RHODE ISLAND FORMS OF ORGANIZATION Adler Pollock & Sheehan PC Susan Leach DeBlasio, Steve Geanacopoulos, Hans Lundsten, and John Russell

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1 Last Updated: October 2013 RHODE ISLAND FORMS OF ORGANIZATION Adler Pollock & Sheehan PC Susan Leach DeBlasio, Steve Geanacopoulos, Hans Lundsten, and John Russell Table of Contents 1. Nonprofit Corporations 2. For-Profit Corporations 3. Limited Liability Companies 4. Low Profit Limited Liability Companies 5. Joint Ventures 6. Partnerships, Limited Partnerships and Registered Limited Liability 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, 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 File articles or certificate of incorporation (containing specific info required by IRS) with state and pay filing fee. File application on Form 1023 with IRS for taxexempt status unless the entity s normal gross receipts are not more than $5,000 and the entity is not a private foundation. Recruit directors, draft bylaws and hold organizational meeting. Take steps to comply with license, tax and employment law/regs. and state solicitation rules. File articles or 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. Management and Control Liability Tax Factors Capital and Loans Managed by directors Members, directors, who appoint officers officers and employees to run day-to-day are generally not liable operations as specified for debts and in bylaws. Some obligations of the nonprofit corporations corporation, including have members (like shareholders) who elect directors. Managed by the shareholders or by directors that are elected by shareholders. Directors appoint officers to run dayto-day operations as specified in bylaws. for unlawful acts of others involved in the affairs of the corporation. They can be held liable for injuries due to their own misconduct but some states provide limited immunity to such persons and also to volunteers. Shareholders are generally not liable for debts and obligations of the corporation, including for unlawful acts of others involved in the business. Unless indemnified by the corporation, directors, officers and employees can be held liable for injuries caused by their own acts or failures to act. 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 A C Corporation is subject to corporate tax on net income. If net income is paid to shareholders as dividends, the individual shareholders are taxed. If a corporation elects to be a S corporation and meets several criteria, it can receive pass through taxation but it is still subject to the Rhode island minimum corporate tax of $500. Can accept charitable donations and grants. Eligible for program related investments (PRIs) by foundations. Can borrow money and issue debt instruments but cannot raise capital by issuing stock. 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. 2

3 B Corp (a forprofit corporation with a social mission that is licensed to use the trade name B Corporation ) Formation See for-profit corporation See for-profit corporation. The B Corp license requires the corporation to incorporate specific socially beneficial performance standards into its governing documents and operating principles. Management and Control Liability Tax Factors Capital and Loans See for-profit See for-profit corporation. corporation. See for-profit corporation. A B Corp should be in a better position to attract PRIs from foundations in the form of loans or equity. LLC File articles of organization or certificate of formation with state and pay filing fee. Negotiate and execute operating agreement. Take steps to comply with license, tax and employment law/regs. 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 member/owners report profits and losses on personal tax returns but would be subject to the Rhode Island annual minimum corporate tax of $500 and obligated to withhold Rhode Island tax non-resident members share of Rhode Island source income. 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. 3

4 L3C (low-profit LLC) Partnership Formation Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states (e.g., VT, IL, MI,UT,ME, RI, WY) No filing requirements unless limited partnership (LP) or limited liability partnership (LLP), but partners should sign partnership agreement. Take steps to comply with name, license, tax and employment law/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 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, Generally not taxed Can raise capital through full control unless as an entity. Partners contributions by partners otherwise specified report profits and and by borrowing money in partnership losses on personal through loans or other agreement. tax returns. debt instruments. 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. 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 Rhode Island Nonprofit Corporation Act governs the formation, operation and dissolution of nonprofit corporations in the state of Rhode Island. The statutory provisions are set forth at Rhode Island General Laws through 108. A nonprofit corporation in Rhode Island is managed by its board of directors and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may, but is not required to, have members. Nonprofit corporations, of course, are specifically organized not to earn profits. No part of the income or surplus of a Rhode Island nonprofit corporation may be distributed to its members, directors or officers; reasonable compensation, however, may be paid for services rendered. A nonprofit corporation has an existence of its own, independent of the terms of office or employment of members, directors, or officers. It can sue or be sued in its own name and can own real estate in its own name. 4

