Spring 2016 Smith
Essential Terms and Concepts
Business Organization Choices
Sole Proprietorship – Owner of the business carries on the business as an individual.
Debt – Owner directly liable for all debts of the proprietorship.
Tax – Owner reports the tax as his own.
General Partnership – UPA definition: “an association of two or more persons to carry on as co-owners of a business for profit” §6(1).
By operation of law – Partnership can come into existence by operation of the law, without any filing of papers.
Creation by ‘estoppel’– If two people represent to the outside world that they are in partnership. See UPA §16.
Limited scope – Applies only where 3d party extends credit to the partnership. Other reliance’s inapplicable.
Life Span – Dissolution: Dissolves upon death, bankruptcy, or withdrawal of any partner.
Absent an agreement, any partner may withdraw and demand liquidation.
Liability to Outsiders – Partners have unlimited liability, personal assets at risk for partnership obligations.
Under some statutes liability of partnership contracts is joint, so partnership assets must first be exhausted.
LLP Statutes – Limit liability of partners for partnership debts and obligation, unless partner supervised another partner or agent engaged in wrongful conduct.
Financial Rights – Partners share equally in profits and losses, which are divided on dissolution.
No statutory right to profits.
No statutory right to compensation for services.
Firm Governance –
Binding the firm: Each partner is an agent of all other partners and can bind the partnership, either by transacting business as agreed by the partners (actual authority) or by appearing in the eyes of 3d parties to carry on partnership business (apparent authority).
Control of firm – Unless otherwise agreed, majority vote needed to decide ordinary partnership matters.
Extraordinary matters or those contravening agreement – require unanimity.
Transferability of Ownership Interests – Partner cannot transfer interest unless all remaining partners agree or partnership agreement permits it.
Partner may transfer his financial interest in profits and distribution, entitling the transferee to a charging order.
Limited Partnership –
Formation – Must be created with written agreement among the partners and certificate filed with state official. RULPA §201.
Dissolution – Limited partnership lasts as long as the partners agree or, absent agreement, until a general partner withdraws.
Nature – 2 kinds of partners
General – Each liable for all debts of the partnership;
Corporate general partner – General partners may be corporations.
Limited – Not liable for debts of partnership beyond their proportional share of contributions.
No participation in control
Liability to Outsiders –
General Partner – Must be at least one ¬ unlimited liability
Limited Partners – Liable only to the extent of their investment.
Firm Governance –
Binding firm: General partners have authority to bind the partnership to ordinary matters.
Limited partners have voting authority over specified matters, but cannot bind the partnership.
Transferability of Ownership Interests –
General Partner – Cannot transfer interest unless all remaining partners agree or partnership agreement permits it.
Limited Partner – Interests freely assignable.
Both – can assign their rights to profits and distributions.
Limited Liability Company (LLC) – Hybrid entity between corporation and partnership.
Partnership aspects – Members of LLC provide capital and manage the business according to their agreement;
Interests are not freely transferable.
Corporation aspects – Members not personally liable for the debts of the LLC entity.
Life Span – LLC arises with the filing of a certificate or articles of organization with a state official.
Many LLC statutes require at least two members.
Duration – Not limited by statutes.
Liability to Outsiders – LLC members, both as capital contributors and managers, are not liable for LLC obligations.
Veil-piercing – Some LLC statutes suggest that members can become individually liable if equity or justice requires.
Firm Governance –
Two Possibilities: (1) Member-managed; (2) Manager-Managed.
Member-Managed – Members have broad authority to bind LLC in much the same way as partners;
Manager-Managed – Members have no authority to bind.
Voting – Generally in proportion to members’ capital contribution.
Transferability of Ownership Interests – Most LLC statutes provide that members cannot transfer LLC interests without all other members’ consent.
Standing Consent – Some LLC statutes permit the articles of organization to provide standing consent for new members.
Transfer of financial rights – Many LLC statutes permit transfer of financial rights to creditors, who can obtain charging orders against the members’ interest.
Tax Implications of Organizational Choice
Business Makes Money & Distributes
Business Makes Money & Retains
Business loses Money
Tax paid once – Partnership acts as tax conduit, and income flows through to partners who pay tax.
Double tax –
Corporation taxed on income when earned.
If dividends are distributed to shareholders ® they pay tax on dividends.
Tax paid once – Partnership’s income flows through to partners who pay tax.
Deferred second tax –
Corporation pays tax when it earns income.
Tax on shareholders deferred until income is distributed or when shares are sold after appreciation. (Double tax unavoidable).
Sheltered income – Partne
l and the agent
A business relationship between the principal and the agent
That the agent promises to act as an Agent
That the Agent does or does not receive compensation
Why is Establishing this Relationship Important: Principal is liable for the actions of his agent.
Principal Agent Triangle: (1) Principal controls the Agent who acts on behalf of the Principal, (2) the Agent deals with the Third Party, (3) the agents dealing creates a relationship and personal liability, of the Principal to the Third Party
A creditor (Cargill) who assumes control of debtor’s business may become liable as principal for the acts of the debtor in connection with the business.
Factors indicating Control:
Right of First Refusal
Right to Entry on Premise
Inability to obtain funding elsewhere without prior approval
Financing of business and the power to stop financing
By Cargill exercising control over Warren’s day to day operation of his business, he sufficiently established a principal/agent relationship. Note: a creditor who has veto power is not enough to become a principal.
How did Cargill manifest consent that Warren act on Cargill’s behalf? By financing Warren to procure the grain for Cargill as part of its ordinary operations.
Subject to Cargill’s control? By directing Warrant to implement its operations and by interfering in Warren’s actions.
Did Warren consent to this? The Court seems to ignore this. Maybe Cargill reasonably believes that Warren is consenting to its control because Warren never says anything to the contrary.
Hypo: Bank gives a loan to a small business. The small business gets goods from a third party and doesn’t pay for them. The third party wants to sue the bank for the money. Would they be able to? No. All the bank did was give a loan, an ordinary loan does not create liability. It’s only when there’s multiple contracts or connections between the bank and the small business. What if bank has the ability to review the small business’s financial records and determine how much debt is too much debt? Still not enough control over the day to day business of the small business. What if you have to ask the bank for permission before borrowing any additional money or if any money can be taken out of the business? Still no. What if the bank is able to give advice to the small business? Still no. What if the loan has a provision that allows it to be called back (make the small business pay it back) at any time if the small business isn’t taking the banks advice? Yes, this plus all the other factors would be enough.