited liability company, as discussed below in Section 3) is likely to be the preferred option because NP Corporations cannot issue capital stock. The directors of a for-profit corporation, however, owe strict duties to the corporation s 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 Jersey Secretary of State of the certificate of incorporation. The incorporator files the certificate of incorporation with the New Jersey Division of Revenue, Corporate Filing Unit, PO Box 308, Trenton, NJ (for administrative reasons, filings are made through the Division of Revenue, not the Secretary of State). One or more natural persons of at least 18 years of age, corporations, foreign corporations or corporate entities, regardless of the incorporator s residence or state of incorporation, may incorporate a nonprofit corporation, with each incorporator required to sign the certificate of incorporation. The filing fee is $75. The certificate of incorporation for a NP Corporation must set forth: the name of the nonprofit 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 New Jersey Secretary of State, and contain one of the 5

6 following: a New Jersey nonprofit corporation, corporation, incorporated, inc. or corp. the purpose or purposes for which the nonprofit corporation is formed, which may be for any purpose other than for pecuniary profit including, without limitation, any of the purposes stated below: o charitable o benevolent o eleemosynary; o educational o cemetery o civic o patriotic o political o religious o social o fraternal o literary o cultural o athletic o scientific o agricultural o horticultural o animal husbandry o volunteer fire company o ambulance, first aid or rescue o professional, commercial, industrial or trade association o labor union and cooperative purposes if the nonprofit corporation is to have members, the qualifications for members or that the qualifications for members shall be as set forth in the bylaws of the nonprofit corporation; if the members are to be divided into classes, the relative right and limitations of the different classes of members to the extent those rights and limitations have been determined or that the rights and limitations shall be as set forth in the bylaws of the nonprofit corporation; if the nonprofit corporation is to have no members, that there shall be no members; the method of electing trustees, or that the method shall be as set forth in the bylaws of the nonprofit corporation; any provision not inconsistent with New Jersey law which the incorporators elect to set forth for the management and conduct of the affairs of the nonprofit corporation, or creating, defining, limiting or regulating the powers of the nonprofit corporation, its trustees and members or any class of members, including any provision which is required or permitted to be set forth in the nonprofit corporation s bylaws; the address, including actual location as well as postal designation, if different, of the nonprofit corporation s initial registered office, and the name of the nonprofit corporation s initial registered agent at that address; the number of trustees, not less than three, constituting the first board and the names and addresses of such trustees (either residential address or other address 6

7 where the person regularly receives mail, other than the address of the nonprofit corporation); the names and addresses of the incorporators (either residential address or other address where the person regularly receives mail, other than the address of the nonprofit corporation; the duration of the nonprofit corporation if other than perpetual; the method of distribution of assets of the nonprofit corporation upon dissolution, or that the distribution shall be as set forth in the bylaws of the nonprofit corporation; and if the certificate of incorporation is to be effective on a date subsequent to the date of filing, the future effective date of the certificate. The corporate existence of the nonprofit corporation begins upon the filing of the certificate of incorporation with the New Jersey Secretary of State. Except as otherwise provided in the certificate of incorporation, generally a nonprofit corporation must be managed by its board of trustees, and the certificate of incorporation or the bylaws may prescribe qualifications for trustees. While the NPCA sets forth general guidelines for powers of the board of trustees, the certificate of incorporation may vest the management of the nonprofit corporation in persons other than the board. The board must consist of at least three trustees. If the nonprofit corporation intends to obtain exemption from federal income taxation, the certificate of incorporation must conform with applicable statutes and regulations. Nonprofit corporations are not legally required to obtain a State of New Jersey determination of tax-exempt status from the New Jersey corporation business tax. However, if a nonprofit corporation intends to obtain an exemption from the New Jersey sales and use tax or petroleum products gross receipts tax, it will be required to submit Form REG-1E, Application for Exempt Organization Certificate. Also, a nonprofit corporation may be required to register with the New Jersey Charities Registration Section and, for raffles, 50/50s, etc., with the New Jersey Legalized Games of Chance Control Commission. A nonprofit corporation may also need a letter of exemption from the New Jersey corporation business tax for banking purposes and if it engages in certain real property transactions. Examples of certificates of incorporation may be found in Public Records, The State of New Jersey, Division of Revenue at pubrec.pdf and in New Jersey Corporations and Other Business Entities as Form 4.01 (See Mackay, John R., New Jersey Corporations and Other Business Entities Form

