1. © 2007 West Legal Studies in Business, A Division of Thomson Learning Chapter 24 Sole Proprietorships, Partnerships, and Limited Liability Companies

2. © 2007 West Legal Studies in Business, A Division of Thomson Learning 2 Which form of business organization is the simplest? Which form arises from an agreement between two or more persons to carry on a business for profit? What are the three essential elements of a partnership? What is meant by joint and several liability? Why is this often considered to be a disadvantage of the partnership form of business? Why do professional groups organize as a limited liability partnership? How does this form differ from a general partnership? What is a limited liability company? What are some of the advantages and disadvantages of this business form? Learning Objectives

3. © 2007 West Legal Studies in Business, A Division of Thomson Learning 3 Introduction Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: –Ease of creation. –Owners’ liability. –Tax considerations. –Need for Capital.

4. © 2007 West Legal Studies in Business, A Division of Thomson Learning 4 AdvantagesDisadvantages Owner is in complete control & receives all profits Owner is personally liable for all torts/contracts FlexibilityLacks continuity after death Ease of creation; maintenance Difficult to raise financing Sole Proprietorships The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship.

5. © 2007 West Legal Studies in Business, A Division of Thomson Learning 5 The Law Governing Partnerships Partners are agents and fiduciaries of one another, but differ from agents in that they are also co-owners and have equal rights to manage and share in the profits and losses. If a commercial enterprise shares profits and losses, a partnership will be inferred. Uniform Partnership Act.

6. © 2007 West Legal Studies in Business, A Division of Thomson Learning 6 The Law Governing Partnerships In the absence of a partnership agreement (oral or written) state statutes govern the rights among partners: –Management: equal, each one vote, majority wins; need unanimous consent for some actions. –Partnership Interest: equal profits, losses shared as profits shared. Uniform Partnership Act.

7. © 2007 West Legal Studies in Business, A Division of Thomson Learning 7 Definition of Partnership (General) Partnership is an “association of two or more persons to carry on business for profit as co-owners a business for profit.” (UPA) AdvantagesDisadvantages Easy to create and maintainPartners are personally liable for all torts/contracts Flexible, informalDissolved upon death Partners share profits and losses equally Difficult to raise financing

8. © 2007 West Legal Studies in Business, A Division of Thomson Learning 8 Partnership Status Sharing profits or losses. Joint ownership of the business. Equal right in the management of the business. No inference if: –Debt. –Wages. –Rent. –Annuity. –Sale of goodwill. CASE 24.1 Cap Care Group, Inc. v. McDonald (2002).

9. © 2007 West Legal Studies in Business, A Division of Thomson Learning 9 Partnership Status Today, many states recognize the partnership as a separate legal entity for the following purposes: –To sue and be sued (for federal questions, yes; for state questions, differs). –To have judgments collected against it’s assets, and individual partners’ assets.

10. © 2007 West Legal Studies in Business, A Division of Thomson Learning 10 Joint Property Ownership and Property Status Partnerships are recognized as separate legal entities (cont’d): –To own partnership property. –To convey partnership property. At common law -- property owned in tenancy in partnership, all partners had to be named and sign the conveyance. Under UPA partnership property can be held and sold in firm name. Entity vs. Aggregate.

11. © 2007 West Legal Studies in Business, A Division of Thomson Learning 11 Partnership Formation Generally, agreements to form a partnership can be: –Oral. –Written, or –Implied by Conduct.

12. © 2007 West Legal Studies in Business, A Division of Thomson Learning 12 Partnership Formation Partnership agreements (Articles of Partnership) can be oral unless Statute of Frauds requires a written agreement. Practically, agreements should be in writing. Partners must have legal capacity. UPA permits corporations to be a partner. A Corporation as a Partner. Partnership By Estoppel: parties who are not partners hold themselves out to 3rd Parties and 3rd Party relies to her detriment.

13. © 2007 West Legal Studies in Business, A Division of Thomson Learning 13 Rights of Partners Management: equal, each one vote, majority wins; need unanimous consent for some actions. Partnership Interest: equal profits, losses shared as profits shared. Compensation: generally, none.

