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

Introduction to Forms of Business and Formation of Partnerships Operation of Partnerships and Related FormsPartners’ Dissociation & Partnerships’ Dissolution and Winding Up Limited Liability Companies, Limited Partnerships, and Limited Liability Limited Partnerships © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Introduction to Forms of Business and Formation of Partnerships I wanted to be an editor or a journalist. I wasnt really interested in being an entrepreneur, but I soon found I had to become an entrepreneur in order to keep my magazine going. Sir Richard Branson, Entrepreneur © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives Choosing a form of business Creation of partnership Purported partners Partnership capital and property Partnership interests37 - 3

Overview 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 Which form you choose depends on where you want to go37 - 4

Basic Forms Sole proprietorship Partnership  General, limited, limited liability, or limited liability limited partnership Corporation  Regular “C”, Subchapter “S”, nonprofit, professional Limited liability company  Including professional form37 - 5

Sole Proprietorship 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 loss37 - 6

Partnership 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 partners37 - 7

Partnership 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, may be created as a general partnership by default (unintentionally)37 - 8

Corporation 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 corporations37 - 9

Corporation 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 structure37 - 10

Limited Liability Company 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 LLC37 - 11

Business Forms Worldwide Though details vary widely, business forms similar to U.S. forms exist worldwide  Example: Commercial Companies Law of the United Arab Emirates provides for the LLC form, but limits shareholder number to 50  No such limitation exists for LLCs in the U.S.37 - 12

The General Partnership Every state has enacted partnership laws The Revised Uniform Partnership Act (RUPA) of 1994, with the 1997 amendments, is a model partnership statute37 - 13

Partnership Creation 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 into it inadvertently, without considering whether they had created a partnership37 - 14

Partnership Creation -- Examples Musicians agree to form a band and share profits Two students buy music memorabilia at yard sales, resale via eBay, and split the profits Friends take turns operating a lemonade stand37 - 15

Partnership Creation – The LLP 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, LLP37 - 16

Partnership or Joint Venture? 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 enterprise37 - 17

Southex Exhibitions v. Rhode I Facts:  1974: RIBA and show producer SEM entered a 5- year contract; RIBA agreed to sponsor and endorse only SEM shows with net show profits shared 55% to SEM and 45% to RIBA  During negotiations, SEM and RIBA discussed agreement’s use of the term “partners” and SEM’s president claimed “no ownership”  1994: Southex acquired SEM’s interest in the agreement and RIBA contracted with another show producer37 - 18

Southex Exhibitions v. Rhode Island Builders Assoc. Procedural History and Legal Reasoning:  Southex sued RIBA to enjoin the 2000 home show claiming the 1974 agreement established a partnership and RIBA breached fiduciary duties by wrongful dissolution  Trial court found for RIBA and Southex appealed  Appellate court reviewed partnership law basics and noted first that the 1974 agreement simply titled “Agreement” rather than “Partnership Agreement”37 - 19

Southex Exhibitions v. Rhode Island Builders Assoc. Legal Reasoning and Holding:  Agreement was for a limited term and plaintiff Southex entered contracts with third parties “in its own name, rather than in the name of the putative partnership.”  Court concluded partnership did not exist and affirmed the judgment for RIBA37 - 20

Non-Partners Not Liable to Third Parties 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.”37 - 21

Purported Partners 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 agreed37 - 22

Palmer v. Claydon Facts:  Palmer sued attorney Claydon for malpractice for legal services  Palmer also sued Lawler alleging Lawler was a purported partner of Claydon37 - 23

Palmer v. Claydon Legal Reasoning and Holding:  The court reviewed evidence indicating Lawler and Claydon might be partners, a matter for a jury to decide precluding summary judgment  Evidence: expense and office sharing, both names on office sign (“Claydon & Lawler”) and stationery, Claydon’s comments…  But Palmer released her claims against Claydon before Lawler’s appeal, so her claims against Lawler were also released37 - 24

Partners and Ownership 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 partners37 - 25

McCormack v. Brevig Facts:  Joan Brevig McCormick and Clark Brevig were siblings and partners in Brevig Ranch  Dispute arose regarding ownership of cattle  Clark’s argument: cattle were gift from mother and not part of partnership property  Joan’s argument: cattle and related earnings listed on partnership tax returns37 - 26

McCormack v. Brevig Reasoning & Holding:  Clark owns as separate property because Joan did not overcome statutory presumption:  Property acquired in a partner’s name without an instrument indicating transfer of title to the partnership ”is presumed to be separate property even if used for partnership purposes”37 - 27

A Partner’s Partnership Interest 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 rights37 - 28

Test Your Knowledge True=A, False = B  The Revised Uniform Partnership Act (RUPA) is a model partnership statute.  Partnership is an “association of two or more persons to carry on as co-owners a business for profit.”  Partnership capital belongs to the individual partners in equal shares.37 - 29

Test Your Knowledge Multiple Choice  The partnership interest includes a partner’s: (a) Management and other rights participation (b) Share of profits and losses and right to receive partnership distributions (c) Ownership interest in partnership capital (d) both A and B (e) none of the above37 - 30

Thought Questions Do you want to start a business? If you wanted to start a business (snowboards, for example), would you choose partnership as the form of business?37 - 31

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

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