Business Entities

Forms of Business Organization
BUSA 2106
Susan Willey, J.D.
Assoc. Professor of Legal Studies
Miller & Cross (2013)
Learning Outcomes
Describe the role of entrepreneurs in starting and
operating businesses
Define the liability of a sole proprietor
Define general partnership and explain the contract and
tort liability of partners
Define limited partnerships and the liability of general and
limited partners
Define LLP and describe the limited liability of partners of
an LLP
Define LLC and describe the limited liability shield
provided by an LLC
Forming a business
Obtain required licenses and
permits
Obtain sufficient insurance
Select a name
Register under fictitious
name statutes
Register name as domain
name on Web
Protect name as
trademark
Select form of business entity
Factors Influencing
the Choice of Business Entity
What are the costs of forming and operating the
business?
Is the business a separate legal entity?
Who manages and controls the business?
How is capital obtained to finance business
operations?
What is the liability of the owners?
Can ownership interests be easily transferred?
What is the duration of the business?
What are the tax implications of the form chosen?
Forms of Conducting
Domestic Business
Sole proprietorship
General partnership
Limited liability
partnership (LLP)
Limited partnership
Limited liability
company (LLC)
Corporation
Business Entities
Entity
% of Total
Businesses
% of Total
Revenue
Sole
Proprietor
73%
5%
Partnership
7%
6%
Corporation
20%
89%
Business Entities
90
80
70
60
50
Sole Prop.
Partnership
Corporation
40
30
20
10
0
% of Entities
% of Revenue
7
GA Active Entities
as of 10/30/12 (GA Secretary of State)
Type of Entity
Insurance Co
Domestic
Foreign
170
1,623
320,013 (up 10%)
22,837
Limited Partner.
16,494
2,247
Non-Profit Corp
65,985
2,277
Prof Corp
11,976
31
201,810
31,504
616,448 (up 4.3%)
60,519
LLC
Profit Corp
TOTAL
http://www.sos.ga.gov/corporations/stats.htm
Sole Proprietorship
Most common
form of
business entity
in US
Simple to form
Owner is the
business
Personal Liability of
Sole Proprietors
Sole proprietor bears the entire risk of
loss of the business
Owner will lose entire capital contribution if
the business fails
Sole proprietor has unlimited personal

liability
Creditors may recover claims against the
business from the sole proprietors personal
assets
10
Ferguson v Jenkins
Jim Ferguson operated
Jims Auto Sales in
Tennessee as a sole
proprietorship
His insurance company
issued a policy to Jim
Ferguson, Jims Auto
Sales in 1999 that
covered Owned Autos
Only
In 2000, Jim bought a

1976 Harley-Davidson;
he titled it in his name
He planned to sell the bike
through his dealership
11
Ferguson v Jenkins (contd)

While driving the cycle, Jim was struck by a car
driven by Jenkins who was underinsured
Jims insurance company claimed that the cycle was
not covered by the dealership policy as it was a
personal vehicle titled in Jims name
Can Jim recover from his insurance company?

Is a motorcycle an Owned Auto under the policy?
Who owns the cycle Jim or the dealership? Does
it matter if he is a sole proprietor?
Ferguson v Jenkins, 204 S.W.3d 779 (2006)
12
Sole Proprietors: An Issue

With the internet, sole proprietors can market
their products worldwide without greatly
increasing their costs
Should they be treated like corporations in
determining venue for litigation?
Court said NO: Expanding the definition of
corporation to include sole proprietorships would be
overly burdensome and inconvenient to sole
proprietors, most of whom would be unable to afford
the expense of litigating in distant states.
13
Sole Proprietorships
Advantages
Easy to form
Owner is the business;
no separate legal entity
Flexibility: Owner has
complete control
Owner has right to
all profits
Subject to less
regulation than other
business forms
Disadvantages
Unlimited personal
liability for business
debts & obligations
Duration limited by
proprietors interest or
death
May be hard to raise
capital
Limited resources,
expertise
14
What is a Partnership?
UPA defines a partnership as a voluntary
association of two or more persons to carry
on as co-owners a business for profit
Elements in UPA definition
Sharing of profits and losses
Joint ownership of the business
Equal right in the management of the business
Other factors? Parties conduct and their