14. © 2007 West Legal Studies in Business, A Division of Thomson Learning 14 Rights of Partners Inspection of the Books: always and also by rep. of deceased partner. Accounting: when other partner(s) committing fraud, embezzlement, wrongful exclusion, or anytime it is just and reasonable. Property Rights 

15. © 2007 West Legal Studies in Business, A Division of Thomson Learning 15 Rights of Partners Each partner has a property right, which includes: –An interest in the partnership. –A right in specific partnership property. –A right to participate in the management of the partnership, as mentioned above.

16. © 2007 West Legal Studies in Business, A Division of Thomson Learning 16 Duties and Liabilities of Partners Fiduciary Duties: Partners are fiduciaries and general agents of one another and the partnership. Authority of Partners: Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity. Scope of Implied Powers. –CASE 24.2 Helpinstill v. Regions Bank (2000).

17. © 2007 West Legal Studies in Business, A Division of Thomson Learning 17 Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her. Joint and Several Liability for Torts: 3rd party can sue either one or all partners. 3rd party may collect against personal assets of all partners. Liability of Incoming Partner & Outgoing Partner. Newly admitted partner has no personal liability for existing partnership debts and obligations. Duties and Liabilities of Partners

18. © 2007 West Legal Studies in Business, A Division of Thomson Learning 18 Partner’s Dissociation Occurs when a partner ceases to be associated with the carrying on of partnership business. Events causing dissociation: –Giving notice of withdrawal. –Contractual event. –Expelled. –Bankruptcy, assignment to creditors, incapacity or death. Wrongful Dissociation. Effects of Dissociation.

19. © 2007 West Legal Studies in Business, A Division of Thomson Learning 19 Partnership Termination Dissolution (termination) can occur for a variety of reasons: –Partners agree to terminate. –Partner’s withdrawal can terminate. Termination has two stages: –Dissolution and “Winding Up” (actual process of collecting and distributing the partnership assets).

20. © 2007 West Legal Studies in Business, A Division of Thomson Learning 20 Dissolution By Acts of the Partners: –Partners can agree to Agreement. –Partner’s Withdrawal. Partnership for term – breach. No term -- no breach. –Admission of a new partner. –Not a transfer of a partner’s interest. By assignment or attachment by creditor.

21. © 2007 West Legal Studies in Business, A Division of Thomson Learning 21 Dissolution By Operation of Law: –Death of a partner. –Bankruptcy of a partner. –Bankruptcy of partnership. –Illegality.

22. © 2007 West Legal Studies in Business, A Division of Thomson Learning 22 Winding Up Partners have no authority after dissolution occurs except to: –Complete transactions already begun. –Wind up by collecting and preserving partnership assets, discharging liabilities, and accounting to each partner for the value of his share.

23. © 2007 West Legal Studies in Business, A Division of Thomson Learning 23 Winding Up If partner has violated the partnership agreement, he: –Must pay damages. –May not participate in winding up. –But other partners may choose to continue. If partner dies: –Other partners act as fiduciaries. –Accounting to deceased partner’s estate. –Survivors get paid for their services.

24. © 2007 West Legal Studies in Business, A Division of Thomson Learning 24 Winding Up Partnership obligations are paid in the following order: –First, 3rd party creditors. –Second, partner loans to partnership. –Third, return of capital contributions. –Fourth, distribution of the balance, if any to partners.

25. © 2007 West Legal Studies in Business, A Division of Thomson Learning 25 Limited Liability Partnerships Creature of state statute, similar to an LLC, except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants). LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

26. © 2007 West Legal Studies in Business, A Division of Thomson Learning 26 Liability in an LLP Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets. The LLP allows professionals to avoid personal liability for the malpractice of other partners. Supervising Partner is also liable for acts of subordinate.

27. © 2007 West Legal Studies in Business, A Division of Thomson Learning 27 Family Limited Liability Partnerships FLLP is a limited liability partnership in which the majority of the partners are related to each other. Used frequently for agriculture.

