Types of Business Associations
The law recognizes a number of different
types of business associations. These
Limited Liability Partnership
Limited Liability Corporation
Source of Law
The law relating to business organizations
is largely a creation of statutory law, since
these organizations get their “life” from the
state. These laws are supplemented by
case law. The laws in the states are
relatively uniform, although are minor
differences from state to state.
There are some key issues that separate each
of these entities. The key for understanding
these entities is to understand these differences.
Who can act for the entity
Whether the entity is a separate legal entity that can
contract and file suit in its own name
Personal liability of individual investors
Sole proprietorship is the simplest form of
business entity. Essentially it is one person (or
family) running a business. Formalities for
creating are minimal, because there is no
difference between the business and the
There is a unity between the individual owner
and the business itself. This means that the
individual owner is fully liable for any business
debts and, conversely, the business is liable for
any individual debts.
Basic Rule of Sole Proprietorships
If the business owes money to a creditor, the creditor
can look to the individual’s assets to collect the debt.
Owner files one tax return which includes any personal
income and any income from the business. Profits of the
business are individual’s profits.
Because only one owner, all management decisions
made by the owner.
Dissolves at the discretion of owner or when he dies,
although an heir could take it over.
Business Name In most states must register your
business name if you operate under a name different
from your own.
Basic Rule of Sole Proprietorships
May also be trademark issues that have to
Otherwise, few legal formalities to comply
with beyond getting city license to do
Advantages—easy to set up and operate
Disadvantages—Personally liable for all
Definition: A partnership is an
association of two or more persons to
carry on as co-owners a business for
Are no formal filing requirements with the
state. Whether or not two people are
acting as partners depends on the facts
and what they have done, not on filing
Partnership can exist in the absence of a
written or oral partnership agreement if the
facts indicate that they intended to operate
as partners and share profits.
Chuck Ulott (C) and Van Hilla (V) enter into a
partnership. C has little money, but has experience
running ice cream stores. V has a lot of money and
understands the financial side of running a business.
They agree to go into business together and operate
C&V Ice Cream Store. V puts up 75% of the money
necessary. C puts up the rest and has primarily
responsibility for running the store. V handles all the
books and contractual dealings with outsiders.
After the first year, they have $80,000 in profit. How will
it be divided between the partners?
Rule: in the absence of an agreement to
the contrary, profits and losses are divided
equally and partners have equal rights in
If there is a formal partnership, there is often a
partnership agreement between the partners
that sets forth how profits will be divided and
how decisions will be made.
In a formal partnership, profits and management are
usually proportional to the level of financial
investment, but not always
One partner may contribute more money, while
another may contribute non-financial resources, such
as expertise, management time, patent rights, etc.
The store hits a rocky road and ends up in
debt for $100,000 to D. C and V close the
business and sell off all the assets, but still
owe D $50,000.
Can D sue C and go after C’s personal
In a general partnership every partner is
personal liable for the debts and
obligations of the partnership.
The store hits a rocky road and ends up in
debt for $100,000 to D. C offers to pay D
$50,000 for his share of the debt. Is C off
Same, but there is a partnership
agreement between C and V under which
C only gets 25% of the profits. C offers D
Each partner is personally liable for the
Does not matter that a partnership
agreement specifies otherwise or that
partner was only entitled to a limited share
Each partner is jointly and severally liable.
D gets a 100K judgment against the
partnership and the partners. D knows
that the partnership only has 25K in
assets, but that C has a bank account with
100K in it. So, he attaches the account.
Can D get the whole account?
If C ends up paying the entire debt, can he
sue V for V’s share?
The modern rule in most jurisdictions is
that the assets of the partnership have to
be exhausted before look to the personal
assets of the individual partners.
Partnership agreement may specify that
debts and liabilities will be split equally, but
that does not bind creditors.
It is a matter to be resolved between the
Liability for Torts
C, while delivering an ice cream cake to a party
on behalf of the store, runs a stop sign and
severely injures P.
Can P sue the partnership?
Can P go after V’s personal assets if the partnership
doesn’t have enough money?
C, while working behind the counter, gets angry
at a customer and hits him over the head with a
tub of ice cream. Same questions.
C gets into the car accident on the weekend
coming home from a party.
Liability for Torts
Partnership is liable for the torts of partners
committed within the scope of partnership
activities (while acting on behalf of partnership).
To the extent that partnership does not have
sufficient assets, individual partners are also
Partnership not liable for torts of partners outside
scope of partnership, but share of partnership of
partner who committed the tort could be seized.
C is sick of running an ice cream store.
His brother is looking for a new career. C
sells his interest in the partnership to
Can C sell?
What if V doesn’t want to be in business
C owes brother money and assigns him
his rights under the partnership. Different
Transfer of Interest
Partnership is voluntary. Thus, one partner
can’t sell his “share” of the partnership to
someone else without the consent of all other
partners. Can’t have a partner forced on you.
