MICHIGAN FORMS OF ORGANIZATION Butzel Long, a professional corporation Robert A. Hudson

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1 Last Updated: January 2013 MICHIGAN FORMS OF ORGANIZATION Butzel Long, a professional corporation Robert A. Hudson Table of Contents 1. Nonprofit Corporations 2. For-Profit Corporations 3. Limited Liability Companies 4. Low Profit Limited Liability Companies 5. Joint Ventures 6. Partnerships and Limited Partnerships 7. Sole Proprietorships 8. New Forms of Hybrid Organizations 9. Resources 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 Formation Management and Control Liability Tax Factors Capital and Loans Nonprofit 501(c)(3) Corporation File articles or certificate of incorporation (containing specific info required by IRS) with state and pay filing fee. File application on Form 1023 for tax-exempt status unless below gross receipts threshold. Recruit directors, draft bylaws and hold organizational meeting. Take steps to comply with license, tax and employment law/regs. Managed by directors who appoint officers to run day-to-day operations as specified Members, directors, officers and employees are generally not liable for debts and in bylaws. Some obligations of the nonprofit corporationscorporation, including have members (like shareholders) who elect directors. for unlawful acts of others involved in the affairs of the corporation. They can be held liable for injuries due to their own misconduct but some states provide limited immunity to such persons and also to volunteers. Generally exempt from federal and state taxes if receive 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 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. For-Profit Corporation 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. Managed by directors that are elected by shareholders. Directors appoint officers to run dayto-day operations as specified in bylaws. Shareholders are generally not liable for debts and obligations of the corporation, including for unlawful acts of others involved in the business. Unless indemnified by the corporation, directors, officers and employees can be held liable for injuries caused by their own acts or failures to act. A C Corporation is subject to corporate tax on net income. If net income is paid to shareholders as dividends, the individual shareholders are taxed. If a corporation elects to be a S corporation and meets several criteria, it can receive pass through taxation. Can raise capital by issuing stock (equity) and by borrowing money through loans or other debt instruments. Corporation may be able to accept PRIs from foundations in the form of loans or equity. B Corp (a forprofit corporation with a social mission that is licensed to use the trade name B Corporation ) See for-profit corporation See for-profit corporation. The B Corp license requires the corporation to incorporate specific socially beneficial performance standards into its governing documents and operating principles. See for-profit corporation. See for-profit corporation. See for-profit corporation. A B Corp should be in a better position to attract PRIs from foundations in the form of loans or equity. 2

3 Formation Management and Control Liability Tax Factors Capital and Loans 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. 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. Can raise capital through contributions by member/owner. Otherwise, same as for-profit corporation. L3C (low-profit LLC) Similar to LLC but must be formed for a charitable or educational purpose. Only permitted in certain states (e.g., VT, IL, MI,UT,ME, WY) 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. Partnership 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. Partners have equal, full control unless otherwise specified in partnership agreement. 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. Generally not taxed as an entity. Partners report profits and losses on personal tax returns. Can raise capital through contributions by partners and by borrowing money through loans or other debt instruments. 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. 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. 3

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

5 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 Bureau of Commercial Services of the Michigan Department of Labor and Regulatory AffairsLicensing and Regulatory Affairs of its articles of incorporation. This document is in essence a contract between the state and the nonprofit corporation in which Michigan grants individual legal status to the corporation in exchange for the corporation s commitment to follow its rules. An individual, partnership, corporation, association, or any other legal entity may, individually or jointly, form a nonprofit corporation by executing and filing articles of incorporation for the corporation. The MNCA requires certain information to be included in the articles of incorporation and it authorizes additional provisions to be included at the option of the incorporators. The articles of incorporation must include: Name of the corporation. The use of the word foundation in the name of a nonprofit corporation is limited to corporations formed for the purpose of receiving or administering funds to perpetuate the memory of persons; preserve objects of historical or natural interest; for educational, charitable, or religious purposes; or for the public welfare. Also, the name must not be the same or confusingly similar to the registered or assumed name of any other for-profit or nonprofit corporation authorized to transact business in Michigan. The incorporators may reserve a desired name by filing an Application for Reservation of Name with the Bureau of Commercial Services, Corporation Division ( Description of specific purposes for which the corporation is organized. A nonprofit corporation s purpose must be specifically stated. A general purpose statement the corporation is formed to engage in any activity within the purposes for which a corporation may be organized under [the MNCA] is not allowed. Certain language is necessary to obtain Internal Revenue Service tax exemption. As a result, it is best to draft the purposes statement with the IRS requirements in mind, even though these are not required under Michigan law. Description of the type of nonprofit corporation. In order to provide flexibility in the control and management of nonprofit organizations, the MNCA provides not only for stock corporations similar in structure to business corporations, but also 5

