9
Partnerships
Introduction to Forms of
Business and Formation of
Partnerships
Operation of Partnerships
Dissolution & Winding Up
McGraw-Hill/Irwin Business Law, 13/e
Limited Liability Companies
© 2007 The McGraw-Hill Companies, Inc. All rights
C H A P T E R
37
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
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
What you choose depends on where you
want to go
37 - 4
Basic Forms
• Sole proprietorship
• Partnership
– 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
37 -and
6
control
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
the individual partner’s federal
37 -on
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
on sub-form
37 -depending
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 tax37 -paying
9
entity for federal income tax
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
37 - structure
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
37 - obligations
11
of the LLC
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
it inadvertently, without
37 - entered
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
splitting the
37 - and
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,
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
37 - persons.”
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
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
belongs to the
37 - presumptively
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:
1.Transferable interest
• Partner’s share of profits and losses and
right to receive partnership distributions
2.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
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
an LLC in the absence of a
40 - govern
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
tax returns
40 - income
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
40 - 25
– An LLC is an entity separate from its
Management of the LLC
• Articles of organization must state
whether the LLC is membermanaged 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
business
40 - ordinary
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
A teamare
effort.
to a member’s
40 - similar
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
their authority
40 - within
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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
duties
40 - fiduciary
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
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
40 - 34 agreement
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
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
to the members
40 - shares
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
oil and gas drilling, and
40 - ventures,
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
40 - 40
• Liability limited up to the amount of their
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
40
43
• - ULPA
of 2001 requires few actions to
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
to the limited partnership and
40 - duties
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
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
partnership interest
40 - the
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
40 - liability
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
40 - 53