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Business Associations/Corporations
University of Mississippi School of Law
Bullard, Mercer E.

BUSINESS ASSOCIATIONS

BULLARD

FALL 2011

I. Business Associations: Advantages & Disadvantages of Particular Enterprises

a. Sole Proprietorship:

i. Individually owned business; no separate legal status apart from its owner.

ii. Advantages

1. Direct control over the business and its assets.

2. Simplicity – lack of separate legal structure provides for ease of operation/flexibility.

3. Lower expenses due to lack of reporting/registration reqts; less formal accounting; fewer and less complicated legal issues (v. corporation)

4. No double taxation, – SP’s aren’t taxed separately like a corp. is.

iii. Disadvantages

1. Sole proprietor subject to unlimited liability for any K or tort damages caused by the business/its agentsàputs personal assets of the owner of SP at risk.

2. SP is usually dependant on the management of the owner which means that death/disability of the SP often results in end/loss of the business.

3. Transferability – the SP ownership cannot be readily sold.

b. Partnership:

i. Association of 2+ people carrying on a business for profit as co-owners.

ii. Advantages

1. Control – a p’ship doesn’t separate ownership and control. They’re dispersed among partners by agreement, which allows the owners to directly control the business and safeguard its assets.

2. Simplicity – Has separate legal structure, but the partners may agree to conduct their business in almost any manner (still must comply with applicable state laws.) Allows for flexibility/simplicity.

3. Typically lower expenses than a corp. which has substantial reporting reqts.

a. But, winding up the p’ship can be expensive and complicated!

4. Taxes – not taxed separately (no double taxation like corp.)

iii. Disadvantages

1. Unlimited Liability – partners subject to liability for any K or tort damages incurred by partners/agents in the course of the p’ship business.

2. Transferability – Partner cannot sell his interest in the p’ship.

c. Limited Partnership:

i. Has a general partner that operates the business and 1+ “limited partners” that contribute investment capital but don’t participate in mgt of the business.

ii. Advantages

1. Limited Liability – liability of partners is limited to the amt of their investment;

a. NOTE: general partner remains subject to unlimited liability!

2. Separation of Ownership and Control – ltd partners can invest capital w/o becoming involved in mgt of a company for which they don’t have the time/expertise.

3. Expenses – simplicity is still (+) here bc the business may be structured relatively freely. A filing must be made with the appropriate state agency and there’s likely more complicated accounting than in a simple p’ship.

iii. Disadvantages

1. Unlimited Liability – for the general partner; subject to unltd liability for any K/tort damage incurred in the business.

a. Note: can limit this by making the general partner a corporation ??

2. Transferability – a ltd partner can’t usually readily sell his interest unless it’s registered under (or exempt from) federal securities laws with all their attending expenses and liabilities.

d. Limited Liability Company (LLC):

i. Basically an ‘incorporated partnership” that allows members to actively participate in mgt or to be passive if they so choose.

ii. Advantages

1. Limited Liability – liability of members is ltd to the amt of their investment, thereby protecting their personal assets.

2. Separation of Ownership & Control – members may invest capital w/o becoming involved in mgt, and/or they can manage the company w/o incurring unlimited liability.

3. Expenses – simplicity in mgt, but there are some expenses associated w/ obtaining a charter from the state, and also more complicated accounting.

4. Taxes – passed through to members of the LLC, therefore avoids double taxation.

iii. Disadvantages

1. Transferability – ownership interest may be transferred by may be restricted by terms of the LLC’s operating agreement.

a. Also, sale of ownership interests may be subject to state/federal securities laws.

e. Limited Liability Partnership (LLP):

i. Another form of incorporated partnership, particularly popular with law firms.

ii. Advantages

1. Limited Liability – liability of members if limited to the amt of their investment.

a. But w/r to law firms, each partner subject to unlimited liability for his OWN acts.

2. Expenses – may structure its operation in any manner it deems fit under the partnership agreement; fairly flexible.

3. Taxes – passed through to members therefore avoids double taxation.

iii. Disadvantages

1. Transferability – not easily transferred.

f. Corporations:

i. Businesses that have a separate legal entity status apart from their owners.

ii. Advantages

1. Limited Liability – liability of stockholders is ltd to the amt of their investment.

a. Encourages risk taking that’s necessary for society to advance!

2. Separation of Management & Control – stockholders may invest capital in the enterprise without becoming involved in mgt.

a. Allows efficient allocation of capital and professional mgt of the company’s operations.

3. Transferability – stock holdings are easily transferable.

a. But – such sales may be subject to the reqts of federal securities laws, and there may not always be a ready market for the stock.

