Midterm Examination
INTRODUCTION____________________________________________________
Note: This examination covers Sole Proprietorships through Limited Liability Partnerships.
This examination is intended to test your knowledge of the materials that we have
covered in class. Please answer each question concisely. Please use headings (e.g., Liability) as
often as possible; this will help you organize your thoughts and present them clearly. You must
answer all questions with complete sentences. Do not use abbreviations, other than those
commonly used for each business organization (e.g., LP). Please write clearly; I will not grade an
answer that I cannot read.
The exam will be graded on your ability to answer each question correctly, spelling and
punctuation, as well as neatness. Answer all questions presented. If you cannot answer a question
completely, answer as best you can; partial answers will be given partial credit.
EXAMINATION____________________________________________________
TRUE/FALSE
Please indicate which statements are true and which are false.
True/False
1. In an agency relationship, a principal acts on behalf of an agent.
True/False
2. Principals can be held liable for the actions of their agents.
True/False
3. An agent must be working on the principal’s behalf in order for the
principal to be held liable for the agent’s actions.
True/False
4. A principal may be held liable for the actions of an independent contractor.
True/False
5. Registration of an assumed business name helps avoid consumers’
confusion with other businesses operating under similar names.
True/False
6. A sole proprietorship can have more than one employee.
True/False
7. Sole proprietors may limit their personal liability for business debts
through contracts.
True/False
8. A sole proprietorship cannot have more than 35 shareholders.
True/False
9. “First in time, first in right” is the rule applicable to the use of a
business name; that is, the first proprietor to use an assumed business
name will be granted the exclusive right to use the name, regardless of
whether the proprietor registered the name with the secretary of state.
True/False
10. Licensing requirements allow states and counties to regulate
businesses.
True/False
11. Sole proprietors are personally liable for all debts and obligations of
their businesses.
True/False
12. Creditors of a sole proprietor may seek payment of business debts
from assets of the sole proprietorship.
True/False
13. Business profits are taxed as a sole proprietor’s personal income.
True/False
14. Sole proprietorships terminate upon the death of the proprietor.
True/False
15. A partnership begins simply by one or more individuals beginning
business.
True/False
16. The business income of a partnership is taxed as the personal income
of the partners.
True/False
17. Creditors of a partnership may seek repayment of business debts from
the personal assets of the partners.
True/False
18. Limited partners manage limited partnerships.
True/False
19. Limited partners are not responsible for the debts and obligations of
their limited partnerships.
True/False
20. Partners may limit their personal liability for business debts and
obligations through a partnership agreement.
True/False
21. A limited liability partnership (LLP) offers limited partners personal
liability protections.
True/False
22. All partners of an LLP may participate in management of partnership
business.
True/False
23. An LLP is regulated by statute and therefore does not need a
partnership agreement to define the rights and duties of the partners.
True/False
24. LLPs offer more expansive personal liability protections to partners
than general partnerships.
True/False
25. The term personal liability refers to a business owner’s personal
responsibility for the income taxes assessed on the profits and losses of the
business.
Answer Key: 1. (F) 2. (T) 3. (T) 4. (F) 5. (T) 6. (T) 7. (T) 8. (F) 9. (F) 10. (T) 11. (T) 12. (T)
13. (T) 14. (T) 15. (T) 16. (T) 17. (T) 18. (F) 19. (T) 20. (F) 21. (F) 22. (T) 23. (F) 24. (T) 25. (F)
SHORT ANSWER
Please answer the following questions in complete and concise sentences.
1. What is an assumed business name?
An assumed business name is a name other than the owner’s name under which a
business operates.
2. Define the term limited liability.
The term limited liability refers to limitations placed on business owners’ personal
responsibility for the debts and obligations of their businesses. If a business organization
provides owners limited liability, creditors cannot look to the business owners’ personal
assets to satisfy business debts and obligations.