6 for membership organizations and directorship corporations controlled by their boards (without members or shareholders). In a nonstock corporation (membership or directorship), the articles must describe the type and value of real and personal property (if any) owned at the time of organization, and state a plan of financing (in general terms). In a directorship corporation, the directors themselves elect all directors. In stock or membership corporations, shareholders or members elect directors (similar to business corporations). Street and mailing address of the corporation s registered office and the name of the corporation s resident agent. Name(s) and address(es) of the incorporator(s). Duration if other than perpetual. It is optional to include the following: Corporate action without a meeting of shareholders or members. Management of the corporation. The articles may create, define, limit, or regulate the power of the corporation, its directors, officers, members, or shareholders. Limitation on volunteer liability. The articles may include a provision that eliminates, subject to some exceptions, the personal liability of a volunteer director or volunteer officer for breach of the director s or officer s fiduciary duty. Assumption of liability. The articles may include a provision whereby the nonprofit corporation assumes liability for all acts or omissions of a volunteer director, volunteer officer, or other volunteer. Creditor rights. Any provision required or permitted by the MNCA to be included in the bylaws of the corporation. Dissolution. The articles may include a provision that permits a shareholder, member, or director to require dissolution of the corporation at will or upon occurrence of a specified event. If included, the existence of the provision must be noted conspicuously on every certificate for shares or membership certificate issued. Limitations on activities. A limitations provision provides that no part of the corporation s net earnings can inure to the benefit of the corporation s shareholders, members, directors, officers, or any other private person. This provision should be used by nonprofit corporations seeking tax-exempt status under IRC 501(c)(3). 6

7 Distribution of assets upon dissolution. This provision provides the corporation must permanently dedicate its assets to an exempt purpose, even upon dissolution. This provision should be used by nonprofit corporations seeking tax-exempt status under IRC 501(c)(3). Each incorporator must sign the articles of incorporation; however, if there are three or more incorporators, a resolution may designate one incorporator to sign the articles on behalf of all the incorporators. The articles of organization are then filed with the Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division. The articles may be filed either in person, by mail, or electronically. The basic filing and franchise fee is $20. The Michigan Department of Labor and Regulatory Affairs provides a basic articles of incorporation form ( The Corporation Division s website is _ ,00.html. 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 (as discussed below). d. Management and Control Either before or after filing the articles of incorporation, a majority of the incorporators must select the initial board of directors. The MNCA requires a nonprofit corporation s board of directors to consist of three of more directors. The incorporators also have the option of adopting the initial bylaws of the corporation. Once the nonprofit corporation has been established, the initial board of directors should hold an organizational meeting either in person or by consent, to ratify the acts in connection with the initial formation of the corporation and adopt bylaws, if the incorporators have not already done so. The bylaws 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 Michigan and the articles of incorporation. Unless the articles of incorporation provide otherwise, the shareholders, members, or board have the power to amend, repeal, or adopt new bylaws. 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. 7