4. Perpetual Life – unlike the sole proprietorship and the partnership, the corporation continues in existence until dissolved.

a. Death of the owner doesn’t terminate life of the corporation.

iii. Disadvantages

1. Double Taxation – corp is taxed separately for any profits it receives and the shareholders are then also taxed if/when any of the remaining income (dividends) is distributed to them.

a. May be avoided in small corporations like an “S-Corp,” which allows a pass-through of profits directly to shareholders.

b. S-corp – limited number of shareholders, most practical alternative for an LLC

2. Management – may manage for their own interests (i.e., higher salaries and perquisites) rather than seeking to maximize the company/shareholder wealth.

3. Expenses – a publicly held corp must comply with extensive reporting and registration reqts per federal securities laws. Accounting and legal issues involving authorization and entity structure is more frequent and more complicated than in other forms of businesses.

II. Agency and Partnerships

a. General Agency Principles

i. Agency is a fiduciary relationship which results from the manifestation of consent of the principal that the agent shall act on his behalf.

ii. An agency relationship is a fiduciary one based on consent. As such, the principal will be held responsible (‘vicarious liability’) for acts of the agent where the agent is acting within the scope of his authority.

iii. Further, an agreement may result in the creation of an agency relationship although the parties didn’t call it as such and didn’t intend the legal consequences of the relationship to follow. (‘de facto’ agency relationship)

iv. 3 Elements of Agency Relationship:

1. Consent of principal for agent to act on his behalf;

a. May be express OR implied

2. Agent is subject to control of principal; and

3. Agent acts on behalf of principal

a. i.e., consents to do so.

v. Fiduciary Obligations

1. Agent is under duty to act solely for the benefit of the principal.

2. Agent may not deal with the principal as an adverse party (i.e., conflict of interest).

3. An agent who profits while working for a principal is under a duty to give that profit to the principal.

vi. Any 3rd party that deals with the agent is bound to the principal even where the agency relationship or identity of the principal is not disclosed.

1. EXCEPTION: when the agent mis

e, cap on profit related to loan pmt.

2. Implied by Sharing of Profits: method to pay a debt or business for profit?

a. Paying profits in lieu of interest to repay the loanàdebtor/creditor

b. Making profits above those related to the loanàp’ship

3. Case Example

a. Martin – owner of KN&K formed K to borrow money from 3 friends. To secure the loan, KN&K agreed to hand over some securities. As pmt for the loan (instead of interest), KN&K agreed to pay the 3 friends 40% of its profits, not to exceed 500K and no less than 100K until the return was made.

i. HELD: no p’ship, bc K provisions deemed not to contemplate profits beyond those made on the loan itself (only related to interest, security, and repayment of the loan).

vi. Fiduciary Obligations – partners are held to “something stricter than the morals of the mktplace” and have fiduciary responsibilities to one another while the partnership lasts.

1. Meinhard – After 20 yrs as partners and while p’ship was still in force, but close to the end, Salmon was approached in capacity as the “sole” lessor with a business deal involving a new lease on the hotel. He accepted this deal for himself w/o telling Meinhard about the opportunity.

a. HELD: Salmon had fiduciary duty to inform his partner of the business deal and allow him to compete for the new lease bc it had come to the partnership.

b. You must inform your partner of the opportunity or it is a breach of your fiduciary duty.

c. If Salmon was approached after the lease expired, (thus ending the p’ship), then he would be ok. If the prop was separate from the lease, then he would have been ok. If he’d been approached bc of his accomplishments of the lease then he’d be ok. Salmon only had duty to disclose and give notice what he was doing (and not breach the fiduciary duty) to break away and go out on his own venture.

vii. Binding Authority – a partner is an agent of the p’ship and has the authority to bind the p’ship and co-partners when acting in the ordinary course of business.

1. Can be bound by actual or apparent authority (see above principles).

2. Dooely – when 1 of 2 partners became unable to work, he decided to hire an employee to replace him over the other partner’s objections (effectively, voting no) and then charged the dissenting partner with the costs incurred as a result of his unilateral decision. Dissenting partner refused to pay.

a. HELD: Dissenting partner not liable for the costs bc he continuously objected and the expense was incurred for the benefit of only ONE partner.

b. What about apparent authority argument?

i. If a RPP (employee) would believe a partner had authority to hire him, then the non-hiring partner could potentially be liable.

ii. If 3rd party had knowledge of the hiring partner’s lack of authority, then cannot make apparent authority argument.

3. Stroud – 1 partner of Stroud Food Ctr told a bread maker (3rd party) not to sell bread to his partner anymore. His partner entered into K to buy the bread anyway and dissenting partner refused to pay 3rd party.

a. HELD: Actual authority – what either party does with a 3rd party is binding on the p’ship when acting in the ordinary course of business.