9 Partnerships Introduction to Forms of Business and Formation of Partnerships Operation of Partnerships Dissolution & Winding Up Limited Liability Companies & Limited Partnerships McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

INTRODUCTION TO FORMS OF BUSINESS AND FORMATION OF PARTNERSHIPS 37 C H A P T E R INTRODUCTION TO FORMS OF BUSINESS AND FORMATION OF PARTNERSHIPS “It sounds boring, but anything is easy to start – starting a novel, starting a business…it’s keeping the thing going that is difficult.” Prue Leith, author and executive, quoted in The Adventure Capitalists (Grout and Curry, 1998)

Learning Objectives Choosing a form of business Creation of partnership Purported partners Partnership capital and property Partnership interests 37 - 3

What you choose depends on where you want to go 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 Refer students to page 897 of the text for a summary chart of business forms and details. What you choose depends on where you want to go 37 - 4

Basic Forms Sole proprietorship Partnership Corporation General, limited, limited liability, or limited liability limited partnership Corporation Regular “C”, Subchapter “S”, nonprofit, professional Limited liability company Including professional form 37 - 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 loss 37 - 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 partners 37 - 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 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 corporations 37 - 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 structure 37 - 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 LLC 37 - 11

Business Forms Worldwide Many nations share similar forms of business, including partnership and corporation, though details vary widely 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 statute 37 - 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 it inadvertently, without considering whether they had created a partnership 37 - 14

Partnership Creation -- Examples Several musicians agree to form a band and share profits Two students stand in line for hours to buy 10 concert tickets. They sell 8 tickets for a $5 fee per ticket and splitting the profits. 37 - 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, LLP 37 - 16

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 - 17

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 agreed Lesson: don’t cloak somebody with apparent partnership! 37 - 18

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 partners In McCormack v. Brevig, the court held that property listed on a partnership’s tax returns was nonetheless property of a partner, not the partnership. 37 - 19

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: Transferable interest Partner’s share of profits and losses and right to receive partnership distributions Management and other rights 37 - 20

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 enterprise 37 - 21

Learning Objectives Limited Liability Companies Limited Partnerships and Limited Liability Limited Partnerships Creation of Limited Partnerships Right and liabilities of members and partners Dissociation and dissolution 40 - 22

Overview The limited liability company (LLC) combines advantages of the corporation with regard to protection from personal liability and favorable tax status of the partnership The Uniform Limited Liability Company Act of 1996 (ULLCA) offers default rules similar to RUPA that govern an LLC in the absence of a contrary agreement of its owners http://www.nccusl.org/Update/ 40 - 23

Taxation of the LLC An LLC may elect to be taxed like a partnership or a corporation for federal income tax purposes Election as partnership more common Therefore, the LLC pays no federal income tax and all income and losses of the LLC are reported by the LLC’s owner-members on their individual income tax returns 40 - 24

Creation of the LLC At least one person (organizers) must file articles of organization with a secretary of state Articles must include LLC name, its duration, and the name and address of its registered agent Owners of an LLC are members An individual, partnership, corporation, or another LLC may be a member of an LLC An LLC is an entity separate from its members 40 - 25

Management of the LLC Articles of organization must state whether the LLC is member-managed or manager-managed If manager-managed, initial managers must be named An LLC probably will have an operating agreement covering how members will share profits, manage the LLC, and withdraw from the LLC 40 - 26

Liability of Members An LLC member has no individual liability on LLC contracts, unless LLC contracts signed in a personal capacity (e.g., as a surety) A member’s liability is usually limited to the member’s capital contributions A member is liable for torts s/he committed while acting for the LLC 40 - 27

A Member-Managed LLC Under the ULLCA, an LLC must choose to be member-managed or manager-managed Each member in a member-managed LLC shares equal rights in the management of the business and each member is an agent of the LLC with implied authority to carry on its ordinary business 40 - 28

A Member-Managed LLC The LLC operating agreement may modify ULLCA default rules by granting more power to some members Creating a class of members whose approval is required for certain contracts Members share power based on capital contributions 40 - 29

A Member-Managed LLC Managers in a manager-managed LLC are elected and removed by a vote of a majority of LLC members A manager’s powers to act for the LLC are similar to a member’s power in a member- managed LLC A team effort. 40 - 30

Tort and Contract Liability An LLC is liable for the contractual obligations incurred by its members or managers acting within their express, implied, or apparent authority An LLC is also liable for the torts and other wrongful acts of managing members and other managers acting within their authority 40 - 31

Duties of Members Each member in a member-managed LLC and each manager in a manager-managed LLC is a fiduciary of the LLC and its members with duties similar to the duties of partners, including the duty of care Nonmanaging members of a manager-managed LLC owe no fiduciary duties But owe a duty of good faith and fair dealing when exercising rights as members 40 - 32

Ownership Interest of Members A member’s ownership interest in an LLC is the member’s personal property Limited ability to sell or transfer LLC rights A member may transfer the distributional interest in the LLC to another person Transferee not a member, but receives right to partnership distributions Limited right of transfer may be altered in the operating agreement 40 - 33

