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Law and the Business Person
Chapter 1
The Civil Law and Common Law Traditions
Why should a business student study law? After all, you
are not going to law school, and if you ever have a legal
problem, you can always consult an
attorney. Perhaps you have never sued anyone, been sued
yourself, been arrested, or written a contract. If all this is
true, the law probably seems like some
foreign country that you have never been to and have no
desire to visit. The truth is, as a businessperson, you can
no longer view the law from a distance.
Your life and the law, whether you like it or not, will be
intertwined, and having a basic understanding of the law’s
scope, application, and in�luence will
serve you well, both in business and in your personal
life.
If you are a manager, business owner, employee, or
entrepreneur, the law will impact your daily decision
making and have far-reaching consequences in all
your business activities. Believe it or not, a law course is
an integral part of your education. This will become
clearer to you as you read cases and witness

for yourself the unfortunate situations that people have
gotten themselves into.
Whereas larger companies have in-house legal departments
or have access to the expertise of large
law �irms, small businesses often operate with little
knowledge of the law and minimal access to
legal counsel, making a legal background even more
valuable in the marketplace. Regardless of size,
any business can bene�it greatly from employing people
at all levels who have at least a basic
understanding of the law and a solid grasp of essential
legal principles so that they can recognize
potential legal problems and refer them to legal counsel
before they become costly matters that
threaten the health of a business. This is especially true
in the United States, which has no uni�ied
legal system but rather an overlay of federal, state, and
local laws. Further, the trend toward more
global commerce and trade, governed by international
treaties such as the North American Free
Trade Agreement, has implications for businesses of all
sizes and types. Today, many business
transactions involve two or more states and may even
include parties separated by the full
continent, so a much greater amount of business is
conducted by various means across state lines.
While no textbook can become a comprehensive hands-on
guide to American law (the legal
encyclopedias that attempt to do so run tens of thousands
of pages and still do not cover all
aspects of the law), it is the purpose of this text to
provide an accurate, easy-to-understand, useful
guide to some areas of the law that have the greatest
impact on business. Business law, as well as

the legal environment of business and legal studies
courses, will provide students with the skills to
recognize and apply the proverbial ounce of prevention to
their business careers and personal
lives. This can prove more useful to employers and to
themselves than pounds of competent, costly
legal advice obtained too late to remedy a problem that
could have been avoided.
Although this course will not "make you a lawyer," it
will provide you with a number of advantages. First, you
will better be able to recognize legal problems
before they happen, a topic often referred to as preventive
law. If you can prevent a situation or con�lict from
developing into a lawsuit, you may save your
business money and the embarrassment of a lawsuit, as
well as maintain a lawful and ethical work environment.
Second, in the event that you are involved
in a controversy, you may be able to resolve the dispute
outside of court through "alternative dispute resolution"
techniques such as negotiations, mediation,
or arbitration. You will learn about each of these and
their advantages and disadvantages. If you do have to deal
with a lawyer, this course will teach you
many legal concepts and the vocabulary to effectively
communicate with legal counsel. You will also learn how
to hire an attorney, manage legal counsel, and
deal with the legal profession.
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Photodisc/Thinkstock
The United States Capitol in Washington, D.C.,
is the meeting place of
Congress, the nation's federal legislative body.
1.1 Law: Its Scope and Origins
No single course or textbook can address all of the
complexities of law. If you stop to think about it, law—
and legal systems—have been in effect since early
civilization began. Thus, there have been many forms of
law and legal systems, too many to enumerate. Suf�ice it
to say that people need rules to maintain
order; otherwise, society would revert to barbarism.
Throughout the ages, philosophers, jurists, political
scientists, political leaders, and common people
from all walks of life have de�ined law in a number of
ways. Cicero viewed law as "nothing but a correct
principle drawn from the inspiration of the gods,
commanding what is honest, and forbidding the contrary."
For the eminent British jurist William Blackstone, law
could be de�ined as "a rule of civil conduct,
prescribed by the supreme power in a state, commanding
what is right and prohibiting what is wrong." Saint
Thomas Aquinas, on the other hand, de�ined
law as "an ordinance of reason for the common good,
made by him who has care of the community." Whatever
our working de�inition, law is often what
Justice Felix Frankfurter described as "all we have
standing between us and the tyranny of mere will." We
will see that this is true and, even more so, come
to appreciate that law also allows us to conduct business,
enter into formal relationships, depend on some

predictability in our affairs, and create order in
our lives.
At its simplest, law comprises rules of behavior that a
government imposes on its
people for the bene�it of society as a whole. As such, it
represents the governing
body’s subjective views of what is best for that society,
combined with precedent and
tradition. And even though most legal systems attempt to
protect society and promote
the common good, there can be radical differences in the
law from one country to
another, and even in different regions within countries, the
50 United States being a
prime example. Although federal and constitutional law
serve to balance and put a
check on state and local law, for example, and in turn,
the federal government is
limited in its powers to legislate and must give states the
power to regulate certain
matters, there is no "one" law, as in a country whose
legal system is based on civil law
(codi�ied statutes alone). Unlike the U.S. common law
system, a civil law system, such
as prevails in Europe and South America, is more
ef�icient and stable, leaving little
room for judicial interpretation and lawyers. Trial by jury
is not an option, so judges
apply the law in a highly predictable, relatively swift
proceeding, and the law itself is
slow to change. In common law jurisdictions like the
United Kingdom and the United
States, however, there is much more litigation, so you
need to be prepared.

One of the reasons that studying law is dif�icult is that
the numerous "factions" that
constitute our legal system are all operating at the same
time. There is state and federal law, statutory law,
administrative law, local law, and so on. For
example, each of the 50 states has a legislative body that
passes state statutes. Each of the states also has a state
court system ruling on cases and making
state "case or judicial law." Operating at the same time is
the federal legislative body—Congress, which makes federal
statutes—and the federal courts,
which make federal case law. These are just a few of the
"places" making law. As you can imagine, there are
thousands of volumes and treatises dealing with
questions about what is the law and legal history, as well
as reporting on all of the new law being made every day.
The law is vast and complicated, no
doubt, but understanding how it works and how the layers
of lawmaking bodies �it together into the larger scheme
is an essential part of your education.
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1.2 Sources of Law
Table 1.1 lists the four major sources of law in the
United States: judicial, statutory, constitutional, and
administrative. Note that each source of law has both
a federal and state component.
Table 1.1: The foundations of the American legal

system
Judicial Law
Federal case law
State case law
Statutory Law
Federal statutes
State statutes
Constitutional Law
U.S. Constitution
State constitutions
Administrative Law
Federal administrative agencies
State administrative agencies
Judicial (Case) Law
The phrase judicial law is used interchangeably with case
law. Judicial law is law made in courts, by judges,
when they rule on a case and write an opinion;
it had its origins in what is called the common law.
When the early pilgrims immigrated to America, they
brought with them their legal system, along with
customs, traditions, and values that helped to shape our
legal system. It is in the nature of common law, however,
that it adapts to the local customs,
traditions, and needs of a people. Thus, despite its
English roots, American law has evolved to �it the needs
of our federalist system and re�lects regional

