Summary of Entity Choices Under Pennsylvania Law
Business law is one of my particular favorite areas of practice within a broad general practice. What I like about the corporate practice is that I am doing something that benefits the parties. Many areas of practice can be strictly adversarial with a winner take all character. In business, the parties are buying, selling, making deals and both sides get some of what they want out of the transaction. I work with businesses and nonprofits that are large, medium and small. Our corporate and commercial services typically include corporate and entity formation, general corporate counsel, annual meetings, buying and selling businesses, financing, letters of credit, collections, joint ventures, partnerships and business combinations.
This guide is intended as a resource to assist entrepreneurs, companies, families and individuals who are starting or growing a business. One of the first steps is figuring out what form of organization best suits your needs. My goal is to explain the options and advantages and disadvantages of various possible entities for your business.
My experience extends well beyond the legal side of business. In addition to my forty one (41) years of practice, from 1985 to 2005 I was a factor, which means I financed businesses based on accounts receivables. I consider factoring to be a hybrid between lending and investing.
During those 20 years, I reviewed about 20 finance applications per year from companies that needed funds. When considering whether or not to fund a company, I had to understand the mechanics of each business, how they got their business, how they performed, whether they could deliver, how they got paid, who their customers were, where the pitfalls were, where the strengths were, what did the balance sheet and profit and loss statement show and whether the rewards were worth the risks. My work with these businesses also included letters of credit, foreign trade, overseas manufacturing, selling domestically and more.
Comparison of Entities
The Pennsylvania law under which corporations are created and operate is the Business Corporation Law of 1988 (“BCL”). 15 Pa. C.S.A. § 101, et. seq. The actual creation of a corporation occurs when the Department of State’s Bureau of Corporations accepts the filed Articles of Incorporation. Acceptable Articles of Incorporation must have the following, under 15 Pa. C.S.A. §1306:
- name, address, and signature of each incorporator;
- name of the corporation;
- Pennsylvania office address (cannot be a P.O. box);
- corporation’s duration;
- whether the incorporation is on a stock or non-stock basis;
- chosen number of shares the corporation is authorized to issue;
- definition of voting rights and designations, which must include any confines or special rights held by sharers;
- Docketing Statement (essentially a cover sheet with basic information about the new entity) ; and
- payment of the corporation fee (which is currently $125).
Each corporation must advertise its intention to file either before or after filing (15 Pa. C.S.A. § 1307). However, proof of advertising should only be filed in the company minutes, not sent to the Bureau of Corporations.
Next is the adoption of bylaws. A corporation’s bylaws structure the actions of its members by setting forth internal rules. This must occur at an organizational meeting, although the meeting does not need to take place in Pennsylvania. The BCL prohibits provisions that are contrary to the law and also requires the inclusion of certain provisions; for the most part, however, a corporation is granted plenty of latitude when writing bylaws.
The BCL’s requirements for bylaws include, among others, provisions related to:
- corporate records and inspection 15 Pa. C.S.A. §1508(d);
- liability for unlawful dividends and distributions 15 Pa. C.S.A. §1553(e);
- dissenters’ rights 15 Pa. C.S.A. §1571(f);
- rights of shareholders (such as notice requirements and the right to remove directors) 15 Pa. C.S.A. §1701(b) & 15 Pa. C.S.A. §1726(b); and
- prohibition against recklessness or willful misconduct 15 Pa. C.S.A. §1746(b).
Managing the Corporation
Three components that the BCL requires every corporation to have are shareholders, directors, and officers. Management of a corporation is under the direction and authority of the board of directors, unless the bylaws specify otherwise. Directors have a legal duty to act solely in the interests of the corporation (a fiduciary duty). Each member of the board also has a duty of loyalty, a duty of care, and is held to a standard of prudence, diligence, and good faith. Documents used in decision making, such as reports and opinions must come from people the director believes to be competent in preparing this information. 15 Pa. C.S.A. §1712. Interestingly, Pennsylvania is the only state where decisions may be influenced by social as well as economic factors, such as the decision’s impact on workers, the community or the region. 15 Pa. C.S.A. §1715(a).
