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Introduction to Forms of Business and Formation of

Partnerships

PA ET RHC 37I wanted to be an editor or a journalist. I wasn't really interested in being an entrepreneur, but I soon found I had to become an entrepreneur in order to keep my magazine going. Sir Richard Branson, Entrepreneur

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Learning Objectives• Choose an appropriate form of

business for a particular enterprise and list characteristics of each form

• Describe creation and risks of being a partner or purported partner

• Identify partnership capital, property, and interests

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• Choosing a form of business is important because the business owner’s liability and control of the business vary greatly among the many forms of business

Overview

Which form you choose depends

on where you want to go

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• Sole proprietorship• Partnership

– General, limited, limited liability, or limited liability limited partnership

• Corporation– Regular “C”, Subchapter “S”, nonprofit,

professional• Limited liability company

– Including professional form

Basic Forms

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• A sole proprietorship has only one owner and is an extension of its owner

• It is not a legal entity and cannot sue or be sued, so creditors/claimants sue the owner

• Advantages: no formalities, taxes flow to owner, owner takes all profit and control

• Disadvantage: owner bears all risk of loss

Sole Proprietorship

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• A partnership has two or more owners or partners and takes several forms: – general, limited (LP), limited liability (LLP),

limited liability limited (LLLP), or professional• A partnership is a legal entity but not a

federal tax-paying entity; thus all income or loss must be reported on an individual partner’s federal income tax return whether or not distributed or allocated to the partners

Partnership

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• Advantages: relatively easy to create, has a legal entity but individual taxation, partners control the business, partners take all gain, flexible structure

• Disadvantages: partners bear all risk of loss jointly and severally, different levels of liability to partners depending on sub-form, may be created as a general partnership by default (unintentionally)

Partnership

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• A corporation is owned by shareholders who elect a board of directors to manage the business, thus ownership & management of a corporation may be separate

• Shareholders have limited liability for the obligations of the corporation

• The corporation is a legal and tax-paying entity for federal income tax purposes– Exception: Subchapter S corporations

Corporation

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• Advantages: shareholders enjoy limited liability for corporate obligations, perpetual existence, ability to raise large amounts of capital

• Disadvantages: greater formality required for formation and operation, double-taxation, complexity of structure

Corporation

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• A limited liability company (LLC) combines the nontax advantages of corporations with favorable tax treatment of partnerships

• An LLC is owned by members, who may manage themselves or retain a manager to run the business

• Members have limited liability for the obligations of the LLC

Limited Liability Company

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• Though details vary widely, business forms similar to U.S. forms exist worldwide– Example: Commercial Companies Law of the

United Arab Emirates provides for the LLC form, but limits shareholder number to 50• No such limitation exists for LLCs in the U.S.

Business Forms Worldwide

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• Every state has enacted partnership laws• The Revised Uniform Partnership Act

(RUPA) of 1994, with 1997 amendments, is a model partnership statute

The General Partnership

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• RUPA defines partnership as an “association of two or more persons to carry on as co-owners a business for profit.”– Partners share profit and loss

• A partnership is a voluntary and consensual relationship and may exist by law even if the parties entered into it inadvertently, without considering whether they had created a partnership

Partnership Creation

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• Musicians agree to form a band and share profits

• Two students buy music memorabilia at yard sales, resale via eBay, and split the profits

• Friends take turns operating a lemonade stand

Partnership Creation -- Examples

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• Generally, partnership law applies to joint ventures, but a court may distinguish the two if the business purpose is limited to a single project rather than series of related transactions– Reason: joint venturers usually held to

have less implied and apparent authority than partners due to limited scope of the enterprise

Partnership or Joint Venture?

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Southex Exhibitions v. Rhode Island Builders Assoc.

