Chapter 25 Sole Proprietorships, Partnerships, and Limited Liability Companies

1. Chapter 25Sole Proprietorships, Partnerships, and Limited Liability Companies

2. Sole Proprietorships The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship. • Taxation. • Organizational Fees. • Transaction of Business in Other States.

3. General Partnerships • A Partnership is created when two or more persons agree to carry on business for profit as co-owners with equal right to manage and share profits. • Partners are agents and fiduciaries of one another, but differ from agents in that they are also co-owners and share in profits and losses.

4. General Partnerships

5. General Partnerships • Sources of Law: • State common law. • Uniform Partnership Act (UPA), adopted by all states in some form. • Revised Uniform Partnership Act (RUPA): adopted by some states. • Case 25.1 Tarnavsky v. Tarnavsky (1998).

6. General Partnerships • 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.

7. General Partnerships • Partnerships are recognized as separate legal entities: • 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.

8. Partnership Formation • Partnership agreements 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. • By Estoppel: parties who are not partners hold themselves out to 3rd Parties and 3rd Party relies to her detriment. • Case 25.2 Atlas Tack Corp v. DiMasi (1994).

9. Rights Among Partners • In the absence of an oral or written partnership agreement, state statutes govern the rights among partners (e.g.,Texas: Vernon's Civil Statutes Art.6132b): • Management: equal, each one vote, majority wins; need unanimous consent for some actions. • Partnership Interest: equal profits, losses shared as profits shared.

10. Rights Among Partners • Rights among partners (cont’d): • Compensation: none. • 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 

11. Rights Among 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.

12. Rights Among Partners • Each Partner has a right to equally share partnership interest: • A proportionate share of the profits earned and a return of capital on the partnership's termination. • A partner may assign his interest. • A partner’s interest is susceptible to a creditor’s lien. Creditors may attach and get a “charging order.” • Assignment or charging order do not dissolve the firm.

13. Duties and Liabilities of Partners • Partners are fiduciaries and general agents of one another and the partnership. • Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity. • Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her.

14. Duties and Liabilities of Partners • Joint and Several Liability for Torts. • JSL means 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. New admitted partner has no personal liability for existing partnership debts and obligations. • Case 25.3 Citizens Bank v. Parham-Woodman (1995).

15. Partnership Termination • Partnerships can be terminated (dissolved) for a variety of reasons: • Partners can 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).

16. Dissolution By Acts • 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.

17. Dissolution by Law By Operation of Law: • Death of a partner. • Bankruptcy of a partner. • Bankruptcy of partnership. • Illegality.

18. Dissolution by Decree By Judicial Decree: • Insanity. • Incapacity. • Business Impracticality. • Improper Conduct. • Other Circumstances (personal dissension).

19. Notice of Dissolution To avoid liability for apparent authority, apply the agency rules by giving: • Actual notice. • Constructive notice.

20. 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.

21. Winding Up • If a partner has violated the partner-ship agreement, she: • Must pay damages. • May not participate in winding up. • But other partners may choose to continue. • If a partner dies: • Other partners act as fiduciaries. • Accounting to deceased partner’s estate. • Survivors get paid for their services.

22. Distribution of Partnership Assets • 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.

23. Distribution of Partnership Assets • If liabilities are greater than assets partners bear losses in proportion in which they shared profits, unless agreed otherwise. • If one partner does not contribute, other partners are liable for his share and they have the right of contribution against that partner who didn’t pay.

24. 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. • Entity that limits the liability of the limited partner(s). • Creature of state statute. Filing a certificate with the Secretary of State is required.

25. Limited Partnerships • The General partner assumes all management and personal 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. • Case 25.4 Miller v. Dept of Revenue (1998).

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

27. Rights and Liabilities of Partners • 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.

28. LP Management • Only General Partners can manage but they have a fiduciary obligation to LP’s. • LP’s enjoy limited liability as long as they do not engage in management functions. • An LP will be liable to a 3rd party if the 3rd party believes, based on conduct, that the LP is a general partner. • Case 25.5 Drucker v. Mige (1996).

29. Dissolution of the LP • 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.

30. Limited Liability Companies • Limited liability companies are relatively new creatures of state statute. • An LLC is a hybrid entity that combines the limited liability of a corporation and the tax advantages of a partnership. • LLC’s are increasingly become the entity of choice for businesses.

31. Limited Liability Companies • 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). • LLC’s are formed by filing articles of organization with the Secretary of State.

32. LLC Formation [2] • 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.

33. LLC Advantages & Disadvantages

34. 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.

35. LLC Management • 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.

36. LLP’s • Creature of state statute, similar to an LLC except that an LLP is designed for professionals who normally do business as a partnership (e.g., lawyers and accountants). • LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

37. 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.

38. 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.

39. LLLP’s • 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.