Chapter 33 Sole Proprietorships & Partnerships

2 Introduction Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: Ease of creation. Owners’ liability. Tax considerations. Need for Capital.

3 AdvantagesDisadvantages Owner is in complete control & receives all profits Owner is personally liable for all torts/contracts FlexibilityLacks continuity after death Ease of creation; maintenance Difficult to raise financing § 1: Sole Proprietorships The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship. Taxation. Organizational Fees. Transaction of Business in Other States.

4 § § 2-3: Partnerships (General)Partnership is created when two or more persons agree to carry on business for profit as co-owners with equal right to manage and share profits (UPA). AdvantagesDisadvantages Easy to create and maintainPartners are personally liable for all torts/contracts Flexible, informalDissolved upon death Partners share profits and losses equally Difficult to raise financing

5 Partnerships [2] Partners are agents and fiduciaries of one another, but differ from agents in that they are also co-owners and share in profits and losses. Sources of Law: State common law. Uniform Partnership Act (UPA), adopted by all states in some form. Revised Uniform Partnership Act (RUPA): adopted by some states.

6 Partnerships [3] If a commercial enterprise shares profits and losses a partnership will be inferred. Exceptions: Partnership not be inferred if profits received as payment in the following situations: Debt by installments of interest on a loan. Wages of an employee. Rent to a landlord. Annuity to a widow or representative of a deceased partner. Sale of good will.

7 § 4: Nature of Partnerships At common law, the partnership was not a separate legal entity from its owners. Today, partnership law in many states recognizes a partnership as an independent entity for some purposes.

8 Nature of Partnerships [2] Today, many states recognize the partnership as a separate legal entity for the following purposes: To sue and be sued (for federal questions, yes; for state questions, differs). To have judgments collected against it’s assets, and individual partners’ assets.

9 Nature of Partnerships [3] Partnerships are recognized as separate legal entities (cont’d): To own partnership property. To convey partnership property. At common law -- property owned in tenancy in partnership, all partners had to be named and sign the conveyance. Under UPA partnership property can be held and sold in firm name.

10 Nature of Partnerships [4] Partnerships are recognized as separate legal entities (cont’d): For “marshalling of assets.” Federal Bankruptcy changes marshaling of assets. To keep its own books. File its own federal/state tax returns.

11 § 5: Partnership Formation Partnership agreements can be oral unless Statute of Frauds requires a written agreement. Practically, agreements should be in writing. Partners must have legal capacity. UPA permits corporations to be a partner. By Estoppel: parties who are not partners hold themselves out to 3rd Parties and 3rd Party relies to her detriment.

12 § 6: Partnership Operations In the absence of a partnership agreement (oral or written) state statutes govern the rights among partners: Management: equal, each one vote, majority wins; need unanimous consent for some actions. Partnership Interest: equal profits, losses shared as profits shared.

13 Partner Rights [1] Rights among partners (cont’d): Compensation: none. Inspection of the Books: always and also by rep. of deceased partner. Accounting: when other partner(s) committing fraud, embezzlement, wrongful exclusion, or anytime it is just and reasonable. Property Rights 

14 Partner Rights [2] Each partner has a property right, which includes: An interest in the partnership. A right in specific partnership property. A right to participate in the management of the partnership, as mentioned above.

15 Partner Rights [3] Each Partner has right to equally share partnership interest: A proportionate share of the profits earned and a return of capital on the partnership's termination. A partner may assign his interest. A partner’s interest is susceptible to a creditor’s lien. Creditors may attach and get a “charging order.” Assignment or charging order do not dissolve the firm.

16 Partner Rights [4] Partner Rights in Partnership Property (cont’d) What she originally brought into the partnership, or acquired on account of the partnership, or purchased with partnership funds. (*but see RUPA) Partners are tenants in partnership of all firm property = other partners have rights of survival if one dies and then they account to the deceased partner’s estate for the value of his interest. (*but see RUPA) Partner cannot sell, assign or take a particular item of partnership property, nor can individual partner’s creditors seize the property; creditors can get a charging order against the partnership for the partner’s interest in the partnership.

17 Partner Duties, Powers and Liabilities [1] Duties and Powers of a Partner: Partners are fiduciaries and general agents of one another and the partnership. Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity. Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her.

18 Partner Duties, Powers and Liabilities [2] Joint and Several Liability for Torts. JSL means 3rd party can sue either one or all partners. 3rd party may collect against personal assets of all partners. Liability of Incoming Partner & Outgoing Partner. New admitted partner has no personal liability for existing partnership debts and obligations.

19 § 7: Partnership Termination Partnerships can be terminated (dissolved) for a variety of reasons: Partners can agree to terminate. Partner’s withdrawal can terminate. Termination has two stages: Dissolution and “Winding Up” (actual process of collecting and distributing the partnership assets).

20 Dissolution [1] By Acts of the Partners: Partners can agree to Agreement. Partner’s Withdrawal. Partnership for term – breach. No term -- no breach. Admission of a new partner. Not a transfer of a partner’s interest. By assignment or attachment by creditor.