intent to associate
15
Sharing of Profits
Agreements to share profits may not create
a Partnership if profits are received as
Wages, rent, interest, etc.
But sharing of profits and losses usually

proves a Partnership exists
To avoid problems, draft a
partnership agreement that
reflects the intent of the parties
16
Is there a
Partnership?
Dan owns six shoe stores
He hired Rubya as manager
of a new store for a monthly
salary and 20% of the profits
Without Dans knowledge, Rubya represented

herself to Classen as Dans partner, showing
Classen the agreement to share profits
Classen extended credit to Rubya, who defaulted
Can Classen hold Dan liable? Are Dan and

Rubya partners? Why or why not?
What if Dan had shown Classen the agreement?
Would he be estopped from denying a partnership?
Problem 3 (page 432)
17
Partnership Agreements
Written agreements should contain
The firm name

The names and addresses of the partners
The principal office of the partnership
The nature and scope of the partnership
business
The duration of the partnership, e.g., for a
term or at will
Capital contributions of each partner
18
Partnership Agreements (contd)

More provisions
Other contributions of partners
Allocation of profits and losses among
partners; if unstated, presumed equal
Partnership salaries and withdrawals
Duties of the partners
Consequences of dissolution: can provide for
buyout or continuation of business
No agreement? State law [UPA] governs

19
Formation of a Partnership
By agreement of the parties
Can be oral, written or implied by conduct
Partnership by estoppel
Third party relies on representation by a
partner that a nonpartner is a member of the
entity
Chavers v Epsco (Ark. 2003) at p 407
20
Has a Partnership
Been Formed?
Tammy worked as a waitress
at Bynums Diner in Valdosta,
owned by her mom (Hazel)
and step-father (Eddie)
The three later signed an agreement
Eddie would relinquish his management
responsibilities for 6 months
Tammy would become co-manager with her mom
The agreement made no mention of profit
21
Is Tammy a Co-owner
or an Employee?
The bank account remained
in Eddies name
A month later, Tammy fell off
a ladder at work, injuring her
knees; she a filed workers
compensation claim
The GA Workers Comp Board determined that she
was an employee and awarded her benefits
The diners insurance carrier sued, arguing that
Tammy was a co-owner, not an employee
Who wins?
22
Is this a Partnership?
In 1995, Stafford, Steve, Mike, Joe and Doug
agreed to sell food at the Atlanta Olympics as
Prairie Cajun Seafood
In May 1996, they applied for a license to
operate the business in Fulton County
In June, Ted sold a mobile kitchen for an
$8,000 check (drawn on the Prairie Cajun
Seafood account) and two promissory notes
totaling $32,000
The notes listed Stafford d/b/a Prairie Cajun
Seafood
23
Is there a Partnership:
Who is Liable?
On July 31, the 5 friends
signed a partnership
agreement, which listed
specific percentages of
profits and losses
They drove the mobile
kitchen to Atlanta, but
business was disastrous
When the notes were not
paid, Ted sued Stafford,
seeking payment
Who is liable on the

notes: Stafford? All 5
partners?
Norris v Fontenot, 867 So.2d 179 (2004)
24
What are the

Rights of Partners?
Right to participate in
management
Right to share in profits
Right to compensation
Right to information, e.g.
books and records
Right to use partnership
property on behalf of P
Right to an accounting
25
Duties of Partners
As agents of partnership, partners owe fiduciary
duties to each other and the partnership
What are fiduciary duties?
Duty of loyalty: Partners must subordinate interest to
that of the partnership and not compete with it
Meinhard v Salmon (NY Ct of Appeals, 1928 at pp 409-410)
Duty of care: Partners must exercise adequate care

and supervision in running the partnership and refrain
from grossly negligent or reckless conduct, intentional
misconduct, or a knowing violation of the law
26
Breach of Fiduciary Duties?

