Chapter 23: Sole Proprietorships, Partnerships, and LLCs

1. Chapter 23: Sole Proprietorships, Partnerships, and LLCs

2. Learning Objectives • What advantages and disadvantages are associated with the sole proprietorship? • What is meant by joint and several liability? Why is this often considered to be a disadvantage of doing business as a general partnership?

3. Learning Objectives • What advantages do limited liability partnerships offer to entrepreneurs that are not offered by general partnerships? • What are the key differences between the rights and liabilities of general partners and those of limited partners? 

4. Learning Objectives • How are limited liability companies formed, and who decides how they will be managed and operated?

5. Introduction • When choosing a business entity, entrepreneurs should consider: • Ease of creation. • Owners’ liability. • Tax considerations. • Need for Capital.

6. Sole Proprietorships • The owner is the business. • Anyone who does business without creating a separate business organization has a sole proprietorship. • Major disadvantage is the owner is personally liable for all losses or liabilities incurred by the business enterprise.

7. Sole Proprietorships

8. Partnerships • A partnership arises from an agreement, express, or implied, between two or more persons to carry on a business for profit. • Governed by either common law or the Uniform Partnership Act (in the absence of express agreement ).

9. Partnerships • Agency Concepts and Partnership Law. • Partnerships are governed both by common law and by statutory laws. • Each partner is deemed to be an agent and fiduciary of the other. • There may be imputation of liability.

10. Partnerships • When does a partnership exist? • Under the UPA there is a presumption of a partnership if: • A sharing of profits or losses. • A joint ownership of the business. • An equal right to be involved in the management of the business.

11. Partnerships • When does a partnership exist? • However, no presumption of partnership if profits received as payment for: • A debt by installments or interest on a loan. • Wages of an employee or for the services of an independent contractor. 

12. Partnerships • When does a partnership exist? • However, no presumption of partnership if profits received as payment for: • Rent to a landlord. • An annuity to a surviving spouse or representative of a deceased partner. • A sale of the goodwill (the valuable reputation of a business viewed as an intangible asset) of a business or property.

13. Partnerships • When does a partnership exist? • Joint ownership of property—or the sharing of profits from the property-- does not, by itself, create a presumption of a partnership. • However the sharing of profits and losses usually does.

14. Partnerships • Entity versus Aggregate Theory. • At common law, a partnership was not a separate legal entity distinct from its owners. • Today, a majority of states recognize the partnership as a separate legal entity for many legal purposes. 

15. Partnerships • Entity versus Aggregate Theory. • To sue and be sued. • To have judgments collected against it’s assets, and individual partners’ assets. • To own and convey partnership property. • Tax Treatment: under federal law it is a “pass through” tax entity.

16. Partnerships • Partnership Formation. • The Partnership Agreement: can be written or oral, unless the Statute of Frauds requires a written agreement. • Duration of Partnership. • Partnership for a Term. • Partnership at Will. 

17. Partnerships • Partnership Formation. • Partnership by Estoppel: • Occurs when a person who is not a partner holds himself out to third parties and the third party relies to her detriment. • In this case the “nonpartner” is considered an agent whose acts are binding on the partnership.

18. Partnerships • Rights of Partners. • In the absence of a partnership agreement: • Management: equal, each one vote, majority wins; need unanimous consent for some actions. • Interest in the Partnership: equal profits, losses shared as profits shared. 

19. Partnerships • Rights of Partners. • In the absence of a partnership agreement: • Compensation: none. • Inspection of the Books. • Accounting: when other partner(s) committing fraud, embezzlement, wrongful exclusion, or anytime it is just and reasonable. 

20. Partnerships • Rights of Partners. • In the absence of a partnership agreement: • Property Rights. Property acquired by the partnership remains partnership property. An individual partner has no right to sell, mortgage, or transfer partnership property.

21. Partnerships • Rights of Partners. • In the absence of a partnership agreement: • Use or possess property on behalf of the partnership. • Assign her right to her share of the profits to another to satisfy individual debt.

22. Partnerships • Duties and Liabilities of Partners. • Fiduciary Duties: partners are fiduciaries and general agents of one another and the partnership. • CASE 23.1 Meinhard v. Salmon (1928). How did Salmon violate his duty of loyalty to Meinhard? 

23. Partnerships • Duties and Liabilities of Partners. • Authority of Partners. • UPA affirms general principles of agency law. • Partner may be able to subject partnership to tort liability. • Partner has apparent authority when carrying out partnership business. 

24. Partnerships • Duties and Liabilities of Partners. • Authority of Partners. • Authorized versus Unauthorized Actions. If partner acts within scope of authority, partnership is bound. Partners generally do not have authority to make charitable contributions.