8 (3d ed., LexisNexis Matthew Bender 2005)) (form updated December 2008). Some general forms of certificate of incorporation for nonprofit corporations may be found in General Forms: Nonprofit Organizations: Forms for Creation, Operation and Dissolution referenced in subparagraph i. of this Section. d. Management and Control Once the nonprofit corporation has been established, the initial board of trustees should meet (or sign a unanimous written consent in lieu of a meeting) 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 trustees and the general operation and management of the nonprofit corporation consistent with the applicable statutes of New Jersey 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. A generic form of bylaws for a New Jersey corporation may be found in New Jersey Corporations and Other Business Entities as Form 4.21 (See Mackay, John R., New Jersey Corporations and Other Business Entities Form 4.21 (3d ed., LexisNexis Matthew Bender 2005)) (form updated December 2008). Some general forms of bylaws for nonprofit corporations may be found in General Forms: Nonprofit Organizations: Forms for Creation, Operation and Dissolution referenced in subparagraph i. of this Section. e. Liability of Members, Directors and Officers The NPCA imposes upon trustees and officers duties of good faith and a degree of care which an ordinarily prudent person in a like position would use under similar circumstances. In performing his or her duties, a trustee is entitled to rely in good faith 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. Trustees also owe the corporation and its shareholders a duty of loyalty. A trustee may not use his or her position within the corporation for self-dealing at the expense of the corporation or exploit for personal benefit a business opportunity that could be utilized by the corporation. The members of a nonprofit corporation are not personally liable for the debts, liabilities or obligations of the nonprofit corporation, and member liability is limited to the extent 8

9 of any unpaid portion of the initiation fees, membership dues or assessments imposed upon the member by the nonprofit corporation, or for any other indebtedness owed by the member to the nonprofit corporation. With certain exceptions, a nonprofit corporation trustee or officer serving without compensation is not liable to any person other than the nonprofit corporation based solely on his or her conduct in the execution of such office unless the conduct evidenced a reckless disregard for the duties imposed by the position. 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. In certain cases, trustees of a corporation who vote for or concur in corporate actions such as the distribution of assets in violation of the NPCA or fraudulent conveyance, or the making of a loan to directors and officers which contravenes the NPCA, will be jointly and severally liable to the corporation for the benefit of the corporation and its creditors to the extent of any injury suffered by such persons, respectively. An nonprofit 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 such director or officer acted in good faith for a purpose which such director reasonably believed to be in, or not opposed to, the best interests of the nonprofit corporation and, in criminal actions or proceedings, in addition, had no reasonable cause to believe that his or her conduct was unlawful. New Jersey provisions for liability of volunteer trustees, officers or members are subject to the Federal Volunteer Protection Act of 1997 (42 U.S.C et seq.). 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, the name of the corporation into which they propose to merge, the terms and conditions of the proposed merger, and 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 9

10 merger, the board must submit the plan for member approval if the corporation has any member entitled to vote. If the nonprofit corporation has no members entitled to vote, the plan of merger must be approved by two-thirds of the trustees present at a meeting called for the purpose of considering and voting upon the proposed merger. After the approval of the merger, a certificate of merger is filed with the New Jersey Secretary of State. The dissolution of a nonprofit corporation may be accomplished by unanimous written consent, by the board and members if there are members entitled to vote on the matter, or by the board if the nonprofit corporation does not have members entitled to vote on the dissolution. Upon adopting a plan of dissolution and distribution of assets, the board must submit the plan to a vote of the members, if any are entitled to vote. The plan of dissolution and distribution of assets must then be approved by a two-thirds vote or via the unanimous written consent of the members in lieu of a meeting. If the nonprofit corporation does not have members entitled to vote, a plan of merger may be approved by two-thirds of its trustees at a meeting of the board or via the unanimous written consent of the board in lieu of a meeting. 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 may not commence any new activities, but a dissolved corporation, its trustees, officers and members may continue to function for the purpose of winding up the affairs of the corporation. g. Recordkeeping, State Reports and State Taxes In addition to filing the certificate of incorporation, each nonprofit corporation must file a signed statement annually disclosing the name of the NP Corporation and jurisdiction of incorporation (if a foreign corporation), the address of the registered office of the nonprofit corporation in New Jersey where the Secretary of the State is to mail a copy of any process against it served upon him or her and the name of its registered agent in New Jersey, and the names and addresses of the trustees and officers of the corporation, which may not be the address of the nonprofit corporation. Charitable organizations that plan to solicit contributions from the public are required to file a registration statement with the New Jersey Attorney General prior to soliciting and to file annual renewal registration statements unless exempted from registration under the New Jersey Charitable Registration and Investigation Act. This includes corporations that are 501(c)(3) tax exempt organizations and any corporation that holds itself out to be established for any benevolent, philanthropic, human, social, welfare, public health, or other eleemosynary purpose or for the benefit of law enforcement personnel, firefighters or other person who protect the public safety, or any person who in any manner employs a charitable appeal as the basis of any solicitation. 10