Pennsylvania corporations must have a president, treasurer and secretary as officers who will execute the decisions made by the board of directors. However, these positions may be filled by a single person, or at least persons who fulfill the role of each position, regardless of their title. 15 Pa. C.S.A. §1732(a). These three officers are the minimum in Pennsylvania, but corporations are able to create additional officers in the bylaws. It is common for the bylaws to include a vice president, assistant secretary, or assistant treasurer. Assistants are helpful when corporate signatures are needed in a hurry.
Shareholders are the owners of the company and are responsible for vital decision making. Shareholders elect directors each year, for example, and they compel other major actions such as sale of assets.
Generally speaking, major policy decisions are carved out for shareholders (unless permissibly altered by the articles and bylaws) including such decisions as whether to dissolve or sell substantially all the assets of the corporation. The general day to day affairs are supervised by the board of directors who are like the parents of the family making the important day to day decisions for the corporation. The decisions and directions of the board of directors are carried out by the executive officers of the company. Often there is a senior executive (such as a “chief executive officer”). In more sophisticated corporations, there can be a chief operating officer and sometimes there is a chief information officer. Financial matters and bookkeeping are often under the direction of a chief financial officer or a controller. There can be other titles for these various offices as well.
Limitation of Liability
Corporations in Pennsylvania are recognized as legal persons independent and separate from the individual owners. A corporation has the right to own property, enter into contracts and bring legal suits, similar to an individual. This autonomy relieves shareholders of personal responsibility for debts or obligations accrued by the corporation, so long as the entity was duly incorporated and is compliant with the law. It is possible for shareholders, officers or directors to be found liable, although courts are reluctant to do so. This outcome is generally the result of criminality such as fraud and similar wrongs.
Pennsylvania corporations, like Pennsylvania people, are subject to taxation. Profits are subject to taxation before being distributed amongst shareholders and then a second time as the shareholder’s income.
The Internal Revenue Code (“IRC”), Subchapter “S” permits businesses which meet certain requirements to avoid double taxation. A corporation that elects to be an “S” Corporation does not retain its profits; rather, the profits “pass through” to the owners, subjecting them to only one round of taxation.
The definition of a legal partnership is “an association of two or more persons to carry on as co-owners a business for profit.” 15 Pa. C.S.A. §8311(a). Though the partnership agreement can be formed by either an oral contract or written contract, the latter is generally preferable. A contract is better for referencing in the future.
Partners have equal duties and rights in management unless they agree otherwise. 15 Pa. C.S.A. §8331(5). Majority rules in instances of disunity, with the exception of adding an additional partner; becoming a member of a partnership requires unanimous consent. 15 Pa. C.S.A. §8331(7).
Limitation of Liability
A general partnership provides no limitation of liability. Each partner shares equally in all liabilities of the business. 15 Pa. C.S.A. §8327. A partnership with limited liability (a limited liability partnership (“LLP”)) is a different type of entity and must register with the Department of State as such.
Under the IRC, a general partnership is treated as a “pass through entity.” Similarly to an “S” Corporation, profits are not retained by the partnership itself but pass through to partners’ tax returns. Income or losses are included on the income tax return of the partner. The rate of taxation is then determined by the personal or corporate rate that the partner is subject to.
In Pennsylvania, a limited partnership where there are limited partners in addition to the general partners is controlled by the Pennsylvania Revised Uniform Limited Partnership Act (“ULPA”). A limited partnership is created when a certificate of limited partnership is filed with the Department of State. 15 Pa. C.S.A. §8511. A certificate of limited partnership specifies:
- name and the address of the limited partnership;
- name and the address of each general partner;
- whether a partner’s interest in the limited partnership is to be evidenced by a certificate of partnership interest, a statement to that effect; and
- any other provision the partners elect to set forth in their certificate, provided it is not in contravention of Pennsylvania’s own provisions related to limited partnerships.