differences and values. As a result, law in the United
States today resembles more the early English common
law system, with its regional differences based
on local customs and traditions, than it does the relatively
uni�ied law of the modern-day United Kingdom.
Before a judge can "make law," there �irst must be a
controversy brought to the courtroom for a decision. Such
a controversy involves two parties: the
plaintiff, or the person bringing the lawsuit, and the
defendant, or the person being sued. A civil lawsuit is
one in which the plaintiff is seeking money, or
restitution. (This should be contrasted with a criminal
action, which is being brought to punish and possibly
incarcerate the defendant.) As more and more
cases are decided, they form a body of law. These cases
become precedent for cases that follow, building one upon
the other. Judges rely on previous cases
to form their opinions and so on down the line.
When a judge decides a case in court, the judge will
often write an opinion that is published in case books, or
compendiums of court opinions. In that way,
others can look up and read the decisions to determine
what the law is and how a judge ruled on a speci�ic
topic. Figure 1.1 provides an example of a case
as it appears in a case book.
Figure 1.1: Example of a case
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Judicial Law
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StareDecisis and Precedent
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Yet another name for a case or an opinion is precedent.
Precedent also means a previous case. If you look at the
case in Figure 1.1, you will see in the last
paragraph a series of citations that begin like this:
Ciofalo v. Vic Tanney Gyms, supra, 10 N.Y.2d
297, 220 N.Y.S.2d 962, 177 N.E.2d 925;
The judge is using each of these cases to decide in the
current case. Each one of these cases is precedent. The
actual use of the case to form a decision in the
current controversy is called staredecisis, which is Latin

for "standing on previous decisions." Stare decisis is a
fundamental principle of both English and
American legal systems. The stability of common law
depends on judges following legal precedent guided by the
doctrine of stare decisis. This stability
allows legal practitioners to predict how a given case will
be decided by examining how similar cases were decided
in the past. Judges don’t "invent" or
"make up" the law, depending on whim; for the most
part, they rely heavily on previous cases to write their
opinions. Under the principle of stare decisis, a
court should follow established legal precedent unless there
is a compelling reason not to do so. This principle is
crucial to common law; if judges did not
follow established precedent, there would be little
predictability to the legal system. Attorneys would have
no solid guidelines upon which to base their
advice to clients and no stable guideposts on which to
base legal arguments and chart legal strategies for arguing
cases in court.
Changing Precedent
Sometimes, however, the judge will reject a previous
decision and refuse to follow it. Recall, for example, the
U.S. Supreme Court decision of Roe v. Wade,
which struck down state laws limiting abortion and held
that abortion is legal. In doing so, the Court rejected
previous cases that stated abortion was illegal.
When do courts reject stare decisis? The decisions of a
state’s highest court are binding on that state’s lower
courts, which must follow it, but are only
persuasive precedent on the courts of other states, which
are free to follow or ignore such precedent. This means
that if a case is being heard in New York
and the attorney attempts to use a Pennsylvania case as

precedent, the judge can refuse to recognize the
Pennsylvania case. Thus, managers should be
aware that state law is binding only within that state, and
the law varies greatly from one state to another. This is
important to you as a business manager
because there may be instances in which "law" from
another state is brought to your attention but does not
apply to you at all. Thus, the doctrine of stare
decisis is limited to decisions within the same jurisdiction,
state, or region.
Another reason that stare decisis is not always followed
is the result of a change in the political climate of the
country. Sometimes opinion around an issue
changes so much that the courts re�lect a change in
attitude and reject well-established doctrine. Consider racial
discrimination in the United States, which
at one time was legal and upheld as constitutional by the
U.S. Supreme Court. Over time, both the law and cases
have changed to re�lect a different
philosophy. This was true in 1954, when the Supreme
Court found racial discrimination illegal in the case of
Brown v. Board of Education. Until that time, the
doctrine of "separate but equal" accommodations for blacks
and whites had been applied by the courts. The Brown
decision eradicated the doctrine and
replaced it with a new "law." Here was an example of
social mores changing to such a degree that the Court
refused to follow previous cases.
In summary, case or judicial law is made in courts by
judges rendering an opinion. Each state has at least one
state court that is hearing controversies and
rendering opinions. Thousands of opinions are being
written each day from all of these states. All of these
state court opinions form a body of law called

case or judicial law because they are based on cases, or
controversies between people. Thus, when you wonder,
"What is the law?" remember that only one
aspect of law includes state court opinions.
Statutory Law
Another key site for lawmaking is in both state and
federal legislatures, which are governing bodies whose job
is to make new laws. Law made by a
legislature is called a statute. Legislatures gain consensus
from their members to pass the bills making new laws,
after which the bills are signed by the
governor (for the state) or the president (for Congress).
At any time in the United States, there are 50 state
legislatures passing state statutes and a federal
legislature (Congress) passing federal laws.
Federal
At the federal level, Congress can legislate over a broad
range of areas through the exercise of its constitutionally
granted powers. These powers are set out
in the federal (U.S.) Constitution in Article I, Section
8. Whenever Congress legislates within its area of
constitutionally granted power, the resulting
legislation has the force of law, although its legality can
be challenged in federal court, as will be discussed later
on. Federal law is not some remote or
arcane academic exercise; it affects each of us on a daily
basis. This is especially true for people involved in
business. As a manager, you will deal with many
important federal laws. For example, the Americans with
Disabilities Act of 1990 spells out how employers must
accommodate disabled workers. This is a
federal law that applies to all businesses, as opposed to a

state law that applies only to businesses within that
particular state. Other examples of federal
statutory law include the Civil Rights Acts of 1964, which
prohibits discrimination on the basis of race, and the Age
Discrimination in Employment Act of
1967, which describes the rules for hiring and �iring
employees above the age of 40. The Senate also plays a
role in international agreements, or treaties, as
it is empowered to ratify treaties negotiated by the
president. These treaties (e.g., the North American Free
Trade Agreement, or NAFTA, approved in 1994)
impact businesses in all 50 states if they engage in
international commerce. See also Timeline of Major Legal
Developments That Affect Modern Businesses.
Figure 1.2 provides an example of a federal statute.
Notice that a federal statute looks completely different
than a case. Federal statutes do not have parties,
nor do they involve a controversy between people. Instead,
they are a pronouncement of the law and therefore are
sometimes much shorter and terse than
a case, which involves people, a speci�ic controversy, and
an explanation of events. Note the citation for where to
�ind the statute in the U.S. Code books.
Figure 1.2: Example of a federal statute
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A Closer Look: Finding the Law on the Internet