3. What is the difference between a limited partnership and a limited liability partnership?
A limited partnership is managed by general partners, who are personally liable for all
debts and obligations of the partnership. Limited partners are merely investors in a
limited partnership’s business and do not have the right to participate in management of
the business. In contrast, limited liability partnerships (LLPs) offer all partners
management rights and limit partners’ vicarious liability for the negligence and
malfeasance of their partners.
4. Explain the difference between a sole proprietorship and a partnership.
A sole proprietorship is a business conducted by one person. A partnership is conducted
by two or more persons or entities.
5. Explain how the business profits and losses of a partnership are taxed.
The profit and losses of a partnership pass through the partnership and are taxed as the
personal income of the partners. The partnership itself is not taxed on its profits and
losses.
ESSAY
Essay Question 1
Craig wants to sell a small commercial cleaning business that he owns. He isn’t sure what
the sale price for the business should be. He owns about $10,000 worth of business equipment
and has several cleaning contracts with large businesses. What are some of the factors he should
consider in determining a fair sales price?
Craig should consider not only the value of the tangible business assets (equipment), but
also the goodwill (reputation) and clientele of the business. These intangible assets of a
business are generally worth more than the tangible assets.
Essay Question 2
Joan, a fifth grader at Larson Elementary School, noticed that many people regularly
brought fast food to the local park next to her school during the noon hour. Joan decided that she
would take advantage of the ready-made clientele and open a hot dog stand in the park during the
summer. She obtained the necessary permits for the stand from the county; she did not make any
filings with the secretary of state. On the first day of summer break, she opened her stand, which
she called Hot Doggity. She had a booming business and was thrilled with the income.
Soon another local hot dog house, Hot Doggedy, started noticing a significant decline in
its lunch-hour business. Hot Doggedy was very surprised at the decline, since it was always a
favorite stop for customers who would eat their lunch in the park that is only half a block away.
Hot Doggedy’s owner noticed the park was still full at lunchtime and people were eating hot
dogs in wrappers that looked just like his, only bearing the name Hot Doggity. As soon as Hot
Doggedy’s owner learned about Joan’s stand, he contacted the secretary of state to complain
about the name of Joan’s hot dog stand. How should the secretary of state decide this matter?
What are the relevant issues that it will consider? Explain your answer.
Joan is using an assumed business name, which needs to be registered with the secretary of
state. Had she registered the name, the secretary may have denied her use of the name
because it is deceptively similar to another assumed business name in use (Hot Doggedy).
Joan’s use of the name appears to be creating consumer confusion, as demonstrated by the
decline of Hot Doggedy’s business. (However, this decline could arguably be attributable to
her location in the park.) Because the names are spelled similarly and are used by similar
businesses (both hot dog vendors), and because of the close proximity of the businesses, the
secretary of state will most likely deny Joan’s use of the name Hot Doggity—it is deceptively
similar to the name Hot Doggedy.
Final Examination
INTRODUCTION____________________________________________________
Note: This examination is cumulative.
This examination covers the materials studied throughout this class. Each question should
be answered directly and concisely. All questions must be answered; do not answer a question by
referring to an answer previously or subsequently offered. All essay questions must be answered
with complete sentences. Do not use abbreviations, other than those commonly used for each
business organization (e.g. LLP). Please write clearly; I will not grade an answer that I cannot
read.
This examination will be graded on your ability to answer each question correctly,
spelling and punctuation, as well as neatness. Answer all questions presented. If you cannot
answer a question completely, answer as best you can; partial answers will be given partial
credit.
SHORT ANSWER
1. List four forms of business organizations that are recognized in your jurisdiction.
This answer varies by jurisdiction; however, the basic organizational forms are
1. sole proprietorship
2. general partnership
3. limited partnership
4. limited liability partnership
5. corporation
6. limited liability company
a. Provide a definition of each of the preceding business organizations.