A partnership agreement is usually written, but the law does not require it to be. Admitting a person as a limited partner can be done orally, within a written partnership agreement, or with other writing stating the intent of the person to become a limited partner. Note, however, that there are certain provisions that Pennsylvania requires to be in writing in order to make those provisions binding, including the following:
- admission of additional partners who were not included in the certificate of limited partnership, 15 Pa. C.S.A. §8521(a);
- voluntary withdrawal of a partner, 15 Pa. C.S.A. §8553(a);
- manner in which profits and losses will be shared among the partners, 15 Pa. C.S.A. §8543;
- manner in which distributions of cash or other assets shall be allocated among the partners, 15 Pa. C.S.A. §8544;
- distributions in kind, 15 Pa. C.S.A. §8555; and
- non-judicial dissolution; 15 Pa. C.S.A. §8517(a)(2) and (4).
In a limited partnership, the role of a general partner remains the same as if in a general partnership. 15 Pa. C.S.A. §8533.Limited partners do not have the right to participate in the management of the partnership’s business except as specified in the partnership agreement. 15 Pa. C.S.A. §8522.
Limitation of Liability
The limited partners have the benefit of limited liability, whereas the general partners maintain the same liability as if they were members in a partnership that did not have any limited partners. 15 Pa. C.S.A. §8533(b).
Like a general partnership, in a limited partnership items of income, gain, and loss pass through to the owners in proportion to their ownership interests unless otherwise specified in the partnership agreement. Because neither capital stock nor foreign franchise taxes are imposed upon limited partnerships, they are very important and useful vehicles for owning real estate.
LIMITED LIABILITY PARTNERSHIPS
A limited liability partnership (“LLP”) is a general or limited partnership that chooses to register with the Commonwealth of Pennsylvania Department of State as an LLP. Generally, LLPs are professional partnerships, like law firms and accounting firms. The name of an LLP must contain the term “company”, “limited” or “limited partnership.”
To create an LLP, a partnership files a form called a Statement of Registration. The Statement of Registration must have the signature of at least one general partner and requires a filing fee of $125.00. Additionally, LLPs have an annual requirement to file a certificate of registration for the preceding year before April 15th. 15 Pa. C.S.A. §8221.
The partnership agreement should describe management, although most of the time the general partners manage the LLP.
Limitation of Liability
A Pennsylvania LLP’s general partners assume responsibility for the ordinary debts that a partnership may incur, such as contractual liabilities. However, in instances of negligent misconduct committed by another partner, the uninvolved partners are not personally liable. 15 Pa. C.S.A. §8204.
LLPs, like LPs and General Partnerships, are pass-through entities. Each partner’s share of income and loss is included on their income tax return.
LIMITED LIABILITY COMPANIES
The Pennsylvania Limited Liability Company Law of 1994 sets forth the requirements for Limited Liability Companies (“LLCs”) in Pennsylvania. 15 Pa. C.S.A. §8901. The owners of an LLC are referred to as members. To form, a Certificate of Organization is filed with the Department of State. The following must be included on the Certificate:
- name of the LLC;
- address of its initial registered office in Pennsylvania;
- name, address, and signature of each organizer of the LLC;
- whether a member’s interest in the company is to be evidenced by a certificate of membership interest, a statement to that effect;
- statement whether management of the LLC will be vested in managers; and
- Whether the company is a restricted professional company, the restricted professional services (such as medical, dentistry, optometry and the like) must be briefly described.
In Pennsylvania, in absence of a designation of management by appointed managers, the LLC is managed by its members. If there are to be appointed managers, the Certificate of Organization must specify so. 15 Pa. C.S.A. §8913. Whether managers are appointed or are members, they are deemed to have the managerial rights of general partners, which grants both types of managers the authority to bind the LLC. 15 Pa. C.S.A. §8904.