5 b. Advantages of Incorporation: pros and cons of nonprofit vs. for-profit The principal advantage of incorporation is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, directors, and staff acting on its behalf. In addition, incorporation establishes continuity; corporations (both nonprofit and for-profit) are subject to a body of statutes that provide very specific guidance as to their formation and operation; and incorporation brings stature to the organization and implies stability. Where profit is not a goal, and the enterprise can be funded without the need for access to capital markets, the nonprofit corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit 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 corporations cannot issue capital stock. The directors of a for-profit corporation, however, owe strict duties to the shareholders to maximize profits and value. Unless the directors and managers can tie the social mission of their for-profit corporation directly to its business purpose, therefore, they can be sued for breach of their duties to shareholders and for misuse of corporate assets if they focus too much on the social mission and forego profits. This problem can be avoided where all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes, but such agreements may be temporary because a change in control or a drop in earnings can lead to amendment or abrogation of shareholder agreements. c. Formation A nonprofit corporation attains its separate legal status through the filing and approval by the Rhode Island Secretary of State of its articles of incorporation. This document is in essence a contract between the state and the nonprofit corporation in which Rhode Island grants individual legal status to the corporation in exchange for the corporation s commitment to follow its rules. One or more persons (as incorporators), whether or not residents of Rhode Island, may form a nonprofit corporation in Rhode Island by completing, signing, and filing the articles of incorporation (by hard copy or electronically) with the Secretary of State ( The articles must include the name of the corporation (which must be distinguishable from other entities on record with the Secretary of State), the period of its duration (which can be in perpetuity), the not-for-profit purpose, the registered agent and 5

6 address, the number of directors (which must be a minimum of three) and their names and addresses, and the names and addresses of the incorporators. The filing fee is $ The articles may also include any other provisions that are not inconsistent with the Rhode Island Nonprofit Corporation Act, including provisions that eliminate or limit the personal liability of a director for a breach of his or her duty as a director except for certain specific violations. Amendments to the articles of incorporation must be signed by the president or a vice president and the secretary or an assistant secretary, and filed with a filing fee of $10.00, and must include the name of the corporation, the proposed amendment (as recommended by the directors and approved by the members, if any, with the dates of any meetings or consent actions). If the nonprofit corporation intends to obtain exemption from federal and state income taxation, the articles of incorporation must conform with applicable statutes and regulations (discussed below). Click here for sample articles of incorporation with an approved 501c3 tax-exempt purpose section for the social sector. d. Management and Control Once the nonprofit corporation has been established, the initial board of directors must meet (in person or by consent) to ratify the acts in connection with the initial formation of the corporation and adopt bylaws which set forth the rules and procedures governing the decision-making process of the board of directors and the general operation and management of the corporation consistent with the applicable statutes of Rhode Island and the articles 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. Click here for a sample set of bylaws of a nonprofit corporation in the social sector. e. Liability of Members, Directors and Officers The articles of incorporation of a nonprofit corporation may eliminate or limit the personal liability of a director to the corporation or its members for monetary damages for breach of the director s duty as a director, except: i) for any breach of the director s duty of loyalty to the corporation or its members; 6

7 ii) iii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; or for any transaction from which the director derived an improper personal benefit. A nonprofit corporation has the power to indemnify any person by reason of the fact that the person is or was a director if: i) he or she conducted himself or herself in good faith; ii) he or she reasonably believed, in the case of conduct in his or her official capacity, that his or her conduct was in the best interests of the corporation, and in all other cases, unless he or she received an improper personal benefit, that his or her conduct was at least not opposed to its best interests; and iii) in the case of criminal proceedings, he or she had no reasonable cause to believe his or her conduct was unlawful. In addition, any person who serves as a volunteer of a nonprofit corporation is not liable to any other person based solely on his or her conduct in carrying out his or her duties unless such conduct constituted malicious, willful, or wanton misconduct. Rhode Island also specifically exempts directors, officers, employees, agents, and volunteers from liability for bodily injury incurred by a person while participating in any athletic or sports event sponsored by the nonprofit corporation, provided the person or his or her parent or guardian has signed a written waiver of liability and acknowledged the assumption of risk. A corporation may also indemnify officers, employees, and agents, and advance expenses to them, to the extent provided by the articles of incorporation, bylaws, vote, or contract. Any director or officer who signs any articles, report, application, or other document filed with the Secretary of State which is known to such director or officer to be false in any material respect is guilty of a misdemeanor and subject to a fine up to $ Any persons who assume to act as a nonprofit corporation without the authority to do so are jointly and severally liability for all debts and liabilities incurred or arising from such actions. f. Mergers, Acquisitions and Dissolution Any two (2) or more legal entities, including a nonprofit and a for-profit corporation, limited partnership, or limited liability company, may merge or consolidate into one of the entities. Domestic nonprofit corporations may also merge or consolidate with foreign legal entities, if the merger or consolidation is permitted by the laws of the other state. Each corporation must adopt a plan of merger, including the terms and conditions of the merger or consolidation. The members, if there are members and they are entitled to 7