8 e. Liability of Members, Directors and Officers Since a corporation is generally considered a distinct legal entity from its shareholders or members, a shareholder or member is not liable for the debts and obligations of the corporation. Directors and officers of a nonprofit corporation owe several duties to the corporation, including the duty of care and the duty of loyalty. Such duties must be carried out in good faith and with that degree of diligence, care, and skill which an ordinarily prudent person would exercise under similar circumstances in a like position. A breach of a fiduciary duty by a director or officer may result in personal liability to the corporation. The MNCA permits limitation of liability in certain circumstances. In each case, language must be included in the articles of incorporation in order for the protection to be effective. A corporation may eliminate the liability of a volunteer director or volunteer officer for breach of fiduciary duty (except in certain cases of fraud, self-dealing, bad faith, or gross negligence). The MNCA also permits a corporation to provide indemnification to its directors, officers, employees, nondirector volunteers, and agents of the corporation. If this protection is in place, volunteer directors will be relieved of liability to outsiders, and the corporation itself will assume that liability. Volunteers will not be liable for acts performed for the nonprofit corporation (with some exceptions, such as bad faith, gross negligence, willful or wanton misconduct, intentional torts, and automobile accidents); the corporation assumes such liability. f. Mergers, Acquisitions and Dissolution The MNCA permits two or more nonprofit corporations to merge into one corporation or consolidate into a new corporation. To effectuate a merger or consolidation, the MNCA requires that the board of each participating Michigan nonprofit corporation adopt a plan of merger of consolidation. The plan of merger or consolidation then must be approved by a majority of the corporation s shareholders, members, or directors (depending on the type of nonprofit corporation). Specific provisions apply if one of the merging corporations is a foreign nonprofit or domestic or foreign business corporation. There are several ways in which a nonprofit corporation may be dissolved. The incorporators or directors may dissolve the corporation by a majority vote if the corporation complies with several conditions which essentially require that the corporation has done nothing more than incorporate. If that option is not available, a nonprofit corporation may be dissolved by its shareholders, members, or directors under MCL The board must adopt a resolution that the corporation be dissolved and that a plan of distribution of assets be implemented. The proposed dissolution must then be approved by a majority of the corporation s shareholders, members, or directors 8

9 (depending on the type of nonprofit corporation). Finally, the articles of incorporation may permit a shareholder, member, or director to require the corporation to dissolve at will or upon the occurrence of a specific event. To complete the dissolution, a certificate of dissolution must be executed and filed with Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division. The filing fee is $10. Dissolution also occurs for failure to file annual reports or pay the annual filing fee for two consecutive years, although any corporation so dissolved may be reinstated upon filing of reports and paying of fees and penalties required by statute. g. Recordkeeping, State Reports and State Taxes A Michigan nonprofit corporation is required to provide a financial report to its shareholders, members, or directors (depending on the type of nonprofit corporation) at least once a year. An annual report must also be filed with the Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division no later than October 1. The Corporation Division mails a pre-printed annual report to the corporation s resident agent. The filing fee is $ If a corporation fails to file the annual report or pay the annual fee for two consecutive years, the corporation will be automatically dissolved although any corporation so dissolved may be reinstated upon filing of reports and paying of fees and penalties required by statute. i) Michigan Business Tax. If a nonprofit corporations is exempt from federal tax, it is also generally exempt from the Michigan Business Tax. ii) iii) Michigan Sales and Use Tax. Nonprofit corporations which are tax-exempt under Internal Revenue Code Section 501(c)(3) (generally charitable organizations) or (c)(4) (civic leagues or similar organizations) are exempt from the sales and use tax on purchases. To document the exemption, the nonprofit corporation should provide a copy of their IRS determination letter and a Michigan Sales and Use Tax Certificate to vendors. The form can be accessed at A nonprofit corporation is not exempt from paying Sales Tax when its sells merchandise, however, the Michigan Department of Treasury exempts most nonprofit organizations from paying Sales Tax if retail sales for the calendar year are less than $5,000. Michigan Revenue Administrative Bulletin No , is available at Employment Tax. Nonprofit corporations which expect to have employees must register with the Michigan Treasury Department (for employee wage withholding) and the Michigan Employment Security Commission (for unemployment taxes). 9

10 iv) Real property taxes. Certain but not all nonprofit corporations may be able to obtain exemption from local property taxes for real property used for their nonprofit purposes (e.g. charitable organizations using property for charitable purposes). 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, Non-Profit 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) 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 Michigan Nonprofit Association, Michigan Economic Development Corporation, Starting a Business in Michigan, 10

