Sole
Proprietorships
and
Partnerships
· Sole
Proprietorship: A business owned by a single
person or family, for which the owner reports business income and expenses on
his or her personal income tax return and is legally responsible for all debts and obligations incurred by the business,
even if it requires that the debts and obligations be paid from other sources
that the owner may have personally. This
is the most common form of business organization, but they generally have low
dollars in total assets.
· General Partnership: An agreement by two or more persons
(or entities) to carry on, as co-owners, a business for profit. There is unlimited liability (joint and/or
several- more on this later) in this business arrangement to the other partners
of their partners torts and decisions- and not just limited to their investment
in the partnership. (This is commonly
called unlimited liability.) Death of a partner ends the partnership.
o
Also, a general partner has a right to
manage the partnership business [4237.01]
· Limited
Partnership:
A
partnership consisting of one or more general partners, who manage the
business and are personally liable for the partnerships debts, and one or more limited
partners, who contribute only assets, do not participate in the management
of the business, and whose liability is limited to the amount of assets
contributed. In other words, an investor. [4237.02]
More later….
· Corporation: A legal entity formed in
compliance with the statutory requirements of its state of incorporation, owned
by shareholders whose
liability is limited to their investment in the corporation, and managed by (i) a board of
directors elected by the shareholders and (ii) officers employed by the
board of directors. More
on the corporation in another lecture.
· "S”
Corporation:
A
closely-held corporation that has met the statutory requirements set out by the
Internal Revenue Code and, thus, is taxed like a partnership, while enjoying
the limited liability afforded by a corporation. The precursor of the LLC,
but quite viable even today.
· Limited Liability
Company ("LLC"): A hybrid form of business which, like an "S" corporation is taxed like a
partnership while offering owners the limited liability of a corporation; but, unlike
an "S" corporation, an LLC can be owned, in whole or in part, by
corporations, partnerships, and/or foreign investors, and need not be
"closely-held" --meaning that it may have unlimited investors.
· Limited
Liability Partnership ("LLP"): Similar to an LLC, a LLP is designed for professionals
who historically have done business as partners (e.g., accountants, attorneys)
but who want to limit their liability for their partners' (but not the partnership’s) misdeeds.
· Joint Venture: A
business venture where two or more persons or entities combine their interests
in a particular enterprise and agree to share in the losses or profits equally
or in proportion to their capital and asset contributions.
· A joint venture resembles a partnership and is taxed like a
partnership. However, there are some differences:
· Joint
venturers have less implied and apparent authority
because the activities of a joint venture are more
limited, as a matter of law, than those of a partnership. Usually a joint venture is established to
perform one task, such as building a bridge or tunnel. But, it can be much broader than that.
·
The death of a joint venturer generally does not terminate the joint
venture. More below…
PARTNERSHIP: DEFINITION AND STATUS
· Partnership: A VOLUNTARY agreement by two or
more persons to carry on, as co-owners, a business for profit. [4231]
Courts often look to the following to
determine whether a partnership exists:
(1) sharing
of profits and losses;
(2) joint ownership of the business; and
(3) equal
right in the management of the business.
· The term "persons,"
for purposes of a partnership, includes corporations in
·
A partnership, while treated as an aggregate of the individual partners for federal income tax purposes, may be treated as a
separate entity for other purposes, such as bringing and defending lawsuits,
bankruptcy, and ownership of property. However, it does NOT generally shield
the partners from any form of liability in a lawsuit or other obligation.
[4234]
·
A partnership is a “pass- through” entity for tax purposes.
PARTNERSHIP FORMATION [4235]
· Partnership
Agreement: A written agreement -- sometimes called "Articles of
Partnership" -- that sets forth the rights and obligations of each partner
with respect to the partnership. Notice, however, a partnership may be established by a mere
handshake or other “agreement” between the parties. It can even be an ORAL agreement. Notice, while
obviously a written agreement is preferable, many informal partnerships exist
based on oral understandings. [4238]
TESTS of Existence of a partnership include:
·
Sharing of
profits
But, this presumption
can be rebutted (disputed) by:
Showing
the funds received are actually repayment of debt or
Wages
or rent owed or
An
annuity payment or
Interest
of a loan or
Consideration
for sale of goods paid from profits.
[4235.03]
Why
would you want to rebut the presumption of partnership? So you would not be liable for partnership debts or liabilities.
·
Co ownership
of property
·
Joint control
and management.
· Who can be a Partner? Maybe it is easier to say
who cannot: [4239]
A minor “may” be a partner,
but may disaffirm (say no). Thus, dangerous to allow a minor
as a P.
An insane person may not be a partner.