During the course of your work, you may have occasion
to research laws. Since you will most likely be accessing
legal materials via the
Internet, an excellent site that is free to all users is the
Cornell University Law School Legal Information Institute
(LII), which can be found at
Cornell Law (http://www.law.cornell.edu/) . One advantage
of online research is that you do not need an actual
citation. For example, if you go
to this website and type in "age discrimination law," the
appropriate statute will appear. Please note the extensive
legal materials that are
available online for free.
Many times, �inding federal statutes is not useful because
their language is overly complex and dif�icult to
understand. In that case, be aware
that there are many resources that will explain or interpret
what a statute actually means in down-to-earth language
along with the
underlying reasons for passage of the law. For example,
the Congressional Research Service located at Federation of
American Scientists
(http://www.fas.org/sgp/crs/misc/97-589.pdf) explains many
complicated federal statutes.
Suppose, for example, that your supervisor asked you to
rewrite part of the employee handbook pertaining to
discrimination. Many reliable
websites exist that can explain the law, from the more
basic aspects to detailed and legally sophisticated
information. While these do not
take the place of utilizing an attorney, there are many
daily tasks that you will perform as a manager for which
access to law sites will be

informative and helpful to your work.
State
Every state has its own legislature, which is usually
patterned after Congress, with two chambers (often, house
and senate) comprising elected members
from the two main political parties, one of which forms a
majority. These legislatures enact state laws in a wide
range of areas, including civil and criminal
law and procedure, business regulation, and, of course,
taxation. The power of state legislatures to regulate both
business and private conduct is far greater
than that of the federal government, since most states
reserve to themselves in their state constitutions broad
powers to legislate in all areas touching on
the welfare of their citizens. In addition, the Founding
Fathers explicitly limited the powers of the federal
government to regulate state matters. In general,
states have the right to regulate all areas of private or
public life as long as they do not infringe on any right
protected by the U.S. Constitution (see Table
1.2).
State and local legislation that does not infringe on a
constitutionally protected right is valid as long as it can
pass a relatively �lexible rationalrelationship
test, which simply means that any state law that is
rationally related to the preservation of a valid societal
interest is valid. This litmus test of
constitutionality is a simple one to pass, since nearly any
law can be rationally justi�ied as serving some valid
purpose. The test is somewhat more stringent,
however, when a vital interest or suspect classi�ication is
involved; in such instances, the state must pass a strict
scrutiny test of constitutionality, wherein

the courts weigh the state’s interest against the
infringement of protected rights in determining the validity
of a statute. For purposes of the strict scrutiny
test, a vital interest can be de�ined as any
constitutionally protected right, such as the rights
enumerated under the Bill of Rights. A suspect
classi�ication
would include a law that makes distinctions based on
race, sex, color, religion, or national origin.
Figure 1.3 provides an example of what a state statute
"looks like." Notice that it begins with a number, in this
case 28-1381, which is a typical way to
recognize that this is statutory law. Next, note that it has
a title, in this case the sentence beginning with "Driving .
. ." Notice that there are differences
between the format of a case and a statute. Remember
that cases begin with the name of the parties and are the
result of a controversy between two
people, whereas a statute is passed by a legislative body.
Figure 1.3: Example of a state statute
http://www.law.cornell.edu/
http://www.fas.org/sgp/crs/misc/97-589.pdf
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Local
In addition to state and federal legislatures, "local"

legislative bodies (e.g., city councils and various town
boards and planning commissions) have the power
to legislate in areas allowed them by their local charters.
These local ordinances also carry the weight of law and
form a part of the state’s statutory law.
Often when doing business, these local laws are the �irst
place to check when a question about the legality of a
certain action arises, such as zoning. Local
laws are frequently restrictive and much more narrow in
scope and intent than either state or federal laws.
Constitutional Law
In addition to judicial and statutory law, 51 constitutions
play a signi�icant role in formulating "the law." There
are 51 constitutions because each state has a
constitution (50) and there is one federal constitution, the
U.S. Constitution. A country or state’s constitution is the
most fundamental source of law. It
delineates in general terms the sovereign state’s form of
government and provides the basic framework for its laws.
Article VI, Section 2, of the U.S.
Constitution speci�ically sets the U.S. Constitution as the
"supreme law of the land" (see Appendix A: The
Constitution of the United States of
America
(http://content.thuzelearning.com/books/AUBUS670.12.2/sectio
ns/appa#appA) ). As such, no other law passed by a state
or the federal government can con�lict
with it; any law that does can be found by the courts to
be unconstitutional and void.
Constitutions are necessarily broad documents. In the
United States, the job of interpreting the federal
constitution and that of every state is left to the
courts. Both state and federal courts have the power to

interpret the U.S. Constitution, but the �inal word on the
analysis of the federal constitution is
reserved to the U.S. Supreme Court, whose interpretation
of the Constitution is �inal and represents binding
precedent on all lower courts, state and federal.
The U.S. Constitution serves as an important source of
law in the areas of governmental power. It empowers
states and the federal government to pass and
enforce laws that regulate people’s interactions with one
another and with their government while limiting the
government’s ability to legislate in certain
areas.
Under our Constitution, the federal government is one of
limited powers. Congress has the power to legislate only
in areas that it has been speci�ically
granted the power to regulate by the U.S. Constitution.
The powers of Congress are enumerated in Article I,
Section 8 (see Table 1.2).
Table 1.2: Powers of Congress listed in Article
I, Section 8, of the U.S.
Constitution
Collect taxes and import duties, pay debts, and provide
for the common defense and
general welfare of the United States
Borrow money
Regulate commerce with foreign nations, among the states,
and with the Indian tribes
Establish rules for naturalization and bankruptcy

Coin money, regulate its value, and �ix a standard of
weights and measures
Punish counterfeiting
Establish post of�ices and post roads
Issue patents and copyrights
Set up federal courts inferior to the U.S. Supreme Court
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De�ine and punish crimes on the high seas and crimes
against the United States
Declare war, grant letters of marque and reprisal, and
make rules regarding the seizure of
property under letters of marque and reprisal
Raise and support armies
Create a navy
Regulate the armed forces
Exercise control over the territory encompassing the seat
of government

Under the U.S. Constitution, states are free to create
legislation to regulate any area not speci�ically
reserved to the federal government. Thus, states
can adopt
any laws they wish within their borders as long as they
do not con�lict with a duly enacted federal law or
transgress upon any right guaranteed by the U.S.
Constitution, as interpreted in the courts.
While the Constitution gives broad regulatory powers to
states and the federal government, it also preserves the
rights of the individual in the Bill of Rights.
The most signi�icant body of constitutional law concerns
itself with the prohibitions on governmental powers
enumerated in the Constitution—in particular,
the guarantees provided to individuals by the Bill of
Rights (the �irst 10 amendments to the U.S. Constitution),
the Fourteenth Amendment, and the U.S.
Supreme Court’s interpretation of the broad language in
which they are framed.
But even the U.S. Constitution is not static. Under Article
V of the Constitution, Congress may propose a
constitutional amendment by a two-thirds vote by
the House of Representatives and the Senate. If a
proposed amendment is approved by Congress, it then goes
to all the states’ legislatures. If three-quarters
of the states’ legislatures approve the amendment, it
becomes part of the Constitution and the preeminent law
of the land. States may also propose
amendments to the Constitution to Congress on their own
initiative by votes for such a proposal in two-thirds of
the states’ legislatures. If the states make
the initiative, Congress must decide whether to allow
rati�ication by constitutional conventions in three-quarters

of the states; the change is then rati�ied
upon its approval by three-quarters of the states’
legislatures, by a constitutional convention in three-quarters
of the states, or by a vote for rati�ication by
three-quarters of the states’ legislatures.
Other than the right to each state’s equal representation in
the Senate, there is no limit to what changes can be
written into the Constitution. To date, the
Constitution has been amended 27 times. In the case of
the Eighteenth Amendment (1919) (better known as
Prohibition), which outlawed the
manufacturing, sale, or transportation of intoxicating
liquors in the United States, Congress changed its mind
and repealed Prohibition in the Twenty-First
Amendment (1933), leaving it up to the individual states
to prohibit the sale of alcoholic beverages as they saw
�it.
Administrative Law
One of the least visible entities that "makes law" is the
state or federal administrative agency, whose members
are appointed by government leaders but
who operate quasi-independently, reporting to Congress and
the public. When Congress decided to regulate nuclear
energy, for example, it created the
Nuclear Regulatory Commission and empowered it with the
ability to both create and enforce rules for the safe civil
use of nuclear energy. Although
Congress could have created and enforced these rules
itself, individual members of Congress have neither the
necessary expertise nor time to engage in such
micromanagement of the regulatory environment. The same
holds true for other agencies whose primary purpose is
the regulation of business and industry,