11 New Jersey exempts nonprofit organizations from state and local sales and use taxes. The Division of Revenue of the State of New Jersey requires all new nonprofit corporations in the state to register with the Division of Revenue, which can be done by completing Form REG-1E, which also applies for exemption from New Jersey sales and use tax. To be approved for exemption, REG-1E must be accompanied with a copy of the certificate of incorporation or other organizing documents, any bylaws, and an IRS 501(c)(3) determination letter. Form REG-1E is obtained from and submitted to the Regulatory Service Branch of the Division of Taxation and is available on the Division s website: Once the form is submitted, it takes approximately three to four weeks for the State to mail the ST-5 exemption certificate. After registering, nonprofit corporations will receive the forms, returns, instructions and other information required for ongoing compliance with New Jersey State taxes and employment regulations. 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 nonprofit corporation or individuals responsible for it (i.e., trustees, 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. 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). 11

12 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). Takagi, Gene. Nonprofit Bylaws - Common Issues Nonprofit Law Blog General Forms: Nonprofit Organizations: Forms for Creation, Operation and Dissolution (Marcia Clifford, et al. ed., Callaghan & Company) (1987). Public Records, The State of New Jersey, Division of Revenue at 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 the normal behavior of for-profit corporations. But even the most skillfully drafted shareholders agreement is not a perfect solution as 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). 12

13 b. Formation The New Jersey Business Corp Act ( BCA ) governs the formation, operation and dissolution of for-profit corporations in New Jersey. One or more individuals of the age of 18 years or over or domestic or foreign corporations may incorporate a for-profit corporation. Unless the certificate of incorporation sets forth a future effective date, which can be up to 90 days after the filing date, the certificate of incorporation becomes effective upon the filing of the certificate with the New Jersey Secretary of State. A business corporation may be formed for any lawful business purpose for which businesses may be incorporated under the BCA. The certificate must be signed by each incorporator, with his or her name and address, and filed with the New Jersey Division of Revenue, Corporate Filing Unit, PO Box 308, Trenton, NJ (for administrative reasons, filings are made through the Division of Revenue, not the Secretary of State). The filing fee is $125. The certificate must include: the name of the corporation; the purpose, which may include a social mission or purpose; the aggregate number of shares which the corporation shall have authority to issue; if the shares are to be, divided into classes, or into classes and series, the designation of each class and series, the number of shares in each class and series, and a statement of the relative rights, preferences and limitations of the shares of each class and series, to the extent that such designations, numbers, relative rights, preferences and limitations have been determined, and a statement of any authority vested in the board to divide the shares into classes or series or both, and to determine or change for any class or series its designation, number of shares, relative rights, preferences and limitations; any provision not inconsistent with the BCA which the incorporators elect to set forth for the management of the business and the conduct of the affairs of the corporation, or creating, defining, limiting or regulating the powers of the corporation, its directors and shareholders or any class of shareholders, including any provision which under the BCA is required or permitted to be set forth in the bylaws; the address of the corporation s initial registered office, and the name of the corporation s initial registered agent at such address; the number of directors constituting the first board and the names and addresses of the persons who are to serve as such directors; 13

14 the names and addresses of the incorporators; the duration of the corporation if other than perpetual; and if the certificate of incorporation is to be effective on a date subsequent to the date of filing, the effective date of the certificate. The number of directors must consist of one or more directors. The corporate name must be such as to distinguish it from the names of corporations of any type or kind; 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 at Public Records, The State of New Jersey, Division of Revenue at pubrec.pdf and in New Jersey Corporations and Other Business Entities as Form 4.01 (See Mackay, John R., New Jersey Corporations and Other Business Entities Form 4.01 (3d ed., LexisNexis Matthew Bender 2005)) (form updated December 2008). c. Management and Control Similar to a nonprofit corporation, 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 such power is subject toshareholder vote on major corporate events. 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 the 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 Jersey 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. While New Jersey for-profit corporations are managed by and under the direction of a board of directors, the BCA 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. A generic form of bylaws for a New Jersey corporation may be found in New Jersey Corporations and Other Business Entities as Form 4.21 (See Mackay, John R., New 14

