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. C H A P T E R Introduction to Forms of Business 37 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 37-1
- 2. 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 37-2
- 3. 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 37-3
- 4. 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 37-4
- 5. 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 37-5
- 6. Partnership • 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 37-6
- 7. 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) 37-7
- 8. Corporation • 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 37-8
- 9. 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 37-9
- 10. 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 37-10
- 11. 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. 37-11
- 12. The General Partnership • Every state has enacted partnership laws • The Revised Uniform Partnership Act (RUPA) of 1994, with 1997 amendments, is a model partnership statute 37-12
- 13. 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 37-13
- 14. 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 37-14
- 15. 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 37-15
- 16. Southex Exhibitions v. Rhode Island Build • 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 37-16
- 17. 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” 37-17
- 18. Southex Exhibitions v. Rhode Island Builders Assoc. • 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 37-18
- 19. 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 37-19
- 20. Non-Partners Generally 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.” 37-20
- 21. 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 37-21
- 22. McGregor v. Crumley • 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 – Insufficient evidence to establish that a partnership existed between Clint and Paige with regard to operation of the dairy farm 37-22
- 23. 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 37-23
- 24. McCormack v. Brevig • 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 37-24
- 25. 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” 37-25
- 26. 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 37-26
- 27. 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. 37-27
- 28. 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 37-28
- 29. 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? 37-29
Notes de l'éditeur
- Refer students to page 959 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 !
- Hyperlink is to the opinion on Findlaw.com website. Photo is of Holstein dairy cattle. Court: “ No evidence was presented at trial to show that Paige shared in the title to the dairy farm. There was also no evidence presented that she shared in the gross returns generated by the dairy operation, or that she had a common right in the cattle. There was no evidence presented that Paige shared in the profits of the business, that there were any profits to share, or that she was compensated as an employee for her labor on the dairy farm. Despite McGregor’s contentions to the contrary, Clint made no admission at trial that Paige was a partner in the dairy operation. …The only testimony he offered with regard to Paige’s conduct was that she handed him a check for the first cattle order in August 2007, that she worked on the farm, and that she refused to discuss the bill for the second shipment of cattle. None of these actions suggest Paige held herself out to McGregor as a partner in the dairy operation, or constitute a direct admission by Paige of a partnership.”
- 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.