PartnershipsIntroduction to Forms of

Business and Formation of Partnerships

Operation of Partnerships

Dissolution & Winding Up

Limited Liability Companies & Limited Partnerships

9

McGraw-Hill/Irwin Business Law, 13/e

© 2007 The McGraw-Hill Companies, Inc. All rights reserved.

INTRODUCTION TO FORMS OF BUSINESS AND FORMATION OF

PARTNERSHIPS

PA ET RHC 37

“It sounds boring, but anything is easy to start – starting a novel, starting a business…it’s keeping the thing going that is difficult.”

Prue Leith, author and executive, quoted in The Adventure Capitalists (Grout and Curry, 1998)

Learning Objectives

• Choosing a form of business

• Creation of partnership

• Purported partners

• Partnership capital and property

• Partnership interests

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• Choosing a form of business is important because the business owner’s liability and control of the business vary greatly among the many forms of business

Overview

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What you choose depends on where you want to go

• Sole proprietorship• Partnership

– General, limited, limited liability, or limited liability limited partnership

• Corporation– Regular “C”, Subchapter “S”, nonprofit,

professional

• Limited liability company– Including professional form

Basic Forms

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• A sole proprietorship has only one owner and is an extension of its owner

• It is not a legal entity and cannot sue or be sued, so creditors/claimants sue the owner

• Advantages: no formalities, taxes flow to owner, owner takes all profit and control

• Disadvantage: owner bears all risk of loss

Sole Proprietorship

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• A partnership has two or more owners or partners and includes several forms: general, limited (LP), limited liability (LLP), limited liability limited (LLLP), or professional

• Though a legal entity, a partnership is not a federal tax-paying entity, thus all income or loss must be reported on the individual partner’s federal income tax return whether or not distributed or allocated to partners

Partnership

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• Advantages: relatively easy to create, has a legal entity but individual taxation, partners control the business, partners take all gain, flexible structure

• Disadvantages: partners bear all risk of loss jointly and severally, different levels of liability to partners depending on sub-form

Partnership

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• A corporation is owned by shareholders who elect a board of directors to manage the business, thus ownership and management of a corporation may be separate

• Shareholders have limited liability for the obligations of the corporation

• The corporation is a legal and tax-paying entity for federal income tax purposes– Exception: Subchapter S corporations

Corporation

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• Advantages: shareholders enjoy limited liability for corporate obligations, perpetual existence, ability to raise large amounts of capital

• Disadvantages: greater formality required for formation and operation, double-taxation, complexity of structure

Corporation

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• A limited liability company (LLC) combines the nontax advantages of corporations with favorable tax treatment of partnerships

• An LLC is owned by members, who may manage themselves or retain a manager to run the business

• Members have limited liability for the obligations of the LLC

Limited Liability Company

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• Many nations share similar forms of business, including partnership and corporation, though details vary widely

Business Forms Worldwide

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• Every state has enacted partnership laws• The Revised Uniform Partnership Act (RUPA) of

1994, with the 1997 amendments, is a model partnership statute

The General Partnership

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• RUPA defines partnership as an “association of two or more persons to carry on as co-owners a business for profit.”–Partners share profit and loss

• A partnership is a voluntary and consensual relationship and may exist by law even if the parties entered it inadvertently, without considering whether they had created a partnership

Partnership Creation

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• Several musicians agree to form a band and share profits

• Two students stand in line for hours to buy 10 concert tickets. They sell 8 tickets for a $5 fee per ticket and splitting the profits.

Partnership Creation -- Examples

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• Unlike an ordinary partnership, creating a limited liability partnership (LLP) must comply with a state’s limited liability partnership statute

• Formation of an LLP requires filing a form with the secretary of state, paying an annual fee, and using proper terminology– Registered Limited Liability Partnership, RLLP,

Limited Liability Partnership, LLP

Partnership Creation – The LLP

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• If a third person deals with two or more people who seem to be partners and is harmed, the third person may sue to recover damages from both of the apparent partners

• RUPA Section 308(e): “persons who are not partners as to each other are not liable as partners to other persons.”

