1. 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.

2. INTRODUCTION TO FORMS OF BUSINESS AND FORMATION OF PARTNERSHIPS37 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)

3. Learning Objectives Choosing a form of business
Creation of partnership
Purported partners
Partnership capital and property
Partnership interests
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4. 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
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5. 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
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6. 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
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7. 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
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8. 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
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9. 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
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10. 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

11. 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

12. Business Forms Worldwide
Many nations share similar forms of business, including partnership and corporation, though details vary widely

13. 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

14. 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

15. 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.

16. 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

17. 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.”

18. 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!

19. 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.

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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.

31. 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

32. 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

33. 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

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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. 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

41. 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

42. 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

43. 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

44. 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

45. 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

46. 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

47. 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

48. 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

49. 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

50. 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

51. 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

52. 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

53. 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