In 1987, Fial and Steeby formed Audit
Consultants as a general partnership
They agreed to share equally the equity,
income and profits of the partnership.
As business grew, they hired independent

contractors to do some of the audit work.
Fials activities generated about 80% of the
partnerships revenues.
27
Fial and
Steeby (2)
Unhappy with their agreement to divide profits
equally, Fial wrote Steeby in 1994 dissolving
the partnership.
Fial then formed a new business called Audit
Consultants of Colorado
Fial terminated the partnerships contracts with

many clients and put them under contract with
the new firm
He asserted that they be assigned based on who
brought them into the business
28
Fial and
Steeby (3)
Fial also terminated the Ps contracts with its
independent-contractor auditors and signed
many to his new firm.
Steeby sued Fial, alleging breach of fiduciary
duty and seeking a final accounting.
Who wins?
How could Fial have terminated the partnership
without risking a lawsuit?
29
Authority of Partners under UPA

Express authority
Each Partner has authority to enter into
contracts on behalf of the partnership
Partner is bound to honor those contracts
Implied authority
Unless a statement limiting a Partners
authority is filed with the state, Partners have
the authority to do what is reasonably
necessary to carry out Partnership business
30
Liability of General Partners

General partners have unlimited personal
liability for the debts of the partnership
1997 UPA also makes partners liable for
partnership contracts, torts and breaches of trust
if P assets inadequate
A partner who commits a tort may be required to
reimburse the partnership for damages it paid
Conversely, the partnership may also be required
to indemnify a partner for liability that resulted
from negligence in the ordinary course of
business
31
Tort Liability to Third Parties

The partnership is liable
to third parties if
a partner, employee, or
agent of the partnership
commits a tortious act
while
acting within the ordinary
course of partnership
business or
with the authority of his or
her co-partners
32
Contract Liability to
Third Parties
Partnerships act through agents/partners
If partners have express, implied or apparent
authority, their contracts are binding on the
partnership
Partners have joint and several liability for

the debts and contracts of the partnership if
the entity is unable to pay them
Each partner can be personally liable for full
amount of the partnerships unpaid debts
33
Liability of Incoming Partners

New partners who are admitted to the
partnership are liable for the existing
debts and obligations of the partnership
only to the extent of their capital
contributions
New partners become personally liable
for debts and obligations incurred by the
partnership after they become a partner
34
How are Partnerships Taxed?

The partnership files an information return that
reports the entitys profits and losses and how they
are allocated to individual partners
These profits and losses pass through the entity
and are taxed on the partners individual returns
35
Partnership Dissociation
Dissociation occurs when a partner ceases to
be associated in the carrying of partnership
business
The dissociated partner
is normally entitled to have his interest purchased
by the partnership
terminates his authority to act for the partnership
and can no longer participate in running the
business
36
Events Causing Dissociation

Under the UPA, partners can be dissociated
By voluntarily withdrawing from the P
By occurrence of an event agreed to in the
partnership agreement
By unanimous vote of other partners, e.g., when a
partner transfers substantially all of his interest in
the partnership
By declaring bankruptcy, becoming physically or
mentally incapacitated, or by death
By court order if the partner has engaged in
wrongful conduct that affects the P
37
More on Dissociation
If a partners dissociation is wrongful, (e.g., in
breach of the P agreement), the partner may be
liable to the P and other partners for damages
Upon dissociation, a partners right to participate
in the management of the P terminates and his
duty of loyalty ends
But under the UPA, a dissociated partner may still be
liable for partnership obligations entered into during a
2-year period following dissociation
38
Termination of a
Partnership Requires
Two steps
Dissolution and Winding Up
Dissolution can be triggered by