28. © 2007 West Legal Studies in Business, A Division of Thomson Learning 28 Limited Partnerships Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner. Limits the liability of some of its owners (the limited partners) to their investment. A LP is a creature of state statute. Filing a certificate with the Secretary of State is required.

29. © 2007 West Legal Studies in Business, A Division of Thomson Learning 29 LP -- Rights and Liabilities The General partner assumes all management and personal liability. General partners are personally liable to 3 rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability.

30. © 2007 West Legal Studies in Business, A Division of Thomson Learning 30 LP – Rights and Liabilities Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. –CASE 24.3 Smith v. Fairfax Realty, Inc. (2003). Limited partners have the right to inspect the LP’s books.

31. © 2007 West Legal Studies in Business, A Division of Thomson Learning 31 LP – Dissolution On dissolution, the limited partner is entitled to return of capital contributions. LP interests are considered securities and regulated by both federal and state securities laws. Limited partners’ liability is limited to the capital investment.

32. © 2007 West Legal Studies in Business, A Division of Thomson Learning 32 LP – Dissolution Dissolved in much the same way as a general partnership (Chapter 33). Retirement, withdrawal, death bankruptcy or mental incompetence of a general partner will trigger dissolution unless the remaining GP’s consent to continue. Creditors are paid first then partners.

33. © 2007 West Legal Studies in Business, A Division of Thomson Learning 33 Limited Liability Limited Partnerships Limited Liability Limited Partnership is a type of limited partnership. Difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment. Most states do not allow for LLLP’s.

34. © 2007 West Legal Studies in Business, A Division of Thomson Learning 34 Nature of the Limited Liability Company Like corporations, LLC’s are creatures of state law. The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). Members of an LLC enjoy limited liability. Can a third party pierce the LLC “veil” and hold managing member liable?

35. © 2007 West Legal Studies in Business, A Division of Thomson Learning 35 LLC Formation Articles of Organization require: –Name of Business. –Principal Address. –Name and Address of Registered Agent. –Names of the Owners; and –How the LLC will be managed. Business name must include LLC or Limited Liability Company.

36. © 2007 West Legal Studies in Business, A Division of Thomson Learning 36 Jurisdictional Requirements An LLC is a legal entity separate from its owners. For federal jurisdiction based on diversity, an LLC may be treated differently than a corporation. For diversity purposes the citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions.

37. © 2007 West Legal Studies in Business, A Division of Thomson Learning 37 Advantages and Disadvantages of the LLC AdvantagesDisadvantages Member liability is limited to amount of investment. State statutes are not uniform. Can be treated as a “pass through” entity for tax purposes. Not all states recognize LLC’s. Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

38. © 2007 West Legal Studies in Business, A Division of Thomson Learning 38 The LLC Operating Agreement Operating agreement is analogous to corporation’s bylaws. Operating agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues. Generally, if the operating agreement is silent, courts will apply partnership principles.

39. © 2007 West Legal Studies in Business, A Division of Thomson Learning 39 Management of an LLC There are two options for management, generally set forth in the articles of organization: –Member-Managed: all of the members participate in management, like a partnership. –Manager-Managed: members are elected to manage the LLC. If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.

40. © 2007 West Legal Studies in Business, A Division of Thomson Learning 40 Operating Procedures Members can set forth LLC decision- making procedures in operating agreement. Operating agreement can include: –Meeting protocols. –Voting rights.

41. © 2007 West Legal Studies in Business, A Division of Thomson Learning 41 Special Business Forms Joint Venture: two or more entities combine efforts or property for a single transaction or project. Unless agreed otherwise, JV’s share profits and losses equally. Common in international transactions when U.S. companies wish to expand overseas.

42. © 2007 West Legal Studies in Business, A Division of Thomson Learning 42 JV Characteristics Resembles a partnership and is taxed like a partnership. However, a JV is limited in time and scope, whereas a partnership is an ongoing business. Other differences: –JV members has less implied and apparent authority than partners. –Death of JV member does not terminate JV. JV members can specify duration. If not, then JV terminates when purpose is accomplished.