Non-Partners Not Liable to Third Parties

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• However, under the doctrine of purported partners, if the third party proves that one apparent partner misled him to believe that the two (or more) people were partners, the third party may sue the partner that caused the deception for damages suffered when the apparent partnership failed to perform as agreed

Purported Partners

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• When a partnership or limited liability partnership is formed, partners contribute cash or other property – partnership capital – to the partnership–Belongs to partnership as an entity

• Tangible and intangible property acquired by a partnership presumptively belongs to the partnership as an entity rather than individual partners

Partners and Ownership

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• As owner of a partnership or LLP, a partner has an ownership interest in the partnership

• The partnership interest includes partner’s: 1.Transferable interest

• Partner’s share of profits and losses and right to receive partnership distributions

2.Management and other rights

A Partner’s Partnership Interest

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• Generally, partnership law applies to joint ventures, but a court may distinguish the two if the business purpose is limited to a single project rather than series of related transactions– Reason: joint venturers usually held to have

less implied and apparent authority than partners due to limited scope of the enterprise

Partnership or Joint Venture?

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Learning Objectives

• Limited Liability Companies• Limited Partnerships and Limited

Liability Limited Partnerships• Creation of Limited Partnerships• Right and liabilities of members

and partners• Dissociation and dissolution40 - 22

• The limited liability company (LLC) combines advantages of the corporation with regard to protection from personal liability and favorable tax status of the partnership

• The Uniform Limited Liability Company Act of 1996 (ULLCA) offers default rules similar to RUPA that govern an LLC in the absence of a contrary agreement of its owners– http://www.nccusl.org/Update/

Overview

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• An LLC may elect to be taxed like a partnership or a corporation for federal income tax purposes– Election as partnership more common

• Therefore, the LLC pays no federal income tax and all income and losses of the LLC are reported by the LLC’s owner-members on their individual income tax returns

Taxation of the LLC

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• At least one person (organizers) must file articles of organization with a secretary of state– Articles must include LLC name, its duration, and

the name and address of its registered agent

• Owners of an LLC are members– An individual, partnership, corporation, or another

LLC may be a member of an LLC– An LLC is an entity separate from its members

Creation of the LLC

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• Articles of organization must state whether the LLC is member-managed or manager-managed– If manager-managed, initial managers must be

named

• An LLC probably will have an operating agreement covering how members will share profits, manage the LLC, and withdraw from the LLC

Management of the LLC

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• An LLC member has no individual liability on LLC contracts, unless LLC contracts signed in a personal capacity (e.g., as a surety)

• A member’s liability is usually limited to the member’s capital contributions

• A member is liable for torts s/he committed while acting for the LLC

Liability of Members

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• Under the ULLCA, an LLC must choose to be member-managed or manager-managed

• Each member in a member-managed LLC shares equal rights in the management of the business and each member is an agent of the LLC with implied authority to carry on its ordinary business

A Member-Managed LLC

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• The LLC operating agreement may modify ULLCA default rules by granting more power to some members– Creating a class of members whose

approval is required for certain contracts

– Members share power based on capital contributions

A Member-Managed LLC

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• Managers in a manager-managed LLC are elected and removed by a vote of a majority of LLC members

• A manager’s powers to act for the LLC are similar to a member’s power in a member- managed LLC

A Member-Managed LLC

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A team effort.

• An LLC is liable for the contractual obligations incurred by its members or managers acting within their express, implied, or apparent authority

• An LLC is also liable for the torts and other wrongful acts of managing members and other managers acting within their authority

Tort and Contract Liability

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• Each member in a member-managed LLC and each manager in a manager-managed LLC is a fiduciary of the LLC and its members with duties similar to the duties of partners, including the duty of care

• Nonmanaging members of a manager-managed LLC owe no fiduciary duties– But owe a duty of good faith and fair dealing when

exercising rights as members

Duties of Members

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• A member’s ownership interest in an LLC is the member’s personal property– Limited ability to sell or transfer LLC rights

• A member may transfer the distributional interest in the LLC to another person– Transferee not a member, but receives right to

partnership distributions

– Limited right of transfer may be altered in the operating agreement

Ownership Interest of Members

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• A member in an LLC has the right is to receive distributions (usually profits)

• ULLCA states that members share profits and other distributions equally, regardless of differences in their capital contributions–This may be altered by the operating

agreement

Distributions to Members

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• Under the ULLCA, members dissociate from an LLC in ways similar to those by which a partner dissociates from a partnership or LLP under RUPA–Under the ULLCA, a partner has the

power to dissociate by withdrawing from the LLC at any time

Dissociation

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• As in partnership, a member’s dissociation may be wrongful or nonwrongful