Acts of the partners as specified in the
partnership agreement
An event makes it unlawful for the P to continue
its business (dissolution by operation of law), or
A court dissolves the partnership by decree
39
Termination: Winding Up
Winding Up
Collecting, liquidating and distributing
the Ps assets
Priorities in Distributing Assets

Creditors are paid first
Then capital contributions are returned
Any remaining money is distributed as
profits to the partners
40
General Partnerships
Advantages
Partners contribute
capital, property
and/or expertise
Partners share work
and accountability
Entity not taxed
Flexible allocation of
profits and losses
Disadvantages
Partners personally
liable for all debts
Potential for conflict
among partners
Duration limited by
life of partners
More difficult to
dissolve than S.P.
41
Limited Liability
Partnership (LLP)
Hybrid that gives all partners a liability shield and
pass through taxation
Partner and supervising partner may be liable for
wrongful acts in scope of LLP, but
innocent partners are generally not liable for
malpractice of other partners
Must comply with state law to form

State may limit LLP to licensed professionals (e.g.,
doctors, lawyers, accountants, engineers) or require
minimum level of insurance
No such limitations in Georgia
42
Limited Partnership
A type of
partnership that
has two types
of partners
General partners
Limited partners
43
Limited Partnership
Debt or obligation
owed to 3rd party
Limited
partnership
Third
party
Capital
investment
Limited
partner
General
partner
Liability limited to
capital contribution
Unlimited personal
liability for partnerships
debts and obligations
44
Formation of Limited Partnership

RULPA requires
Certificate of limited partnership filed with
the state
Disclosure of names and contributions of
general and limited partners
Written agreement is recommended:

WHY?
45
Management, Control
and Tax of LP
General partners can participate in
management
General partners owe fiduciary duties to the
company and all partners (including limited
partners)
LP is separate legal entity (can own

property and sue) but pass through for
tax purposes
46
Liability of Partners in LP
General partners: unlimited personal liability to
Ps creditors
What if corporation is the general partner?
Limited partners: liability is limited to capital

contribution unless
Formation is defective
Company name includes limited partners name
Limited partner participates in management
Limited partner co-signs a personal guarantee
47
Permissible Activities
of Limited Partners
Being an agent, employee or contractor
of the LP or a general partner
Serving as a consultant or advisor to a
general partner re the LP
Acting as a surety for the LP
Approving or disapproving an
amendment to the LP agreement
Voting on certain partnership matters
48
Is this limited
partner liable?
Asner and Burton formed
a LP called ProSkate to sell
inline skates.
Asner was the general partner
Burton was the limited partner
Burton put up $15,000 and Asner contributed

equipment and a computer
A & B properly filed a certificate of limited
partnership with the state
49
Asner & Burton (contd)

A few months after opening the business, Asner
became seriously ill.
Burton took over management of ProSkate.
Without consulting Asner, Burton entered into a large
contract with Thomas.
When Asner returned to work, he decided to

cancel the Thomas contract due to slow sales
(from bad weather) and excess inventory.
Thomas sued ProSkate, Asner and Burton.
If Thomas wins, can Burton be held personally
liable?
50
Is this limited partner liable?

Linnane Magnavox was a LP organized
under Kansas law.
Linnane was the
general partner
Richard Stover was
the limited partner who
provided capital but took
no part in day-to-day
management of the company.
51
GE v Stover
Linnane Magnavox entered into a contract with
GE Credit to obtain financing for the partnership.
GE refused to grant credit to the under-capitalized
partnership until Stover signed as guarantor of the
credit
Linnane Magnavox defaulted on the debt and

Linnance was adjudicated bankrupt.
GE Credit sued Stover to recover the debt.
Who wins? Is the limited partner liable for the Linnane
Magnavox debt?
52
Rights of Limited Partners