1. Sole proprietorship: business operated by one person for profit
2. General partnership: business operated by two or more persons
(including corporations, etc.) for profit
3. Limited partnership: business operated by two or more persons for
profit with managers (general partners) and investors (limited
partners)
4. Limited liability partnership: a general or limited partnership that
registers as a limited liability partnership and thereby protects
partners from vicarious liability for the negligence or malfeasance of
the other partners
5. Corporation: a legal entity that is separate and distinct from its
owners and traditionally is characterized by (a) continuity of life, (b)
centralized management, (c) limited liability, and (d) free
transferability of interests
6. Limited liability company: an unincorporated entity that offers its
members management rights, limited personal liability, and the passthrough taxation of partnerships
b. What are the advantages of a corporation versus a limited liability partnership?
Corporations offer continuity of life, free transferability of interests, limited
personal liability, and centralization of management. With the exception of S
corporations, corporate owners suffer double taxation. In contrast, partnerships
generally terminate on the death or withdrawal of a partner, impose restrictions
on ownership, offer all partners (general partners) management rights, and
subject partners to personal liability for the debts and obligations of their
partnerships. However, unlike corporations, partnerships receive pass-through
taxation.
2. What are the disadvantages of a limited liability partnership?
In a limited liability partnership, not all partners can participate in the management of
the business, and all partners remain personally liable for their own negligence and
malfeasance as well as those they participated in or supervised.
3. Identify and define four types of corporations.
1. C corporation: basic business corporation owned by investors and
managed by an elected board of directors and appointed officers.
2. Statutory close corporation: small corporation whose shareholders
often participate in business management. Minimal formalities are
required for formation of a close corporation; however, ownership is not
freely transferable.
3. Professional corporation: corporation owned by professionals for the
purpose of rendering professional service. It protects professionals from
personal liability for negligence or malfeasance of their associates;
however, they remain liable for their own negligence and malfeasance.
4. Nonprofit corporation: corporation formed by nonprofit organizations.
Profits of nonprofit corporations may not be distributed to shareholders,
directors, or officers.
5. Note: S corporation is not a separate corporate designation. Rather, it
is an IRS designation.
a. What are the two basic corporate forms?
1. C corporation
2. Statutory close corporation
b. What is an S corporation?
An S corporation is an IRS designation available to qualified small
corporations. S corporations are taxed as partnerships.
4. What does it mean for a business to offer its participants “limited liability”? Why is limited
liability considered advantageous?
Limited liability protects a business owner’s personal assets from attachment by
creditors for satisfaction of business debts and obligations.
5. What is the basic document that must be prepared to form a corporation?
Articles of incorporation
a. If a corporation’s formation documents are not prepared correctly, what is the
status of the business (i.e., is it a corporation or not)?
A business owner who in good faith attempts to satisfy the state’s statutory
incorporation procedures but fails to strictly comply may have his or her business
classified as a de facto corporation if the business is conducted in good faith as
though it were in fact a corporation. As a de facto corporation, a creditor of the
corporation cannot hold the shareholders personally liable for the corporate
debts and obligations.
b. If a corporation is properly formed, is it possible to reach the personal assets of the
shareholders? On what theories?
There are two exceptions to the general rule that a shareholder will not be held
personally liable for the debts and obligations of the corporation. A shareholder
may be held personally liable (1) to prevent fraud or injustice (piercing the
corporate veil) or (2) if the shareholder personally guarantees loans made to the
corporation. The three most common reasons that the corporate veil may be
pierced are (1) failure to comply with necessary corporate formalities, (2)
commingling of personal and corporate assets and (3) inadequate capitalization.
6. What is a limited liability company (LLC), and what are the advantages of this business form?
An LLC is a business entity offering its members personal liability protections, shared
management rights, finite duration, pass-through taxation, and limited transferability of
interests. The primary advantages are shared management rights, limited liability, and
partnership taxation.