11 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 articles 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 shareholder/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 to render the for-profit corporation much less attractive to investors (potential new shareholders). b. Formation The Michigan Business Corporation Act (the MBCA ) (MCL ) governs the formation, operation and dissolution of for-profit corporations in Michigan. An individual, partnership, corporation, trust, or any other legal entity may form a nonprofit corporation, individually or jointly, by executing and filing articles of incorporation for the corporation. The MBCA requires certain information to be included in the articles of incorporation and it authorizes additional provisions to be included at the option of the incorporators. The articles of incorporation must include: The name of the corporation. The name must contain the word corporation, company, incorporated, or limited or an abbreviation of one of those words. 11

12 The name must not be confusingly similar with the name of an existing domestic or foreign corporation, nonprofit corporation, limited partnership or limited liability company, or with a name which has been reserved or assumed by another entity. The incorporators may reserve a desired name by filing an Application for Reservation of Name with the Bureau of Commercial Services, Corporation Division ( The purpose for which the corporation is formed. The purpose may be specifically or generally stated. The articles may simply state that the corporation is formed to engage in any activity for which a corporation may be formed under the MBCA, the broadest possible authority. The aggregate number of shares which the corporation is authorized to issue. Also, if the shares are separated into separate classes or series, the number of shares contained in each, and their relative rights, preferences, and limitations must be stated in the articles. Street and mailing address of the corporation s registered office and the name of the corporation s resident agent. The corporation must maintain a registered office in Michigan and must also maintain a resident agent at that address. The registered office may be the same as the corporation's business office within the state or may be a different address. Name(s) and address(es) of the incorporator(s). The duration of the corporation if other than perpetual. The articles may also contain other provisions so long as they are not inconsistent with the MBCA or another Michigan statute. Each incorporator must sign the articles of incorporation. The articles of incorporation are then filed with the Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division. The articles may be filed either in person, by mail, or electronically. The cost of filing articles of incorporation includes a $10 filing fee and an organization and admission fee determined by the corporation s number of authorized shares, the minimum total fee is $60. The Michigan Department of Labor and Regulatory Affairs provides a basic articles of incorporation form ( The Corporation Division s website is _ ,00.html. 12

13 c. Management and Control A for-profit corporation has a hierarchical control structure. It is managed by or under the direction of a board of directors and its officers, although its shareholders vote on important corporate issues, such as election of directors, mergers, sale of all assets and dissolution. Either before or after filing the articles of incorporation, a majority of the incorporators must select the initial board of directors. Unless required by the articles or bylaws, a director does not need to be a shareholder. Corporations may have as few as one director. The first board of directors holds office until the first annual meeting of shareholders. At the first annual meeting of shareholders and each annual meeting thereafter, the shareholders elect directors to hold office. In addition to selecting the initial board, the incorporators have the option of adopting the initial bylaws of the corporation before or after filing the articles of incorporation. Alternatively, the bylaws may be adopted by the initial board of directors or shareholders. Similar to a nonprofit corporation, once the for-profit corporation has been established, the initial board of directors should hold an organizational meeting either in person or by consent, to ratify the acts in connection with initial formation of the corporation, appoint officers, and adopts bylaws, if not already adopted by the incorporators or are to be adopted by the shareholders, which set forth the rules and procedures governing the operation and management of the corporation consistent with the applicable statutes of Michigan and the articles of incorporation. Unless the articles of incorporation provide otherwise, the shareholders or the board of directors have the power to amend, repeal, or adopt new bylaws. 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. A corporation must have a President, a Secretary, and a Treasurer and may also elect to have a Chairman of the Board, one or more Vice Presidents and such other officers as the Bylaws may prescribe or the Board may determine. Section 488 of the MBCA permits closely held corporations to be governed by numerous provisions that otherwise are not permissible for corporations. Section 488 grants broad flexibility to the shareholders in determining how the business and affairs of the corporation will be managed and in structuring the relationship among the shareholders, the directors, and the corporation. Among the types of provisions authorized by Section 488 are the following: 13