15 Jersey Corporations and Other Business Entities Form 4.21 (3d ed., LexisNexis Matthew Bender 2005)) (form updated December 2008). Some general forms of bylaws for nonprofit corporations may be found in General Forms: Nonprofit Organizations: Forms for Creation, Operation and Dissolution referenced in subparagraph i. of this Section. d. Liability of Shareholders, Directors and Officers A director must perform his or her duties as a director in good faith and with that degree of care which an ordinarily prudent person in a like position would use 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 exploit for personal benefit a business opportunity that could be utilized by the corporation. In certain cases, directors of a corporation who vote for or concur in corporate actions will 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 members for damages for breach of the duty of care owed to the corporation. 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 is or was a director or officer of the corporation against judgments, fines, amounts paid in settlement, penalties and reasonable expenses if such director or officer acted in good faith for a purpose which he or she reasonably believed to be in and not opposed to the best interests of the corporation and, in criminal actions or proceedings, in addition, had no reasonable cause to believe that his or her conduct was unlawful. A New Jersey for-profit corporation is generally considered to be a distinct legal entity separate from its shareholders. Accordingly, the shareholders of a New Jersey 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. Despite the protections afforded by the BCA, a New Jersey court may hold a shareholder liable for the acts (or failure to act) of a corporation where, for instance, the corporation is a sham and exists for no other purpose than as a vehicle to perpetrate fraud, to accomplish a crime, or otherwise to evade the law, or the controlling shareholder so 15

16 dominated the subsidiary that it had no separate existence but was merely a conduit for the parent. 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 annually disclosing the name of the corporation and jurisdiction of incorporation (if a foreign corporation), the address of the registered office of the corporation in New Jersey and the name of its registered agent in New Jersey (for service of process), the names and addresses of the directors and officers of the corporation (other than the corporation s address), the address of the corporation s main business or headquarters office, and the address of its principal business office in New Jersey. The BCA 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. Each corporation must make available for inspection at its registered office or at its principal office if its principal office is in New Jersey a record containing the names and addresses of all shareholders, the number class and series of shares held by each and the dates when they respectively became the owners of record. g. Taxation New Jersey corporations doing business in New Jersey are subject to New Jersey corporate income tax. Unlike sole proprietorships and partnerships, income earned by New Jersey for-profit corporations doing business in the state may be subject to double taxation. In other words, the corporation pays federal and state taxes on the income it earns, and the shareholders are then also 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 ( 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. 16

17 The Division of Revenue of the State of New Jersey requires all new business entities in the state to register with the Division of Revenue by completing all of the applicable forms in the NJ-REG packet. By completing and filing the Business Registration Form included in NJ-REG, (and the Public Records Filing for New Business Entity form, if applicable) with the Division of Revenue, a for-profit corporation will be registered for applicable taxes and related liabilities that are administered by the Department of Labor and Division of Taxation. After registering, for-profit corporation will receive the forms, returns, instructions and other information required for ongoing compliance with New Jersey State taxes and employment regulations. New Jersey 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 pay the amount owed under a net income tax computation method or a minimum assessment, whichever is greater. It is recommended for the corporation to seek tax advise to determine its franchise tax liability. h. Resources Internal Revenue Service: Tax Information for Business Corporations, July 2009, (page last reviewed or updated by IRS February 25, 2011). IRS publication discussing general tax laws that apply to ordinary domestic corporations IRS publication discussing Subchapter S corporations (page last reviewed or updated by IRS December 15, 2010). Mackay, John R., New Jersey Corporations and Other Business Entities (3d ed., LexisNexis Matthew Bender 2005) 3. Limited Liability Companies (LLCs) a. Using LLCs to Pursue Social Change The New Jersey Limited Liability Company Act (the NJ LLC Act ) governs the formation, operation and dissolution of limited liability companies in the State of New Jersey ( LLCs ). 17

