Chapter 37 – Introduction to Forms of Business and Formation of Partnerships
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Chapter 37 – Introduction to Forms of Business and Formation of Partnerships
- 1. Introduction to Forms of Business and Formation of Partnerships Operation of Partnerships and Related Forms Partners’ Dissociation & Partnerships’ Dissolution and Winding Up Limited Liability Companies, Limited Partnerships, and Limited Liability Limited Partnerships © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Introduction to Forms of Business and Formation of Partnerships I 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 © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 3. Learning Objectives Choosing a form of business Creation of partnership Purported partners Partnership capital and property Partnership interests 37 - 3
- 4. Overview 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 Which form you choose depends on where you want to go 37 - 4
- 5. Basic Forms 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 37 - 5
- 6. Sole Proprietorship 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 37 - 6
- 7. Partnership A partnership has two or more owners or partners and includes several forms: general, limited (LP), limited liability (LLP), limited liability limited (LLLP), or professional Though a legal entity, a partnership is not a federal tax-paying entity, thus all income or loss must be reported on the individual partner’s federal income tax return whether or not distributed or allocated to partners 37 - 7
- 8. Partnership 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) 37 - 8
- 9. Corporation A corporation is owned by shareholders who elect a board of directors to manage the business, thus ownership and 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 37 - 9
- 10. Corporation 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 37 - 10
- 11. Limited Liability Company 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 37 - 11
- 12. Business Forms Worldwide 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. 37 - 12
- 13. The General Partnership Every state has enacted partnership laws The Revised Uniform Partnership Act (RUPA) of 1994, with the 1997 amendments, is a model partnership statute 37 - 13
- 14. Partnership Creation 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 37 - 14
- 15. Partnership Creation -- Examples 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 37 - 15
- 16. Partnership Creation – The LLP 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 37 - 16
- 17. Partnership or Joint Venture? 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 37 - 17
- 18. Southex Exhibitions v. Rhode I 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 37 - 18
- 19. Southex Exhibitions v. Rhode Island Builders Assoc. 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” 37 - 19
- 20. Southex Exhibitions v. Rhode Island Builders Assoc. Legal Reasoning and 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 37 - 20
- 21. Non-Partners Not Liable to Third Parties 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.” 37 - 21
- 22. Purported Partners 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 37 - 22
- 23. Palmer v. Claydon Facts: Palmer sued attorney Claydon for malpractice for legal services Palmer also sued Lawler alleging Lawler was a purported partner of Claydon 37 - 23
- 24. Palmer v. Claydon Legal Reasoning and Holding: The court reviewed evidence indicating Lawler and Claydon might be partners, a matter for a jury to decide precluding summary judgment Evidence: expense and office sharing, both names on office sign (“Claydon & Lawler”) and stationery, Claydon’s comments… But Palmer released her claims against Claydon before Lawler’s appeal, so her claims against Lawler were also released 37 - 24
- 25. Partners and Ownership 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 37 - 25
- 26. McCormack v. Brevig Facts: Joan Brevig McCormick and Clark Brevig were siblings and partners in Brevig Ranch Dispute arose regarding ownership of cattle 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 37 - 26
- 27. McCormack v. Brevig 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” 37 - 27
- 28. A Partner’s Partnership Interest 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 37 - 28
- 29. 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. 37 - 29
- 30. Test Your Knowledge Multiple Choice The partnership interest includes a partner’s: (a) Management and other rights participation (b) Share of profits and losses and right to receive partnership distributions (c) Ownership interest in partnership capital (d) both A and B (e) none of the above 37 - 30
- 31. 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? 37 - 31
Editor's Notes
- Sir Richard Branson, created and applied the “Virgin” brand to music recording and distribution, airlines, telecommunications ventures, and in 2004, a space tourism venture. His first venture at age 16 was a magazine entitled, Student . Opportunity to discuss fact that all business start as entrepreneurships.
- Refer students to page 937 of the text for a summary chart of business forms and details.
- The RUPA declares that that a person’s sharing the profits of a business is presumptive evidence that s/he is a partner in the business. Sharing management, such as taking turns operating (managing) the lemonade stand, is also evidence of partnership.