In some states, a corporation
may not be a partner (but in
· Partnership
Duration: The partnership agreement may specify the duration of the partnership
in terms of a date or the completion of some undertaking.
· A partnership whose term is limited is a partnership for a term.
Any dissolution of the partnership prior to the term, without the consent
of all of the partners, will leave the partner or partners responsible for the
dissolution personally liable for any resulting losses.
· A partnership agreement silent
as to duration implies a partnership at will. The
partnership may be dissolved by any partner at any time without incurring
liability.
· Partnership
by Estoppel: Whenever a third party has reasonably and detrimentally relied on the
representation, by a partner, that a non-partner was part of the partnership,
the non-partner is deemed to be the partnership's agent and the partnership is
liable for his or her acts. [4236.01]
MANAGEMENT & VOTING RIGHTS ( aka
Authority) [4241]
· Authority of a partner is
merely an extension of agency law.
· Recall actual (real)
authority versus apparent authority.
· Under the UPA, UNLESS OTHERWISE AGREED BETWEEN THE
PARTNERS:
(1) all partners have equal management
rights;
(2) each
partner has an equal vote, regardless of the
relative size of his or her capital contribution; and
(3) partnership
decisions require a majority vote of the
partnership, unless otherwise agreed,
except in the following cases, which require unanimous
consent:
(a) altering the
essential nature of the partnership's business or
entering a wholly new business;
(b) admitting new partners or altering the capital structure of the partnership;
(c) assigning partnership property into a trust
for the benefit of creditors, disposing of
goodwill, or undertaking any act that would make conduct of the partnership's
business impossible;
(d) confessing judgment against the partnership (saying we did
wrong); or
(e) amending
the partnership agreement.
Why? It’s obviously a major
change in the previously existing agreement, business, or financial
underpinnings of the business, and thus all
need to agree to the changes.
PARTNERSHIP INTEREST & COMPENSATION
· Partnership Interest:
An individual partner's personal asset consisting of a proportionate share of
the profits earned and a return of initially-invested capital upon termination.
· Assignment
of Partnership Interest: A partner may assign his or her interest in the partnership to
another party, who will then be entitled to receive the partner's share of
profits and, upon termination, the partner's capital contribution. However, the assignee does not
become a partner, and thus has no say in management and no right to inspect the
partnership's books.
· Lien
on Partnership Interest: A partner's interest may also be subject to
a judgment creditor's lien. If so, the judgment creditor may obtain a charging
order which will entitle the judgment creditor to the partner's share of profits
and, upon termination, the partner's capital contribution. Again, the judgment creditor does NOT become a partner.
· Compensation:
Generally speaking, partners do not receive a salary for any work they do for
the benefit of the partnership; rather, they are paid a share of the partnership's profits.
However, the partnership can agree otherwise.
ACCOUNTING RIGHTS
· Partnership
Books:
Partnership books and records must
be kept accessible to all partners. This often becomes a point of dispute in
the “real world.”
· Each partner has the right to receive, and each partner has a
corresponding duty to produce, full and complete information concerning the
conduct of all aspects of partnership business.
· Right to Inspect and Copy: Every partner, whether active or inactive,
is entitled to inspect all books and records on demand and may copy any
materials.
· A partner can demand a formal
accounting of the partnership's assets when:
(1) provided for in the partnership agreement;
(2) a
partner is wrongfully denied access to the business and/or the partnership's
books;
(3) another
partner has breached his or her fiduciary duties to the partnership; or
(4) "just and reasonable."
PROPERTY RIGHTS [4247]
A partner has the following property rights:
(1) an
interest
in the partnership, entitling the partner to share in the partnership's profits
and to receive a return of capital upon the termination of the partnership, in
proportion to the partner's investment;
(2) a
right in partnership property; and
(3) a
right to participate in the management of the partnership.
· Partnership Property
includes:
· all property originally brought into
the partnership and
· all property subsequently acquired,
by purchase or otherwise, on account
of the partnership.
· Every partner is co-owner with the other partners of all
partnership property, and no partner can sell, assign, or in any way deal with
any item of partnership property except
for the purposes of the partnership.
PARTNERSHIP DUTIES AND AUTHORITY
· Fiduciary Duties:
Partners stand in a fiduciary relationship to one another just as principals
and agents do.
· Each partner has a duty to act in good
faith and for the benefit of the
partnership.
· Each partner must also subordinate his or her personal interests to those of
the partnership. [4248]
· Authority
of Partners: Each partner is an agent
of the partnership and of each other partner; therefore, agency concepts of
actual and apparent authority and ratification apply to acts of a partner. [4241]
· Any act
within the scope of a partner's authority binds the partnership. ç NOTICE THE IMPLICATIONS!!
