BUSINESS ORGANIZATIONS
DOBBYN
FALL 2012
I) Selection of a Form of Business:
1) Sole Proprietorship
a) Management: one person owns the business (more than one is a partnership)
b) Liability: the sole proprietor is personally liable for all tort and contract debt himself
(i) to mitigate this, business will carry Comprehensive General Liability Insurance (CGL)
(A) only insures against negligent torts
(B) by law, cannot insure against K debts or deliberate torts
c) Taxes: the sole proprietor is personally liable for all taxes, there is no separate entity to tax
d) Profits: all earnings and losses go directly to the sole proprietor
e) Creation: the sole proprietorship is created without any formality
(i) “turn the key and open the cash register”
(ii) However, may have to register a fictitious name for the business – requires $$
f) Note: an employer sole proprietor has a master-servant relationship w/employees (vicarious liability?)
2) Partnership
a) Definition/Elements:
(i) An association of two or more persons
(ii) Doing Business
(iii) As co-owners
(iv) For Profit
b) Liability: the partnership is not a separate entity for tort or contract liability – partners are liable for contract and tort debts of the partnership
(i) Tort Liability: Each partner is jointly and severally liable for all torts committed in the course of operating the business.
(ii) Contract Liability: If one partner becomes insolvent, the partnership is dissolved in order to satisfy the partner’s creditors.
c) Taxes: The partnership is not a separate entity from the partners themselves for tax purposes.
(i) Must file an informational return as an entity, but you are NOT TAXED on it.
(ii) Loss accrues to the individual partners for tax purposes
d) Profits: The partnership agreement can split the profits and losses in any manner in which the partners wish.
(i) Absent an agreement, the partners split the profits and losses equally.
(ii) A partner may enforce the right to profits in an action for an accounting.
(iii) Upon dissolution, after discharging partnership obligations, profits and losses are divided among the partners.
e) The partnership is a separate entity in:
(i) Holding land in its own name
(ii) Bringing suit in the partnership name
f) Governance:
(i) Each partner is an agent of all other partners and can bind the partnership, either by transacting business as agreed by the partners (actual authority), or by appearing in the eyes of third parties to carry on partnership business (apparent authority).
(ii) Fiduciary duties to each other to act in good faith with due care and undivided loyalty – breaches are actionable in court.
g) The partnership can be created through contract – meeting of the minds
(i) Formality: a fictitious name must be registered for the partnership ($$)
(ii) The partnership should really have a written partnership agreement, but it is not required
(iii) All partnership rules fall under the Uniform Partnership Act
(iv) Does not require legal documentation for its creation
h) Reverse Liability:
(i) If one partner is insolvent, then creditors can get to the insolvent partner’s share of the partnership.
(ii) If creditors come in, then the partnership is dissolved – reverse liability.
3) Limited Partnership
a) Structure: there must be at least one general partner
(i) General Partner: Held personally liable for all tort and contract debt incurred by the business
(ii) Limited Partner: Liability is limited to the amount limited partner invested in the company (usually viewed merely as investors).
b) There can be as many limited partners as the partnership desires
(i) The limited partner is brought in solely to raise money.
(ii) To induce limited partners to part with their money, they are granted limited liability.
(A) Limited Liability – the limited partner can only lose his initial investment
(B) Limited Partner can lose Limited Liability by:
(i) Taking part in the management of the business – effectively the limited partner is holding himself out to the public for suit
(ii) Placing name of business – this would be misleading to the public.
(iii) Limited partners have voting authority over specified matters, but cannot bind the partnership.
c) The limited partnership agreement specifies the share of losses and profits, and thus limited partners can record losses if desired
(i) Rules for the creation of limited partnership can be found in the Uniform Limited Partnership Act
(A) There must be an agreement
(B) There must be a fictitious name filing ($$)
(C) There must be a filing of the limited partnership ($$)
(ii) Pre-dissolution distributions are by agreement, as is compensation of the general partner
d) NO REVERSE LIABILITY: If a limited partner becomes insolvent, then the partnership does not dissolve.
(i) If the general partner becomes insolvent, the same result as if all had been in a partnership occurs.
e) IRS does not allow a shell of a corporation to be the general partner and thus requires minimum capitalization
f) Master Limited Partnerships: multiple partnerships rolled together
(i) Example: 1000 limited partnerships rolled together, may want to issue stock in the Master Limited Partnership, and trade on the stock exchange.
