19 - 131 - 1 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 34 Entrepreneurship, Sole Proprietorships, and General Partnerships.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 19 - 131 - 1

Chapter 34Entrepreneurship, Sole

Proprietorships, and General Partnerships


EntrepreneurEntrepreneur

A person who forms and A person who forms and operates a new business operates a new business either by him- or herself or either by him- or herself or with others.with others.


Entrepreneurial Forms of Conducting Business

Sole Sole ProprietorshipProprietorship General General

PartnershipPartnership

Limited Limited PartnershipPartnership

Limited Liability Limited Liability CompanyCompany

Limited Liability Limited Liability PartnershipPartnership


Sole Proprietorship• Owner is actually the business.• Business is not a separate legal

entity.• Most common form of business

organization in the United States.


Advantages of a Sole Proprietorship

• Ease and low cost of formation.• Owner can make all

management decisions.– hiring and firing employees.– No other approvals required.

• Sole proprietor owns all of the business

• Has the right to receive all of the business’s profits.

• Easily transferred or sold


Disadvantages of a Sole Proprietorship

• Access to capital is limited to:– personal funds plus – any loans he or she can obtain.

• Legally responsible for the business’s contracts

• Responsible for any torts committed in the course of employment.


Creation of a Sole Proprietorship

• No formalities.• No federal or state government

approval is required.• Some local governments require

a license to do business within the city.


Personal Liability of a Sole Proprietor

• The sole proprietor bears the risk of loss of the business.– Will lose his or her entire

capital contribution if the business fails.

• The sole proprietor has unlimited personal liability.

• Creditors may recover claims against the business from the sole proprietor’s personal assets.


Personal Liability of a Sole Proprietor (continued)

Sole Sole Proprietor Proprietor (Owner)(Owner)

Sole Sole ProprietorshipProprietorship Third PartyThird Party

Capital investmentCapital investment

Debt or obligation Debt or obligation owedowed

Personal liability for sole Personal liability for sole proprietorship’s debts and proprietorship’s debts and

obligationsobligations


General Partnership

• Voluntary association

• Two or more people

• Carry on business for profit

• Creates rights and duties between partners and with third parties

• General partners personally liable for the debts and obligations of the partnership.


General Partnership

Third PartyThird Party

Debt or obligation Debt or obligation owedowedGeneral General

PartnershipPartnership


General General PartnerPartner




Personal liability for Personal liability for partnership’s debts and partnership’s debts and

obligationsobligations


Uniform Partnership Act (UPA)

• Model act • Codifies partnership law• Most states have adopted • Covers most problems that arise

in the formation, operation, and dissolution of ordinary partnerships


Entity Theory of Partnership• UPA considers partnerships as

separate legal entities.• Partnerships can:

– Hold title to personal and real property

– Transact business in the partnership name

– Sue in the partnership name


General Partnership Name• Can operate under name of

any one or all of partners• May use fictitious name

– Must file fictitious business name certificate

– Publish notice– Cannot be similar to name

used by another business


Requirements for a General Partnership

• UPA states that a partnership is:1.A voluntary association of two

or more persons Includes natural persons,

partnerships, corporations

2.Carrying on a business3.As co-owners

All partners must agree to participation

4.For profit


Evidence of Partnership

• Prima facie evidence:– Receipt of a share of business

profits

• Compelling evidence:– Agreement to share in profits

and losses – Right to participate in

management


Partnership Agreement• May be written or oral

– Statute of Frauds applies

• No formalities required• Recommended that it be in

writing– Called partnership agreement

or articles of partnership– UPA will fill gaps


Rights Among Partners

• Unless otherwise agreed, each partner:– Has a right to participate

in management, and– Has an equal vote on

partnership matters.• Under UPA, a simple

majority decides most ordinary partnership matters.


Partners’ Rights to Share in Profits

• UPA mandates right to an equal share in profits and losses

• Agreements often provide otherwise– If agreement describes

sharing of profits, but losses are silent, then losses are shared in same proportion

– If agreement states sharing of losses, but is silent as to profits, then profits are shared equally


Right to Compensation and Reimbursement

• UPA provides that no partner is entitled to remuneration – Implied partners will devote

full time and service to partnership

• Partner entitled to indemnification– Partner to be reimbursed for

expenditures incurred on behalf of the partnership


Right to Return of Loans and Capital

• Partner entitled to repayment of loan– Right is subordinated to

claims of creditors who are not partners

• Partners entitle to have capital contributions returned at termination of partnership– Right is subordinated to rights

of creditors


Right to Information

• Partner has right to true and full information – From any partner – All things affecting

partnership

• Partner has a duty to provide information

• Partnership books must be kept at partnership’s principal place of business– Partners have absolute right

to inspect and copy records


Duty of Duty of LoyaltyLoyalty

Duty of Duty of ObedienceObedience

Duty of Duty of CareCare

Duty to Duty to InformInform

Duties Among Partners


Duty of Loyalty• Duty that a partner owes not to

act adversely to the interests of the partnership.

