Business Law Chapter 21

Sole Proprietorship

A business in which one person (sole proprieter) is in control of the mangagement and profits.

Cooperative

A cooperative is an organization formed by individuals to market products. The cooperative is a business organization in which the members usually pool their resources to gain some kind of advantage in the market. For instance, farmers might pool certain crops to ensure that they get a high market price for their crops. Usually, members of the cooperative receive dividends in proportion to how many times a year they engage in business with the cooperative. Cooperatives may be incorporated or unincorporated. Unincorporated cooperatives are treated like partnerships, meaning that the members share joint liability for the cooperative's actions. Members of incorporated cooperatives, on the other hand, enjoy limited liability just as do the shareholders of a corporation.

Business Trust

A form of business organization, created by a written trust agreement, that resembles a corporation. A business trust is a business organization governed by a group of trustees, who operate the trust for the beneficiaries. A written trust agreement establishes the duties and powers of the trustees and the interests of the beneficiaries. As with a corporation, the trustees and beneficiaries enjoy limited liability, and, in most states, business trusts are taxed like corporations.

General Partnership

A general partnership consists of an agreement that the partners will divide the profits (usually equally) and management responsibilities and share unlimited personal liability for the partnership's debts. Thus, in our Internet business example, you and your best friend would form a general partnership by agreeing to share the management responsibilities and profits as well as assuming unlimited personal liability.

Syndicate

An investment group that comes together for the explicit purpose of financing a specific large project is a syndicate. Syndicates are often used in the purchase of professional sports teams. The syndicate is quite useful in the sense that it can raise large amounts of money in a small amount of time. Syndicates are usually considered a type of joint venture; thus, they are almost always governed by partnership law.

Limited Liability Partnership (LLP)

If you and your fellow partners have created a limited liability partnership (LLP), a different form of partnership than the LP, all the partners assume liability for any partner's professional malpractice to the extent of the partnership's assets. In other words, the limited liability partnership is different from other forms of partnership because the partners' liability for professional malpractice is limited to the partnership. If one partner in an LLP is guilty of malpractice, the other partners' personal assets cannot be taken. Therefore, professionals who do business together commonly use the LLP. It is the extra protection awarded partners in an LLP that makes the LLP a separate form of partnership from a limited partnership. Limited partnerships are not the same as limited liability partnerships.

Chain-Style Business Operation

In a chain-style business operation, the franchise operates under the franchisor's business name and is required to follow the franchisor's standards and methods of business operation.

Manger-Managed

In a manager-managed LLC, the members select a group of managers to manage the affairs of the company. The managers may be selected from the members or may be nonmembers. The managers have the apparent and actual authority to enter into contracts on behalf of the LLC, whereas the members who are not managers do not have such authority. The managers owe the LLC and its members the same fiduciary duties as the officers and directors of a corporation owe to the corporation and its shareholders.

Manufacturing Agreement

In a manufacturing arrangement, the franchisor provides the franchisee with a formula or necessary ingredient to manufacture a product. The franchisee then manufactures the product and sells it according to the franchisor's standards.

Member-Managed

In a member-managed LLC, all members participate in management, with decisions in the ordinary course of business activities made by a majority vote. The consent of all members, however, is required to sell, lease, exchange, or otherwise dispose of all, or substantially all, of the company's property; approve a merger or conversion to a different form; undertake any other act outside the ordinary course of the company's activities; and amend the operating agreement. The members in such an LLC all have the apparent and actual authority to enter into contracts on behalf of the LLC.

Creation of the Franchise

In the franchise relationship, the parties make a franchise agreement regarding various factors: the payment to the franchisor, the location of the franchise, the restrictions the franchisee must follow, and the method of termination of the franchise.

Termination of the Franchise

The franchise agreement establishes how the franchise will be terminated. The franchise is usually established for a trial period, such as a year. If the franchisee does not meet the requirements established in the franchise agreement, the franchisor can terminate the franchise agreement, but the franchisor must give the franchisee sufficient notice of the termination. Furthermore, the termination usually must have cause. Much of the litigation associated with franchises regards wrongful termination of a franchise. The typical agreement gives the franchisor broad authority to terminate a franchise. In recent years, however, many states have been giving the franchisee greater termination protection.