·
The knowledge of one partner
regarding partnership affairs is imputed to all other partners.
·
What one partner does binds the others
to the outside world if the partner has apparent
authority, and most do. The partners may
have agreed that the other partners cannot bind them, but this gives them an
action only against the partner that bound them and doesn’t give them the right
to disavow the “bad” agreement the partner set up.
PARTNERSHIP LIABILITY [4242]
· Joint
Liability: All partners incur joint
liability for partnership obligations and debts. However, a partner is not
liable for his or her partner's personal
debts.
· Joint and Several Liability: Some
states including Texas permit a plaintiff to sue one or more individual
partners, and to collect a judgment arising from the partnership's acts or
omissions from one or more of the individual partners. In other words, if one
partner cannot pay a judgment that all partners have to pay, the others
have to pay for the nonpaying partner and then try to get the funds from the
nonpaying partners!!! Say 5 partners are
broke and only one is solvent, the solvent partner gets to pay for the sins of
the others! NOW YOU SEE WHY YOU SHOULD BE SO TERRIBLY CONCERNED ABOUT LIABILITY
AND WITH WHOM YOU ARE A PARTNER!!!
· Incoming
Partners: Newly-admitted partners are liable for debts and obligations incurred
before they joined the partnership only to the extent of their capital contribution.
PARTNERSHIP TERMINATION [4250-51]
Dissolution: The formal disbanding of a
partnership, which can be brought about by:
(1) the terms of the
partnership agreement;
(2) voluntary or
involuntary withdrawal;
(3) the addition of
on or more new partners;
(4) death of a
partner;
(5) bankruptcy of a
partner or of the partnership; or
(6) judicial decree.
Why?
Again, the basic notion under which you agreed to be in business together has
changed…
• Winding Up: Once dissolution is formalized and notice has been
given to all partners and all creditors of the partnership, the partners are
only authorized to (i) complete transactions begun
but not completed as of the dissolution and (ii) wind up the partnership’s
affairs i.e., collect and preserve partnership assets, pay partnership debts,
and account to each partner for the value of his or her interest in the
partnership.
DISTRIBUTING
PARTNERSHIP ASSETS [4252]
• When a partnership terminates, creditors
of the partnership, as well as creditors of individual partners, may make claims on the partnership’s
assets.
è Creditors of the partnership,
however, take priority
over creditors of individual partners. ç
• Partnership
assets are distributed as follows:
(1) Payment
of third party debts; then
(2) Refunds of loans or advances
made by partners to or for the
partnership; then
(3) Return of partner’s
capital contribution; then
(4) Distribution
of the remaining assets to the partners in proportion to their ownership
interest or pre-termination share of profits (if different).
LIMITED
PARTNERSHIPS [4254]
• Formation: Forming a limited partnership
requires complying with relevant statutes and preparing a certificate of
limited partnership and filing it with the appropriate authorities.
• Rights of Limited Partners: Limited partners
enjoy most of the same rights as general partners, including the right to inspect
the partnership’s books and to demand other information about the partnership’s
operations; and, upon dissolution, limited partners are entitled to the return
of their capital contribution as provided for in the certificate of limited
partnership.
• Liabilities of Limited Partners:
A limited partner’s liability is limited to the
amount of his or her capital contribution as long as he or she does
not participate in management. In this sense, the LP partner is like a
shareholder in that only a certain amount of capital is at risk. A limited partner who
actively participates in management is subject to the same liability as a
general partner.
• Dissolution: A limited partnership will dissolve
for most of the same reasons as a general partnership, but only in the
event that a general partner, e.g., dies, goes bankrupt, etc.
Joint Ventures [4255]
·
Very similar in nature to a GP, but are usually set up to handle a
particular business purpose and then disband. For example, drilling an oil
well, building a building, a bridge, or a tunnel. Usually used in cases where the activity is
very capital intensive
and the parties want to share the risk, both
financial and operational.
• Limited Liability Partnership (“LLP”):
A form of partnership that allows professionals (e.g., accountants,
attorneys) to enjoy the tax benefits of partnership while avoiding personal
liability for the malpractice of other partners.
• Family Limited Liability Partnership
(“FLLP”): An LLP in which the majority of the partners are persons related by
blood or marriage or fiduciaries of persons so related. All of the partners
must be natural persons.
• Limited Liability Limited Partnership (“LLLP”): An LLP in which the liability of the general
partner, as well as the limited partners, is limited to the amount of his investment in the firm.
As noted
earlier, LLC’s will be discussed more
under corporations. Generally it is a
mix of the best of partnerships and corporations.