18 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, LLCs are 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 (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 (social benefit purposes, distribution of assets upon dissolution, etc.) and it meets numerous requirements largely designed to guard against profits accruing to private individuals. These conditions will be discussed in the Taxation section. b. Formation To form and organize an LLC under the NJ LLC Act, a certificate of formation must be filed with the New Jersey Division of Revenue, Corporate Filing Unit, P.O. Box 308, Trenton, NJ (for administrative reasons, filings are made through the Division of Revenue, not the Secretary of State). The NJ LLC Act also provides that the member or members of an LLC may enter into an operating agreement, a document that is not filed with the New Jersey Secretary of State, but that determines the rights, duties and obligations of the members. (See Management and Control section below for further discussion.) 18

19 The certificate of formation must set forth the following information: the name of the NJ LLC, which must contain the words Limited Liability Company or the abbreviation L.L.C. ; the address of the registered office and the name and address of the registered agent for service of process; whether the LLC is to have perpetual existence, or, if the LLC is to have a specific date of dissolution, the latest date on which the LLC is to be dissolved; and any other matters the members determine to include therein. The certificate of formation is executed and filed by one or more persons authorized to form an LLC. Any legally competent individual or entity may organize an LLC and such individual or entity is not required to be a New Jersey resident. The NJ LLC Law permits the formation of single-member LLCs. The fee for filing the certificate of formation with the New Jersey Secretary of State is $125. An LLC is deemed to have been formed at the time of the filing of the certificate of formation, unless the certificate of formation provides for a future effective date or time. The certificate of formation may be filed with the New Jersey Secretary of State prior to members entering into an operating agreement. The operating agreement may be entered into before, at the time of, or after the filing of the certificate of formation, and may be made effective as of the formation of the LLC or at such other time or date as provided in or reflected by the operating agreement. An LLC may engage in any type of lawful business, purpose or activity. An LLC has the right to exercise all of the powers and privileges granted by the NJ LLC Act, by any other law, or by its operating agreement. The purposes and powers of an LLC may be restricted by provisions in the operating agreement if desired by the members. A generic form of the certificate of formation for a NJ LLC may be found at Public Records, The State of New Jersey, Division of Revenue at: treasury/revenue/pdforms/pubrec.pdf and in New Jersey Corporations and Other Business Entities as Form (See Mackay, John R., New Jersey Corporations and Other Business Entities Form (3d ed., LexisNexis Matthew Bender 2005)) (form updated December 2008) Some general forms of bylaws for nonprofit corporations may be found in General Forms: Nonprofit Organizations: Forms for Creation, Operation and Dissolution referenced in subparagraph i. of this Section. c. Management and Control Typically, an operating agreement entered into by the members governs the management of an LLC. The operating agreement which is like the certificate of incorporation, 19

20 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 operating agreement. The operating agreement defines the rights, duties and liabilities of the members, and managers, if applicable, of the LLC. The NJ LLC Act provides members of an LLC with great flexibility in establishing the management and structure of the LLC. In most cases, the rules set forth in the NJ LLC Act are default rules that may be modified in the operating agreement and are otherwise only applicable when the operating agreement is silent on the issue. Unless otherwise provided in the operating agreement and certificate of formation, the management of an LLC is vested in its members in proportion to their percentage interests in the profits of the LLC and, unless otherwise provided by the operating agreement, the decision of members owning more than 50 percent of such interests is controlling. However, an operating agreement may provide for one or more managers or any other management structure that the members desire and reflect in the operating agreement to manage the affairs of the LLC, in whole or in part. Virtually any natural person, legal entity, association, government or representative may be a member of an LLC. In connection with the formation of an LLC, a person is admitted as a member of the LLC upon the later of (i) the formation of the NJ LLC or (ii) the time provided in and upon compliance with the operating agreement, or if the operating agreement does not so provide, when the person s admission is reflected in the records of the LLC. Once an LLC has been formed, a person may be admitted as a member pursuant to the terms of the operating agreement. An LLC may have an operating agreement that provides for classes or groups of members having such relative rights, powers and duties as such operating agreement may provide. The operating 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 operating agreement may also provide for the taking of any action, including the amendment of the operating agreement, without the vote or approval of any member or class or group of members. Under the NJ LLC Act, except as otherwise provided by the operating agreement, an interest in an LLC is freely assignable, in whole or in part. An assignee of an interest in an LLC must comply with the procedure provided for in the operating agreement in order to be admitted as a member, or have any right to participate in the management of the business and affairs of the LLC, or, in the absence of such a provision, upon either the approval of all the members of the LLC, other than the assignor,. Absent anything to the contrary in the operating agreement, a member of an LLC may resign as a member in accordance with procedures described in the operating agreement, or, in the absence of an 20