Business Entities
Many Choices
Focus on Proprietorships and
Partnerships
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Key Entities
• Corporations
– C Corp.
– S Corp
• Partnerships
– General partnership (GP)
– Limited partnership (LP)
– Limited liability partnership (LLP)
• Limited liability company (LLC)
• Sole proprietorship
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Why create a legal entity?
• Separation of ownership and control.
• Limited liability.
• Taxes
– Expenses deductible
– But .... double taxation issues
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Business entities can be “people” too
• “.. corporations are people – the owners and others the
corporation represents in litigation.” - Prof. Larry Ribstein
• Legislatures and courts treat business entities as if they were real
people.
• A business entity can contract or be liable for breach of contract.
• A business entity has legal rights:
• “The Court has recognized that First Amendment protection
extends to corporations. ... This protection has been extended
by explicit holdings to the context of political speech. ... Under
the rationale of these precedents, political speech does not
lose First Amendment protection “simply because its source is
a corporation.” Citizens United v. FEC (2010).
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S.
C Corp.
Corp
LLC
Gen.
Sole
Partnershi
Proprietor
p
Owners have limited liability for business debts
and obligations
X
X
X
Created by registration with state
X
X
X
Perpetual duration
X
X
X
Unlimited owners
X
X
X
Owners need not be U.S. Citizens or residents
X
X
X
X
May be owned by another business entity
rather than individuals
X
X
May issue stock
X
X
X
X
Able to distribute special allocations under
some circumstances
X
X
Not required to hold annual meetings, record
meeting minutes
X
X
Owners report business profit and loss on
personal tax returns
Owners can split profit and loss with business
for a lower overall tax rate
X
X
X
X6
Sole proprietorship
• No legal separation between owner and
business.
• No good reason to ever have one.
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Partnerships
• Key attributes:
– Formed by simple expression of will.
– Equality and relationship reinforcing approach of UPA
s401: equal shares in profit and loss, equal right to
manage, unanimous consent to bring in new partner,
changes in agreement or extraordinary matters
require unanimity.
– End as easily as start via expression of will – focus on
individual partner’s adaptability rather than firm’s.
– Fiduciary duty’s role as a check on opportunism.
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Partner or Employee?
• 3 broad overlapping categories
– Ownership: investment, ownership, liability for
debts
– Remuneration: degree to which compensation
based on firm’s profits
– Management: right to engage in policymaking,
participation in and voting power with regard to
governance, ability to assign work and direct Ees,
ability to act for firm.
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General Partnership
• An association of two or more persons to carry
on as co-owners of a business for profit.
• Each partner has unlimited joint and several
liability for the debts and obligations of the
business against all of their assets.
• Each partner has full management authority.
• Income is “passed through” to partners to be
taxed.
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GP
XYZ Partners
GP
GP
GP
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• Dave, Joe, & Lee are 1/3 partners in DJL Partners. Dave and Joe
want to lease a building A; Lee wants to lease building B.
– Partnership agreement silent: Dave & Joe outvote Lee and
lease building A.
– Partnership agreement states “Lee shall serve as managing
partner and have authority to lease property on behalf of the
partnership.” Lee leases building B.
– Partnership agreement states: “Lee shall serve as managing
partner and have authority to enter into agreements in the
normal course of business, provided however that Lee shall
not have authority to lease property on behalf of the
partnership without the express consent of the partners.” Lee
should not lease building B but if Lee does, the lease will be
good as the agreement cannot negate Lee’s apparent
authority to enter into lease.
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• Default form of business / default rules provided.
• “an association of two or more persons to carry on as coowners of a business for profit.” (Uniform Partnership Act)
• Inadvertent formation possible: “Partnership results from
contract, express or implied. If denied, it may be proved by the
production of some written instrument, by testimony as to
some conversation, by circumstantial evidence. If nothing else
appears, the receipt by the defendant of a share of the profits
of the business is enough .... Mere words will not blind us to
realities. Statements that no partnership is intended are not
conclusive. If as a whole a contract contemplates an
association of two or more persons to carry on as co-owners of
a business for profit, a partnership there is.” - Martin v. Peyton,
NY 1927
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• Partnership agreement is the primary source
of law governing the partnership.
• Statutory mandatory rules on:
– Varying partners’ right to information.
