D216 Business Law for Accountants - Set 4 - Part 2

Correct Answer: The duty of obedience

The duty of obedience requires the agent to follow the principal's lawful and clearly stated instructions. Selling below the clearly stated fifty-dollar floor disregarded a lawful, specific instruction, so the agent breached the duty of obedience. Option a is incorrect because performance concerns carrying out the agency with reasonable diligence and skill. The agent did act, but the wrong was ignoring a clear price instruction, which is disobedience; competence in effort is not the issue here. Option b is incorrect because loyalty concerns acting solely for the principal's benefit and avoiding conflicts or secret profit. Nothing shows the agent profited secretly or served another interest; the failure was disregarding a clear, lawful order. Option d is incorrect because accounting concerns keeping and rendering records of the principal's funds and property. The agent's error was selling under the instructed floor, an obedience failure, not any inability to account for money received.

Correct Answer: The duty of cooperation

The duty of cooperation bars a principal who grants an exclusive territory from competing there or appointing another to compete. By selling directly and adding a second agent in the exclusive state, Acme violated the duty of cooperation. Option a is incorrect because compensation concerns paying the agent the agreed or customary value for services. Acme's wrong was undercutting the exclusive territory, which obstructs performance, not any failure to pay the agent for work done. Option c is incorrect because safe working conditions concern providing a safe environment and warning of hazards. Competing inside the exclusive territory has nothing to do with workplace safety; it breaches cooperation by defeating the exclusive bargain instead. Option d is incorrect because indemnification concerns covering an agent's legal liability incurred on the principal's behalf. No lawsuit or judgment against the agent is involved; the violation is competing in the exclusive territory, breaching cooperation.

Correct Answer: The duty of indemnification

Indemnification requires the principal to cover the agent's legal liability, such as a judgment, incurred because of the principal's failure while the agent acted properly. The course anchor is that indemnification covers a lawsuit or judgment, which fits. Option a is incorrect because compensation is the principal's duty to pay for the agent's services, not to cover legal liability. A judgment the agent suffered for the principal is addressed by indemnification, a distinct obligation. Option b is incorrect because reimbursement covers out-of-pocket expenses and funds the agent advanced, not a court judgment. A lawsuit loss traceable to the principal is indemnification territory, so reimbursement misidentifies which principal duty answers these facts. Option c is incorrect because cooperation concerns assisting the agent and not obstructing performance. It does not address paying a judgment entered against the agent; that legal liability incurred for the principal belongs to the duty of indemnification.

Correct Answer: A sole proprietorship

The law treats any new single-owner business as a sole proprietorship automatically unless the owner adopts another form. She filed nothing and chose no structure, so by default her candle business is a sole proprietorship. Option b is incorrect because an LLC is a creature of statute that exists only after filing articles of organization. She filed nothing, so she cannot be an LLC; doing nothing leaves her in the default sole proprietorship form. Option c is incorrect because a partnership requires two or more co-owners of a business for profit. She is the only owner, so there is no partnership; a lone owner who files nothing operates as a sole proprietorship by default. Option d is incorrect because an S corporation requires incorporating under state law and then electing Subchapter S status. She never incorporated or made any election, so she is simply a sole proprietor by default, not a corporation.

Correct Answer: Yes, the owner has unlimited personal liability

In a sole proprietorship the owner is the business and bears unlimited personal liability for its debts. With no separate entity or shield, creditors can reach the owner's personal assets, including home equity and savings, to satisfy the debts. Option a is incorrect because a sole proprietorship provides no separation between business and personal assets. The owner is personally liable for all business debts, so creditors are not limited to business property and may pursue personal wealth directly. Option b is incorrect because a sole proprietorship offers no liability shield whatsoever. That protection comes from forms like the LLC or corporation; the sole proprietor and the business are one, leaving personal assets fully exposed to creditors. Option d is incorrect because recovery is not confined to the truck. With unlimited personal liability, creditors may reach the owner's other personal assets, such as savings and home equity, so limiting collection to one piece of equipment is wrong.

Correct Answer: A general partnership

A general partnership forms when two or more persons carry on a business as co-owners for profit, and it can arise by conduct with no filing. Sharing profits and management as joint owners creates one even without a written agreement. Option b is incorrect because a limited partnership is a statutory creation requiring a filed certificate of limited partnership. These friends filed nothing, so they cannot form an LP; their conduct as co-owners instead creates a general partnership by default. Option c is incorrect because a corporation never arises by default or by conduct. It requires incorporating under state law and filing articles of incorporation, none of which occurred, so the friends' venture is a general partnership. Option d is incorrect because they jointly own one business and share its profits and management, which is co-ownership, not two solo ventures. Co-owning a for-profit business together makes them partners in a general partnership rather than sole proprietors.

Correct Answer: Yes, under joint and several liability

Under joint and several liability, the rule in most states, a creditor may sue any one partner separately for the full obligation, even a partner who neither participated nor knew of the conduct. The creditor may pursue the innocent partner. Option a is incorrect because liability is not confined to the partner who made the deal. Joint and several liability makes every partner fully answerable for partnership obligations, so a creditor can hold a non-acting partner fully liable. Option b is incorrect because innocent partners are not immune from partnership debts. Joint and several liability reaches even a partner who did not participate or know, so lack of involvement does not shield that partner from full liability. Option c is incorrect because the creditor is not limited to a proportional share against one partner. Joint and several liability allows recovery of the full obligation from any single partner, who may later seek contribution from the others.

Correct Answer: Yes, early withdrawal breaches a term partnership

In a partnership for a term, withdrawing before the term ends is a breach of the agreement, and the withdrawing partner can be liable for resulting damages. Leaving eighteen months into a three-year term without justification is wrongful dissociation. Option a is incorrect because the freedom to leave anytime without liability belongs to a partnership at will, not one for a fixed term. Here a definite three-year term existed, so premature withdrawal is a breach, not a cost-free departure. Option c is incorrect because partnerships can absolutely have a fixed term or a specific undertaking. This one ran three years to finish a project, so leaving early breaches that term; the claim that terms never exist is false. Option d is incorrect because the wrongfulness of the early exit does not depend on whether the partnership profits. Withdrawing before the agreed term ends is a breach regardless of the firm's financial results, exposing the departing partner to damages.

Correct Answer: One vote each and no default salary

By default each partner gets one vote regardless of capital contributed, and partners are not entitled to a salary, only a share of profits, unless they agree otherwise. So voting is equal and no salary is owed absent agreement. Option a is incorrect because voting does not track capital by default and no salary is owed automatically. Partners get one vote each unless they agree otherwise, and compensation is normally a profit share, so both parts fail. Option b is incorrect because default voting is one partner one vote, not weighted by contribution. It rightly says no salary applies by default, but the unequal-vote premise is wrong, so the option does not state the rule. Option d is incorrect because although votes are equal by default, no salary is automatic. A partner's default pay is a share of profits, not a salary, so claiming a salary applies without agreement misstates the compensation default.

Correct Answer: No, liability limited to her investment

A limited partner who does not manage the business is not personally liable for partnership debts beyond the amount invested. Because she stayed a passive investor and never managed, creditors cannot reach her personal assets past that investment. Option b is incorrect because a limited partner is not free of all exposure; her investment itself is at risk. She simply is not liable beyond that contributed amount, so saying she owes nothing at all overstates the protection. Option c is incorrect because only the general partner in an LP faces unlimited liability. The limited partner's liability is capped at her investment as long as she does not manage, so treating all partners as unlimited misdescribes the structure. Option d is incorrect because contributing capital is exactly what a limited partner does and does not expand her liability. Her investment is at risk, but her personal assets beyond it stay protected because she never crossed into management.

Correct Answer: She may lose her limited-liability protection

A limited partner who takes part in managing the business risks losing limited-liability protection and being treated like a general partner toward those who reasonably believed she was one. Her active management exposes her personal assets to that creditor. Option a is incorrect because limited partners may not manage freely without consequence. The bargain trades limited liability for staying out of management, so directing daily operations jeopardizes her protection rather than leaving her status untouched. Option b is incorrect because managing does not automatically make her the sole general partner or remove anyone else. The consequence is that she risks losing her liability shield toward those who reasonably relied, not a wholesale structural change. Option d is incorrect because a limited partner's participation in management does not transform the LP into a corporation. Entity conversion requires separate statutory steps; her conduct simply threatens her own limited-liability protection, leaving the LP intact.

Correct Answer: A limited liability limited partnership

A limited liability limited partnership is an LP in which even the general partner's liability is capped at the investment, so all partners enjoy limited liability. That distinguishing feature, a shielded general partner, is exactly what the group wants. Option b is incorrect because an ordinary general partnership exposes every partner to unlimited personal liability. It provides no shield at all, so it is the opposite of a structure that caps the general partner's exposure to the amount invested. Option c is incorrect because in a standard limited partnership the general partner still bears unlimited liability. Only the limited partners are shielded, so an ordinary LP does not give the general partner the capped liability the group seeks. Option d is incorrect because a sole proprietorship has one owner with unlimited personal liability and no partners at all. It cannot describe a multi-partner arrangement, let alone one that limits a general partner's liability, so it does not fit.

Correct Answer: A limited liability company

A limited liability company is the hybrid that combines a corporation's limited liability with a partnership's pass-through taxation, and its owners are called members. That exact pairing of features, plus the member terminology, identifies the LLC. Option a is incorrect because a general partnership offers pass-through taxation but no limited liability, and its owners are partners, not members. It fails the limited-liability half of the request, so it cannot be the hybrid described here. Option b is incorrect because a C corporation provides limited liability but is subject to double taxation, not pass-through treatment, and its owners are shareholders. It misses the single-taxation feature and the member terminology the founders want. Option d is incorrect because a sole proprietorship has a single owner with unlimited personal liability. It provides neither limited liability nor multiple members, so it cannot match a hybrid built for several owners seeking a corporate-style shield.

Correct Answer: By piercing the veil for commingling

Courts may pierce the LLC veil and impose personal liability where members flagrantly disregard formalities, most commonly by commingling personal and business funds. The member's use of the account as a personal piggy bank is exactly that kind of abuse. Option a is incorrect because LLC members are generally shielded, with liability capped at their investment. Personal liability is the exception, reached through veil-piercing for serious abuse like commingling, not an ever-present default applying to every member. Option c is incorrect because the LLC form does limit members' liability in the ordinary case. The shield can be lost through veil-piercing for flagrant abuse, but that is an exceptional remedy, not proof that the form never protects owners. Option d is incorrect because single-member LLCs are lawful and permitted in most states. The court's basis for reaching the member is abuse of the form through commingling, not any supposed illegality of owning an LLC alone.

Correct Answer: As a partnership, a pass-through entity

A multi-member LLC is taxed as a partnership by default, a pass-through entity with no entity-level income tax, so profits flow to members who report them personally. The described treatment, no company tax and member-level reporting, is partnership taxation. Option a is incorrect because corporate taxation with double tax is an election, not the default for a multi-member LLC. By default the LLC is a pass-through taxed like a partnership, so no entity-level tax applies without an election. Option b is incorrect because disregarded-entity treatment applies to a single-member LLC taxed like a sole proprietorship. This LLC has multiple members, so its default classification is partnership taxation, not the single-owner disregarded-entity approach. Option c is incorrect because the income is taxed once at the member level, not untaxed entirely. Pass-through means the entity pays no income tax but the members do on their shares, so saying neither pays any tax is wrong.

Correct Answer: Member-managed, decisions by member majority

Unless the articles specify otherwise, an LLC is member-managed by default, meaning all members participate and decisions are typically made by a majority of the members. With the articles silent, that default member-managed, majority-rule structure applies here. Option a is incorrect because hiring outside managers describes the manager-managed option, which must be chosen, not the default. By default all members manage, so professional outside managers are not required unless the members affirmatively elect them. Option b is incorrect because the default does not concentrate control in one appointed member. Member-managed LLCs give all members a role, with ordinary decisions made by majority, so a single member controlling everything is not the default. Option d is incorrect because the state secretary merely receives filings and never manages a private LLC. Management by default rests with the members themselves, acting by majority, so pointing to a state official misidentifies who runs the company.

Correct Answer: Double taxation of a C corporation

A C corporation is a separate legal person taxed at the entity level on profits and again at the shareholder level on dividends. That two-layer structure is double taxation, the defining tax disadvantage of the corporate form described here. Option a is incorrect because partnership pass-through taxation is taxed only once, at the owner level, with no entity-level income tax. The scenario describes two layers of tax, the opposite of pass-through treatment, pointing instead to a C corporation. Option c is incorrect because an LLC by default is a single-taxation, pass-through entity, not one taxed twice. The described entity-plus-dividend taxation is corporate double taxation, so attributing it to an LLC's default treatment is incorrect. Option d is incorrect because a tax-exempt nonprofit is organized for a non-profit purpose and generally avoids income tax on mission activities. The scenario describes a for-profit entity taxed twice, a C corporation, not any tax-exempt structure.

Correct Answer: Electing S corporation status

Electing Subchapter S status lets a qualifying corporation keep limited liability while income passes through to shareholders and is taxed once. With few individual U.S. shareholders and one class of stock, the corporation qualifies to make the S election. Option a is incorrect because converting to a general partnership would strip away the limited liability the corporation wants to keep. Pass-through taxation with a retained liability shield comes from an S election, not from abandoning the corporate form. Option b is incorrect because a benefit corporation is defined by its public-benefit purpose and reporting, not by any pass-through tax treatment. Filing as one does not eliminate corporate-level tax, so it fails to accomplish the single-taxation goal. Option c is incorrect because alien corporation status merely describes a company formed in another country doing business in the United States. It is a classification by origin, not a tax election, and it does nothing to secure pass-through taxation.

Correct Answer: Corporate shareholder and two stock classes

An S corporation must have only individual eligible shareholders and one class of stock. This company fails on both counts because a corporation owns shares and it has issued two classes of stock, either of which alone defeats the election. Option a is incorrect because no minimum shareholder count disqualifies an S corporation; the limit is a ceiling of one hundred. Having few owners is fine, so the real defects are the corporate shareholder and the second stock class. Option b is incorrect because being organized under state law is exactly what a domestic corporation is, which S status requires. State incorporation helps eligibility, so the disqualifiers are instead the corporate shareholder and the two classes of stock. Option d is incorrect because S corporations are closely held, not publicly held; a public market is not required and would be atypical. The genuine barriers here are the ineligible corporate shareholder and the prohibited second class of stock.

Correct Answer: A bond, a debt security

A bond is a debt security under which the corporation borrows from an investor who becomes a creditor, repaid principal at maturity with fixed interest. The described instrument, with no ownership stake and a promise to repay, is a bond. Option a is incorrect because common stock is an equity security representing ownership with voting rights, not a loan. The investor here is a creditor promised repayment with interest, which describes debt, so a bond rather than common stock fits. Option c is incorrect because preferred stock is equity representing ownership with dividend priority, not a debt owed at maturity. The holder described is a lender and creditor, not an owner, so the instrument is a bond, not preferred stock. Option d is incorrect because a preemptive right is a shareholder's chance to buy newly issued shares to avoid dilution, not a security an investor lends against. It is neither debt nor equity, so it cannot describe this bond.