Select Page

Business Associations
University of North Carolina School of Law
Hazen, Thomas Lee

Business Associations

Professor Hazen

Fall 2016

CHAPTER 1à BUSINESS ASSOCIATIONS— BACKGROUND AND HISTORY

THEORIES OF THE FIRM:

Fiduciary Model

Traditional viewà Managers have “fiduciary” duties that ensure alignment of interests between passive owners and active managers.

Jurists provide discipline for breaches of fiduciary duties by managers.

Contractual Theory (“Nexus of Contracts”)

“Chicago School”à business relationships are governed by contractual agreements and the free market will correct misbehavior of management, rather than judicially created discipline for breaches of fiduciary duties.

Shareholders are assured only of rights they might have under contract with corporation.

Problems Arising from the Separation of Ownership From Control

Basic Problemà Conflict of interest between passive owners and active managers. Managers may work to maximize their own profit rather than maximizing the value of the firm.

Neo-Classical Economists “Chicago School” View à Managers must have “incentive compensation that substantially ties their fortunes to that of the owners.

“Agency Costs”à collective term for the costs of bonding, signaling and monitoring management, as well as the amount of management misbehavior that continues in the face of these steps to deter it.

“Bonding”à Attempt to align the interest of management and passive owners by “bonding” management compensation to the success of the firm.

Stock options or bonuses based on profitability.

“Signaling” à Actions to “link” management’s incentives to those of the firm’s owners “signals” to investors that the firm’s managers will work to maximize profits.

“Monitoring” à devices put in place to police mismanagement. Might include use of “outside directors” or independent accountants.

ADVANTAGES AND DISADVANTAGES OF DIFFERENT TYPES OF ENTERPRISES:

PROPRIETORSHIPS

“Proprietorships” à individually owned businesses that have NO separate legal status apart from their owner.

Advantages:

Direct Controlà No separation of ownership and control. Owner of proprietorship directly controls and operates the business

Simplicityà Easy to operate and more flexible because there is NO separate legal entity status. NO registering with the state; NO need to call shareholder meetings, etc.

Expensesà Less expensive in its operations. NO need to comply with expensive reporting and registration requirements under federal securities laws. Accounting is less formal.

Taxes à Proprietorship is NOT taxed separately. Income and expenses are passed directly through to the owner. (In contrast—corporations are “double taxed”).

Disadvantages:

Unlimited Liability à sole proprietor is subject to unlimited liability for any contractual or tort damages caused by business or its agents. Personal assets may be seized by creditors.

Management à Dependent on management of the owner—NOT a professional manager. Death or disability of proprietor can result in loss of business.

Transferability à Ownership of the proprietorship can NOT be readily sold. The entity is usually an integral part of its owner’s personal management and control having NO separate structure that can be easily transferred.

GENERAL PARTNERSHIPS

“Partnership” à an association of two or more persons carrying on a business for profit as co-owners.

General Partnerships are the common law “default” and can be created by conduct.

Advantages

Control à Partnership does NOT separate ownership and control. Ownership and control is dispersed among partners by agreement. Owners directly control business.

Simplicity à The partnership has a separate legal structure, but the partners may agree to conduct their business in almost any manner (flexibility). However, Partnerships must be conducted in accordance with state partnership laws.

:

Limited Liabilityà The liability of members is limited to the amount of investment.

Separation of Ownership and Controlà LLC members may invest capital without being involved with management OR members can manage the company if the operating agreement permits, without incurring unlimited liability. Maximum flexibility.

Expensesà Simplicity in management in an LLC because biz may be structured freely under the operating agreement. However, a charter must be obtained from the state. Accounting may be more complicated than a partnership.

Disadvantages:

Transferabilityà Ownership interest may be transferred, but transfer may be restricted by operating agreement. Sale of ownership interest may be subject to fed securities laws.

LIMITED LIABILITY PARTNERSHIPS (LLP’s”)

“Limited Liability Partnership”à Another form of incorporated partnership that exists only by statute. Particularly popular with law firms.

Advantages

Limited Liability à

Liability of members of the LLP is limited to the amount of their investment.
For a law firm

Unlimited liability for your own acts
Protection from personal liability for acts of other partners BUT not partnership interest (may be seized by creditors of the partnership)

Expenses à LLPs may structure their operations as they deem fit under the agreement.

Taxesà Taxes may be passed through to members directly, avoiding double taxation

Disadvantages

Transferability à ownership interest in an LLP is NOT easily transferred.