21 Dissolution [2] By Operation of Law: Death of a partner. Bankruptcy of a partner. Bankruptcy of partnership. Illegality.

22 Dissolution [3] By Judicial Decree: Insanity. Incapacity. Business Impracticality. Improper Conduct. Other Circumstances (personal dissension).

23 Notice of Dissolution To avoid liability for apparent authority, apply the agency rules by giving: Actual notice. Constructive notice.

24 Winding Up Partners have no authority after dissolution occurs except to: Complete transactions already begun. Wind up by collecting and preserving partnership assets, discharging liabilities, and accounting to each partner for the value of his share.

25 Winding Up [2] If partner has violated the partnership agreement, he: Must pay damages. May not participate in winding up. But other partners may choose to continue. If partner dies: Other partners act as fiduciaries. Accounting to deceased partner’s estate. Survivors get paid for their services.

26 Distribution of Partnership Assets Partnership obligations are paid in the following order: First, 3rd party creditors. Second, partner loans to partnership. Third, return of capital contributions. Fourth, distribution of the balance, if any to partners.

27 Distribution of Partnership Assets [2] If liabilities are greater than assets partners bear losses in proportion in which they shared profits, unless agreed otherwise. If one partner does not contribute, other partners are liable for his share and they have the right of contribution against that partner who didn’t pay.

28 Partnership Buy-Sell Agreements Partners can agree in advance that, in the event of the death of one of the partners or some other event, what occurs: e.g., how much the deceased partner or her estate will get for interest, or whether the other partners can acquire the partnership interest. Partnership can buys life insurance to cover this accounting on partner’s death.

29 Case 33.1: Helpenstill v. Regions Bank (Authority of Partners) FACTS: Helpinstill and Brown were partners in MBO Computers. They opened a partnership bank account at Longview National Bank, each agreeing in writing that he would be individually liable for any overdrafts created on the account. Longview Bank was later acquired by Regions Bank. Brown, who was actively managing the business, regularly wrote overdrafts on the account and covered them later with deposits.

30 FACTS (cont’d) Later, to pay creditors of the partnership, Brown began shuffling funds between MBO accounts at the Longview bank and two other banks in a check-kiting scheme. Brown was convicted and sentenced to a term in a federal prison. Regions sued Helpinstill to recover $381,011.15, the amount of the overdrafts. Helpinstill argued that he was not liable because Brown’s check kiting was not within the ordinary course of partnership business. Case 33.1: Helpenstill v. Regions Bank (Authority of Partners)

31 HELD: FOR REGIONS BANK. Helpinstill’s liability to the bank was established as a matter of law. The overdrafts were created by the partnership during the ordinary course of business. As a matter of partnership law, each partner is liable for the partnership’s debts. The “kiting” scheme not change the fact that the creation of overdrafts was in the ordinary course of the partnership’s business. Case 33.1: Helpenstill v. Regions Bank (Authority of Partners)

32 Case 33.2: Citizens Bank v. Parham-Woods (Liability of Incoming Partner) FACTS: Citizens lent PW, a partnership, $2 million to construct a new office building. Their agreement provided for the money to be disbursed in installments. Most of the funds had been disbursed before Hunley, Tas, and Tas joined the firm. When the partnership failed to repay the loan, the bank sold the building and obtained a deficiency judgment for more than $1.2 million. The bank filed suit in a federal district court against the firm and the partners to recover.

33 HELD: FOR PARTNERS. The court held that, under UPA 17, Hunley and the Tases were liable only to the extent of the part­ nership property. “[A] partnership obligation arises * * * when the creditor extends the credit to the partnership.” In this case, “that occurred on April 30, * * * That is not changed merely because the passage of part of the consideration was delayed pursuant to a schedule which also was set before Dr. Hunley and the Tases became partners.” Case 33.2: Citizens Bank v. Parham-Woods (Liability of Incoming Partner)

34 Case 33.3: Creel v. Lilly (Winding Up) FACTS: Creel, Lilly, and Altizer formed a general partnership called “Joe’s Racing” to sell NASCAR racing memorabilia. Their agreement stated, in paragraph 7(a), that “at the termination of this partnership a full and accurate inventory shall be prepared, and the assets, liabilities, and income * * * shall be ascertained.” Nine months later, Creel died, and his wife, the personal representative, failed to disburse money in the partnership account.

35 FACTS (cont’d( Lilly and Altizer sued Creel, computed the value of the business, offered her payment for Creel’s share, ceased doing business as Joe’s Racing, and used the assets to begin doing business as “Good Ole Boys Racing.” HELD: FOR LILLY & ALTIZER. Winding up does not require a forced sale of all partnership assets to determine the value of the business. On the death of a partner, it is acceptable to pay the deceased partner’s estate its proportionate share of the value of the partnership. Case 33.3: Creel v. Lilly (Winding Up)