Right to share
profits and losses of
the partnership as
stated in partnership
agreement
Right to information
Right to vote on
certain partnership
matters
53
Limited Partnerships (LP)

Advantages
Attractive to
investors who dont
want to participate
Limited partners
liable up to amount
of capital
contribution
Flow through tax
Disadvantages
Requires certificate
of LP
General partners
are personally liable
Defective formation
and/or participation
may expose limited
partners to liability
54
Limited Liability Company

Hybrid unincorporated business that combines
Management and control as if general partnership
Pass through tax status of partnership, unless single
member LLC (taxed as sole proprietorship)
Limited liability of corp (but no S-Corp restrictions)
Must file articles of organization with state

An LLC is a separate legal entity that can own
property, sue and be sued, enter into and enforce
contracts, etc
No limit on number or types of members
Georgia permits single member LLCs
55
Limited Liability Company

Limited liability
Company (LLC)
Debt or
Obligation owed
Third
party
Capital
investment
Member
Member
Member
Liability limited to capital

contribution
No personal liability for
Companys debts and obligations
56
Management of LLC
Owners are members
Members adopting
operating agreement
Specifies voting rights,
meetings, etc
Kuhn v Tumminelli (p 420) re
consequences of no OA
Management is by members
or a designated manager
Manager owes fiduciary duties
to LLC and members
Polk v Polk ( p 420)
57
Articles of Organization: LLC

Articles of organization must set forth:
The name of the LLC
The address of the LLCs initial office
The name and address of the initial agent for service
of process
The name of each organizer
Whether the LLC is a term LLC and if so, the length
of the term
Whether the LLC is to be manager-managed
58
Liability of an LLC
LLC is liable for any loss or injury
caused to anyone as a result of a
wrongful act or omission by a member,
manager, agent, or employee of the LLC
who commits the wrongful act while
acting within the ordinary course of
business of the LLC or
with authority of the LLC
59
Liability for PreOrganization Contracts?

Corporations can adopt and enforce
pre-incorporation contracts made on its
behalf by incorporators
Is same true of LLCs?
2008 California decision said YES in 02
Development, LLC v 607 South Park, LLC
60
Member Liability
Member liability is limited
to capital contribution
But, Court may pierce LLC
veil to hold members liable
if
LLC defectively formed
Wrongful conduct by LLC
members
LLC is inadequately
capitalized
61
Dissociation
from an LLC
Member can dissociate from LLC; Reasons
Voluntary withdrawal, expulsion by other LLC
members, or court decree
Members bankruptcy, incompetence or death
Effect?
Member can no longer act as agent of LLC or
participate in management; duties end
Under ULLCA, the LLC must purchase the
members interest at FMV within 120 days
62
Dissolution of the LLC

Dissociation doesnt automatically trigger
dissolution
But, when an LLC is dissolved, winding up
occurs similar to a partnership
Assets are collected, liquidated and distributed
After assets are distributed to creditors, capital
contributions are returned to members and
remaining money is distributed to members
63
Limited Liability Companies

Advantages
Owners have limited
liability (like Corp)
Taxed as partnership
All owners can
participate fully in
management
No limits on member
eligibility
Disadvantages
Must file articles of
organization
Can lose LLC status
if undercapitalized,
wrongful conduct or
defective formation
Non-uniform state
laws
64
Franchises
Franchise: Any
arrangement in which
the owner of a
trademark, trade
name or copyright
licenses another to
use their intellectual
property in selling
goods or services
65
Types of Franchises
Distributorship
Manufacturer licenses a dealer
to sell its products
Chain-Style Business Operation