25. Partnerships • Duties and Liabilities of Partners. • Joint Liability of Partners. if partner is sued for partnership debt, partner has right to insist that other partners be sued with her. • Joint and Several Liability: third party can sue either one or all partners. 3rd party may collect against personal assets of all partners.

26. Partnerships • Duties and Liabilities of Partners. • Liability of Incoming Partners: new admitted partner has no personal liability for existing partnership debts and obligations.

27. Partnerships • Partner’s Dissociation. • Occurs when one partner ceases to be associated in the partnership business. • Allows partner to have her interest purchased by the partnership. • Terminates her voting interest in the partnership. 

28. Partnerships • Partner’s Dissociation. • Events That Cause Dissociation: • Notice. • Triggering Event. • Unanimous Vote. • Court or Arbitrator Order. • Partner’s bankruptcy, assignment of interest, incapacity, or death. 

29. Partnerships • Partner’s Dissociation. • Wrongful Dissociation. • Dissociating partner breaches partnership agreement. • Dissociating partner files bankruptcy. • May be liable for costs.

30. Partnerships • Partner’s Dissociation. • Effects of Dissociation. • Rights and Duties. • Liability to Third Parties. Partnership bound for two years by acts of outgoing partner, unless proper notice given.

31. Partnerships • Partnership Termination: termination of a partnership occurs in two stages: • Dissolution (is the legal “death” of the partnership).  • Winding up and Distribution of Assets (collecting and distributing partnership assets). 

32. Partnerships • Winding Up. • After dissolution, partnership continues to wind up the partnership affairs. Obligations are paid as follows: • 1. Payment of debts, including those owed to partner and nonpartner creditors. • 2. Return of capital contributions and distribution of profits to partners. 

33. Partnerships • Winding Up. • If liabilities are greater than assets partners bear losses in proportion in which they shared profits, unless agreed otherwise.

34. Limited Liability Partnerships • Designed for professionals service firms, it allows limits on personal liability of the partners but allows “pass through” tax advantages. • LLP allows professionals to avoid personal liability for the malpractice of other partners.

35. Limited Partnerships • An LP is an entity that limits the liability of some of its owners (the limited partners). • Consists of at least one general partner and one limited partner to carry on a business for profit.

36. Limited Partnerships • Formation of an LP. • An LP is a creature of state statute and must follow statutory requirements. • Documents must be filed with the a secretary of state who will issue a certificate of limited partnership.

37. Limited Partnerships • Liabilities of the LP. • Only General Partners can manage, but they have a fiduciary obligation to LP’s. • Limited partners enjoy limited liability as long as they do not engage in management functions. 

38. Limited Partnerships • Liabilities of the LP. • A General partner assumes all management and personal liability. • A Limited Partner has no management rights, and liability is limited to the amount of investment; however a limited partner can be liable if he participates in management.

39. Limited Partnerships • Dissociation and Dissolution. • A general partner has the right to dissociate unless the LP agreement states otherwise. • On dissolution, the limited partner is entitled to return of capital contributions. 

40. Limited Partnerships • Dissociation and Dissolution. • LP interests are considered securities and regulated by both federal and state securities laws. • Limited partners’ liability is limited to the capital investment. 

41. Limited Partnerships • Dissociation and Dissolution. • 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.

42. Limited Partnerships • Dissociation and Dissolution. • An LP is dissolved in much the same way as a general partnership. • Retirement, withdrawal, death, bankruptcy or mental incompetence of a general partner will trigger dissolution. • On dissolution, creditors are paid first then partners. 

43. Limited Partnerships • Dissociation and Dissolution. • Then partners are paid according to the terms of the buy-sell agreement, if one exists. • CASE 23.2 Craton Capital, LP v. Natural Pork Production II, LLP (2011). What document did the court rely on in its ruling?

44. Limited Liability Companies • 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 becoming the entity of choice for businesses.

45. 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). • Members of an LLC enjoy limited liability.

46. Limited Liability Companies • Formation of an LLC. • Requires filing articles of organization with central state authority: • Name of Business. • Principal Address. • Name and Address of Registered Agent. • Names of the Owners. 

47. Limited Liability Companies • Formation of an LLC. • How will the LLC will be managed? • And what about ‘pre-formation’ contracts? • LLC’s may apply the well-established rules relating to corporations and preincorporation contracts.

48. Limited Liability Companies • Jurisdictional Requirements. • An LLC is a legal entity separate from its owners. • For federal diversity jurisdiction, the LLC may be treated differently than a corporation. Citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions.

49. Limited Liability Companies • Advantages of the LLC. • Limited Liability: liability of members limited to amount of investment. • Flexibility in Taxation. • Management and Foreign Investors. • Foreign investors can be member-owners of an LLC.

50. Limited Liability Companies • Disadvantages of the LLC. • There are not many disadvantages to an LLC. • The main disadvantage is the lack of uniformity with state laws.