including the Federal Aviation Administration, the
Securities and Exchange Commission, the National Labor
Relations Board, the Federal Trade Commission,
and the Federal Communications Commission, among many
others.
At the state level, state legislatures and governors also set
up administrative agencies to help them regulate business
and carry out other important
governmental functions. Taken together, the rules that all
federal and state agencies promulgate are quasi-judicial
and quasi-legislative. That is, they have
the force of law and form the most important component
of administrative law. Like statutes, however, most
administrative rules and many administrative
agency decisions are subject to judicial review, the
process whereby statutes, administrative rules, and
administrative agency decisions are reviewed by
courts when challenged. (See Chapter 5, Administrative
Law
(http://content.thuzelearning.com/books/AUBUS670.12.2/s
ections/sec5.1#sec5.1) , for a fuller
discussion.)
All agencies have this in common: a need to regulate a
highly technical industry or business environment in order
to ensure safety and fair practices.
Administrative agencies are empowered by either the
executive or legislative branches of the state or federal
government to assist them in carrying out
necessary governmental functions that they lack either the
time or expertise to carry out themselves.
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Wikimedia Commons/Public Domain
John Marshall was the �irstchiefjustice to enact
the
power of judicial review.
1.3 The Three Branches of Government and the
Balance of Power
The U.S. government comprises three branches: judicial,
executive, and legislative. These branches were
designed to balance each other so that one cannot become
too powerful. For example, the courts can
review the actions by the legislative and executive
branches.
No matter how clear the language of a statute or how
plain its import, it is generally impossible in a
common law jurisdiction to interpret a statute, or the
federal or state constitutions, at face value.
Ultimately, the validity of any statute is determined by
the courts, as is its meaning. A case in point is
the Second Amendment to the U.S. Constitution, which
reads: "A well-regulated militia being necessary
to the security of a free state, the right of the people to
keep and bear arms shall not be infringed." Any
reasonable interpretation of that amendment that looks at
the plain meaning of the language used,
particularly when viewed with its revolutionary framers’
inherent distrust of government, leads one to

believe that the U.S. Constitution guarantees the right of
citizens to own and bear guns. Nevertheless,
the amendment has been interpreted to mean only that
individual states can raise their own militias
(e.g., national guards) if they so choose.
Regardless of the wisdom of such an interpretation, one
message is clear: any statute, including the U.S.
Constitution, means only what the courts ultimately decide
it means. This has been the case ever since
Marbury v. Madison (5 U.S. 137 [1803]), when Chief
Justice John Marshall �irst announced the power of
judicial review (the power of courts to declare the acts
of legislative bodies, including the U.S.
Congress, void if they violate the courts’ interpretation of
the Constitution). In what is arguably the
greatest act of judicial activism in the history of U.S.
jurisprudence, Chief Justice Marshall argued, "It is a
proposition too plain to be contested that the Constitution
controls any legislative act repugnant to it, or
that the legislature may not alter the Constitution by an
ordinary act. . . ." This novel proposition was
not challenged. The power of the courts generally, and
ultimately of the U.S. Supreme Court, to declare any act
of the U.S. Congress or any federal or state
law unconstitutional has now been well established by
more than 200 years of legal precedent. Nothing in the
U.S. Constitution itself explicitly reserves this
right to the courts, and British courts did not historically
enjoy a similar privilege (only the king, queen, or
Parliament itself could invalidate a royal edict or
Act of Parliament). Arguably, the chief justice could have
been successfully impeached for overstepping his bounds
and infringing on congressional legislative
privilege. By not challenging the decision, Congress left
the courts as the ultimate authority on the Constitution,

empowering the judicial branch of
government to curb the actions of legislative and executive
branches when these, in its view, transgressed the U.S.
Constitution.
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Key Terms
Click on each key term to see the de�inition.
administrative agency
ns/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.
2/sections/fm/books/AUBUS670.12.2/section
A governmental entity established to regulate a particularly
complex, technical area of business or industry (e.g.,
nuclear power, communications,
securities exchanges) that relies on special expertise.
administrative law
Law made by a state or federal administrative agency.
Bill of Rights

The �irst 10 amendments to the U.S. Constitution,
enumerating the individual rights and powers of citizens.
case law
Law made by a judge (or panel of judges) as the result
of a controversy between two parties. Also called judicial
law.
citation
The abbreviations following legal sources that tell the
reader where to �ind the original text of the law.
common law
The name given to the body of law established by the
English and brought to the United States as the �irst law
established in the colonies. Can also
mean caselaw or the aggregate body of case law.
Congress

The federal legislative body that enacts federal statutes.
controversy
A dispute between two or more parties that may be
decided in court.
federal (U.S.) Constitution
The "supreme law of the land" to whose standards all
laws must be submitted.
federal statute
A law passed by Congress and signed into law by the
president.
judicial law
See case law.
judicial review

The power of courts to declare the acts of legislative
bodies, including the U.S. Congress, void if they violate
the courts’ interpretation of the U.S.
Constitution.
lawsuit
https://content.ashford.edu/books/AUBUS670.12.2/sections/fm/
books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sect
ions/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.
12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AU
BUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/b
ooks/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/secti
ons/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.1
2.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUB
US670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/boo
ks/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections
/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/
sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS6
70.12.2/sections/fm/books/AUBUS670.12.2/sections/fm#

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A controversy brought to court by litigants: the plaintiff
and defendant.
litigation
The act of suing someone in court; a plaintiff bringing a
lawsuit against a defendant.
precedent
A previous case or body of cases that holds sway over
current legal decisions in a common law system.
quasi-judicial
In the context of administrative agencies, describes the

process of adjudicating disputes over agency rules or their
application in hearings similar to
trials, presided over by administrative law judges—that is,
when an agency acts "like a court."
quasi-legislative
Describes the process of creating one’s own rules (such as
when an administrative agency exercises a legislative
power).
stare decisis
The use by a judge of previous decisions (precedent) to
make a legal decision or ruling.
state constitution
Each state’s governing document that sets the standard for
all laws within its borders. State constitutions are
established, written, and amended by
the state legislature.
state statute

A law passed by a state legislature and signed into law
by the governor.
statute
A law passed by either a state or federal legislature.
U.S. Code(U.S.C.)
The set of books that contains all the federal statutes
passed by Congress.
Chapter 1 Flashcards

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Critical Thinking and Discussion Questions
1. Why do business managers and others need to
understand the foundations, origins, and scope of the law?
2. What is the advantage to the American legal system of
using stare decisis?
3. How does the concept of judicial review empower the
court system?
4. Locate the website for your state’s legislature. Find a
recent law passed by your state legislature and give the
citation for the statute as well as a brief
summary of the legislation.
5. Locate a case on the Internet. What is the citation for
the case? What happened in the case? How did you go
about �inding the case? Does the case use
stare decisis in its decision, and if so, how?
6. Why were administrative agencies created? Find the
website for an administrative agency and explain what
types of issues the agency deals with and
whether it holds hearings. If the agency does hold
hearings, describe the types of opinions it issues.
7. Suppose that Judge Harrison is hearing a case in her
court and that the attorneys present her with two disparate
cases to use in her decision. Based on
the concept of stare decisis, how would the judge go
about making her decision? Does Judge Harrison have to
use previous cases to make a ruling in the
current case?

