1. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Slides developed by Les Wiletzky PowerPoint Slides to Accompany ESSENTIALS OF BUSINESS AND ONLINE COMMERCE LAW 1 st Edition by Henry R. Cheeseman Chapter 16 Sole Proprietorships, Partnerships, and Limited Liability Companies Chapter 16 Sole Proprietorships, Partnerships, and Limited Liability Companies

2. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 2 Limited Liability Partnership Limited Liability Company Corporation General Partnership Limited Partnership Sole Proprietorship Entrepreneurial Forms of Conducting Business

3. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 3 Sole Proprietorship  A form of business where the owner is actually the business  The business is not a separate legal entity  Sole proprietorships are the most common form of business organization in the United States

4. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 4 Advantages of a Sole Proprietorship  The ease and low cost of formation  The owner’s right to make all management decisions concerning the business  The sole proprietor owns all of the business and has the right to receive all of the business’s profits  A sole proprietorship can be easily transferred or sold if and when the owner desires to do so

5. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 5 Disadvantages of a Sole Proprietorship  The sole proprietor’s access to capital is limited to personal funds plus any loans he or she can obtain  The sole proprietor is legally responsible for the business’s contracts and the torts committed by the proprietor and his or her employees in the course of employment

6. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 6 Sole Proprietorship Sole Proprietor (Owner) Sole Proprietorship Third Party Capital investment Debt or obligation owed Personal liability for sole proprietorship’s debts and obligations

7. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 7 Creation of a Sole Proprietorship  There are no formalities  No federal or state government approval is required  Some local governments require all businesses (including sole proprietorships) to obtain a license to do business within the city  A sole proprietorship can operate under the name of the sole proprietor or a trade name

8. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 8 Personal Liability of Sole Proprietors  The sole proprietor bears the risk of loss of the business  The owner will lose his or her entire capital contribution if the business fails unlimited personal liability  The sole proprietor has unlimited personal liability  Creditors may recover claims against the business from the sole proprietor’s personal assets

9. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 9 General Partnership  A voluntary association of two or more persons for carrying on a business as co- owners for profit partnership  Also called a partnership  General partnerspartners  General partners, or partners are personally liable for the debts and obligations of the partnership

10. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 10 General Partnership Third Party Debt or obligation owed General Partnership Capital investment Personal liability for partnership’s debts and obligations General Partner

11. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 11 Uniform Partnership Act (UPA)  Model act that codifies partnership law  Most states have adopted the UPA in whole or part  The UPA covers most problems that arise in the formation, operation, and dissolution of ordinary partnerships

12. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 12 Formation of a Partnership voluntary  A partnership is a voluntary association  Partnership name  The partnership agreement  Right to participate in management  Right to an accounting  Partners’ rights to share in profits  Tort liability

13. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 13 Summary: Personal Liability of General Partners IssueJoint LiabilityJoint and Several Liability Type of lawsuitContract actionTort action DefendantsPlaintiff must name all partners as defendants Plaintiff can sue partners individually RecoveryIf successful, the plaintiff can recover the judgment against all or any of the defendants If successful, the plaintiff can recover the judgment against all or any of the named defendants IndemnificationPartner who pays judgment can recover contribution from other partners for their share of the judgment

14. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 14 Dissolution of Partnerships (1 of 3)  Partnership for a term A partnership for a fixed duration  Partnership at will A partnership with no fixed duration power right to do so  A partner has the power to withdraw and dissolve the partnership at any time, but he or she may not have the right to do so

15. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 15 Dissolution of Partnerships (2 of 3)  Wrongful dissolution When a partner withdraws from a partnership without having the right to do so at that time The partner is liable for damages caused by the wrongful dissolution of the partnership  Notice of dissolution Notice of dissolution must be given to certain third parties The degree of notice depends on the relationship of the third person with the partnership

16. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 16 Dissolution of Partnerships (3 of 3)  Continuation of a partnership after dissolution The surviving or remaining partners have the right to continue the partnership after dissolution  Liability of outgoing partners The dissolution of a partnership does not itself discharge the liability of outgoing partners for existing partnership debts and obligations

17. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 17 Limited Partnership  A type of partnership that has two types of partners: General Partners General Partners – who invest capital, manage the business, and are personally liable for partnership debts Limited Partners Limited Partners – who invest capital but do not participate in management and are not personally liable for partnership debts beyond their capital contribution

18. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 18 The Revised Uniform Limited Partnership Act (RULPA) Uniform Limited Partnership Act (ULPA) of 1916  Contained a uniform set of provisions for the formation, operation, and dissolution of limited partnerships  Most states originally enacted this law Uniform Limited Partnership Act (ULPA) of 1916  Contained a uniform set of provisions for the formation, operation, and dissolution of limited partnerships  Most states originally enacted this law Revised Uniform Limited Partnership Act (RULPA)  A 1976 revision of the ULPA  Provides a more modern comprehensive law for the formation, operation, and dissolution of limited partnerships  A majority of states have adopted the RULPA Revised Uniform Limited Partnership Act (RULPA)  A 1976 revision of the ULPA  Provides a more modern comprehensive law for the formation, operation, and dissolution of limited partnerships  A majority of states have adopted the RULPA

19. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 19 Limited Partnership Liability limited to capital contribution No personal liability for partnership’s debts and obligations Personal liability for partnership’s debts and obligations Capital investment Debt or obligation owed Limited Partnership Third Party Limited Partner General Partner

20. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 20 Formation of Limited Partnerships (1 of 2)  The creation of limited partnerships is formal and requires public disclosure RULPA  The entity must comply with the statutory requirements of the RULPA or other state statute  Certificate of Limited Partnership  Certificate of Limited Partnership – a document that two or more persons must execute and sign that makes the limited partnership legal and binding

21. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 21 Formation of Limited Partnerships (2 of 2)  Limited Partnership Agreement  Limited Partnership Agreement – a document that sets forth: The rights and duties of the general and limited partners; and The terms and conditions regarding the operation, dissolution, and termination of the limited partnership

22. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 22 Summary: Liability of Limited Partners General RuleLimited partners are not individually liable for the obligations or conduct of the partnership beyond the amount of their capital contribution. Exceptions to the General Rule Limited partners are individually liable for the debt, obligations, and tortious acts of the partnership in three situations: 1. Defective Formation 2. Participation in Management 3. Personal Guarantee

23. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 23 Limited Liability Partnership (LLP) (1 of 4)  A special form of partnership where all partners are limited partners and there are no general partners  None of the partners is personally liable for the debts and obligations of the partnership beyond his or her capital contribution

24. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 24 Limited Liability Partnership (LLP) (2 of 4) Liability limited to capital contribution No personal liability for partnership’s debts and obligations Capital investment Debt or obligation owed Limited Liability Partnership (LLP) Third Party Limited Partner

25. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 25 Limited Liability Partnership (LLP) (3 of 4)  The LLP is taxed as a partnership  Each partner’s share of the income or loss from the partnership is reported on his or her individual income tax return  The LLP is required to file an informational income tax return with the IRS  LLPs are mainly used by professionals such as accountants and lawyers

26. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 26 Limited Liability Partnership (LLP) (4 of 4)  Many state laws require LLPs to carry a minimum of $1 million of liability insurance that covers negligence, wrongful acts, and misconduct by partners or employees of the LLP  This requirement guarantees that injured third parties will have compensation to recover for their injuries

27. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 27 LLP: Articles of Partnership  Must be filed with the secretary of state of the state in which the LLP is organized domestic LLP  The LLP is a domestic LLP in the state in which it is organized foreign LLP  The LLP must register as a foreign LLP in any other state in which it wants to conduct business

28. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 28 Limited Liability Company (LLC) (1 of 3)  An incorporated business entity that combines the most favorable attributes of general partnerships, limited partnerships, and corporations  An LLC may elect to be taxed as a partnership  The owners can manage the business  The owners have limited liability

29. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 29 Limited Liability Company (LLC) (2 of 3)  Limited liability companies are creatures of state law, not federal law  Limited liability companies can only be created pursuant to the laws of the state in which the LLC is being organized Limited liability company codes Limited liability company codes regulate the formation, operation, and dissolution of LLCs

30. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 30 Limited Liability Company (LLC) (3 of 3)  Legal Entity  Legal Entity – An LLC is a separate legal entity (an artificial person) that can: Own property Sue and be sued Enter into and enforce contracts Be found civilly and criminally liable for violations of law

31. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 31 Limited Liability Company (LLC) Liability limited to capital contribution No personal liability for company’s debts and obligations Capital investment Debt or obligation owed Limited Liability Company (LLC) Third Party MemberMemberMemberMember

32. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 32 The Uniform Limited Liability Company Act (ULLCA)  A model act that provides comprehensive and uniform laws for the formation, operation, and dissolution of LLCs  The ULLCA is not law unless a state adopts it as its LLC statute  Many states have adopted all or part of the ULLCA as their limited liability company law

33. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 33 Formation of an LLC  Most LLCs are organized to operate businesses and real estate developments  An LLC can be organized in only one state even though it can conduct business in all other states  The name selected must meet the requirements of the LLC codes of the states that are under consideration

34. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 34 Operating Agreement  An agreement entered into among members that governs the affairs and business of the LLC and the relations among members, managers, and the LLC  The operating agreement may be amended by the approval of all the members unless otherwise provided in the agreement

35. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 35 Taxation of LLCs  For federal income tax purposes an LLC is taxed as a partnership unless it elects to be taxed as a corporation  Thus, an LLC is not taxed at the entity level  Its income or losses “flow through” to the members’ individual income tax returns  This avoids double taxation

36. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 36 Members’ Limited Liability  Member  Member – an owner of an LLC limited liability  Members have limited liability  Members are liable for the LLC’s debts, obligations, and liabilities only to the extent of their capital contributions  The debts, obligations, and liabilities of an LLC are solely those of the LLC  A member is personally liable if he or she personally guarantees repayment of the debts of the LLC  Member  Member – an owner of an LLC limited liability  Members have limited liability  Members are liable for the LLC’s debts, obligations, and liabilities only to the extent of their capital contributions  The debts, obligations, and liabilities of an LLC are solely those of the LLC  A member is personally liable if he or she personally guarantees repayment of the debts of the LLC

37. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 37 Liability of the LLC  An LLC is liable for any loss or injury caused anyone as a result of a wrongful act or omission by a member, manager, agent, or employee of the LLC who commits the wrongful act while acting within the ordinary course of business of the LLC or with authority of the LLC [ULLCA § 302]

38. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 38 Member-Managed LLC member-managed  In a member-managed LLC, all members can bind the LLC to authorized contracts  Each member has equal rights in the management of the business irrespective of the size of his or her capital contribution  Any matter relating to the business of the LLC is decided by a majority vote of the members

39. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 39 Manager-Managed LLC manager-managed  In a manager-managed LLC, only the managers can bind the LLC to authorized contracts  The members and non-members who are designated managers control the management of the LLC  The members who are not managers have no rights to manage the LLC unless otherwise provided for in the operating agreement

40. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 40 Agency Authority to Bind an LLC to Contracts Member-Managed LLC  In a member-managed LLC, all members can bind the LLC to authorized contracts Member-Managed LLC  In a member-managed LLC, all members can bind the LLC to authorized contracts Manager-Managed LLC  In a manager-managed LLC, only the managers can bind the LLC to authorized contracts Manager-Managed LLC  In a manager-managed LLC, only the managers can bind the LLC to authorized contracts

41. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 41 No Fiduciary Duty Owed by a Non- manager Member  A non-manager member of a manager- managed LLC owes no fiduciary duties of loyalty, care, or good faith and fair dealing to the LLC or its members  Basically, a non-manager member of a manager-managed LLC is treated equally to a shareholder in a corporation

42. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 42 Franchise  Established when one party licenses another party to use the franchisor’s trade name, trademarks, commercial symbols, patents, copyrights, and other property in the distribution and selling of goods and services  Generally, the franchisor and the franchisee are established as separate corporations

43. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 43 Advantages to Franchising 1.The franchisor can reach lucrative new markets 2.The franchisee has access to the franchisor’s knowledge and resources while running an independent business 3.Consumers are assured of uniform product quality

44. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 44 Parties to a Typical Franchise Agreement Grant of franchise and license to use trademarks, service marks, and trade secrets Franchisor (Licensor) Franchisee (Licensee)

45. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 45 Types of Franchises (1 of 3) Distributorship Franchise  The franchisor manufactures a product and licenses a retail franchisee to distribute the product to the public  e.g., the Ford Motor Company manufactures automobiles and franchises independently owned dealers to sell them to the public

46. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 46 Types of Franchises (2 of 3) Processing Plant Franchise  The franchisor provides a secret formula or process to the franchisee  The franchisee manufactures the product and distributes it to retail dealers  e.g., the Coca-Cola Corporation licenses regional bottling companies to manufacture and distribute soft drinks under the “Coca-Cola” and other brand names

47. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 47 Types of Franchises (3 of 3) Chain-Style Franchise  The franchisor licenses the franchisee to make and sell its products or distribute services to the public from a retail outlet serving an exclusive territory  Most fast-food franchises use this form  e.g., the Pizza Hut Corporation franchises independently owned restaurant franchises to make and sell pizzas to the public under the “Pizza Hut” name

48. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 48 Franchise Agreement  An agreement that the franchisor and the franchisee enter into that sets forth the terms and conditions of the franchise: Quality control standards Training requirements Covenant not to compete Arbitration clause Use of franchisor’s trade name, logo, and trademark Conditions for the termination of the franchise

49. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 49 Liability of Franchisors and Franchisees contracts  Franchisors and franchisees are liable for their own contracts tort liability  Franchisors and franchisees are liable for their own tort liability  e.g., if a person is injured by a franchisee’s negligence, the franchisee is liable

50. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 50 Termination “For Cause” “just cause”  A franchisor can terminate a franchise agreement for “just cause” e.g., nonpayment of franchise fees by the franchisee e.g., continued failure to meet quality control standards

51. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 51 Wrongful Termination wrongful termination  If a franchisor terminates a franchise agreement without just cause, the franchisee can sue the franchisor for wrongful termination  The franchisee can recover damages caused by the wrongful termination and recover the franchise

52. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 52 License licensor licensee  An arrangement where a party that owns trademarks and other intellectual property (the licensor) contracts to permit another party (the licensee) to use these trademarks and intellectual property in the distribution of goods, services, software, and digital information

53. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 16 - 53 Parties to a Typical Licensing Agreement Grant of permission to use trademarks, service marks, trade names, and other intellectual property Licensor Licensor Licensee Licensee