Business Entities

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Business Entities

Many ChoicesFocus on Proprietorships and

Partnerships

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Key Entities• Corporations– C Corp.– S Corp

• Partnerships– General partnership (GP)– Limited partnership (LP)– Limited liability partnership (LLP)

• Limited liability company (LLC)• Sole proprietorship

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Why create a legal entity?

• Separation of ownership and control.• Limited liability.• Taxes– Expenses deductible– But .... double taxation issues

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Business entities can be “people” too• “.. corporations are people – the owners and others the

corporation represents in litigation.” - Prof. Larry Ribstein• Legislatures and courts treat business entities as if they were real

people.• A business entity can contract or be liable for breach of contract.• A business entity has legal rights:• “The Court has recognized that First Amendment protection

extends to corporations. ... This protection has been extended by explicit holdings to the context of political speech. ... Under the rationale of these precedents, political speech does not lose First Amendment protection “simply because its source is a corporation.” Citizens United v. FEC (2010).

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C Corp.

S. Corp LLC

Gen. Partners

hip

Sole Propriet

orOwners have limited liability for business debts and obligations X X XCreated by registration with state X X XPerpetual duration X X XUnlimited owners X X XOwners need not be U.S. Citizens or residents X X X XMay be owned by another business entity rather than individuals X XMay issue stock X XOwners report business profit and loss on personal tax returns X X X XOwners can split profit and loss with business for a lower overall tax rate XAble to distribute special allocations under some circumstances X XNot required to hold annual meetings, record meeting minutes X X X

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Sole proprietorship

• No legal separation between owner and business.

• No good reason to ever have one.

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Partnerships• Key attributes:– Formed by simple expression of will.– Equality and relationship reinforcing approach of

UPA s401: equal shares in profit and loss, equal right to manage, unanimous consent to bring in new partner, changes in agreement or extraordinary matters require unanimity.

– End as easily as start via expression of will – focus on individual partner’s adaptability rather than firm’s.

– Fiduciary duty’s role as a check on opportunism.

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Partner or Employee?

• 3 broad overlapping categories– Ownership: investment, ownership, liability for

debts– Remuneration: degree to which compensation

based on firm’s profits– Management: right to engage in policymaking,

participation in and voting power with regard to governance, ability to assign work and direct Ees, ability to act for firm.

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General Partnership• An association of two or more persons to carry

on as co-owners of a business for profit.• Each partner has unlimited joint and several

liability for the debts and obligations of the business against all of their assets.

• Each partner has full management authority.• Income is “passed through” to partners to be

taxed.

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XYZ Partners

GP

GP

GP

GP

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• Dave, Joe, & Lee are 1/3 partners in DJL Partners. Dave and Joe want to lease a building A; Lee wants to lease building B.– Partnership agreement silent: Dave & Joe outvote Lee and

lease building A.– Partnership agreement states “Lee shall serve as managing

partner and have authority to lease property on behalf of the partnership.” Lee leases building B.

– Partnership agreement states: “Lee shall serve as managing partner and have authority to enter into agreements in the normal course of business, provided however that Lee shall not have authority to lease property on behalf of the partnership without the express consent of the partners.” Lee should not lease building B but if Lee does, the lease will be good as the agreement cannot negate Lee’s apparent authority to enter into lease.

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• Default form of business / default rules provided.• “an association of two or more persons to carry on as co-

owners of a business for profit.” (Uniform Partnership Act)• Inadvertent formation possible: “Partnership results from

contract, express or implied. If denied, it may be proved by the production of some written instrument, by testimony as to some conversation, by circumstantial evidence. If nothing else appears, the receipt by the defendant of a share of the profits of the business is enough .... Mere words will not blind us to realities. Statements that no partnership is intended are not conclusive. If as a whole a contract contemplates an association of two or more persons to carry on as co-owners of a business for profit, a partnership there is.” - Martin v. Peyton, NY 1927

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• Partnership agreement is the primary source of law governing the partnership.

• Statutory mandatory rules on:– Varying partners’ right to information.

– Eliminating duty of good faith and fair dealing.

– Eliminating partners’ fiduciary duties to each other.

– Varying principle of joint and several liability.

– Varying power to dissociate from partnership.

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• In partnership dispute, ask FIRST “was there a partnership agreement and what does it say?” THEN ask what law says.

• WRITE THINGS DOWN!

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Fiduciary obligations of partners• Meinhard v. Salmon, 164 N.E. 545 (NY 1928): Copartners

owe to one another, while the enterprise continues, the duty of finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arms’ length, are forbidden to those bound by fiduciary ties . . . Not honesty alone, but the punctilio of an honor the most sensitive, is the the standard of behavior.”

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Partner as Agent: UPA 301• Subject to the effect of a statement of partnership authority

under Section 303: • (1) Each partner is an agent of the partnership for the

purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.

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Dissolution & Dissociation• The difference between “dissociation,” “dissolution” and

“termination”?• Dissolution: “the change in relation of the partners caused

by any partner ceasing to be associated with the carrying on as distinguished from the winding up of the business” (UPA 1914 s. 29)

• Termination: what happens after winding up completed (UPA 1914 s. 30)

• Dissociation: a partner leaving partnership, may lead to dissolution (new term in UPA 1997)

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Key Points on Partnerships• Partnerships are fundamentally contractual entities, unlike

corporations.– Incorporated firms exchanged autonomy for state-granted

privileges; partnerships did not.• UPA statute model is of a closely held and informal firm.– Default rules of equal power to control and share in profits; each

is co-principal; veto rights over major decisions such as entry of new partners.

– Exit is by dissolution not sale.– Vicarious liability the norm; hence, creditor demands for personal

guarantees. • Rise of the LLC as tort cases increased risk for partnerships.

• UPA limits some managerial rights and creates new opportunities to continue business if some leave; partnership creates new entities.

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Limited Partnership• An association of two or more persons to carry on as

co-owners of a business for profit.• Each GENERAL partner has unlimited joint and

several liability for the debts and obligations of the business against all of their assets; LIMITED partners do not.

• General partner has full management authority; Limited partner does not.

• Income is “passed through” to partners to be taxed.

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XYZ, LP

LP

LP

LP

LP

GP, Inc.Shareholder

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Where do we see this mostly?• Tax shelter investment (oil & gas, real estate)

where pass through taxation and centralized management needed

• Venture capital and leveraged buy out firms• Estate planning tools for family limited

partnerships• GP is usually thinly capitalized corporation.

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• Typical LP agreement issues:–Admission of new GP and LP.–Voting.–Withdrawal or removal of GP and LP.–Remedies for breach.–Manner and process of

dissolution/wind up.

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Newer Limited Liability Entities

• LLP & LLLP – created in 1980s in response to malpractice claims against lawyers, accountants, etc. State laws vary.

• LLC – combine partnership tax advantages with corporate limited liability rule and flexibility in structure

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Limited Liability Partnership (LLP)

• A general partnership that adopts limited liability by filing a registration with state.

• Some LLP statutes allowed only professionals to elect. Others allow anyone.

• Some LLP statutes require insurance to protect 3rd parties.

• Differences in scope of limitation for professional negligence vs. tort and contract.

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Limited Liability Partnership

• GP that has filed a certificate with state, declaring it is an LLP and including LLP in name.

• Statutory change to basic partnership law.• Closer to GP than to LP.• Mostly used by professional firms (lawyers).

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• A form of GP, governed by GP rules– Typically authorized by provision of GP statute

- a GP + protection

• Allows GPs to protect personal assets from partnership debts exceeding partnership assets.– Fundamental change in basic partnership law.

– Creature of statute - state laws vary (full shield vs. partial shield)