Chapter 23: Sole Proprietorships, Partnerships, and LLCs

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Chapter 1: Legal EthicsCHAPTER 23: SOLE PROPRIETORSHIPS,

PARTNERSHIPS, AND LLCS

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Learning Objectives1. What advantages and disadvantages

are associated with the sole proprietorship?

2. What is meant by joint and several liability? Why is this often considered to be a disadvantage of doing business as a general partnership?


Learning Objectives3. What advantages do limited liability

partnerships offer to entrepreneurs that are not offered by general partnerships?

4. What are the key differences between the rights and liabilities of general partners and those of limited partners?


Learning Objectives5. How are limited liability companies

formed, and who decides how they will be managed and operated?


Introduction • When choosing a business entity,

entrepreneurs should consider:– Ease of creation.– Owners’ liability.– Tax considerations.– Need for Capital.


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.


Advantages DisadvantagesOwner is in complete control & receives all profits

Owner is personally liable for all torts & contracts

Flexibility Lacks continuity after death

Ease of creation; maintenance Difficult to raise financing

Sole Proprietorships


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 ).


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.


Partnerships• When does a partnership exist?–Under the UPA there is a presumption

of a partnership if:1. A sharing of profits or losses. 2. A joint ownership of the business.3. An equal right to be involved in the management of

the business.


Partnerships• When does a partnership exist?–However, no presumption of partnership if

profits received as payment for:1. A debt by installments or interest on a loan. 2. Wages of an employee or for the services of an

independent contractor.


Partnerships• When does a partnership exist?–However, no presumption of partnership if

profits received as payment for:3. Rent to a landlord. 4. An annuity to a surviving spouse or

representative of a deceased partner. 5. A sale of the goodwill (the valuable

reputation of a business viewed as an intangible asset) of a business or property.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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?


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.


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.


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.


Partnerships• Duties and Liabilities of Partners.–Liability of Incoming Partners: new

admitted partner has no personal liability for existing partnership debts and obligations.


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.


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.


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


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.


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).


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.


Partnerships• Winding Up.– If liabilities are greater than assets partners bear

losses in proportion in which they shared profits, unless agreed otherwise.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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?


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.


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.


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.


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.


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.


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.


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.


• The LLC Operating Agreement.– The LLC operating agreement is the same as a

corporation’s bylaws.– Written agreement is preferred.– Partnership law may apply: if the operating

agreement is silent, courts will apply partnership principles.

Limited Liability Companies


• Management of an LLC.– An LLC can be either member-managed, or

manager-managed. – Fiduciary Duties. Managers and members owe

fiduciary duties to the LLC and each other.

• CASE 23.3 POLK V. POLK (2011). What was the lower court’s “reversible error”?



• Management of an LLC.– Decision-Making Procedures.• Generally set forth in the operating agreement. Can

include, for example:–Choosing or removal of managers.–Meetings.–Voting Rights.–Sale of interests.



Limited Liability Companies Dissociation and Dissolution of an LLC.–Dissociation.•Member has power, but not right, to

dissociate from the LLC at any time.• Trigger events: voluntary withdrawal,

expulsion by other members or court order, bankruptcy, incompetence, or death.


Limited Liability Companies Dissociation and Dissolution of an LLC.–Dissociation.• Dissociating member loses the right to

participate in the management , and the right to act as an agent.•Member also has the right to have her

interest bought out by other members.


Limited Liability Companies Dissociation and Dissolution of an

LLC.–Dissociation.• If the dissociation violates the operating

agreement, it is wrongful and the member can be held liable for damages.



LLC.–Dissolution.• Dissociated member has no right to force

the LLC to dissolve. • Remaining members can choose to

continue or dissolve.



LLC.–Dissolution.• Operating agreement ‘trigger’ events will

cause dissolution. •Members who did not wrongfully

dissociate may participate in the winding up process.

Chapter 23: Sole Proprietorships, Partnerships, and LLCs

Documents

Transcript of Chapter 23: Sole Proprietorships, Partnerships, and LLCs