A governmental entity established to regulate a particularly
complex, technical area of business or
industry (e.g., nuclear power, communications, securities
exchanges) that relies on special expertise.
C l i c k c a rd t o s e e t e r m �
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Chapter 28
Sole Proprietorships and Partnerships
Beginning with this chapter, we will explore the most
common forms of business organization in order to
understand their fundamental makeup and
examine the bene�its and liabilities of structuring a
business under each distinct form of business organization.
One of the �irst decisions that must be made
by anyone seeking to establish a new business is what
organizational form to choose. The most common types of
business organizations are:
1. Sole proprietorships;

2. Partnerships;
3. Limited partnerships;
4. Corporations; and
5. Limited liability companies (LLCs).
As we will see, each type of business organization offers
certain bene�its as well as drawbacks that should be
carefully weighed before deciding which form
is best suited to the new venture. Table 28.1 provides a
comparison of the different types of business entities. The
requirements for starting a business
under each of the available forms of business organization
vary widely. For example, individuals who start a business
under their own name alone or in
traditional partnerships will have very few organizational
formalities, whereas those who wish to organize a new
business as a limited partnership,
corporation, or limited liability company (LLC) will need
to strictly follow the requirements of their state's limited
partnership, corporation, or LLC acts.
Consult the of�ice of the secretary of state in your
location for registration requirements.
Table 28.1:Business entity comparison
SoleProprietorship General Partnership Limited
Partnership
TYPE OF
ENTITY
SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION

DEFINED A business owned and run by one
person.
An association of two or more people
for a pro�it.
An entity that is created by permission
of the state whose ownership is
represented by shares of stock.
ADVANTAGES No meetings; run the business by
yourself; no disagreements with others
about how to run the business; liable
only for own mistakes.
Have two or more people to help in
running the business and share the
liability. Have others to discuss the
business plan with and share ideas for
the business.
Limited liability of the owners and tax
advantages.
DISADVANTAGES Taxed on income like regular income;
have all of the liability; have no one else
to contribute ideas.
Taxes. The pro�its of the partnership are
taxed as personal income on each
partner's individual tax return, but the
entity must �ile Form 1065 with the IRS.
Expensive and complicated to create;
must follow state rules and comply with

state and federal �iling laws.
WHO OWNS The sole proprietor. The partners. The
shareholders.
HOW FORMED Many states require a business
certi�icate to be �iled at the county
clerk's of�ice; some also require an EIN
(federal) number.
Many states require a business
certi�icate to be �iled at the county
clerk's of�ice; as between the partners,
the agreement can be informal and oral.
Preincorporators must �ile Articles of
Incorporation with the secretary of
state; state must issue charter. Other
forms required. If public, must comply
with federal and state law regarding the
initial issuance of shares of stock.
WHO OPERATES The sole proprietor. The general
partners, but they can turn
over day-to-day management to a
managing partner.
The corporate of�icers.
LIABILITY OF
OWNERS
The sole proprietor's assets, personal
and business-related, are all subject to a
lawsuit.

All the partner's assets (personal and
business) are subject to a lawsuit.
Liability is limited to one's investment
(i.e., in shares of stock).
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HOW TAXED As personal income on Form 1040.
Income is reported on Form 1040 as
personal income and paid at the
personal rate, but the partnership also
has to �ile Form 1065.
At the state's corporate rate.
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28.1 Sole Proprietorships
The oldest and simplest form of business organization is
the sole proprietorship. Under this form of business
organization, the owner of a business
personally operates and is solely responsible for all
aspects of the enterprise. A sole proprietor who is hired

by another to perform services may also be an
independent contractor. An independent contractor usually
performs one job and works at his or her own discretion.
Thus, if ABC Corporation hired Fisher
Painting, a sole proprietorship owned by Martha Fisher,
Martha would be both a sole proprietor and an
independent contractor. (For other employment
issues relating to sole proprietorships, see Chapter 21
ections/ch21#ch21) , Establishing the
Employment Relationship, and Chapter 27
ections/ch27#ch27) , Principal–Agency Law.)
Formationof a Sole Proprietorship
The greatest bene�it of the sole proprietorship form of
business organization is that few formalities are required
for its formation. To a certain extent,
people wishing to go into business for themselves in a
business that carries their own name can start the
enterprise at any time without the need to seek
state or local approval.
Creating a Tax Entity
The �irst step in starting a sole proprietorship is to open
a bank account so that the business can receive money
and pay debts, either with checks or
electronically. To open a business account, the bank will
require a federal tax identi�ication number (TIN). This
nine-digit number could be the
proprietor's Social Security number or an employer
identi�ication number (EIN) that the IRS assigns the
business (in the format 12-3456789) and is used
for �iling tax returns. (All the information to obtain the

federal tax number can be found at GovServices
(http://www.taxid-gov.us) .)
All sole proprietors do not need to set up an EIN. If a
sole proprietorship does not have employees, it is not
required to have an EIN. In fact, the IRS
generally prefers that sole proprietors use their Social
Security number. However, employers with one or more
part-time or full-time employees, no matter
how small their business, must have one. Also, if they
plan to use an EIN to differentiate between personal and
business �inances, they should have an EIN
before applying for business permits. In addition, if they
pay subcontractors or others for services valued at more
than $600 in a calendar year, they may
need to get an EIN. Anyone who registers as a limited
liability company, corporation, partnership, or joint venture
must have an EIN.
Before a sole proprietor can collect any money from
sales, the state tax division will require that the business
register for permission to collect sales tax.
This process may take months, so planning ahead is
essential. Once the federal TIN and state tax collection
permission have been acquired, there are no
other formalities to go through before business can begin.
Licensing
Some types of businesses require licenses to do business,
such as bars (liquor license) or real estate �irms. So a
sole proprietorship must comply with all
state and federal regulations applicable to business
concerns. While there may be few formalities for actually
forming the business, it is not as simple as
simply setting up a lemonade stand.

Doing Business As
Persons who wish to do business under an assumed name
must apply for a permit from the appropriate state
of�ice in their state (typically the secretary of
state's of�ice) and pay a nominal fee for the privilege of
doing business under a trade name. The primary purpose
of this requirement is to prevent different
persons from doing business under the same name in the
same area, which might cause consumers confusion, and to
have on record the names and
addresses of the owners of these businesses so that they
may be readily found and held accountable for any civil
or criminal transgressions. Thus, Rick
Carpenter generally needs no special permission to start a
carpentry business under the name Rick Carpenter or Rick
Carpenter's Carpentry Service, but he
would need to get what is commonly termed a Doing
Business As (DBA) certi�icate from the appropriate
of�ice in his state if he wanted to call his business
Good Homes Carpentry, Expert Carpentry Works, or any
other assumed name.
Benefits of Sole Proprietorships
As already discussed, there are few formalities to launch
a sole proprietorship, and as a result, persons starting a
business often choose this form to begin
with. Other types of businesses, such as limited
partnerships, corporations, and LLCs, require the drafting
and �iling of speci�ic forms and approval from
government of�icials before the business can get off the
ground—a process that requires an investment of time and
money to complete.