– Eliminating duty of good faith and fair dealing.
– Eliminating partners’ fiduciary duties to each
other.
– Varying principle of joint and several liability.
– Varying power to dissociate from partnership.
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• In partnership dispute, ask FIRST “was there
a partnership agreement and what does it
say?” THEN ask what law says.
• WRITE THINGS DOWN!
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Fiduciary obligations of partners
• Meinhard v. Salmon, 164 N.E. 545 (NY 1928): Copartners
owe to one another, while the enterprise continues, the
duty of finest loyalty. Many forms of conduct permissible
in a workaday world for those acting at arms’ length, are
forbidden to those bound by fiduciary ties . . . Not
honesty alone, but the punctilio of an honor the most
sensitive, is the the standard of behavior.”
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Partner as Agent: UPA 301
• Subject to the effect of a statement of partnership
authority under Section 303:
• (1) Each partner is an agent of the partnership for the
purpose of its business. An act of a partner, including
the execution of an instrument in the partnership
name, for apparently carrying on in the ordinary course
the partnership business or business of the kind carried
on by the partnership binds the partnership, unless the
partner had no authority to act for the partnership in
the particular matter and the person with whom the
partner was dealing knew or had received a
notification that the partner lacked authority.
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Dissolution & Dissociation
• The difference between “dissociation,” “dissolution”
and “termination”?
• Dissolution: “the change in relation of the partners
caused by any partner ceasing to be associated with
the carrying on as distinguished from the winding up
of the business” (UPA 1914 s. 29)
• Termination: what happens after winding up
completed (UPA 1914 s. 30)
• Dissociation: a partner leaving partnership, may lead
to dissolution (new term in UPA 1997)
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Key Points on Partnerships
• Partnerships are fundamentally contractual entities, unlike
corporations.
– Incorporated firms exchanged autonomy for state-granted
privileges; partnerships did not.
• UPA statute model is of a closely held and informal firm.
– Default rules of equal power to control and share in profits; each
is co-principal; veto rights over major decisions such as entry of
new partners.
– Exit is by dissolution not sale.
– Vicarious liability the norm; hence, creditor demands for personal
guarantees.
• Rise of the LLC as tort cases increased risk for partnerships.
• UPA limits some managerial rights and creates new opportunities to
continue business if some leave; partnership creates new entities.19
Limited Partnership
• An association of two or more persons to carry on as
co-owners of a business for profit.
• Each GENERAL partner has unlimited joint and
several liability for the debts and obligations of the
business against all of their assets; LIMITED partners
do not.
• General partner has full management authority;
Limited partner does not.
• Income is “passed through” to partners to be taxed.
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GP, Inc.
Shareholder
LP
XYZ, LP
LP
LP
LP
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Where do we see this mostly?
• Tax shelter investment (oil & gas, real estate)
where pass through taxation and centralized
management needed
• Venture capital and leveraged buy out firms
• Estate planning tools for family limited
partnerships
• GP is usually thinly capitalized corporation.
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• Typical LP agreement issues:
– Admission of new GP and LP.
– Voting.
– Withdrawal or removal of GP and LP.
– Remedies for breach.
– Manner and process of
dissolution/wind up.
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Newer Limited Liability Entities
• LLP & LLLP – created in 1980s in response to
malpractice claims against lawyers,
accountants, etc. State laws vary.
• LLC – combine partnership tax advantages
with corporate limited liability rule and
flexibility in structure
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Limited Liability Partnership (LLP)
• A general partnership that adopts limited
liability by filing a registration with state.
• Some LLP statutes allowed only professionals
to elect. Others allow anyone.
• Some LLP statutes require insurance to protect
3rd parties.
• Differences in scope of limitation for
professional negligence vs. tort and contract.
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Limited Liability Partnership
• GP that has filed a certificate with state,
declaring it is an LLP and including LLP in
name.
• Statutory change to basic partnership law.
• Closer to GP than to LP.
• Mostly used by professional firms (lawyers).
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• A form of GP, governed by GP rules
– Typically authorized by provision of GP statute
- a GP + protection
• Allows GPs to protect personal assets
from partnership debts exceeding
partnership assets.
– Fundamental change in basic partnership law.
– Creature of statute - state laws vary (full
shield vs. partial shield)
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