8 vote, must approve a recommendation by the board of directors to merge or consolidate. If there are no members or no members entitled to vote, then the board of directors adopts the plan of merger or consolidation. Following the approval by the members, if any, or the board of directors, the officers must file articles of merger or consolidation with the Rhode Island Secretary of State, and the Rhode Island Secretary of State will then issue a certificate of merger or consolidation. The filing fee for the articles of merger or consolidation is $25.00 for a merger or consolidation with another nonprofit corporation, $50.00 for a merger or consolidation with a limited partnership, or $ for merger with a for-profit corporation or limited liability company. A nonprofit corporation may also dissolve and wind up its affairs. The members, if there are members and they are entitled to vote, must approve a recommendation by the board of directors to dissolve. If there are no members or no members entitled to vote, then the board of directors must approve the dissolution. If there are assets, then the assets are first used to pay the liabilities and obligations of the corporation. Assets that are received and held by the corporation subject to limitations permitting their use only for charitable, religious, benevolent, educational, or similar purposes, must be conveyed to one or more domestic organizations engaged in substantially similar activities as the dissolving corporation. Any other assets are distributed in accordance with the provisions of the articles of incorporation or bylaws. In most cases, a plan of distribution is required to be adopted in the same manner as the articles of dissolution. The officers must file articles of dissolution with the Rhode Island Secretary of State with a filing fee of $10.00, and the Rhode Island Secretary of State then issues a certificate of dissolution. The superior court also has the power to liquidate the assets of a nonprofit corporation for a number of reasons, such as if the directors are deadlocked in the management of the corporation, and irreparable injury is occurring or likely to occur, or the directors activities are illegal, oppressive, or fraudulent, or the members are deadlocked, or the corporate assets are being misapplied, or the corporation is not able to carry out its purposes. g. Recordkeeping, State Reports and State Taxes A nonprofit corporation must file an annual report with the Rhode Island Secretary of State in June each year with a filing fee of $20.00, listing the names and addresses of its officers and directors. Nonprofit corporations must keep correct and complete books and records of account and also minutes of all proceedings of members, if any, boards of directors, and committees having any of the authority of the board of directors. At its principal office in Rhode Island or at its registered office in this state, the nonprofit corporation must maintain a record of the names and addresses of its members (if any) entitled to vote. Any member or his or her agent may inspect the books and records of a nonprofit corporation for any proper purpose at any reasonable time. 8

9 Charitable trusts are specifically also regulated by the Department of Attorney General. These laws are set forth at Rhode Island General Laws through 17. "Charitable trusts, as defined in this statute, means any fiduciary relationship with respect to property arising as a result of a manifestation of an intention to create it and subjecting the person by whom the property is held to equitable duties to deal with the property for charitable, educational, or religious purposes. Charitable trusts must file an initial registration statement with the Attorney General, with a filing fee of $50.00, and any fiduciary holding property for the trust must file each year on or before July 1 a written report (on either the form supplied by the Attorney General or the Form 990 filed with the Internal Revenue Service) with the Attorney General for the last preceding fiscal year of the trust, showing the property held and administered, the receipts and expenditures in connection with the trust, the names and addresses of the beneficiaries of the trust, and any other information that the Attorney General may require. The filing fee is $ In addition, the Attorney General must be provided with notice with respect to all court proceedings which affect charitable trusts in the state of Rhode Island, such as cy-pres proceedings, petitions to amend charitable trusts, petitions to amend the articles of incorporation or bylaws of a nonprofit corporation, and other cases of equity. The Administrator of the Charitable Trusts Unit of the Attorney General reviews all such matters and participates in petitions and other litigation. There are substantial penalties for failure to comply with these laws. In general, a nonprofit corporation need not file any tax returns with the Rhode Island Division of Taxation unless it has earned unrelated business income. In any such case, the nonprofit corporation must file a Form RI-1120C three and a half months after the end of its fiscal year with the Rhode Island Division of Taxation. A nonprofit corporation may be exempt from sales and use taxes. The nonprofit corporation may file Form Application For Certificate Of Exemption For An Exempt Organization From The Rhode Island Sales and Use Tax and the 501(c)(3) Determination Letter from the Internal Revenue Service with the Rhode Island Division of Taxation. There is a $25.00 filing fee. Income tax exemption is automatic for any nonprofit corporation that has received such a determination letter from the Internal Revenue Service. Rhode Island state law exempts certain property from taxation used by certain types of nonprofit corporations for schools and religious purposes. Generally, nonprofit corporations that are also tax-exempt organizations must file an annual information return with the Internal Revenue Service. Tax-exempt organizations that have annual gross receipts not normally in excess of $25,000 are not required to file the annual information return, but may be required to file an annual electronic notice on Form 990-N. In addition, churches and certain religious organizations, certain state and local instrumentalities, and other organizations are excepted from the annual return filing 9