Autonomy
If you ask a sole proprietor what the other greatest
advantage is to this form of business, he or she will most
likely reply that it is not having to share the
management with anyone else. The sole proprietor does
not have to ask for anyone's permission, wait for votes or
meetings, or seek others' approval.
Business decisions can occur quickly. Partnerships and
corporations, on the other hand, require the members to
reach a consensus and, in the case of
corporations, sometimes onerous formalities before major
business decisions (e.g., the sale of substantial portions of
the assets of the business or the
acquisition of business property) can be made. These
processes can interfere with the smooth operation of some
businesses and make instituting major
changes slow and often tedious.
Freedom From Vicarious Liability of Co-Owners
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Just as important as the autonomy that the sole
proprietorship permits the business owner is the freedom

from liability for the negligent acts or bad
business decisions of others. General partners in a
partnership are deemed to be agents of the partnership and
of one another under the common law of
partnership (see Chapter 27
ections/ch27#ch27) for a full treatment of principal–agency
law). Thus, if
there are partners A, B, and C, and only C is negligent,
A and B will also be liable. In a corporation (discussed
in Chapter 30
ns/ch30#ch30) ), directors and of�icers of a corporation
are deemed to be agents of the
corporation they serve.
Under the law of agency, principals can be bound by the
authorized acts of their agents and are liable for the
negligent acts of their agents committed
during the course of the agency. Thus, partners in a
partnership can be held liable for contracts entered into
on behalf of the partnership by any other
partner as well as for the negligent acts of any partner
that injures a third party. Likewise, a corporation can be
held liable for the authorized acts of its
of�icers and directors, as well as their negligence. Sole
proprietors, however, need never worry about being
responsible for the bad judgment, negligence, or
bad faith of a co-owner, since they are the only owners;
they are responsible only for their own acts and for the
acts of their agents.
Cost Savings
There are signi�icant �inancial advantages for the sole
proprietorship in terms of tax savings and lower

administrative costs. Unlike most corporations, the
sole proprietorship does not pay federal, state, or local
income taxes as a business entity; instead, all income
earned by the business is taxed as simple
income to the owner. This means that if the business
makes $250,000, then that �igure is reported on the sole
proprietor's tax return as income (on a
Schedule C form). Because bookkeeping and legal
formalities for the business are simpli�ied, the
administrative costs are usually lower than for other forms
of business organization. For example, the sole
proprietorship often has less need for legal and accounting
services compared with other business
organizations.
Drawbacks of Sole Proprietorships
While there are many bene�its rooted in the simplicity of
the sole proprietorship, a number of tangible drawbacks
stem from this form of business
organization. Chief among these is the unlimited
personal liability of the sole proprietor for all debts
incurred by the business. The sole proprietorship is
not recognized as a separate entity from its owner; as a
consequence, the debts of the business are deemed to be
the personal debts of the owner, and the
sole proprietor has unlimited personal liability for all the
debts, contractual obligations, and legal judgments the
business incurs. If the business fails, its
owner not only can lose the capital invested in the
business but can also face the prospect of having his or
her personal assets raided to satisfy business
debts if the business assets are insuf�icient to cover
business debts. Consequently, the business failure of a
sole proprietorship often means personal
bankruptcy.

Another downside of the sole proprietorship is that the
owner must rely solely on his or her own assets and
expertise in running the business, including
dealing with pro�its and losses. While the business
owner need not share pro�its or consult with others on
business decisions, neither can the sole
proprietor count on others to lend their expertise, share
business losses, or shoulder part of the responsibilities for
the business's daily operation. Such
assistance can be obtained in the form of hiring
employees, but individuals who draw a salary are seldom
as committed to the enterprise or as motivated to
ensure its success as those whose fortunes are tied
directly to the success or failure of the business. Further,
the lack of co-owners of a business enterprise
can be a particularly important drawback when the
business owner needs to raise capital to expand or to
cover extraordinary expenses.
Property Status and Transferability of Sole
Proprietorships
A sole proprietorship is considered personal property (see
also Chapter 19
ections/ch19#ch19) ). As
such, it can be transferred in whole or in part at any
time by its owner through sale or testamentary gift
(through a will). If a business concern that is
organized as a sole proprietorship is sold or otherwise
transferred by its owner, its nature can change, depending
on both the terms of its transfer and the
wishes of the new owners. A sole proprietorship
transferred to a single person who continues to run the
business as a sole proprietor, for example, retains

its previous status, whereas one transferred to two or
more persons as joint owners becomes a partnership. A
sole proprietorship can also be reorganized
as a corporation if its new owner so desires. The type of
business organization can also be changed by a present
owner by reorganizing the business from a
sole proprietorship to a partnership, corporation, or any
other business organization recognized by the state.
Termination of the Sole Proprietorship
If there are few formalities for starting a sole
proprietorship, there are none for ending one. The sole
proprietorship can terminate as a business concern at
any time at the will of its owner. Alternatively, it can
end by operation of law—upon the death, incapacity, or
bankruptcy of the owner. Consistent with this
business form, when the business ends, its owner will
remain personally liable for the completion of any
outstanding contracts and for meeting any other
outstanding business obligations. If the business ends
owing to the death or incapacity of its owner, the owner's
estate or guardian will be responsible for
paying creditors out of estate funds.
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28.2 Partnerships
When two or more people wish to start a business
together, the sole proprietorship is not a viable entity, and
they must consider another form. One of the
more popular (and less expensive) businesses to begin is a
partnership. There are two types of partnerships: general
partnerships (discussed here) and
limited partnerships (discussed in Chapter 29
ections/ch29#ch29) ).
Partnership law differs from state to state, but all states
have adopted (in one form or another) the Uniform
Partnership Act (UPA). Because there are 50
different states, you need to consult individual state law
to ascertain the most current version. If you wish to see
samples of the act, the following websites
will give you the �lavor of the rules: Click here
(http://www.law.fsu.edu/journals/lawreview/issues/232/lar
son.html) (Florida) and here
(http://codes.lp.�indlaw.com/cacode/CORP/1/2/5.5)
(California). Other states' laws can be accessed on
the Internet. All states de�ine partnership as "an
association of two or more persons to carry on as co-
owners a business for pro�it. . . ." (§ 101(6) Uniform
Partnership Act (1997)). Any time that two or
more individuals are engaged in a business as co-owners
with the intent to make a pro�it, a partnership arises
automatically (de jure, or by law), and the
rights and responsibilities of each partner will be dictated
by the law of partnership in the state where the
partnership was formed.