7. What are the taxation advantages of a partnership?
The profits and losses of a partnership are taxed as the personal income of the partners.
Partnership losses may offset other sources of personal income of the individual
partners.
8. Should a limited liability company designate its status (LLC) in its name?
Yes. LLCs must notify the public of their status.
a. Do other forms of business organizations have to designate their status in their
names? Why?
Yes. All business organizations that offer owners personal liability protections must
notify the public of their organizational status in order to put the public on notice of
their respective liability protections.
ESSAY
Essay Question 1
Dave and Cindy recently graduated from the U of M School of Law. They want to
start a general practice law firm together. They were best friends in law school and are
confident in each others’ ability to practice law. They both have about $1,000.00 to invest
in the business, and neither has any significant personal assets (neither owns a home, and
both have junker cars from their law school days).
They aren’t sure how to form their business association, and they visit the
attorney that you work for to learn about their options. Your attorney tells you that she
will recommend that they form an LLP, an LLC, or a professional corporation. What
form would you recommend and why? In answering this question, discuss the liability
issues and tax ramifications of your choice.
Each of the organizational forms listed would be viable. However, law
firms generally prefer the “partnership” designation; therefore, an LLP probably
would be the most desirable for Dave and Cindy. LLPs offer their partners the
right to participate in business management as well as personal liability
protections from the negligence or malfeasance of other partners. In addition,
LLPs receive pass-through taxation; therefore, the profits and losses of the firm
will be taxed as the personal income of Dave and Cindy.
Essay Question 2
What are the differences between the LLP, the LLC, and the corporation?
Distinguish each form of business organization.
LLPs offer business owners the right to participate in business
management, limited liability (for the negligence or malfeasance of other
partners), and pass-through taxation.
LLCs allow business owners the right to participate in management,
limited liability for all debts and obligations of the company, and pass-through
taxation.
Corporations generally provide centralized management (unless the
corporation is a statutory close corporation), limited liability for all debts and
obligations of the corporation, and possibly pass-through taxation if S election is
made. However, unless a corporation qualifies as an S corporation, corporate
profits will be taxed twice; once at the corporate level and then again when
corporate profits are distributed as dividends to shareholders.
Distinguishing the three forms, LLCs offer more extensive liability
protections than LLPs and can provide more advantageous taxation rates than
corporations.
Essay Question 3
Kent and Craig are brothers who want to start a horse-training business. They
both have considerable experience working with horses, and both want to be involved in
the business, including daily training of horses. They have spoken to an insurance agent
about getting insurance to cover the potential liabilities, but they were told that they can’t
get insurance to cover this type of high-risk business (because of the potential for
personal injury).
They come to your firm seeking advice about forming their business; they are
particularly concerned about their potential liabilities, especially to any other trainers that
they might hire. What business form(s) would you recommend to your supervising
attorney for this business? Why? What are the advantages and disadvantages of this
business form? Explain what protections this business form would offer them from
potential liabilities.
Due to the high-risk nature of their business, Kent and Craig should
consider forming either an LLC or a corporation. Both of these organizational
forms offer extensive liability protections to their owners. However, some states
do not allow high-risk or uninsurable businesses to form LLCs; therefore, this
organizational form may not be available to this business in all states.
Essay Question 4
Gerard is an incredible candy maker and would like to go into business for
himself, but he needs some money to get started. His parents want to help him get his feet
on the ground and start his career. They agree to invest in his business; however, they
don’t want to be involved in any part of the business, they are just trying to help him out.
Gerard asks your supervising attorney for advice on how to organize his business. The
task is assigned to you. What business form would suit the needs of Gerard? Why? What
are the advantages of this business form?
A limited partnership is advisable for Gerard and his parents. A limited
partnership would allow Gerard’s parents to invest in his business venture
without participating in management decisions. Limited partnerships are
relatively simple to form, offer limited liability to investors, and offer the
advantage of pass-through taxation.