Can assign a partnership interest to creditor.
Inthat case the “new” partner would have no
management input and would simply be entitled to the
partner’s share of the profits.
Partner would still be liable for losses.
Management and Control
Unless otherwise provided in the
Every partner has a right to participate in the
management of the partnership business
Any difference arising as to ordinary matters
is decided by a majority vote
The right of a partner to participate in the
management of the partnerships business
is one reason that partners have unlimited
1. C orders new stools for the store from G. V
doesn’t know about the purchase beforehand,
but when he finds out he opposes it. V calls G,
says that C didn’t have his authority and
cancels the contract.
Can G sue the partnership for breach of contract?
2. Same, but V expressly told C not to purchase
the stools before C placed the order.
3. Same, but G is aware that V opposes the
4. C orders a motorcycle for his own personal use
in the name of the partnership.
Authority of Partners
Every partner is an agent of the
partnership for the purpose of its business.
An agent is one who acts for another and
whose actions can bind or obligate
Rule: Every partner has the ability to bind
the partnership to a contract if the contract
relates to the operation of the business, so
long as he has actual or apparent
Actual Authority and Apparent
A partner has actual authority if he is in fact authorized
by partners to enter into the transaction.
Apparent authority exists when the contract was not
approved by the other partners but it was the type of
contract ordinarily entered into by businesses of that
type and their conduct or actions did not reasonable lead
third parties to believe that such authority exists.
Thus, partners bound unless
The partner in fact has no actual authority,
The contract is not of the type usually entered into by the
the person he was dealing with knew he had no authority or
under the circumstances should have known the person had no
Capacity To Sue And Be Sued
States that follow the Uniform Partnership
Act don’t allow partnerships to sue or be
sued in their own name. Suits must be
brought against the partners themselves.
Revised Uniform Partnership Act states
allow partnerships to sue or be sued in
their own name.
Only a handful of states have adopted the
Fred, Ginger, Barney and Wilma form a
partnership, “Flintrubble” to make bowling balls.
They all contribute money and time. After a year
Fred is angry about decisions made by the
others and tries to leave.
Can Flintrubble continue as a partnership if he does
If Fred is allowed to leave (by the law or his
partners), is he entitled to any money? How much?
Dissolution of Partnership
Unless stated otherwise in partnership
agreement, a partnership can be dissolved at
any time by any partner.
Since a partnership is an aggregation of the
individual partners, it ceases to exist if one
Remaining partners can continue, by forming a
NEW partnership, but leaving partner must be
paid his share of the partnership’s assets.
Typically, P gets the greater of the value of the
liquidation value of assets or a proportional
share of what the partnership would get if sold
as a going concern.
If a partnership agreement sets a specific term
for the length of the partnership, a partner can’t
rightfully withdraw early.
If withdraw wrongfully the partnership ends, but
terminating partner will be subject to damages,
which may be specified in the partnership
When a partnership ends, it must “wind up” by
paying off all creditors and resolving all
Essentially a species of partnership,
except that a joint venture is formed for
some limited investment or operation,
such as the construction of a single
building, while partnership is generally
formed as a continuing business
In limited partnerships there are both
general partners and limited partners.
General partners are just like regular partners
and have unlimited liability and participate in
Limited partners are only liable up to the
amount of their investment. Don’t have
management rights. Like investors in a
Limited Liability Partnerships
Main difference with a partnership is that the partners
are only personally liable for obligations arising out of
their own conduct.
In many states there is a requirement for liability
Usually have to be registered with the state, unlike
Frequently used by law firms and medical practices.
Everyone has a say in management, but everyone isn’t
personally liable for the malpractice of a single partner,
although all assets owned by the partnership would be.
Status: a corporation is a legal entity
created under the authority of the state
Corporation can sue and be sued and can
own property in its own name.
A corporation is treated as a “person” for
many purposes under the law.
Liability: A corporation is responsible for
its own debts.
Shareholders are ordinarily not responsible
for corporate debts.
Liability is limited to the amount of the
Ownership interest is represented by
shares, which are usually freely
Duration: Existence is perpetual.
Corporations only exist because state laws give them
Thus, must get a “certificate of incorporation” from the
state to be a corporation.
Must meet the requirements of the state to legally exist
as a corporation.
Do not have to file for incorporation in the state where
primarily operate, can file in another state.
Many US corporations are formed under Delaware law,
because it has favorable laws regarding corporations.
Corporations are governed by the laws of the state in
which they incorporate, even if they operate primarily in
Powers of Corporations
Modern corporate statutes set forth a long list of powers
held by every corporation. These include:
Sue and be sued
Have a corporate seal
Own and sell property
Adopt and amend bylaws
Adopt pension and compensation plans
Hold stock in other corporations
To participate with others in any corporation, partnership or other
To make donations.
Management of Corporations
Corporate statutes require corporations to
These set out many of the details on internal
governance of the corporation.