The contractual provisions contained in the agreement
de�ine the relationship as well as the rights and
responsibilities the partners owe to one another. In
the absence of a partnership agreement, or in cases in
which the partnership agreement fails to de�ine key rights
and responsibilities, the state's common
law of partnership (and, where applicable, the state's
partnership act) will de�ine these rights and obligations.
Formationof a Partnership
Like the sole proprietorship, the partnership form of
business organization does not require speci�ic formalities
for its creation. Oral and written agreements
to enter into a partnership are generally equally binding.
A partnership can also arise by operation of law even
absent a speci�ic agreement: Any voluntary
association by two or more persons to conduct a business
for pro�it as joint owners automatically results in the
creation of a partnership by operation of
law, whether or not the joint owners speci�ically intended
it. This holds true if two people start to sell a product
but decide between themselves that they
are not partners or they don't consider themselves a
partnership.
One would think that people contemplating going into
business together would want to put their understanding in
writing. That way, if any disputes or
misunderstandings arose, the agreement could serve as a
guide. In far too many cases, however, partners do not
execute a written partnership agreement.
This may be because of the cost of hiring an attorney, or
mere laziness or aversion to discussing the minutiae of
the agreement. It may also result from the
partnership being a close family relation or friend with

whom they don't foresee con�lict. Whatever the reason, it
is a poor excuse, because forming an
agreement is easy and the forms are available online. For
an example, click here
(http://lergp.cce.cornell.edu/Business_Management/Sample%20
Partnership%20Agreement_110410.pdf) . The consequences
of not setting forth the terms of the
partnership can be dire—the loss of the business, personal
debt, and damaged personal relationships. It pays to be
ready for the worst (dissolution, divorce,
creditors, and personal problems of a partner) in order to
protect the interests of all parties involved. See Figure
28.1 for a sample partnership agreement.
Figure 28.1: Sample partnership agreement
9#ch29
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Agency Rights and Duties of Partners
When partners act within the scope of their authority,
they are agents of the partnership and of each other. As
such, they bind the partnership to any
contracts they enter into on the partnership's behalf within
the regular course of business. As is true of all agents,
partners have �iduciary duties to the
partnership and to each other. As co-owners of the
business, partners also have the interests of principals in
the enterprise; since each partner is both an
agent and a principal of the partnership, each partner also
owes every other partner the duties of a �iduciary. As
such, partners must place partnership
interests above their own personal gain and must execute
their duties as partners with the utmost good faith. (See
Chapter 27
ns/ch27#ch27) for a list of �iduciary duties of agents and
principals.) Table 28.2 illustrates these
relationships.
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Table 28.2:Partnership relationships
PARTNER 1 PARTNER 2 PARTNER 3
Principal of 2 and 3 Principal of 1 and 3 Principal of
1 and 2
Agent of 2 and 3 Agent of 1 and 3 Agent of 1
and 2
The general duties owed by agents to their principals,
discussed in Chapter 27, apply to each partner in the
partnership. Thus, partners owe the partnership
and one another:
The duty of loyalty;
The duty of obedience (they must carry out the rightful
requests of the majority of the partners);
The duty to exercise reasonable care and diligence in the
exercise of their partnership duties;
The duty to notify the partnership of any facts learned
that are relevant to the partnership; and
The duty to make an accounting to the partnership of any
bene�its derived from conducting partnership business as
well as any expenses incurred on

the partnership's behalf.
By the same token, the partnership owes each individual
partner:
The duty of reimbursement and indemni�ication; and
The duty of cooperation.
Contractual Rights and Duties of Partners
Although all partners are duty bound as agent and
principal, they are generally free to control the nature of
their relationship to one another and the duties
they owe one another and the partnership by drafting the
partnership agreement. This is true as long as they do not
violate the law or the public policy of
the states in which they do business. Unless there are
provisions to the contrary in the partnership agreement,
partners have an equal right to manage the
business and to share in its pro�its. The mere fact that
one partner makes a greater capital contribution to the
partnership will not give that partner a
greater voice in the management of the business or a
greater share in its pro�its unless it is provided in the
partnership agreement. Similarly, partners must
share in the losses of the business in accordance with the
share of pro�its they receive from it. Thus, if partners
share pro�its equally, they will also share
losses equally. If, however, the partners adopt a formula
for the unequal allocation of pro�its among themselves,
the same formula will apply to the (unequal)
sharing of losses between the partners unless they agree
otherwise.
Limitations on Partners' Ability to Define Their

Rights and Obligations
Although partners are generally free to de�ine their
obligations to each other and to the partnership in the
partnership agreement, some acts are speci�ically
forbidden by law. The Uniform Partnership Act (UPA)
prohibits several activities by partners:
Engaging in certain activities that include unreasonably
restricting the right of partners to access partnership books
and records;
Eliminating the duty of loyalty (though partners may
de�ine what types of activities are not considered a
violation of the duty of loyalty, as long as these
are reasonable);
Eliminating the duty of care or the obligation of good
faith owed by each partner to the partnership;
Restricting the rights of third parties under the act; and
Unilaterally binding the partnership to a contract that
assigns the partnership property for the bene�it of
creditors, disposes of the partnership's
goodwill, or confesses a judgment.
Each of these is discussed in more detail below.
Limitations of Partners' Ability to Bind the
Partnership
Because they are agents, partners can individually bind the
partnership to contracts entered into on its behalf during
the regular course of business. The
same rules of agency apply: there must be express,

implied, or apparent authority. Therefore, if the partner is
authorized, and he or she orders of�ice
equipment from a store in the name of the partnership,
the partnership is legally obligated to pay the bill. There
are certain acts, however, for which the
unanimous consent of all partners is required. The reason
for this is that these acts are so dangerous for the
partnership that every single partner's consent
is needed. These acts include assigning partnership
property for the bene�it of creditors, disposing
of the partnership's goodwill, and confessing a
judgment (Uniform Partnership Act § 9(3)(a–e)).
Assigning Partnership Property for the Bene�it of
Creditors
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Generally, assigning partnership property means that to
resolve a debt with a creditor, the partnership transfers its
interest in speci�ic partnership property.
In such a secured transaction, if the partnership does not
pay the debt, the creditor may keep the property. The
UPA prohibits one partner from assigning
partnership property to a third party without the
permission of all the other partners. This rule makes sense
because, as a partner, you would not want one
of the other partners assigning property interests without
your permission; otherwise, the property of the partnership
could be pledged to another without

your knowledge.
Disposing of the Partnership's Goodwill
Goodwill is the intangible "name recognition" of a
business that has meaning to customers, and in some
cases, may be worth a great deal of money. In this
case, the partnership would be selling its name or
goodwill to a third party. The UPA prohibits one partner
from selling the goodwill of the business without
the permission of the other partners. Again, this is an
essential asset of the business: that all partners should
have a say in assigning property to someone
outside of the business.
Confessing a Judgment
A judgment occurs at the conclusion of a civil trial, when
the jury or judge pronounces a "winner." In the case of
confessing a judgment, however, the debtor
is agreeing that he or she owes the creditor money
without going to court. For a partnership to confess a
debt, all the partners must be in agreement; one
partner cannot sign a "confession" that binds the other
partners.
Acts That Interfere With the Partnership's Business
Submitting a partnership claim to arbitration or doing any
other act that would make it impossible to carry out the
ordinary business of the partnership is
likewise prohibited by the UPA.
Limitation on Partners' Right of Compensation
Students are often surprised to learn that partners do not