In some cases, it is advisable to include in the operating agreement, which is the agreement that controls the relationship among the members, provisions for a structure similar to a corporation in which the members act as directors who appoint officers for a term. This provides for a participating and decision making structure similar to a corporation but with the ease and benefits of operating an LLC.
Limitation of Liability
Members are not required to be responsible for potential liability. 15 Pa. C.S.A. § 8922(a). This feature sets LLCs apart from limited partnerships and is a major factor in the popularity of LLCs in the United States.
LLCs are especially appealing because owners maintain limited liability protection similar to that of a corporation but are taxed as partnerships for federal tax purposes, meaning they are pass-through entities. A single member LLC can elect to be treated as a corporation for tax purposes but is otherwise treated as a “disregarded entity” that is taxed on the owner’s tax return. However, when choosing an entity with which to do business in Pennsylvania, an important factor to consider is that LLCs are subject to Pennsylvania’s capital stock/ foreign franchise taxes. Since the foreign franchise tax applies to foreign LLCs, it is covered in the “Foreign Entities” section of this blog post.
The capital stock tax is a property tax imposed upon the value of a domestic corporation’s stock based upon the company’s taxable property and assets within Pennsylvania. An LLC is subject to the tax because it is imposed on a corporation as that term is defined in 72 Pa. C.S.A. § 7601(a) and it includes the limited liability company as a corporation. However, the capital stock/franchise tax is being gradually eliminated and is scheduled to be fully eliminated by 2016.
A registered corporation wishing to do business in Pennsylvania is subject to chapter 41 of the Business Corporation Law. 15 Pa. C.S.A. § 4101, et. seq. Prior to conducting business in Pennsylvania, foreign corporations must obtain a Certificate of Authority which is issued by the Department of State. 15 Pa. C.S.A. §4121(a). Without a certificate, foreign corporations are not able to bring suit in Pennsylvania. The application for a Certificate of Authority must include:
- name of the corporation;
- jurisdiction under which the corporation is incorporated;
- address of the corporation’s principal place of business in the state of incorporation;
- address of the corporation’s proposed registered office in Pennsylvania; or, alternatively, the name of a commercial registered office;
- statement that the purposes of the corporation involve pecuniary profit, as nonprofits must state that they are not incorporated for such purposes;
- any necessary government approval; and
- payment of the $250 fee.
Foreign corporations are required to advertise either their intention to apply for a Certificate of Authority or the application itself. Like domestic corporations, proof of publication should then be filed in the company minutes and not sent to the Department of State.
For tax purposes, once an application has been received, the Department of State sends to the foreign registrant the Pennsylvania Enterprise Registration Form (the PA Form 100). All entities must complete this form to register for certain taxes and services administered by the Pennsylvania Department of Revenue and the Pennsylvania Department of Labor and Industry.
A foreign LLP, a limited liability partnership formed in another state but doing business in Pennsylvania, is required to register with the Commonwealth in order to transact business in Pennsylvania. The protection from liability of partners in a foreign registered LLP may not be greater than is available to partners in a Pennsylvania LLP. 15 Pa. C.S.A. § 8211(c).
The Pennsylvania Department of State website has plenty of useful information. The Bureau of Corporations and Charitable Organizations has made available a number of forms to be used when filing new entities as well as making changes in existing entities. Visit Pennsylvania Department of State | Forms to access these forms.
The Bureau is open from 8:00 am to 5:00 pm Monday through Friday. The courier or personal delivery address for corporate documents is:
Department of State
Bureau of Corporations and Charitable Organizations
401 North Street
Harrisburg, PA 17120
The mailing address is:
Department of State
Bureau of Corporations and Charitable Organizations
P.O. Box 8722
Harrisburg, PA 17105-8722
You may reach the bureau by telephone by calling (717) 787-1057 between 8:00 am and 4:45 pm or by facsimile at (717) 783-2244.