10 requirement. The Internal Revenue Service publishes Publication 557, Tax-Exempt Status for Your Organization, which is helpful in this area. In addition, Publications 4221-PC and 4221-PF explain the filing and recordkeeping rules that apply to section 501(c)(3) tax-exempt public charities and private foundations respectively. Tax-exempt organizations, other than private foundations, must file Form 990, Return of Organization Exempt From Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt From Income Tax. The Form 990-EZ is designed for use by small tax-exempt organizations and nonexempt charitable trusts. An organization may file Form 990-EZ, instead of Form 990, only if it satisfies certain thresholds relating to its gross receipts during the year and its total assets (as shown in the balance sheet of Form 990-EZ) at the end of the year. All private foundations exempt under 501(c)(3) must file Form 990-PF, Return of Private Foundation. Form 990, Form 990-EZ, or Form 990-PF must be filed by the 15th day of the 5th month after the end of the organization's accounting period. The tax-exempt status of any organization that has failed for three consecutive years to fulfill these filing requirements will be revoked by the IRS. h. Insurance Nearly every type of activity by a nonprofit corporation can become the target of some kind of a claim by a firm or an individual that alleges damage or injury by the corporation or individuals responsible for it (i.e., directors, officers or employees). Even if the claim is without merit, the costs of defending against the claim can be very substantial. To encourage qualified individuals to accept positions as directors and officers, many nonprofit corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation s offices, at sponsored meetings and the like. Liability insurance for nonprofit corporations is often a very complicated matter. Consultation with an experienced and knowledgeable agent or consultant is essential in order to obtain the right coverage at the lowest premium. i. 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) 10

11 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) Volume 18, No. 6, American Bar Association Section of Business Law, Business Law Today, July/August 2009: Our mini-them: Nonprofit Organizations. Takagi, Gene. Nonprofit Bylaws - Common Issues Nonprofit Law Blog 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 has a social mission or objective. The for-profit form of organization may be preferable to the nonprofit form in certain situations where the ability to raise capital by selling shares in the organization is perceived to be desirable or essential to the growth of the business. However, if a for-profit corporation is used, it is important to ensure (1) that the corporation's articles of incorporation specify the social mission as the purpose, or one of the purposes, of the organization and (2) that the revenues, net profits and other resources of the business be dedicated to the social mission only as and to the extent approved by all shareholders; otherwise, directors of the corporation could be sued for breach of their fiduciary duties owed to shareholders. Though incorporating a social mission in the purpose of the organization would authorize the corporation to pursue social objectives, it would not require the corporation to do so only the shareholders/owners have this power. And unless all shareholders agree to pursue social aims, dissenters could sue the corporation s directors and managers for failing to operate the corporation in the best economic interests of the shareholders. A shareholders agreement is probably the best way to address this problem. Such an agreement, entered into by all shareholders and the corporation, would require the corporation to be managed and operated so as to pursue specified social objectives thereby overriding fiduciary duties and similar legal principles that govern normal behavior of for-profit corporations. But even the most skillfully drafted shareholders agreement is not a perfect solution because agreements can always be abrogated and amended and the owners of the shares can change via sale, gift or inheritance. Moreover, a tightly drafted shareholders agreement which makes it difficult to respond to business changes over time would tend 11