- Hyperlink is to the case opinion on the Justia.com website. The Rhode Island Builder’s Association, Inc. (RIBA), is an association of home construction companies. In 1974, RIBA’s executive director, Ross Dagata, made an agreement with Sherman Exposition Management, Inc. (SEM), a professional show owner and producer, regarding future productions of the RIBA home shows at the Providence Civic Center. The preamble in the 1974 Agreement announced that “RIBA wishes to participate in such shows as sponsors and partners.” The term of the 1974 Agreement was five years, renewable by mutual agreement. RIBA also agreed to sponsor and endorse only shows produced by SEM, to persuade RIBA members to exhibit at those shows, and to permit SEM to use RIBA’s name for promotional purposes. In turn, SEM promised to obtain all necessary leases, licenses, permits and insurance, to indemnify RIBA for show-related losses, to grant RIBA the right to accept or reject any exhibitor, to audit show income, and to advance all the capital required to finance the shows. Net show profits were to be shared: 55 percent to SEM; 45 percent to RIBA. The 1974 Agreement provided that all show dates and admission prices, as well as the Rhode Island bank at which show related business would be transacted, required agreement by both parties. If the Civic Center became unavailable for reasons beyond SEM’s control, SEM was to be excused from its production duties, provided that SEM promoted no other home show in Rhode Island. RIBA retained the right to conduct a home show at another venue, after notice to SEM. When the 1974 Agreement was being negotiated, SEM and RIBA had conversations relating to the meaning of the term “partners” in the agreement. Manual Sherman, SEM’s president, informed RIBA’s Ross Dagata that he “wanted no ownership of the show” because he was uncertain about the financial prospects for home shows in the Rhode Island market. Sherman advised Dagata: “After the first year, if I’m not happy, we can’t produce the show properly or make any money, we’ll give you back the show.” Although SEM owned other home shows which it produced outside Rhode Island, Sherman consistently described himself simply as the “producer” of the RIBA shows. In 1994, Southex Exhibitions, Inc., acquired SEM’s interest under the 1974 Agreement. By 1998, Southex determined that in order to maintain its financial stake in the RIBA home shows, the 1974 Agreement either needed to be renegotiated or allowed to expire according to its terms in 1999. RIBA in turn expressed dissatisfaction with Southex’s performance, and eventually entered into a management contract with another producer, Yoffee Exposition Services, Inc.
- Southex sued RIBA to enjoin the RIBA 2000 home show on the grounds that the 1974 Agreement established a partnership between RIBA and Southex’s predecessor, SEM. Southex argued that RIBA breached its fiduciary duties to Southex by its wrongful dissolution of their partnership and its subsequent appointment of another producer. The federal district court denied Southex’s request for a preliminary injunction and found that the 1974 Agreement did not create a partnership. Southex appealed. Appellate court: “Southex insists that the 1974 Agreement contains ample indicia that a partnership was formed…First, the 1974 Agreement is simply entitled “Agreement,” rather than “Partnership Agreement.” Second, rather than an agreement for an indefinite duration, it prescribed a fixed (albeit renewable) term. Third, rather than undertake to share operating costs with RIBA, SEM not only agreed to advance all monies required to produce the shows, but to indemnify RIBA for all show related losses as well…. Similarly, although RIBA involved itself in some management decisions, SEM was responsible for the lion’s share. Partners normally share equal rights in management. Furthermore, Southex not only entered into contracts but conducted business with third parties, in its own name, rather than in the name of the putative partnership…. Southex urges that the 1974 Agreement necessitated a finding of partnership formation, in that it unambiguously describes the contracting parties as “partners.” …Although the manner in which the parties themselves characterize the relationship is probative, the question ultimately is objective intent. Judgment for RIBA affirmed.” Another annoyed judge!
- Appellate court: “Southex insists that the 1974 Agreement contains ample indicia that a partnership was formed…First, the 1974 Agreement is simply entitled “Agreement,” rather than “Partnership Agreement.” Second, rather than an agreement for an indefinite duration, it prescribed a fixed (albeit renewable) term. Third, rather than undertake to share operating costs with RIBA, SEM not only agreed to advance all monies required to produce the shows, but to indemnify RIBA for all show related losses as well…. Similarly, although RIBA involved itself in some management decisions, SEM was responsible for the lion’s share. Partners normally share equal rights in management. Furthermore, Southex not only entered into contracts but conducted business with third parties, in its own name, rather than in the name of the putative partnership…. Southex urges that the 1974 Agreement necessitated a finding of partnership formation, in that it unambiguously describes the contracting parties as “partners.” …Although the manner in which the parties themselves characterize the relationship is probative, the question ultimately is objective intent. Judgment for RIBA affirmed.” Another annoyed judge!
- The potential for liability is why people want to be clear about who is – and who is not – a partner.
- Lesson: don’t cloak somebody with purported or apparent partnership !
