Chapter 37: Introduction to Forms of Business and Formation of Partnerships

Choosing a Form of Business
Sole Proprietorship
Only one owner, the sole proprietor, who
Has the right to make all the management decisions of the business;
All the profits are his or hers;
Is personally liable for all the obligations and debts of the business;
Responsible for employees’ authorized contracts and torts
Formed very easily and inexpensively
Automatically created by a person going into business for him or herself through failure to choose another business form
Not a legal entity
Cannot sue or be sued
Creditors must sue the owner
All income must be reported on the owner’s individual federal income tax return
Partnership
Has two or more owners, called partners, who
Have the right to make all of the management decisions for the business;
Share all the profits of the business equally;
Are personally liable for all debts and obligations;
Liable for torts committed in the course of business by employees and their partners
Created automatically when two or more persons own a business together without selecting another form
Not a tax-paying entity, like sole proprietorship
All income must be reported on the individual partners’ federal income tax returns
Any business losses are deductible on individual partners’ federal income tax returns
Usually continues when one partner dies or leaves the business
Ownership interest is not freely transferable - a purchaser of an interest is not automatically a partner unless the other partners agree to allow the partnership
Limited Liability Partnership (LLP)
Like a partnership, except
A LPP partner has no liability for most partnership obligations
But he or she retains liability for his or her own wrongful acts, such as malpractice liability
May elect to have the LLP taxed as a partnership or corporation
If taxed as a corporation, the LLP pays federal income tax on its income, but the individual partners pay federal income tax only on the compensation paid and the partnership profits they receive
May be created only by filing a form with the secretary of state
Limited Partnership (LP)
Consists of one or more general partners and one or more limited partners
General partners have rights and liabilities similar to partners in a partnership
Manage the business; and
Have unlimited liability for obligations
Limited partners
Usually have no liability for obligations
But have no right to manage the business
May elect to be taxed either as a partnership or corporation
If taxed like a partnership,

a)General partners can deduct losses without limit and report their shares of the LP’s income and losses on individual tax returns

b)Limited partners must pay federal income taxes on their share of the profits, but may deduct losses only to the extent of their investment in the business

If taxed like a corporation,

a)The LP pays taxes on its net income

b)Partners pay taxes only on compensation paid and profits distributed to them

Not dissolved when a limited partner dies or leaves the business
May be dissolved when a general partner dies or leaves if no other general partners remain
Rights may not be wholly transferred to another person without agreement by the other partners to admit the person as a new partner
May be created only by complying with a state statute permitting LPs

Limited Liability Limited Partnership (LLLP)
A limited partnership whose partners have elected limited liability status for all partners
Created by making a filing with the secretary of state
General partner will still have unlimited liability for any torts he commits while acting for the LLLP
Corporation
Owned by shareholders who elect a board of directors to manage the business
No shareholder has the right to manage
No officer or director has to be a shareholder
Liability
Shareholders have limited liability for the obligations of the corporation
Directors and officers have no liability for the contracts they or the corporation’s employees sign only in the name of the corporation
Taxes
Corporation pays taxes on its profits
Shareholders do not report their shares of corporation profits on their individual tax returns
They only report distributions in the form of dividends; and
Sale of their investments for a profit
Do not deduct corporate losses, can only report individual losses from the sale of shares
Thus, there is a possibility for double tax liability
S Corporation status
Corporation and shareholders are taxed like a partnership
Income and losses of the business are reported on the shareholders’ individual federal income tax returns
May have no more than 100 shareholders, have only one class of shares, and be owed only by individuals and trusts
Not dissolved when a shareholder leaves or dies
Shareholder may sell shares to other persons without limitation in absence of an agreement to the contrary
Professional Corporation
Identical to a business corporation in most respects
Formed only by a filing with the secretary of state
Managed by a board of directors unless a statute permits otherwise
Shareholders have no personal liability as to obligations of the corporation, but retain unlimited liability for professional malpractice
Shareholders must consist of only professionals holding the same type of license
Can elect S Corporation treatment
Limited Liability Company (LLC)
Intended to combine nontax advantages of a corporation with favorable tax treatment of partnerships
Owned by members who may manage the LLC themselves, or elect mangers
Members have limited liability
Professionals in a professional LLC have unlimited liability for their own malpractice
Can elect to be taxed like a partnership or corporation
Transfer of interest allows transferee to receive only the member’s distributions, unless all members or LLC agreement permits transferee to become a member
Death, retirement or bankruptcy of a member usually does not dissolve the LLC
Joint Ventures
An arrangement not to establish an ongoing business involving many transactions, but rather a single project
Generally partnership law applies
Usually determined to have less implied and apparent authority than partners
Southex Exhibitions, Inc. v. Rhode Island Builders Association, Inc.:
Although parties referred to one another as “partners” in their agreement, the court found no partnership existed
Agreement was for a fixed term
Operating costs were not shared
One party was responsible for lion’s share of management
Thus, no objective intent
Mining Partnerships
Persons cooperating in the working of either a mine or an oil or gas well are treated as partners if there is
Joint ownership of a mineral interest;
Joint operation of the property; and
Sharing of profits and losses
Interest is freely transferable
Limited Liability Partnerships (LLP)
Must expressly agree to create LLP by complying with a statute
Requires
Filing of a form with the secretary of state
Paying an annual fee; and
Adding the words or acronym “Registered Limited Liability Partnership,” “Limited Liability Partnership,” “RLLP” or “LLP”