Franchise operates under franchiser's
trade name, maintaining the franchiser's
quality and operational standards
Manufacturing
Franchisor licenses manufacturer to
make its product, using franchiser's
ingredients or formula
66
Regulating Franchises
Federal Regulation
Industry-specific laws
protect some
franchisees from bad
faith terminations
FTC Franchise Rule
requires disclosure of
material facts to
prospective
franchisees
State Regulation
Similar rules to protect
franchisees from
unfair practices
Rules typically require
disclosure of
operational costs,
recurring expenses,
and profits earned
67
Franchise Contracts:
Standard Clauses
Payment: Initial fee or lump-sum price for
license plus percentage of annual sales
Premises: Purchase or lease of real
estate, guidelines for construction or
remodeled facility, etc.
Organizational requirements: Entity
selected, capital structure of business, sales
quotas, training, record keeping, etc.
68
Franchise Contracts:
More Provisions
Location: Exclusive or
non-exclusive territories
granted by franchisor
Quality Control: Food,
product or services must
meet specified
standards to protect
franchisors name and
reputation; often permits
inspections
69
Terminating a Franchise
Termination may be
at expiration of stated period, e.g., lease
for cause, breach of the franchise
agreement or failure to maintain quality
controls or sales quotas
Wrongful termination suits

Frequently assert bad faith by franchisor,
e.g., termination was arbitrary or unfair
70
Good Faith and Fair Dealing

Law imposes duty of good faith and fair
dealing on franchisors when terminating a
franchise agreement
Purpose
Limit arbitrary, unfair terminations
Allows franchisee to sue for damages if
wrongful termination
71
The Holiday
Inn Case
HAI had 10-year franchise agreement with Holiday Inn
to renovate and operate a hotel
Parties had collaborated for decades
HAI sought to renew the agreement and Holiday Inn

required $3 M in renovations
HAI made renovations, but Holiday Inn did not renew
and instead granted a franchise to another local hotel
New franchisee was part of internal business plan not disclosed
to HAI
Did Holiday Inn violate its duty of good faith and fair
dealing? Why or why not?
Holiday Inn v Hotel Associates, Inc (Ark 2011) at p 428
72

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Forms of Business Organization

Miller & Cross (2013)

320,013 (up 10%)

616,448 (up 4.3%)

Miller & Cross (2013)

Sole proprietor has unlimited personal

In 2000, Jim bought a

Ferguson v Jenkins (contd)

Can Jim recover from his insurance company?

Ferguson v Jenkins, 204 S.W.3d 779 (2006)

Sole Proprietors: An Issue

Miller & Cross (2013)

Other factors? Parties conduct and their

But sharing of profits and losses usually

Without Dans knowledge, Rubya represented

Can Classen hold Dan liable? Are Dan and

Problem 3 (page 432)

The firm name

Partnership Agreements (contd)

No agreement? State law [UPA] governs

Miller & Cross (2013)

Who is liable on the

Norris v Fontenot, 867 So.2d 179 (2004)

What are the

Duty of care: Partners must exercise adequate care

Breach of Fiduciary Duties?

As business grew, they hired independent

Fial terminated the partnerships contracts with

Miller & Cross (2013)

Authority of Partners under UPA

Liability of General Partners

Tort Liability to Third Parties

Partners have joint and several liability for

Liability of Incoming Partners

How are Partnerships Taxed?

Miller & Cross (2013)

Miller & Cross (2013)

Events Causing Dissociation

Dissolution can be triggered by

Miller & Cross (2013)

Priorities in Distributing Assets

Must comply with state law to form

Miller & Cross (2013)

Formation of Limited Partnership

Written agreement is recommended:

LP is separate legal entity (can own

Limited partners: liability is limited to capital

Miller & Cross (2013)

Burton put up $15,000 and Asner contributed

Asner & Burton (contd)

When Asner returned to work, he decided to

Is this limited partner liable?

Linnane Magnavox defaulted on the debt and

Rights of Limited Partners

Limited Partnerships (LP)

Limited Liability Company

Must file articles of organization with state

Limited Liability Company

Liability limited to capital

Articles of Organization: LLC

Liability for PreOrganization Contracts?

Miller & Cross (2013)

Miller & Cross (2013)

Dissolution of the LLC