12 to render the for-profit corporation much less attractive to investors (potential new shareholders). b. Formation The Rhode Island Business Corporations Act (Chapter 1.2 of Title 7 of the General Laws of Rhode Island) (herein referred to as "RIBCA") governs the formation, operation and dissolution of for-profit corporations in Rhode Island. A for-profit corporation is formed when one or more individuals, acting as incorporator or incorporators, prepare, sign and file with the Rhode Island Secretary of State articles of incorporation. The individual or individuals acting as the incorporator or incorporators need not meet any residency or citizenship requirements. According to 202 of the RIBCA, the articles of incorporation must contain the following: i) a corporate name which is distinguishable from the name of any other entity on file with the Rhode Island Secretary of State and which must contain the word "corporation", "company", "incorporated", or "limited", or an abbreviation of one of such words; ii) iii) iv) the total number of shares which the corporation has authority to issue; the address of the corporation's initial registered office in the State of Rhode Island, which may be, but need not be, the same as the corporation's place of business; the name of the corporation's initial registered agent at the initial registered office (the registered agent may be an individual resident in the State of Rhode Island, an entity formed in the State of Rhode Island, or a foreign entity authorized to transact business in Rhode Island); v) the name and address of the incorporator(s). In addition, the articles of incorporation may contain other optional provisions, not inconsistent with law, which the incorporators elect to set forth in the articles of incorporation for the regulation of the internal affairs of the corporation. In the case of a corporation which intends to engage in a social mission or objective, it would be advisable to include a provision which identifies the social mission or objective as the purpose, or one of the purposes, of the corporation. Permissible optional provisions also include a provision which names the initial directors of the corporation. The official form of the Articles of Incorporation (Form No. 100) is available online at the website of the Rhode Island Secretary of State at: The incorporators may file the articles of incorporation with the Rhode Island Secretary of State in either paper format or by electronic transmission, and the articles must be accompanied by all the required filing fees. The legal existence of the corporation commences when the Secretary of State certifies that the instrument has been filed by endorsing upon the signed instrument the word "filed" and the date and time of its filing. Articles of incorporation will not be accepted for filing unless accompanied by both a 12

13 filing fee of $70.00 and a license fee based on the number of shares (but not less than $160.00) which the corporation is authorized to issue. The formula for calculating the license fee is set forth in 1602(c) of the RIBCA. c. Management and Control Except as may be otherwise provided in the RIBCA or in the articles of incorporation, the business and affairs of a corporation are managed by the board of directors. The board of directors of a corporation consists of one or more members. The number of directors is fixed by, or in the manner provided in, the articles of incorporation or the bylaws. Directors need not be residents of Rhode Island or shareholders of the corporation unless the articles of incorporation or bylaws require it. The articles of incorporation or bylaws may prescribe other qualifications for directors. Although the directors have broad authority to manage the business and affairs of a corporation, certain actions including the election of directors, mergers, sale of all or substantially all assets of the corporation, and dissolution of the corporation cannot be undertaken without the vote and approval of the shareholders. After the articles of incorporation are filed, if the initial directors are named in the articles of incorporation, they hold an organizational meeting to complete the organization of the corporation by appointing officers, adopting bylaws and transacting any other business that is appropriate. If the initial directors are not named in the articles of incorporation, the incorporator(s) hold an organizational meeting to either: (i) elect directors and complete the organization of the corporation, or (ii) elect a board of directors who in turn complete the organization of the corporation. The bylaws of the corporation may contain any provisions for the regulation and management of the affairs of the corporation not inconsistent with the RIBCA or the articles 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; and conflicts of interest. As mentioned above, the initial bylaws of a corporation must be adopted by its incorporators or by its board of directors at its organizational meeting. Subsequently, the bylaws may be amended by the shareholders, or, unless otherwise provided in the articles of incorporation or the bylaws, by the board of directors, but any amendment to the bylaws by the board of directors may be changed by the shareholders. Initial directors hold office until the first annual meeting of shareholders and until their successors have been elected and qualified. At the first annual meeting of shareholders and at each subsequent annual meeting, the shareholders elect directors to hold office 13