• Dissociation terminates a member’s status as a member, and a dissociated member is treated as a transferee of a member’s distributional interest

• In Re Garrison-Ashburn, LC concerns dissociation

Dissociation

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• Dissolution of an LLC is similar to that of an LLP or partnership

• When an LLC dissolves, any member who has not wrongly dissociated may wind up the business– LLC bound by reasonable acts of members

during winding up

Dissolution

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• After all the LLC assets sold, proceeds distributed first to LLC creditors, then members’ contributions are returned

• Any remaining proceeds are distributed in equal shares to the members

Dissolution

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• Substantially similar to RUPA, the ULPA of 2001 is the first comprehensive statement of American limited partnership law– Only ULPA applies to limited partnerships

• The limited partnership (or LLLP) form is perpetual and used primarily in tax shelter ventures, real estate ventures, oil and gas drilling, and professional sports

Uniform Limited Partnership Act

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• Limited partnerships has two owner classes: – General partners contribute capital, manage the

business, share in profits, and possess unlimited liability for its obligations

– Limited partners contribute capital and share profits, but possess no management powers• Liability limited up to the amount of their

investments in the business

• Limited partnership agreements common

The Limited Partnership

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• A variant of a limited partnership is the limited liability limited partnership (LLLP) which offers limited liability status for all its partners, including general partners

• Except for liability of general partners, limited partnerships and LLLPs are identical

Limited Liability Limited Partnership

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• A limited partnership (or LLLP) may be created only by complying with the applicable state statute, but requirements are minimal

• A certificate of limited partnership must be executed (signed by all general partners) and submitted to the secretary of state

Creating the LP or LLLP

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• A partner may contribute any property or other benefit to the limited partnership

• Under ULPA, profits and losses are shared on the basis of the value of each partner’s capital contribution unless there is a written agreement to the contrary

• ULPA of 2001 requires few actions to be approved by all the partners

Rights of LP and LLLP Partners

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• ULPA is clear that limited partners have no inherent right to vote on any matter

• Default rule is that no new partner may be admitted unless each partner has consented to the admission– Limited partnership agreement may provide

for other admission procedures

Rights of LP and LLLP Partners

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• Each partner in a limited partnership owns a transferable interest in the limited partnership as personal property

• A partner’s transfer of his transferable interest has no effect on his status as a partner, absent a contrary agreement

Transferable Interest

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• A general partner of a limited partnership or LLLP has same right to manage and same agency powers as a partner in an ordinary partnership, including the duty of care

• A general partner of a limited partnership or LLLP is in a position of trust and therefore owes fiduciary duties to the limited partnership and the other partners

Management & Duties

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• Through a derivative action or derivative suit, a partner may sue to enforce a limited partnership right of action against a person who has harmed the limited partnership

Derivative Actions

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• Partners have the power to withdraw from the limited partnership at any time, but ULPA gives the partners no right to withdraw, absent a contrary provision in the limited partnership agreement

• Under ULPA, a withdrawing partner has no right to receive the value of the partnership interest

Withdrawing

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• ULPA of 2001 adopts terminology and the framework of partnership law, thus ULPA establishes dissociation and dissolution rules

• A limited partner dissociates upon limited partner’s death, withdrawal, or expulsion from the partnership

Dissociation of the LP and LLLP

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• A dissociated limited partner is not a limited partner, has no rights as a limited partner, and is treated as a mere transferee of the dissociated limited partner’s transferable interest

• ULPA treats dissociation of general partners as RUPA treats partner dissociations in a partnership

Dissociation of the LP and LLLP

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• A general partner’s express and implied authority to act for the limited partnership terminates upon dissociation, the partner may retain apparent authority

• A dissociated general partner will remain liable on a limited partnership obligation incurred while a partner unless creditor agrees to a release of liability– No liability for post-dissociation obligations

Dissociation of the LP and LLLP

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• ULPA provides that a limited partnership (or LLLP) is not dissolved, wound up, or terminated merely because a partner dissociated from the limited partnership

• When a limited partnership dissolves, winding up follows automatically by the general partners

Dissolution of the LP and LLLP

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• After general partners have liquidated the assets, proceeds are distributed first to creditors and if proceeds exceed creditors’ claims, the remainder is paid to the partners in the same proportions that they shared distributions

Dissolution of the LP and LLLP

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