• Facts: – 1974: RIBA and show producer SEM entered a

5-year contract; RIBA agreed to sponsor and endorse only SEM shows with net show profits shared 55% to SEM and 45% to RIBA

– During negotiations, SEM and RIBA discussed agreement’s use of the term “partners” and SEM’s president claimed “no ownership”

– 1994: Southex acquired SEM’s interest in the agreement and RIBA contracted with another show producer

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• Procedural History and Legal Reasoning: – Southex sued RIBA to enjoin the 2000 home

show claiming the 1974 agreement established a partnership and RIBA breached fiduciary duties by wrongful dissolution

– Trial court found for RIBA and Southex appealed

– Appellate court reviewed partnership law basics and noted first that the 1974 agreement simply titled “Agreement” rather than “Partnership Agreement”

Southex Exhibitions v. Rhode Island Builders Assoc.

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• Legal Reasoning & Holding: – Agreement was for a limited

term and plaintiff Southex entered contracts with third parties “in its own name, rather than in the name of the putative partnership.”

– Court concluded partnership did not exist and affirmed the judgment for RIBA

Southex Exhibitions v. Rhode Island Builders Assoc.

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• Unlike an ordinary partnership, creating a limited liability partnership (LLP) must comply with a state’s limited liability partnership statute

• Formation of an LLP requires filing a form with the secretary of state, paying an annual fee, and using proper terminology– Registered Limited Liability Partnership,

RLLP, Limited Liability Partnership, LLP

Partnership Creation – The LLP

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• If a third person deals with two or more people who seem to be partners and is harmed, the third person may sue to recover damages from both of the apparent partners

• RUPA Section 308(e): “persons who are not partners as to each other are not liable as partners to other persons.”

Non-Partners Generally Not Liable to Third Parties

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• However, under the doctrine of purported partners, if the third party proves that one apparent partner misled him to believe that the two (or more) people were partners, the third party may sue the partner that caused the deception for damages suffered when the apparent partnership failed to perform as agreed

Purported Partners

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• Facts and Holding:– McGregor sued Clint Crumley and Paige

Crumley, husband and wife, for breach of contract for the sale and delivery of cows for a dairy operation

McGregor v. Crumley

– Insufficient evidence to establish that a partnership existed between Clint and Paige with regard to operation of the dairy farm

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• When a partnership or limited liability partnership is formed, partners contribute cash or other property – partnership capital – to the partnership– Belongs to partnership as an entity

• Tangible and intangible property acquired by a partnership presumptively belongs to the partnership as an entity rather than individual partners

Partners and Ownership

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• Facts:– Joan Brevig McCormick and Clark Brevig

were siblings and partners in Brevig Ranch– Dispute arose regarding cattle ownership

• Clark’s argument: cattle were gift from mother and not part of partnership property

• Joan’s argument: cattle and related earnings listed on partnership tax returns

McCormack v. Brevig

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• Reasoning & Holding:– Clark owns as separate property because

Joan did not overcome statutory presumption: •Property acquired in a partner’s name

without an instrument indicating transfer of title to the partnership ”is presumed to be separate property even if used for partnership purposes”

McCormack v. Brevig

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• As owner of a partnership or LLP, a partner has an ownership interest in the partnership

• The partnership interest includes partner’s: 1. Transferable interest

• Partner’s share of profits and losses and right to receive partnership distributions

2. Management and other rights

A Partner’s Partnership Interest

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Test Your Knowledge• True=A, False = B

– The Revised Uniform Partnership Act (RUPA) is a model partnership statute.

– Partnership is an “association of two or more persons to carry on as co-owners a business for profit.”

– Partnership capital belongs to the individual partners in equal shares.

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• Multiple Choice– The partnership interest includes a

partner’s: a) Management and other rights participationb) Share of profits and losses and right to

receive partnership distributionsc) Ownership interest in partnership capitald) both A and B e) none of the above

Test Your Knowledge

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Thought Questions• Do you want to start a

business? If you wanted to start a business (snowboards, for example), would you choose partnership as the form of business?