14 Unequal distribution rights within a class (although this would not be permitted to Subchapter S corporations). The identity of the board and/or the manner of selecting board members. Use of director proxies and weighted voting among directors. Provisions governing the exercise or division of voting power among shareholders and providing weighted voting rights between classes of shares or within the same class of shares, whether in general or with regard to specific matters. Requirements that the corporation be dissolved on the request of one or more shareholders or upon occurrence of certain events. Delegation to shareholders or other persons of powers normally reserved for the Board, including the right to break deadlocks. Section 488 provisions must be set forth in a provision of the articles of incorporation or bylaws approved by all persons who are shareholders at the time of adoption, or in a written agreement signed by all persons who are shareholders at the time of the agreement and made known to the corporation. If amended by an amendment to the articles of incorporation or bylaws, the amendment must be approved by all shareholders. If amended by written agreement, the amendment must be in a writing signed by all shareholders, unless the original agreement provides otherwise. Section 488 provisions must be conspicuously noted on certificates and persons who become shareholders without knowledge of such restrictions are entitled to rescind their purchase. d. Liability of Shareholders, Directors and Officers Since a corporation is generally considered a distinct legal entity from its shareholders, a shareholder is not liable for the debts and obligations of the corporation. However, under certain extraordinary circumstances, a court of equity may elect to "pierce the veil" of a corporation and impose personal liability upon shareholders for corporate actions and obligations. Although this practice is rare, among the factors which might lead a court to pierce the veil are the failure to observe corporate formalities (such as keeping corporate records, electing Directors and officers, holding meetings or taking action by written consent) and the commingling of corporate and noncorporate funds and assets. A Director or officer must discharge his or her duties to the corporation and its shareholders in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner he or she reasonably believes to be in the corporation's best interest. Directors and officers may be liable to the corporation for violating these duties, although a corporation may include in its Articles of Incorporation a provision eliminating or limiting the monetary liability of directors for breach of their duty under certain circumstances. Also, a corporation may 14

15 indemnify its directors, officers, employees, and agents of the corporation, subject to some exceptions, for attorneys fees and other expenses. e. Raising Capital Subject to certain tax elections (i.e., a Subchapter S election), for-profit corporations generally offer a great deal of flexibility in raising capital, ranging from various kinds of equity (e.g. common stock, preferred stock, options, warrants) to numerous types of debt instruments (e.g. convertible notes, subordinated notes, bonds, commercial paper). f. Recordkeeping and State Reports A corporation is required to keep minutes of the meetings of its shareholders, board of directors, and executive committee (if it has one). A Michigan corporation is also required to provide a financial report to its shareholders at least once a year. In addition to filing its articles of incorporation with the Bureau of Commercial Services, a corporation must also file a certificate whenever its articles of incorporation are amended, whenever it changes its registered agent or registered office, and whenever it engages in a merger or share exchange transaction. All Michigan for-profit corporations must file an annual report with the Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division by no later than May 15 of each year. MCL (1). The Corporation Division mails a pre-printed annual report to the corporation s resident agent. The filing fee is $25. Failure to file on time and pay the filing fee will result in a penalty of $10 per month or part of a month that the report or fee is delinquent up to a maximum penalty of $50. More importantly, a corporation s failure to file the annual report or pay the annual fee for two consecutive years, will result in automatic dissolution of the corporation, although any corporation so dissolved may be reinstated upon filing of reports and paying of fees and penalties required by statute. g. Taxation Michigan corporations doing business in the State of Michigan are subject to the Michigan Business Tax. Unlike sole proprietorships and partnerships, income earned by Michigan for-profit corporations doing business in the state may be subject to double taxation. That is, the corporation pays federal and state taxes on the income it earns and the shareholders are taxed at their personal income tax rate on any profits that are distributed to them by the corporation as dividends. A corporation may, however, elect to be governed by Subchapter S of the Internal Revenue Code to avoid double taxation. Subchapter S corporations are not taxed at the corporation level. Rather, the income and losses of a Subchapter S corporation are passed through to the shareholders in relation to 15