• Duty is imposed by law • Cannot be waived.• In case of conflict between

partnership interests and personal interests, partner must choose the interest of the partnership.


Partners breach their duty of loyalty if they:

1. Self-deal with the partner-ship without permission

2. Usurp a partnership opportunity

3. Compete with the partner-ship without permission

4. Make secret profits from partnership business

5. Disclose confidential partnership information

6. Misuse partnership property

7. Make other breaches of their fiduciary duty


Duty of Care• Partners must use the same

level of care and skill that a reasonable person in the same position would use in the same circumstances.

• A breach of the duty of care is negligence.

• A partner is liable to the partnership for any damages caused by his or her negligence.


Duty to Inform• Duty partner owes to inform his

or her co-partners of all information he or she possesses, that is relevant to the affairs of the partnership.

• Knowledge is imputed to other partners.


Duty of Obedience• Duty that partners must adhere

to the provisions of the partnership agreement and the decisions of the partnership.

• Partner who breaches this duty is liable to the partnership for any damages caused by the breach.


Right to an Accounting• Partners cannot sue partnership• They may bring an action for an

accounting– Formal judicial proceeding in which

the court is authorized to:• Review the partnership and the

partners’ transactions, and• Award each partner his or her

share of the partnership assets


Tort Liability• Partnership is liable for the

tortious act of a partner, employee, or agent that is committed while the person is acting within the ordinary course of partnership business or with the authority of his or her co-partners.– Both negligence and intentional

torts covered


Joint and Several Liability• Partners are jointly and severally

liable for tort liability of the partnership.– i.e., the plaintiff can sue one

or more of the partners separately.

– If successful, the plaintiff can recover the entire amount of the judgment from any or all of the defendant-partners.

– Release of one partner does not discharge the others.


Contract Liability• Partners are jointly liable for

contracts and debts of partnership.

• Third party must name all partners in suit.– If suit does not list all, judgment

cannot be collected.– If one is released, all are released.

• Successful third party may collect judgment against any or all partners.– Partners may seek indemnification if

they pay more than their share.


Summary: Personal Liability of General Partners

Issue Joint Liability Joint and Several Liability

Type of lawsuit

Contract action Tort action

Defen-dants

Plaintiff must name all partners as defendants

Plaintiff can sue partners individually

Recovery If successful, the plaintiff can recover the judgment against all or any of the defendants

If successful, the plaintiff can recover the judgment against all or any of the named defendants

Indemni-fication

Partner who pays judgment can recover contribution from other partners for their share of the judgment

Partner who pays judgment can recover contribution from other partners for their share of the judgment


Liability of Incoming Partners• New partner who is admitted to

the partnership is liable for the existing debts and obligations (antecedent debts) of the partnership only to the extent of his or her capital contribution.

• The new partner is personally liable for debts and obligations incurred by the partnership after becoming a partner.


Dissolution of General Partnership

• Defined as:– “Change in the relation of the

partners caused by any partner ceasing to be associated in the carrying on of the business”.

• Partnership for a term– For a fixed duration– Until event occurs– Terminates automatically at end of

time or when objective accomplished.

• Partnership at will– Partner may rightfully withdraw and

dissolve partnership at any time.


Winding-Up• Process of liquidating the

partnership’s assets and distributing the proceeds to satisfy claims against the partnership.

• The surviving or remaining partners have the right to wind-up the partnership.

• A bankrupt partner cannot participate in the winding-up of a partnership.


Notice of Dissolution• Terminates partners’ actual

authority to enter into contracts or act on behalf of partnership

• Notice must be given to certain third parties– Third parties who dealt with

partnership must be given actual notice.

– Third parties who had knowledge of partnership must be given actual or constructive notice.

– Third parties who had no knowledge owed no notice.

• If no notice given, apparent authority to continue to bind partnership


Distribution of AssetsUpon the winding-up of a dissolved partnership, the assets of the partnership are distributed in the following order :

1. Creditors (except partners who are creditors)

2. Creditor-partners3. Capital contributions4. Profits


Wrongful Dissolution• Partner has power to withdraw at

any time, but may not have the right to withdraw.– Withdraws before expiration of term– Withdraws before occurrence of

event

• Partner is liable for damages caused by the wrongful dissolution of the partnership.


Continuation of Partnership after Dissolution

• Remaining partners have right to continue after dissolution

• Continuation agreement– Sets forth events that allow for

continuation, amount paid to out-going partners, and other details.

• Old partnership dissolved and new partnership created– Creditors of old partnership become

creditors of new partnership – Have equal status with creditors of

new partnership


Liability of Outgoing Partners

• Dissolution of partnership does not discharge liability of outgoing partners for existing partnership debts and obligations


Right of Survivorship

• Upon the death of a partner, deceased partner’s right in specific partnership property vests in the remaining partner or partners

• Does not pass to heirs or next of kin– Value passes to beneficiaries and

heirs

• Upon death of last partner, rights in specific partnership property vest in the deceased partner’s legal representative

19 - 131 - 1 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 34 Entrepreneurship, Sole Proprietorships, and General Partnerships.

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