Revised Uniform Partnership Act of 1994 (RUPA)
Model partnership statute, which aims to codify partnership law in one document for purposes of consistency and uniformity
Dominant source of partnership law in the U.S.
Definition of Partnership
An association of two or more persons
To carry a business
As co-owners
Sharing of the profits of a business is presumptive evidence of an individual’s partnership,
Except when a share of the profits is received in payment
Of a debt
Of interest on a loan
Of wages to an employee or services to an independent contractor
Of rent
Of an annuity or other retirement or health benefit to a beneficiary or representative of a deceased partner
For the sale of the goodwill of a business or other property
For profit
When parties arrange their affairs in a manner that otherwise establishes an objective intent to create a partnership, courts find a partnership exists
Purported Partners
Liability based on substantial, detrimental reliance on the appearance of a partnership, where none actually exists
Elements
A person purports to be or consents to being represented as a partner of another person or partnership;
A person’s silence in response to a statement that he or she is another’s partner constitutes consent to the purported partnership
Mere knowledge alone is insufficient
If a person makes a public statement that he is a partner of another, the purported partner is liable to any third person who relies on the statement
A third party relies on the representation; and
The third party transacts with the actual or purported partnership
Effects
Purported partner is liable as though he were an actual partner
Liable on contracts entered by third parties, believing he or she was a partner
Liable for torts committed in the course of the relationship
Partnership Capital
All property actually acquired by a partnership by transfer or otherwise is partnership property and, belongs to the partnership as an entity
Property belongs to the partnership if it is transferred
To the partnership in its name
To any partner acting as a partner by a transfer document that names the partnership; or
To any partner by a transfer document indicating the partner’s status as a partner or that a partnership exists
Property acquired with partnership funds is presumed to be partnership property
McCormack v. Brevig: The court found cattle did not belong to a partnership where nothing in the record suggested that the cattle were purchased with partnership assets or transferred to individuals in their capacity as partners, and no assignment of the cattle to the partnership occurred
Partner’s Partnership Interest
Partnership interest: a partner’s ownership interest, which represents all of a partner’s rights in a partnership, including
The partner’s transferable interest; and
Includes the partner’s share of profits and losses and the right to receive distributions
Transferee does not become a partner, but is entitled to receive the partner’s distributions
Transferee can also ask the court to dissolve a partnership if the partnership is at will
The transferring partner remains a partner and may continue to manage unless the other partners vote to expel him or her by unanimous agreement
The partner’s management and other rights
A partner has no individual ownership rights in partnership property, but does have the right to use partnership property for partnership purposes
Charging order
A creditor may ask a court to issue an order charging all or part of the partner’s transferable partnership interest to pay an unsatisfied judgment amount
Obtained without the partner’s consent
Partner may continue as a partner and in management
Purchaser of a transferable interest may ask that the court dissolve and wind up the partnership at will
Other partners may eliminate the threat by redeeming the charging order (pay the creditor the amount due)
May expel the partner suffering the charging order
Effect of Partnership Agreement
Partners may restrict the transfer of a partner’s transferable interest or impose negative consequences on a partner who transfers an interest or suffers a charging order
Any restriction, however, must not unreasonably limit the ability of a partner to transfer a property interest
Restriction will also not be enforceable against a transferee without notice