- Note: this case may confuse students because the court stated that evidence of the purported partnership precluded summary judgment. However, Palmer apparently released Claydon from the case before Lawler’s appeal, probably in settlement. In other words, Lawler would have had to go to trial had Palmer not release Claydon. Linda Palmer sued John Claydon, an attorney, for legal malpractice in connection with legal services he provided her in several land transactions. Palmer also sued George Lawler. Lawler was not a partner of Claydon, did not provide any services to Palmer, and did not participate in Claydon’s services provided to Palmer. Palmer alleged, however, that Lawler was liable for Claydon’s malpractice because he was a purported partner of Claydon. Lawler asked the court to grant him summary judgment. Court: Lawler asserts as a first ground that he was not a law partner of Claydon and did not hold himself out to be. He states that he and Claydon were never partners but that they shared space and expenses. He states that he and Claydon “never shared clients, nor employed each other to represent our clients” and did not commingle their funds received from the practice of law nor share profits or losses from the practice of law. Palmer asserts that the two attorneys held themselves out to be a partnership by identifying their practice as “Claydon & Lawler” on a sign at their law office and on their stationery and in their telephone directory listing. She further avers that Claydon introduced Lawler to her as his law partner; and that Lawler, in a telephone conversation with her, identified himself as Claydon’s law partner. …The affidavits submitted plainly establish that there are disputed issues of material fact concerning (a) whether defendant Lawler held himself out as a participant in a partnership or allowed that impression to be created by defendant Claydon and (b) whether Palmer relied on the representation that a partnership existed. The existence of these disputed issues of material fact precludes summary judgment on the first ground raised by Lawler. Lawler has failed to establish entitlement to summary judgment on this ground; however, he asserts a separate and distinct ground based on Palmer’s release of Claydon. Lawler claims that even if he is assumed to have held himself out as a partner of Claydon, the release and withdrawal of Palmer’s claims against Claydon serves to release him from liability. In the absence of any express provision in the Act limiting the effect of releases of purported partners, the common law principles apply. The release of Claydon, about which there is no genuine dispute of material fact, as a matter of law releases Lawler from the vicarious liability imposed on him by Conn. Gen. Stat. 34–329(a). Motion for summary judgment granted to Lawler.”
- Court: “Lawler asserts as a first ground that he was not a law partner of Claydon and did not hold himself out to be. He states that he and Claydon were never partners but that they shared space and expenses. He states that he and Claydon “never shared clients, nor employed each other to represent our clients” and did not commingle their funds received from the practice of law nor share profits or losses from the practice of law. Palmer asserts that the two attorneys held themselves out to be a partnership by identifying their practice as “Claydon & Lawler” on a sign at their law office and on their stationery and in their telephone directory listing. She further avers that Claydon introduced Lawler to her as his law partner; and that Lawler, in a telephone conversation with her, identified himself as Claydon’s law partner. …The affidavits submitted plainly establish that there are disputed issues of material fact concerning (a) whether defendant Lawler held himself out as a participant in a partnership or allowed that impression to be created by defendant Claydon and (b) whether Palmer relied on the representation that a partnership existed. The existence of these disputed issues of material fact precludes summary judgment on the first ground raised by Lawler. Lawler has failed to establish entitlement to summary judgment on this ground; however, he asserts a separate and distinct ground based on Palmer’s release of Claydon. Lawler claims that even if he is assumed to have held himself out as a partner of Claydon, the release and withdrawal of Palmer’s claims against Claydon serves to release him from liability. In the absence of any express provision in the Act limiting the effect of releases of purported partners, the common law principles apply. The release of Claydon, about which there is no genuine dispute of material fact, as a matter of law releases Lawler from the vicarious liability imposed on him by Conn. Gen. Stat. 34–329(a). Motion for summary judgment granted to Lawler.” Note: this case may confuse students because the court stated that evidence of the purported partnership precluded summary judgment. However, Palmer apparently released Claydon from the case before Lawler’s appeal, probably in settlement. In other words, Lawler would have had to go to trial had Palmer not release Claydon.
- This case began in 1995 when Joan filed suit against Clark and their partnership to obtain an accounting and dissolution. The trial court ruled and an appeal followed. McCormick v. Brevig, 1999 MT 86, 294 Mont. 144, 980 P.2d 603 (McCormick I). After the remand of McCormick I, the District Court held a bench trial and ordered dissolution and winding up of the Partnership’s business. Joan McCormick appealed. The case in the text, decided in 2004, is the appeal of the trial court ruling. McCormick v. Brevig, 2004 MT 179, 322 Mont. 112, 96 P.3d 697 (McCormick II). With regard to only one issue of many before the bench, the court in McCormick II held that property listed on a partnership’s tax returns was nonetheless property of a partner, not the partnership. The case went back to the trial judge. One pertinent issue to the case in the text is that the District Court District Court ordered a calf-share rental arrangement between Clark and the Partnership. Notes on the next page explain the statutory basis for this arrangement. Both Joan McCormick and Clark Brevig appealed again. McCormick v. Brevig, 2007 MT 195, Sup. Ct. No. 05-697 (McCormick III). Wouldn’t you know, this case was appealed AGAIN and on the SAME DAY as the opinion in McCormick III was issued. The latest appeal was promptly (that day) dismissed as moot. Brevig Charolais Ranch is in Lewiston, Montana.
- The cattle in the photo are Charolais. Interestingly, in Montana, where the case occurred, a state “take-up” statute exists (81-4-217. Retention of trespassing stock.) in which a trespassing animal can be held (taken-up) by the property owner until payment of damages, including “the charge per head per day for caring for and feeding.” If Clark owns the cattle and they have been grazing on partnership-owned land, the partnership will have the right to payment of damages. In addition, Montana (and most states) have an accession and intermingling law (70-4-102): “When things belonging to different owners have been united so as to form a single thing and cannot be separated without injury, the whole belongs to the owner of the thing which forms the principal part, who must, however, reimburse the value of the residue to the other owner or surrender the whole to him.”
- True. True. False. Partnership capital b elongs to partnership as an entity
- The correct answer is (d).
- Opportunity to discuss choices about forming a business.