14 until the next succeeding annual meeting. Each director holds office for the term for which he or she is elected and until his or her successor has been elected and qualified. The officers of a corporation consist of a president, a secretary and a treasurer, and such other officers as are authorized by the bylaws or the board of directors. The initial slate of officers is chosen by the incorporators or by the initial board of directors. Thereafter, the officers of the corporation are usually elected by the board of directors on an annual basis and serve at the pleasure of the board of directors. The officers have such authority and perform such duties as may be set forth in the bylaws or determined by resolution of the board of directors. Model forms for the organization of a Rhode Island for-profit corporation, including articles of organization and by-laws may be found in a seminar publication of the Rhode Island Bar Association Continuing Legal Education entitled "Practical Skills Organizing a Rhode Island Business, Publication " d. Liability of Shareholders, Directors and Officers Section 801 of the RIBCA requires that a director shall discharge his duties as a director (i) in good faith; (ii) with the care that a person in a like position would reasonably believe appropriate under similar circumstances; and (iii) in a manner he or she reasonably believes to be in the best interests of the corporation. In discharging his or her duty of care, a director is entitled to rely on information prepared by officers and employees of the corporation or by outside professionals whom the director reasonably believes to be reliable and competent. In addition, directors also owe their corporation a duty of loyalty which requires that a director act in the best interests of the corporation and its shareholders, as distinguished from his or her own personal interest if in conflict with the interests of the corporation and its shareholders. Directors can have liability to the corporation or its shareholders in circumstances where the directors have breached their duties of care and/or loyalty. However, under the business judgment rule, a court will usually not impose liability on directors for decisions that in hindsight appear to have been wrong, as long as the decisions were made in good faith for a rational business purpose and as long as the directors discharged the duties of care and loyalty which they owe to the corporation and its shareholders. In this connection, it should be noted that the articles of incorporation of a corporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its shareholders for monetary damages for breach of the director's duty of care (but not his duty of loyalty) save in certain situations spelled out in 202(b)(3) of the RIBCA. Officers of the corporation are held to owe to the corporation and its shareholders the same duties of care and loyalty which are owed by the directors. 14

15 Subject to the guidelines in 814 of the RIBCA, the articles of incorporation and/or bylaws of the corporation will usually contain provisions obligating the corporation to indemnify and hold harmless its officers and directors from and against any liabilities and expenses they may incur or suffer arising out of a breach of their duties owed to the corporation and its shareholders. In addition, corporations often make D&O liability insurance available to their directors and officers as an extra layer of protection against possible exposure to liability for breach of their fiduciary duties. Directors and officers will often condition their service to the corporation on the availability of strong indemnification provisions in the articles of incorporation and bylaws and, where the corporation can afford it, D&O insurance. Normally, a shareholder, by reason of his shareholder status alone, is not personally liable for the debts and obligations of a corporation. This rule of limited liability is often a primary motivation for the formation of the corporation. By virtue of the "corporate shield", a shareholder's exposure for the debts and obligations of the corporation is limited to his or her investment in the corporation. However, in rare instances, a court may hold a shareholder liable for the debts, actions or omissions of a corporation under a so-called "piercing the veil" theory. 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 Section 1502 of the RIBCA requires each corporation to keep correct and complete books and records of account and minutes of the proceedings of its shareholders and board of directors. It also requires each corporation to keep at its registered office or principal place of business, legal counsel's office, or at the office of its transfer agent or registrar, a record of its shareholders giving the names and addresses of all shareholders and the number and class of shares held by each. Any director or shareholder of the corporation, upon written demand stating the purpose for the demand, has the right to examine, in person, or by agent or attorney, at any reasonable time or times, for any proper purpose, the corporation's relevant books and records of account, minutes, and record of shareholders and to make extracts therefrom. Section 1501 of the RIBCA requires each corporation to file an annual report with the Rhode Island Secretary of State between January 1 and March 1 of each year following the year of incorporation. The form of annual report (Form No. 630) is available online 15