(ii) These partnerships exist, however the IRS said they look “too much like a corporation” and would be taxed as such unless 90% or more of the Master Limited Partnership’s income is “passive income.”
(A) Passive Income = Rent, holding companies, etc.
(iii) Usually involved in oil well digging
(A) General partner and limited partners
(B) Oil exploration income = passive income
(C) Arguable that the exception has swallowed the rule
g) Delaney v. Fidelity Lease Limited: 517 S.W.2d 420 (Tex. 1974)
(i) Issue: Whether a limited partner in a limited partnership becomes liable as a general partner when he also participates as an active officer, director and shareholder of a corporation which is the sole general partner of that limited partnership.
(ii) Facts: Fidelity Lease Limited (Δ) failed to take possession of the premises called for by a lease, and did not pay any of the rental thereon. Suit for breach of the lease by ∏ joined as Δs the general partner of Fidelity, Interlease Corporation.
(iii) Holding: A limited partner does not become liable as a general partner solely because of his participating in the affairs of the corporation as an officer, director, or stockholder.
(A) Insulation from personal liability is said to be the natural consequence of the incorporation process, and is supported by the theory or “fiction” that incorporation results in the creation of an “entity” separate and distinct from the individual shareholders.
(i) An exception may be urged here, however – that the corporate structure is being used as a vehicle for circumventing the terms of statute.
(ii) Otherwise, in absence of some sort of deception, the creditor more or less assumes the risk of loss when he deals with the corporate “shell.”
(iii) Assuming the Risk of Loss: if a person knowingly deals with an undercapitalized corporation he is, in effect, ass
y (LLC)
a) Every jurisdiction now allows the LLC
b) It is created by the filing of a document according to the statute and is comprised of members and not shareholders.
c) There is NO BOARD OF DIRECTORS, but rather a manager.
(i) LLCs can be member-managed or manager managed
(A) Members in a member-managed LLC have broad authority to bind the LLC in much the same way as partners, but not in a manager-managed LLC.
(B) Voting power in a member-managed LLC is in proportion to the members’ capital contributions, though some statutes specify equal management rights
d) Most LLC statutes allocate financial rights according to member contributions, though some provide for equal shares.
e) Taxes:
(i) Tax as a partnership, i.e. profits and losses can flow to the members
(ii) There is an avoidance of the double tax bite
f) Old Rule – Kintner Regulations:
(i) Corporation has the following characteristics, and if the LLC lacks any TWO of these, then it is taxable as a partnership (Kintner Regulations for Corporations):
(A) Centralized management (can establish member-managed structures)
(B) Perpetual existence (providing for dissolution upon withdrawal)
(C) Free alienability (restricting transferability of member interests)
(D) Limitation of Liability
g) New Rule – “Check the Box”:
(i) The “Old Rule” was replaced with the Check the Box Regulations, which allows all members of the LLC to check the box on income tax to be taxed as a partnership as long as it’s not already a corporation.
h) Advantages of LLC’s:
(i) The LLC is better than a partnership because there is NO liability;
(ii) Better than a limited partnership because there is no general partner;
(iii) Better than a corporation because there is no double tax, no limitation on management, and the benefit of losses can be passed to the members;
(iv) Better than a Subchapter S because unlimited members who can be corporate or people, aliens, and losses can be distributed anyway desired.
i) Negatives of the LLC:
(i) Relatively expensive to set up
(ii) Brand new animal and some doubt as to how the law will develop as far as Fiduciary duties, distribution of assets upon withdraw, whether different terms can be agreed upon in contract that differ from state statutory law, etc.
6) Subchapter S Corporations:
a) Incorporated under state law and retains all its corporate attributes, including limited liability. But it is not subject to an entity tax, and all corporate income, losses, deductions, and credits flow through to the shareholders.
b) Eligibility:
(i) S corporation must be a domestic corporation
(ii) There can be no more than 75 individual shareholders, though certain tax-exempt entities can be shareholders (such as employee stock ownership plans, pension plans, charities)
(iii) No shareholder can be a nonresident alien
(iv) There can be only one class of stock