16 their ownership interests. To be eligible for this tax treatment, S corporations must meet certain requirements including, but not limited to, having only one class of stock and no more than 100 shareholders. h. Resources Michigan Department of Labor and Regulatory Affairs Bureau of Commercial Services, Corporation Division PO Box Lansing, MI Phone: Website: Michigan Department of Treasury Business Taxes, Michigan Economic Development Corporation, Starting a Business in Michigan, 3. Limited Liability Companies (LLCs) a. Using LLCs to Pursue Social Change Combining certain characteristics of both partnerships and corporations, LLCs are legal entities that can be formed for the purpose of earning profits, pursuing a social mission, or both, although some states require an LLC to be formed only for a business purpose. LLCs differ from for-profit corporations because they are formed and owned by members rather than shareholders; however, similar to S corporations and partnerships, LLCs are eligible for pass-through income tax treatment. This means that income and expenses are reported as though the members incurred them directly, and profits or losses are taxed at the ownership (member) level, rather than 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 (this is accomplished through the LLC s adoption of a well-drafted operating agreement ). On the other hand, as with the shareholders of corporations, the members of an LLC may be divided into classes, 16

17 each with its own economic or voting 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 permitting nonprofit LLCs to exist. Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) if it elects to be treated as a separate legal entity for tax purposes and its operating agreement includes the language mandated by the organizational test (purposes, distribution of assets upon dissolution, etc.) and it meets numerous requirements largely designed to guard against inurement and private benefit. These conditions will be discussed in the Nonprofit Taxation section. b. Formation The Michigan Limited Liability Company Act (the MLLCA ) (MCL ) governs the formation, operation and dissolution of LLCs in Michigan. An individual, partnership, limited liability company, trust, custodian, estate, association, corporation, governmental entity, or any other legal entity, may organize an LLC, individually or jointly, by executing and filing articles of organization. An organizer of the LLC is not required to become a member of the LLC. The MLLCA requires certain information to be included in the articles of organization and it authorizes additional provisions to be included at the option of the organizers. The following provisions are required: The name of the LLC. The name must contain the words Limited Liability Company, or the abbreviation, LLC or LC. The name may not include the word Corporation or Incorporated or the abbreviation Corp. or Inc. Also, the LLC s name must be distinguishable from the registered or assumed name of any corporation, limited partnership, or other LLC that has filed with the Bureau. Organizers of the LLC may reserve a desired name by filing an Application for Reservation of Name with the Bureau of Commercial Services, Corporation Division ( The purposes for which the LLC is formed. The purpose may be specifically or generally stated. A general purpose statement, such as the limited liability company may engage in any activity within the purposes for which limited liability companies may be formed under [the MLLC] is often used. Street and mailing address of the LLC s registered office and the name of the LLC s resident agent. 17

18 Management by manager. If the business of the LLC is to be run by managers, a statement to that effect must be included. Duration if other than perpetual. At the option of the members, other provisions may be added to the articles of organization, including any provision required or permitted to be in an operating agreement under the act, as long as the additions do not conflict with Michigan law. In the event of a conflict between a provision contained in the articles and one contained in an operating agreement, the articles control. The articles may, but are not required, to set out the LLC s powers. An LLC s powers include all those necessary or convenient to effect any purpose for which the LLC is formed, including all the powers granted to corporations. Although more are permitted, only one organizer is required to sign the articles of organization. The articles of organization are then filed with the Michigan Department of Labor and Regulatory Affairs, Bureau of Commercial Services, Corporation Division. The articles may be filed either in person, by mail, or electronically. The cost of filing articles of organization is $50. The Michigan Department of Labor and Regulatory Affairs provides a basic articles of organization form ( The Corporation Division s website is _ ,00.html. c. Management and Control The MLLC does not require an operating agreement. If an LLC does not have an operating agreement, the statutory default provisions of the MLLCA control. If an LLC has an operating agreement, the agreement must be in writing. Typically, an LLC operating agreement among the members will govern the management of an LLC. The operating agreement which is like the articles of incorporation, bylaws and a shareholder agreement all in a single document may contain provisions requiring adherence to a social purpose and such purpose and the values it embodies may be interwoven throughout the operating agreement. LLC organizers have a great deal of flexibility in drafting the operating agreement. As there are few statutory requirements, the agreement can be as simple or as detailed as the organizers require. An LLC is managed either by its members collectively (decentralized management) or by managers (centralized management). If the articles of organization fail to specify that the LLC is to be run by managers, the LLC will be member-managed. If the LLC is 18

