The Entrepreneur’s Options

1. BUSINESS LAW TODAYEssentials 9th Ed.Roger LeRoy Miller - Institute for University Studies, Arlington, TexasGaylord A. Jentz - University of Texas at Austin, Emeritus Chapter 19 The Entrepreneur’s Options

2. Learning Objectives • What are some of the major forms of business organization used by entrepreneurs in the United States? • What advantage and disadvantage are associated with each major business form? • Why have limited liability companies and limited liability partnerships come into widespread use in recent years? • What is a joint venture? What are some other special business organizational forms, and why are they used? • What is a franchise, and how does a franchising relationship arise?

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. Sole Proprietorships The owner is the business itself; anyone who does business without creating a separate legal business organization is a sole proprietorship.

5. Partnerships • Partnership arises from agreement, express or implied, between two or more persons to carry on a business together for profit. • 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. • Law: Uniform Partnership Act.

6. Uniform Partnership Act • In the absence of an express partnership agreement (oral or written) most states have enacted the UPA to 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.

7. When Does a Partnership Exist? • Intent to associate is a key element of a partnership, and all “partners” must consent. • Three key elements: • A sharing of profits and losses, AND • A joint ownership of the business, AND • An equal right to be involved in the management of the business.

8. Partnership Formation • Generally, agreements to form a partnership can be: • Oral. • Written, or • Implied by Conduct. • Duration. • Partnership agreement can specify duration. • If limited, called “Partnership for a Term.”

9. Partnership Formation • Partnership agreements (Articles of Partnership) should be written. • Partners must have legal capacity. UPA permits corporations to be a partner. • Partnership By Estoppel: parties who are not partners hold themselves out to 3rd Parties and 3rd Party relies to her detriment.

10. 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.

11. 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 

12. 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.

13. 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. • Authorized vs. Unauthorized Actions.

14. Liabilities of Partners • 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. Newly admitted partner has no personal liability for existing partnership debts and obligations.

15. 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 the limited partners to their investment. • An LP is a creature of state statute so filing a certificate with the Secretary of State is required.

16. LP - Rights and Liabilities • The General partner assumes all management and personal liability. • Both general and limited partners have a fiduciary duty to each other. • CASE 19.1 1515 North Wells, LP v. 1513 North Wells, LLC. An LP agreement cannot contract away the fiduciary duties. So a general partner is liable for breach of fiduciary duty to limited partners.

17. LP - Rights and Liabilities • General partners are personally liable to 3rd parties for breach of contract and tort liability. A corporation (or an LLC) can be a general partner and with limited liability. • 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. • Limited partners have the right to inspect the LP’s books.

18. Corporations • Corporation is the most widely used business form in the United States. • Creature of statute (must be formed by state agency, usually secretary of state). • Corporations are owned by shareholders, managed by directors and officers. • Limits shareholder liability to investment. • More details in Chapter 20.

19. Limited Liability Companies • LLC’s are creatures of state law, like corporations. • Owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). • Members of an LLC enjoy limited liability. • LLC’s can sue and be sued by employees or third parties.

20. LLC Articles of Organization • 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.”

21. LLC Limited Liability • LLC, as a legal entity, is liable for acts of members and LLC obligations. • However, members are not personally liable for LLC obligations, and are only liable up to their investments. • CASE 19.2 Allen v. Dackman (2009). Owner of interests in an LLC is not the legal “owner” of real property and not personally liable for injuries to tenants on property owned by LLC.

22. Operating an LLC • 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.

23. 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.

24. LLC - Advantages and Disadvantages

25. Limited Liability Partnerships • LLP: hybrid form of business that allows for ‘pass-through’ for tax purposes, but limits personal liability from malpractice of other partners. • LLP is formed under state law. • Family LLP is a limited liability partnership in which the majority of the partners are related to each other. • Used frequently for agriculture.

26. 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.

27. 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.

28. Special Business Forms • Syndicates. • Investment group of individuals/firms who finance a project together. • Joint Stock Companies. • Hybrid of partnership and corporation, with many similarities of partnership. • Business Trusts. • Created by private agreement with beneficiaries. • Cooperatives.

29. Franchises • Franchise is an arrangement between a Franchisor (owner of a trademark or trade name) and a Franchisee can sell goods or services. • 25% of all retail sales based on franchise merchandising.

30. Types of Franchises • Distributorship. • Involves licensing a product and may include a territory. • Chain-Style Business Operation. • Involves licensing a trademark (or brand). • Franchisee required to followed standardized operations and quality control. • Sometimes franchisee may be required to buy supplies from franchisor. • Manufacturing or Processing Plant. • Involves essential ingredients or formula to make a product.

31. Laws Governing Franchising • Generally governed by contract law. • If involves sale of goods over $500, UCC Article 2 applies. • Federal Regulation of Franchising. • FTC “Franchise Rule” requires certain material disclosures. • State Regulation. • Often involves bad faith and deceptive practices.

32. The Franchise Contract • Key Provisions: • Payment. • Business Premises and Organization. • Location of the Franchise. • Quality Control (key issue). • Pricing Arrangements (including supplies from franchisor).

33. Termination of the Franchise • Duration is determined by contract. • Notice is by contract, or within a reasonable time. • Franchisor can give franchisee an opportunity to “cure” an ordinary breach, but not a material breach. • CASE 19.3LJL Transportation, Inc. v. Pilot Air Freight Corp. (2009). Even though a franchise contract contains a “right-to-cure” clause, a franchisee’s material breach of contract can justify immediate termination of contract.

34. Termination of the Franchise • Wrongful Termination. • Favor franchisor. • Federal and state laws attempt to protect franchisee from arbitrary and unfair actions. • Importance of Good Faith and Fair Dealing.