16 at the website of the Rhode Island Secretary of State ( and may be filed in paper format or online by electronic transmission. g. Taxation A for-profit corporation pays federal and state taxes on the income it earns, and its shareholders pay taxes on dividends distributed by the corporation. S corporations, however, are not subject to double taxation; their income is generally not taxed at the federal or state level, but the income and losses of the 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. A corporation (other than an S corporation) that is subject to tax in this state is subject to the Rhode Island business corporation tax on the portion of its net income allocated to this State at the rate of 9%. If that liability is less than the greater of the minimum annual business corporation tax ($500) and the annual franchise tax, which is assessed at the rate of $2.50 for each multiple (or part thereof) of $10,000 in authorized capital stock, the corporation's tax liability for that year is appropriately increased. For purposes of the annual franchise tax, capital stock having no par value is deemed to have a par value of $100 per share. Also, a corporation that was not engaged in any business activity in this state during the preceding year is subject to a reduced level of franchise tax. To the extent an S corporation is not subject to federal income tax its income will not be subject to the annual business corporation tax. An S corporation, however, is subject to the minimum annual business tax ($500) or, if applicable, the state franchise tax. In addition, if an S corporation has a non-resident shareholder the corporation is required to withhold and remit tax to the State on the non resident shareholder's share of the corporation's income subject to Rhode Island tax. The withheld tax is allowed as a credit against the nonresident shareholder's Rhode Island personal income tax liability. h. Resources Rhode Island Secretary of State Corporations Division website ( A Practical Guide to Organizing a Business in Rhode Island, MCLE New England, Edited by Christopher D. Graham, 1 st Edition The Bureau of National Affairs, Inc., State Portfolios: Corporate Income Taxes, Portfolio nd : Income Taxes: Computation of State Taxable Income (Minnesota through Wyoming), Section Rhode Island. Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders (2002). 16

17 3. Limited Liability Companies ( LLC(s) ) a. Using LLCs to Pursue Social Change The Rhode Island Limited Liability Company Act, R.I.G.L , et seq (the RI LLC Act ), governs the formation, operation and dissolution of LLCs in the State of Rhode Island. Combining certain characteristics of both partnerships and corporations, LLCs are privately owned legal entities that can be formed for the purpose of earning profits, pursuing a social mission, or both, although some states require an LLC to be formed only for a business purpose. LLCs differ from for-profit corporations because they are formed and owned by members rather than shareholders; however, like S corporations and partnerships, LLCs are eligible for pass-through income tax treatment. This means that income and expenses are reported as though the members incurred them directly, and profits or losses are taxed at the ownership (member) level, rather than the entity (company) level. Members of LLCs can be individual investors as well as for-profit corporations and taxexempt nonprofit corporations. For this reason and also because of pass-through taxation which eliminates double taxation (the effect of taxing income at the corporate level and again when it is included in the owner s income), LLCs are preferred over for-profit corporations as vehicles for social enterprise, especially for joint ventures between a taxexempt nonprofit with a social change mission and a for-profit business. LLCs are akin to partnerships because the members have broad discretion to allocate profit and loss and management powers among themselves (via an operating agreement ). On the other hand, as with the shareholders of corporations, the members of an LLC can be divided into classes, each with its own economic rights, and members have limited personal liability (discussed below). Two states, Tennessee and Kentucky, specifically authorize the formation of nonprofit LLCs. The statutes of numerous states, including California, have language that permits nonprofit LLCs to exist. Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) if it elects to be treated as a separate legal entity for tax purposes and its operating agreement includes the language mandated by the organizational test (purposes, distribution of assets upon dissolution, etc.) and it meets numerous requirements largely designed to guard against inurement and private benefit. These conditions will be discussed in the Nonprofit Taxation section. 17

18 b. Formation To form and organize an LLC under the RI LLC Act, one or more persons must deliver executed articles of organization to the Rhode Island Secretary of State. When the Secretary of State accepts the articles of organization for filing and issues the certificate of organization, the LLC is formed under the name and subject to the conditions and provisions stated in its articles of organization. The articles of organization must set forth the following: (1) the name of the LLC, which name shall end with either the words limited liability company or the upper or lower case letters l.l.c. with or without punctuation; (2) the name and address of its resident agent in the State of Rhode Island; (3) a statement whether, under the articles of organization and any written operating agreement made or intended to be made, the LLC is intended to be: (i) treated as a partnership; (ii) as a corporation; or (iii) disregarded as an entity separate from its member for purposes of federal income taxation; (4) the address of the principal office of the LLC if its determined at the time of organization; (5) any other provision, not inconsistent with law, which the members elect to set out in the articles, including, but not limited to, any limitation of the purposes or duration for which the LLC is formed, and any other provision which may be included in an operating agreement; (6) a statement of whether the LLC is to be managed by its members or by one or more managers, and if the LLC has managers at the time of its formation, the name and address of each manager; and (7) the name and address of the person authorized to sign and who does sign the articles of organization. The person authorized to sign the articles of organization need not be a member of the LLC but only authorized to do so by the persons forming the LLC. The RI LLC Act requires that each domestic or foreign registered LLC shall have a resident agent for service of process in the LLC who shall be either: (i) an individual resident of the State of Rhode Island; or (ii) a corporation, limited partnership, or LLC, and in each case either domestic or one authorized to transact business in the State of Rhode Island. As of July 1, 2009, the fee for filing original articles of organization was $ The articles of organization become effective upon the issuance of a certificate from the Rhode Island Secretary of State indicating the document was accepted for filing or at any later date set forth within the articles of organization, but in no event later than thirty (30) days after the filing of said articles of organization. An LLC may engage in any business which a limited partnership may carry on, except for the provision of professional services (as defined in R.I.G.L and includes for examples physicians, dentists, attorneys at law, professional engineers, architects, opticians, etc.), and has perpetual existence until dissolved or terminated in accordance with the RI LLC Act, unless a more limited purpose or duration is set forth in the articles of organization. 18