19 managed by managers, the operating agreement must either specify the exact number of managers or establish a procedure by which the number of managers will be determined. Managers are not required to be members of the LLC. The operating agreement may also address issues such as the qualification requirements and rights and responsibilities of managers and their term of office. A person may by admitted as a member of an LLC upon formation by signing the initial operating agreement. The MLLCA defines person as an individual, partnership, limited liability company, trust, custodian, estate, association, corporation, governmental entity, or any other legal entity. After formation of an LLC, a person can become a member by satisfying the requirements for membership contained in the operating agreement or, if there is no such provision, by the unanimous vote of the members entitled to vote. A person may also become a member by assignment as provided in MCL In an LLC with centralized management, unless otherwise provided in the articles of organization or operating agreement, each manager has one vote and the vote of a majority of all managers is required to decide or resolve any differences of opinion. In an LLC with decentralized management, unless the articles of organization or the operating agreement provide otherwise, each member has one vote. The operating agreement may establish and allocate the voting rights of members and may provide that certain members or groups of members have only limited voting rights or none at all. Unless the articles of organization or the operating agreement provide otherwise, approval of a matter submitted to members for a vote requires a vote of a majority in interest of all members entitled to vote. The articles or operating agreement may increase the percentage vote required but may not be decreased to below a majority vote. Regardless of whether an LLC has centralized or decentralized management, only the members (and not the managers) have the right to vote on certain essential matters, including the LLC s potential dissolution or merger and any amendments to the articles of organization. A member s property interest in an LLC can take two forms: (1) the right to receive distributions (profits) as a member and (2) the ownership of the membership interest itself. Under the MLLC, a membership interest is assignable in whole or in part, except as provided in the operating agreement. An assignment of a membership interest only entitles the assignee to receive, to the extent assigned, the distributions to which the assignor would otherwise be entitled. Unless otherwise provided in the operating agreement, an assignee of a membership interest in an LLC having more than one member may become a member only on the unanimous vote of the other members. Thus, the operating agreement may provide for free transferability of interests and the 19

20 admission of assignees as members. A member may withdraw from an LLC only as provided in the operating agreement. The MLLCA provides that unless the operating agreement provides otherwise, distributions are allocated in equal shares to all members. The operating agreement may allocate distributions on the basis of capital contributions or on any other basis. d. Limited Liability of Members and Managers An LLC is bound by the actions of every manager as an agent of the entity. A manager of an LLC is required to act in good faith, with the care an ordinarily prudent person in a similar circumstance would use and in conformity with what the manager perceives to be in the best interest of the LLC. Except as otherwise stated in the operating agreement, a member or manager is not personally liable for the acts, debts, or obligations of the LLC. However, just as with corporations, a court of equity may pierce the limited liability shield and impose personal liability on a member or manager under certain circumstances. Subject to certain exceptions, the operating agreement or articles of organization may eliminate or limit a manager s monetary liability to the LLC or its members for a breach of the manager s duty of care. The operating agreement may also, with limited exceptions, permit the LLC to indemnify a manager from any losses and liabilities the manager incurs while acting as manager. e. Merger, Dissolution and Term of Existence Two or more Michigan LLCs may merge pursuant to a plan of merger which requires the approval of the members of each LLC. Approval must be by the unanimous vote of the members entitled to vote unless the operating agreement provides otherwise. A Michigan LLC may also merge with other business organizations, which are defined under MCL a(1)(a) as domestic or foreign corporations, limited partnerships, general partnerships, or any other domestic or foreign business enterprises, incorporated or unincorporated (except Michigan LLCs). An LLC may either be the surviving entity or it may be merged into a corporation or limited partnership that will be the survivor. The LLC must prepare a plan of merger and submit it to the members of the constituent Michigan LLC for approval. A unanimous vote of the members entitled to vote in each constituent Michigan LLC is required for approval, unless an operating agreement of the constituent company provides otherwise. The MLLCA provides that an LLC will have a perpetual existence unless a specified time is otherwise provided in the articles of organization. The articles of organization or the operating agreement may provide for dissolution upon the happening of a specific event. 20