automatically, or even customarily, receive a salary. In
fact, partners serve without compensation
for their services unless the partnership agreement provides
otherwise. Instead, partners are paid their respective share
of the pro�its by taking a draw,
meaning that they take from the partnership's account their
share of the pro�its. According to the Revised Uniform
Partnership Act (RUPA), a partner is
also entitled to reasonable compensation for winding up
the business after the dissolution of the partnership
(RUPA (1997) § 401(h)).
Partners' Capital Contributions
In the event that a partner dies or withdraws from the
partnership, that person is entitled to the repayment of his
or her capital contribution. Recall that
this was the seed money each partner contributed to fund
the start of the partnership. Additionally, suppose that a
partner made a loan to the partnership
or paid a partnership bill out of personal funds. If so,
payments or advances to the partnership by any partner
above and beyond the agreed-upon initial
capital contribution will earn interest for the partner as of
the date it is made.
Admission of New Partners
Admission of new partners into an existing partnership
agreement can be made only with the unanimous consent
of all partners (RUPA (1997) § 401(i)).
Partners' Right to Inspect Partnership's Books
Every partner has the right to inspect the partnership
books at any time. The books must be kept at the

principal of�ice of the partnership and made
available to every partner, at all times, for inspection and
copying. RUPA also gives the right to inspect to other
interested parties: a partner's agents and
attorneys as well as former partners, their agents, and
attorneys, pertaining to the period during which they were
partners (RUPA (1997) § 403(b)). While
this might not seem like an important right, being able to
send an assistant (agent) to photocopy hundreds of pages
of information can be a signi�icant time-
saver for an attorney or partner facing litigation.
Partners' Liability for Partnership Debt
Partners are jointly and severally liable for all
partnership debts. This means that partners can be sued
individually or together by any person to whom
the partnership owes a debt. These include debts that arise
from contracts, tort liability, or liability to the state and
federal governments for taxes or fees
connected with running the business. Thus, each partner is
subject to unlimited personal liability for partnership debts.
If a single partner is sued by a
creditor, the partner must fully discharge the debt out of
his or her personal assets and would then be able to seek
reimbursement from the other partners
for their individual share of the liability. If the other
partners are insolvent, however, the solvent partner could
be left with no recourse.
New partners admitted to an existing partnership are liable
only for partnership debts incurred after they join the
partnership, and partners who dissociate
themselves from the partnership are liable only for debts
incurred up to the time of their dissociation, but not
after.

Partners' Property Rights
Because a partnership is an entity distinct from its
partners, the partnership holds title to the partnership
property. Property that is acquired by or in the
name of the partnership is the property of the partnership
and does not belong to any individual partner (RUPA §
203). The partnership can hold and
dispose of property in the same way in which a
corporation or an LLC can hold and dispose of property—
in the "name of the partnership," not in the name
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of individual partners. This brings the partnership form of
business organization in line with other forms of business
organization that are creatures of
statute, such as the limited partnership, corporation, and
LLC.
Purported Partners
In our discussion of agency by estoppel in Chapter 27
ections/ch27#ch27) , we saw that if a principal
misleads a third party into believing that a person who is
not an agent is in fact the principal's agent, the principal
will be unable to disavow acts of the
purported agent. After all, the third party relied on the

purported agent's misrepresentations and may have suffered
some tangible loss as a consequence.
The principal is thereby prevented from denying the
existence of the agency or the lack of authority of the
purported agent when he or she is sued by an
innocent third party, who justi�iably relied on the
existence of the agency because of the misrepresentation.
The same common law tenet applies to partnerships.
Partners can be prevented from denying a purported
partner's partnership status if the partners allow
an innocent third party to mistakenly and justi�iably
believe that a nonpartner is a partner. In such cases, a
partnership by estoppel exists. This means that
the partners are prevented (estopped) from denying the
nonpartner's partnership status with regard to any innocent
third person:
If a person, by words or conduct, purports to be a
partner, or consents to being represented by another as a
partner . . . the purported partner
is liable to a person to whom the representation is made,
if that person, relying on the representation, enters into a
transaction with the actual
or purported partnership. (RUPA § 308(a) (1997))
Partners are also liable for the purported agent's actions
as though the person were in fact a partner. Under the
common law, UPA, and RUPA, if all partners
in the partnership consent to the misrepresentation, all
partners are bound by it. However, if fewer than all the
partners consent to the misrepresentation,
only those partners who consented to the misrepresentation
are jointly and severally liable to any innocent third
parties who relied on the
misrepresentation in dealing with the purported partner

(RUPA § 308(b) (1997)). The following examples will
illustrate:
Adam tells Betty that he is a partner of
Charlene and David. Betty believes him and
enters into a contract with Adam to sell
the partnership of
Adam, Charlene, and David $1,000,000 worth of
of�ice supplies and equipment. The contract
will not bind Charlene or David, as the
statements
by Adam were not made in their presence or
with their acquiescence. Only Adam is liable
under this contract.
Charlene and David in Charlene's presence,
and Charlene does not dispute the statement.Betty
later
enters into a contract with Adam to sell the
partnership of Adam, Charlene, and David
$1,000,000 worth of of�ice supplies and
equipment. The
contract will bind Charlene but not David, as the
statements by Adam were not made in
David's presence or with his acquiescence. Only
Adam
and Charlene are liable under this contract.
Charlene and David in the presence of both
Charlene and David, who do not dispute the
statement.Betty
later enters into a contract with Adam to sell
the partnership of Adam, Charlene, and David
$1,000,000 worth of of�ice supplies and

equipment.
The contract will bind Charlene and David (as well as
Adam) because the misrepresentation was made
in their presence and was not objected to
by either of them.
7#ch27
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28.3 Partnership Dissociation
Even if the partners formed their business with the idea
that they would continue for many years, it is not
uncommon for people to have a falling out. At
that juncture, the partners then wonder how to end the
partnership that they formed. The name given to ending a
partnership is dissociation. There are a
number of voluntary and involuntary ways in which a
partner may be dissociated from the partnership.
If the partnership is one "at will," then by de�inition, it
has no ending date. Any partner can leave the partnership
at any time without incurring further
liability. Sometimes the partnership agreement states that it
will end upon the happening of an event. For example,
the partnership agreement might say:
TERM OF THE PARTNERSHIP
This partnership will end when the house at

124 Elm Street is purchased, the renovations
complete, and the house is sold to a third-
party
purchaser.
In such a case, the partnership ends upon the happening
of an event that all the partners agreed to upon
partnership formation.
Sometimes the actions of a partner are so egregious that
the other partners do not want that person associated with
the partnership anymore. When this
occurs, the partners may expel the partner from the
partnership if they have a partnership agreement that
provides for such a scenario. Without an
agreement, a partner can still be expelled from a
partnership, but it must be by unanimous vote of the
partners and only for reasons such as "It is unlawful
to carry on the partnership business with that partner." If
the partnership cannot agree to expel a partner, then the
partnership can go to court and seek a
judicial determination for a reason such as the partner
engaging in wrongful conduct that "adversely and
materially affected the partnership business." Both
UPA and RUPA have lists of reasons to terminate a
partnership. Examples of reasons to terminate a partnership
vary from state to state, depending on how
that state adopted the UPA. For examples of what two
states have adopted as reasons for termination, click here
(http://delcode.delaware.gov/title6/c015/index.shtml)
(Delaware) and here
(http://www.leg.state.nv.us/NRS/NRS-
087.html#NRS087Sec4343) (Nevada).
Winding Up

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