Basic rules of corporate structure and
management of corporations are set forth
in state statute, although some can be
modified by bylaws.
Basic structure of a corporation has three
levels—Shareholders, Board of Directors and
Shareholders have no management control, but elect
the board of directors.
Like voters, power flows from them at time of election, but
have little control thereafter.
Board of directors is responsible for managing the
business, major strategic decisions, etc.
Officers are appointed by the BOD and handle day-to-
day operations. CEO, etc.
Except in close corporations, shareholders do
not have power over the management of
corporate affairs. Management is in BOD
Shareholder approval is required for certain
fundamental changes in the corporation such as
amendment of the articles, merger, sale of
substantially all assets and dissolution.
Power to elect directors
Shareholders have the power to adopt and amend
Under most state laws corporations must have a
shareholder meeting at least once a year.
Exceptions to rule that shareholders can’t manage
A close corporation is one in which
Corp. is owned by a small number of shareholders, most or all
off whom are active in management.
No general market for the stock
Bylaws limit the transferability of stock
Under many state laws, if qualify as a close corporation
the affairs of the corporation can be managed by the
shareholders even if that would interfere with the
traditional duties of BOD
Often used for small and family owned businesses
The initial directors are either designated in the
articles or elected at a meeting of the
The number of directors is set out in the articles
A director need not be a shareholder unless the
bylaws say otherwise.
Vacancies can be filled by either the
shareholders or the directors unless the vacancy
was caused by the removal of a director by the
shareholders, in which case only the
shareholders can fill.
General rule is that directors hold office until the
next annual meeting, i.e. for one year terms.
Board can be classified so that staggered terms.
If three classes, then 1/3 up for election every year.
Under Delaware law, directors can be removed by
shareholders without cause.
Under common law, could only be removed for cause
(fraud, dishonesty, etc.) unless the bylaws said
In some states courts can remove directors if a
designated percentage of the shareholders petition
Functioning as Board
Absent a statute, directors can act only at a duly
convened meeting at which a quorum is present.
Notice is not required for a regular meeting. But
is for a special meeting.
Voting: assuming a quorum is present, vote
has to be by a majority of those present.
It is common for Boards to create committees of
board members to handle certain matters.
Only limit is that committee can’t be delegated to
handle fundamental matters, such as mergers,
dividends, amending by-laws, etc.
Duty of Board Members
Directors occupy a “fiduciary relationship” to the
corporation and must exercise the care of
ordinarily prudent and diligent persons in like
positions under similar circumstances.
At a minimum, this requires that directors stay
informed about what the officers are doing and
provide some degree of oversight.
If directors fail to reasonably investigate and stay
informed about the activities of officers and
officers act in a way that damages the business,
directors may be liable to shareholders.
Business Judgment Rule
Where the act or omission involves no
fraud, illegality or conflict of interest, but is
a question of policy or business judgment,
a director who acts in good faith and with
reasonable diligence is not personally
liable for mere errors of judgment or want
of prudence short of clear and gross
Rationale for Business Judgment
The standard of “reasonable care and prudence” is often
difficult to apply to the judgmental decisions on “business
risks” which directors are often called upon to make.
Potential profit often corresponds to the potential risk,
Shareholders often assume the risk of bad business
After-the-fact judgment is an imperfect device to
evaluate business decisions
if liability were imposed to readily, it might deter many
persons from serving as directors.
Limitations on Business Judgment
A director cannot invoke the business judgment
rule if he has not been “reasonably diligent”, as
where he knew or should have known that he
did not have sufficient facts to make a
judgment, yet failed to make reasonable efforts
to inform himself.
Can’t invoke if the director has authorized illegal
Many cases impose a higher duty of care on
directors of banks and other financial institutions,
particularly in overseeing the activities of officers
Security Act: Sec. Act of 1033 makes directors liable for
misstatements or omission of material fact in a
registration statement required to be filed when a
corporations issues securities, unless they exercise due
Rule 10b-5—Directors are liable for fraudulent
misstatements or omissions of material fact by the
corporation if the participated or had knowledge off the
fraud, or if their lack of knowledge resulted from willful
or reckless disregard of the truth.
Illegal dividends. Directors who participate in declaring
a dividend from an unlawful source, or under other
circumstances making a dividend illegal, are jointly and
severally liable to the extent of the injury to creditors
and preferred shareholders.
Extent of liability
Director will be held personally liable only for
corporate losses suffered as the direct and
proximate result of his breach of duty. I.e., must
show that breach caused a loss and must prove
the extent of the loss.
Acts of others—A director is liable for the
wrongful acts of other officers and directors only
if he participated in the wrongful acts, was
negligent in failing to discover the misconduct or
was negligent in appointing the wrongdoer.
Not a defense that not being paid or was a
figurehead. Still have a duty.
Age or infirmity is not a defense.
As long as act in good faith, are entitled to
rely on the reports of corporate officers
As long as act in good faith, are entitled to
rely on expert reports from attorneys,