19 The required form of articles of organization may be located on the website for the Rhode Island Secretary of State website on the corporations form home page ( c. Management and Control Although not required by the RI LLC Act, it is recommended that an LLC have an operating agreement to govern the management of the LLC. A typical operating agreement would contain the following provisions for example: duration of the LLC; purpose of the LLC; list of members; membership interests and capital contributions of the members; division of profits, losses and distributions; compensation of the members; management of the LLC either by the members or managers; insurance; death, resignation, expulsion, bankruptcy or dissolution of a member; sale, transfer or assignment of membership interest; mechanism to amend, restate or repeal the operating agreement; federal income tax classification and any other applicable provision not inconsistent with Rhode Island law. An LLC may have an operating agreement that provides for classes or groups of members having such rights as said 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 without the vote or approval of any member or class or group of members. The business of the LLC shall be managed by the members unless the articles of organization or an operating agreement provide for management by one or more managers. If management is vested in the members of the LLC: (1) the members are deemed to be managers for purposes of applying the provisions of the RI LLC Act; and (2) each of the members has the power and authority and is subject to all duties and liabilities of managers. The members of an LLC are entitled to vote in proportion to the capital value of the membership interests unless the articles of organization or operating agreement provide otherwise. The articles of organization or a written operating agreement may deny, restrict or enlarge the management rights and duties of any member or group or class of member and may provide that business and affairs of the LLC shall be managed by or under the authority of one or more managers who may, but need not be, members. A member or a manager of a LLC shall discharge his or her duties in good faith, with the care that an ordinarily prudent person in a similar position would use under the circumstances, and in the manner the member or the manager reasonably believes to be in the best interests of the LLC. If the business and affairs of the LLC is managed by more 19

20 than one manager, the managers shall act by majority vote, with each manager being entitled to one vote unless stated otherwise in the operating agreement. The contribution of a member to a LLC must be in the form of a capital contribution. The profits and losses of a LLC shall be allocated to each member on the basis of the member s capital value, unless stated otherwise in the articles of organization or operating agreement. Membership interests are freely assignable under the RI LLC if the other members unanimously consent to said assignment and except as otherwise provided for in an operating agreement. The consent of a member may be evidenced in any manner specified in an operating agreement, but in the absence of specification, consent is evidenced by a written instrument, dated and signed by the member, or evidenced by a vote taken at a meeting of the members called in accordance with the operating agreement and maintained with the records of the LLC. A sample form of operating agreement for a Rhode Island LLC may be found in a seminar publication of the Rhode Island Bar Association entitled Practical Skills Organizing a Rhode Island Business, Ref # , Nov/Dec d. Limited Liability of Members and Managers Under the RI LLC Act, a member or manager of a LLC is not liable for the obligations of the LLC solely by reason of being a member or a manager except as otherwise provided by the RI LLC Act. The RI LLC Act states that a member or a manager must discharge his or her duties in good faith and demonstrate the care that an ordinarily prudent person in a similar position would use under the circumstances. Although an operating agreement may limit the amount of a member s or manager s liability, a member or manager shall be liable for the following activities: (1) breach of the duty of loyalty to the LLC or its members; (2) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (3) wrongful distribution; or (4) any transaction from which derived an improper personal benefit, unless the transaction was with the informed consent of the members or a majority of the disinterested managers. In addition, a member or a manager who votes for or assents to a distribution in violation of the operating agreement or of the restrictions on making distributions is personally liable to the LLC for the amount of the distribution that exceeds what could have been distributed without violating the operating agreement or of the restrictions on making distributions section of the RI LLC Act. 20