Partnerships 9

Introduction to Forms of
Business and Formation of
Partnerships
Operation of Partnerships
Dissolution & Winding Up
Limited Liability Companies
& Limited Partnerships
McGraw-Hill/Irwin Business Law, 13/e

© 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

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 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

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 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

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 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 and control
• Disadvantage: owner bears all risk of loss

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 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 on the individual partner’s
federal income tax return whether or not
distributed or allocated to partners

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 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 depending on sub-form

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 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 tax-paying entity
for federal income tax purposes
– Exception: Subchapter S corporations

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 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 structure

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 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
obligations of the LLC

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 Business Forms Worldwide
• Many nations share
similar forms of business,
including partnership and
corporation, though
details vary widely

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 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

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 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 entered it inadvertently, without
considering whether they had created a
partnership

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 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 and
splitting the profits.

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 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, RLLP,
Limited Liability Partnership, LLP

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 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 persons.”

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 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
agreed

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 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 presumptively belongs to the
partnership as an entity rather than individual
partners

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 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

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 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 scope of the
enterprise

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 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
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 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 govern an LLC in the absence of a
contrary agreement of its owners
– http://www.nccusl.org/Update/

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 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 income tax returns

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 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
– An LLC is an entity separate from its members

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 Management of the LLC
• Articles of organization must state whether the
LLC is member-managed 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

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 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

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 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 ordinary business

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 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

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 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 are similar to a member’s power
in a member- managed LLC

A team effort.
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 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 within their
authority

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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 fiduciary duties
– But owe a duty of good faith and fair dealing when
exercising rights as members

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 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
– Limited right of transfer may be altered in the
operating agreement

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 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
agreement

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 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

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 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 dissociation

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 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

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 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 shares to the
members

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 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 ventures, oil and gas
drilling, and professional sports

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 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
• Liability limited up to the amount of their investments
in the business
• Limited partnership agreements common

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 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

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 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

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 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
• ULPA of 2001 requires few actions to be
approved by all the partners

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 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

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 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

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 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 duties to the limited
partnership and the other partners

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 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
partnership

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 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 the partnership interest

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 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

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 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

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 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 liability
– No liability for post-dissociation obligations

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 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

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 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 they shared
distributions

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