Sole Proprietor

The single person at the head of a sole proprietorship.

Dissolution of LLCs

Under the ULLCA, an LLC dissolves on the happening of any event that the operating agreement specifies will cause dissolution, the consent of all the members, the passage of 90 consecutive days during which the company has no members, or the issuance of a court order for dissolution. Under the ULLCA and most state LLC statutes, a member's voluntary withdrawal from the LLC, referred to as dissociation, does not terminate the LLC.

Limited Liability Company

an unincorporated business that is taxed like a partnership, with the members paying personal income taxes, and has the limited liability of a corporation

Key Reasons for the Rapid Acceptance of LLCs

As previously mentioned, the LLC form offers its members the same limited liability for business debts as that offered by the corporate form. However, unlike the corporate form, it does not require profits and losses to be allocated in proportion to ownership interests. Also unlike corporations, LLCs are not required to hold an annual meeting and draft meeting minutes, so record keeping is simpler and more flexible. Unlike the case in limited partnerships, to obtain limited liability, the owner (referred to as a member) does not have to give up his or her right to participate in management of the LLC. In fact, an additional advantage of the LLC form is the flexibility it offers members in terms of alternative ways to structure its management

Franchise-Law

Because franchisors are usually larger than franchisees and have more resources, they often have the upper hand in franchise relationships. Federal and state laws, however, have been established to protect the franchisee in the franchise relationship. In addition, several laws that are more specific have been established to govern the franchise relationship. For example, the Federal Trade Commission has a franchise rule requiring franchisors to present prospective franchisees with the material facts necessary for the franchisee to make an informed decision about entering a franchise relationship. Moreover, the Automobile Dealers' Franchise Act of 1965 prohibits car dealership franchisors from terminating franchise relationships in bad faith. Thus, for example, DaimlerChrysler could not terminate its franchise relationship with a dealer because the dealer failed to meet impossible standards. Finally, the Petroleum Marketing Practices Act of 1979 outlines the reasons for which a franchisor may terminate a gas station franchise. Franchises must also be aware of federal antitrust laws. Antitrust laws prohibit specific forms of anticompetitive behavior and might be applicable to franchises.

Dissolution

Before the termination of any partnership can be considered complete, a partnership must experience what are referred to as the dissolution stage and the winding-up stage. The first of these stages, dissolution, is considered complete when any partner stops fulfilling the role of a partner to the business (by choice or default). Section 29 of UPA defines dissolution as "the change in the relation of the partners caused by any partner's ceasing to be associated with the carrying on, as distinguished from the winding up"—the activity of completing unfinished partnership business, collecting and paying debts, collecting partnership assets, and taking inventory—"of the business."

Distributorships

Distributorships are franchises in which the franchisor manufactures a product and licenses a dealer to sell the product in an exclusive territory. A car dealership is an example of a distributorship.

Joint Venture

A joint venture is a relationship between two or more persons or corporations created for a specific business undertaking. This relationship may entail financing, producing, and selling goods, securities, and commodities. Participants in the joint venture usually share the profits and losses of the joint venture equally. Despite the similarities, there are several minor differences between partnerships and joint ventures in the eyes of the law. First, if one of the members of a joint venture dies, the joint venture is not automatically terminated. Second, the members of a joint venture have less authority than general partners because members of a joint venture are not agents of the other members. The parties who comprise a joint venture usually share equal management of the task for which they have come together. They, however, can make an agreement to give one party greater management responsibilities. Furthermore, all the parties usually assume liability for the project. Each party can be held responsible for the liability of another party in the joint venture. Like a partnership, a joint venture may be formed without drawing up a formal agreement. Case 21-1 provides a judicial discussion of the elements necessary for the establishment of a joint venture.

Formation and Management of LLCs

A limited liability company is formed by filing articles of organization in the state in which members want to establish their LLC. