What issues should be considered when forming an entity?

After the legal form of the entity has been selected, you should consider the following matters while preparing to establish the entity: (1) the jurisdiction of the entity and (2) the governance structure (including how the entity will be governed and who will be responsible).

Key considerations:

  • What is jurisdiction?
  • What jurisdiction should I select for my Water Fund?
  • Who will govern/manage the entity?

What is jurisdiction?

For the purposes of forming an entity, jurisdiction refers to the territory within which a court or government agency may properly exercise its power. For example, the state of Delaware is a separate jurisdiction from the state of California, just as Japan is a separate jurisdiction from the United States. When an entity is formed in a given jurisdiction it is then subject to the laws of that jurisdiction. These laws govern the types of entities that can be created within that jurisdiction as well as the default rules that apply to each entity’s structure and governance.

What jurisdiction should I select for my Water Fund?

Selecting the jurisdiction of an entity is one of the first items that needs to be decided before forming an entity as the jurisdiction choice will dictate the sort of entity that can be formed, the filings that need to be made, and other formalities that need to be observed in order to establish and operate the entity. 

A number of considerations inform the selection of a jurisdiction for a Water Fund:

  • Principal Place of Business

    First, a logical choice for the jurisdiction of organization of a water fund would be where the water fund’s principal place of business will be. The principal place of business is the primary location where an entity’s business is performed. It is generally where management of the entity is located and where the books and records or main facilities of the entity are located. A convenient way to think of the principal place of business is the headquarters of the entity. It makes sense to form an entity where the principal place of business is located because it can limit the administrative burden of also filing to do business (to obtain qualification to do business as a foreign corporation) in an alternate jurisdiction (as further described below) and because there will likely be legal and other experts in close proximity to the entity’s principal place of business that will be available to advise the entity with respect to entity formation, corporate governance, and local tax questions.

  • Places Where Business Will be Conducted

    Another option is to form an entity in the jurisdiction in which most of the business of the water fund will be located or where the water fund will mostly operate, even if that jurisdiction is not, as a legal matter, the principal place of business of the entity. There are several reasons why a water fund might be formed in the jurisdiction where its operations will be conducted rather than its principal place of business, among them, it could be the case that the laws in the jurisdiction where some of the operations will be conducted are preferable. It could also be the case that there are third party contributors who would like to invest in the water fund that would prefer for the water fund to be formed in a particular jurisdiction for tax or other reasons, such as currency exchange restrictions or intellectual property protection.

  • Preferable Legal Regimes

    One could also choose to form a water fund in a jurisdiction, regardless of whether that jurisdiction is where the principal place of business or the majority of operations are located, that allows for corporate forms or certain legal rules that would be preferable to the water fund. Given the variation in corporate structures allowed among different jurisdictions and the laws applicable to them, it can make sense for a water fund to be formed in a jurisdiction whose laws best enable the goals, corporate structural needs, and tax needs of the water fund. For example, an individual may want to form a Delaware limited liability company for the relative flexibility it affords with respect to corporate governance and the speed with which an entity can be established, despite the water fund having no physical presence or other nexus to the State of Delaware. One thing to note is that while jurisdictions like Delaware will generally freely allow foreign entities to form in its state, despite not having physical presence in the state, there are likely jurisdictions that will require an entity to have a physical presence in the jurisdiction or some other type of connection to the jurisdiction in order to form an entity therein.

  • Non-profit Considerations

    Non-profit entities have additional matters to consider in deciding their jurisdiction of incorporation, including state-specific chartable solicitation rules associated with seeking donations from the public, which may require a separate registration with state authorities, particularly for a “foreign” non-profit corporation incorporated in another state. Since the costs of maintaining a qualification as a foreign corporation may be more onerous to a non-profit than to a for-profit corporation, a non-profit corporation may wish to consider more seriously incorporating in the state where most of its activities will occur, in order to minimize such foreign corporation registration costs.

Who will govern/manage the entity?

Partnership

A limited partnership is generally managed by a general partner. The person or entity serving as general partner is liable for all liabilities of the partnership incurred while such person is general partner. By contrast, the limited partners of a partnership generally have no liability with respect to the obligations of the partnership, but also have no decision-making power, although they hold economic rights.

Limited Liability Company

A limited liability company can be governed/managed by one or more members—called a member-managed LLC—or a manager or group of managers—a manager-managed LLC. The members of a limited liability company are those who hold equity in the limited liability company.

Two types of management:

  • Member-Managed

    The members of a member-managed limited liability company have the authority to manage, operate, and control the affairs of the company by a vote of the members. If the LLC is a single-member member-managed LLC, then that member alone will have decision-making authority over the entity.

  • Manager-Managed

    A manager-managed LLC can either be managed by a manager appointed by the members, or may be managed by a board of managers (which can be members and non-members alike) selected by the members who will have the authority to manage, operate, and control the LLC. Members can, in the organizational documents of the LLC, delegate all authority for governing the LLC to the manager or managers. Alternatively, the members can reserve certain decision-making authority to themselves, and allow the manager or managers to only make certain decisions and take certain actions on behalf of the LLC.

Corporation

Generally both for-profit and non-profit corporations are governed by a board of directors who are elected to serve for terms of one year or more. The board of directors is ultimately responsible for the management of the corporation, however it can delegate its responsibility to officers responsible for the day-to-day operations of the corporation. That said, under the laws of most U.S. jurisdictions, certain corporate actions, generally significant changes to the corporation such as merging with another entity or dissolving the entity, must be approved by the Board and cannot be delegated to officers.

Fiduciary Duties of Directors of For-Profit Corporations: Under the laws of most U.S. jurisdictions, the directors of a corporation owe fiduciary duties of (i) care and (ii) loyalty to the corporation and its shareholders.

  • Duty of Care

    The Board’s duty of care requires directors to act with the care that a person under similar circumstances would reasonable believe to be appropriate under certain circumstances. The Board’s duty of care requires it to act in an informed manner after fully considering the information available to it and deliberating issues fully as a board.

  • Duty of Loyalty

    The Board’s duty of loyalty requires it to act in the best interests of the Company and its stockholders and not out of the self-interest of its members. The members of the Board must not act out of personal motivations such as financial gain or entrenching the members of the Board.

Role of Directors

Directors generally can fulfill these duties by regularly attending board meetings, diligently reviewing materials provided to the Board, intelligently engaging in board discussions, and disclosing any conflicts of interest to the Board and corporation so remedial measures can be taken. Directors must observe these duties in taking actions on behalf of the corporation and in some cases directors can face personal liability for breach of these duties.

Roles and responsibilities:

  • Fiduciary Duties of Directors of Non-Profit Corporations

    The board of directors of a non-profit is responsible for ensuring the non-profit fulfills its mission, is well-managed and remains fiscally sound. The fiduciary duties of non-profit corporation directors are similar to those of for-profit directors, including the duties of care and loyalty. However, there may be differences in some jurisdictions. For instance, directors of a non-profit organization typically do not owe fiduciary duties to the members of a non-profit corporation (to the extent that are any – members do not have a financial stake in the organization). Directors of non-profit corporations instead may owe duties, in addition to the corporation, to those served by the non-profit corporation and (when funds are earmarked for specific activities) to the non-profit’s donors.

  • Duty of obedience

    Directors of a non-profit may owe a duty of obedience to understand and act to promote the non-profit’s mission. In some jurisdictions, including the State of California, no more than 49% of a tax exempt non-profit corporation’s directors may be “interested” in the non-profit, meaning that they or a family member receive compensation for services rendered to the entity.

In the case of each of the entity types listed above, the initial general partner, members, managers, and directors (as applicable) will typically be identified in either the initial governance documents of the entity or in resolutions or written consents adopted or executed in connection with the entity’s formation.

Role of Board Advisory Committees

The Board may also delegate its oversight of certain issues to committees of the board, which can be composed of a subset of the board members who have either interest or special expertise in certain matters. Many boards have committees such as a compensation committee (that reviews matters of executive compensation), audit committee (that supervises the internal accounting controls of the company and engages with auditors in annual audits), nomination and corporate governance committee (that nominates directors for election to the board and reviews the entity’s corporate governance procedures), among others. Generally, a board will draft a charter for any standing committee it creates. The charter will set forth the responsibilities of the committee, guidelines for appointing members to the committee, and authorize the committee to take certain actions.