Distributions to Members A member in an LLC has the right is to receive distributions (usually profits) ULLCA states that members share profits and other distributions equally, regardless of differences in their capital contributions This may be altered by the operating agreement 40 - 34

Dissociation Under the ULLCA, members dissociate from an LLC in ways similar to those by which a partner dissociates from a partnership or LLP under RUPA Under the ULLCA, a partner has the power to dissociate by withdrawing from the LLC at any time 40 - 35

Dissociation As in partnership, a member’s dissociation may be wrongful or nonwrongful Dissociation terminates a member’s status as a member, and a dissociated member is treated as a transferee of a member’s distributional interest In Re Garrison-Ashburn, LC concerns dissociation 40 - 36

Dissolution Dissolution of an LLC is similar to that of an LLP or partnership When an LLC dissolves, any member who has not wrongly dissociated may wind up the business LLC bound by reasonable acts of members during winding up 40 - 37

Dissolution After all the LLC assets sold, proceeds distributed first to LLC creditors, then members’ contributions are returned Any remaining proceeds are distributed in equal shares to the members 40 - 38

Uniform Limited Partnership Act Substantially similar to RUPA, the ULPA of 2001 is the first comprehensive statement of American limited partnership law Only ULPA applies to limited partnerships The limited partnership (or LLLP) form is perpetual and used primarily in tax shelter ventures, real estate ventures, oil and gas drilling, and professional sports 40 - 39

The Limited Partnership Limited partnerships has two owner classes: General partners contribute capital, manage the business, share in profits, and possess unlimited liability for its obligations Limited partners contribute capital and share profits, but possess no management powers Liability limited up to the amount of their investments in the business Limited partnership agreements common 40 - 40

Limited Liability Limited Partnership A variant of a limited partnership is the limited liability limited partnership (LLLP) which offers limited liability status for all its partners, including general partners Except for liability of general partners, limited partnerships and LLLPs are identical 40 - 41

Creating the LP or LLLP A limited partnership (or LLLP) may be created only by complying with the applicable state statute, but requirements are minimal A certificate of limited partnership must be executed (signed by all general partners) and submitted to the secretary of state 40 - 42

Rights of LP and LLLP Partners A partner may contribute any property or other benefit to the limited partnership Under ULPA, profits and losses are shared on the basis of the value of each partner’s capital contribution unless there is a written agreement to the contrary ULPA of 2001 requires few actions to be approved by all the partners 40 - 43

Rights of LP and LLLP Partners ULPA is clear that limited partners have no inherent right to vote on any matter Default rule is that no new partner may be admitted unless each partner has consented to the admission Limited partnership agreement may provide for other admission procedures 40 - 44

Transferable Interest Each partner in a limited partnership owns a transferable interest in the limited partnership as personal property A partner’s transfer of his transferable interest has no effect on his status as a partner, absent a contrary agreement 40 - 45

Management & Duties A general partner of a limited partnership or LLLP has same right to manage and same agency powers as a partner in an ordinary partnership, including the duty of care A general partner of a limited partnership or LLLP is in a position of trust and therefore owes fiduciary duties to the limited partnership and the other partners 40 - 46

Derivative Actions Through a derivative action or derivative suit, a partner may sue to enforce a limited partnership right of action against a person who has harmed the limited partnership 40 - 47

Withdrawing Partners have the power to withdraw from the limited partnership at any time, but ULPA gives the partners no right to withdraw, absent a contrary provision in the limited partnership agreement Under ULPA, a withdrawing partner has no right to receive the value of the partnership interest 40 - 48

Dissociation of the LP and LLLP ULPA of 2001 adopts terminology and the framework of partnership law, thus ULPA establishes dissociation and dissolution rules A limited partner dissociates upon limited partner’s death, withdrawal, or expulsion from the partnership 40 - 49

Dissociation of the LP and LLLP A dissociated limited partner is not a limited partner, has no rights as a limited partner, and is treated as a mere transferee of the dissociated limited partner’s transferable interest ULPA treats dissociation of general partners as RUPA treats partner dissociations in a partnership 40 - 50

Dissociation of the LP and LLLP A general partner’s express and implied authority to act for the limited partnership terminates upon dissociation, the partner may retain apparent authority A dissociated general partner will remain liable on a limited partnership obligation incurred while a partner unless creditor agrees to a release of liability No liability for post-dissociation obligations 40 - 51

Dissolution of the LP and LLLP ULPA provides that a limited partnership (or LLLP) is not dissolved, wound up, or terminated merely because a partner dissociated from the limited partnership When a limited partnership dissolves, winding up follows automatically by the general partners 40 - 52

Dissolution of the LP and LLLP After general partners have liquidated the assets, proceeds are distributed first to creditors and if proceeds exceed creditors’ claims, the remainder is paid to the partners in the same proportions that they shared distributions 40 - 53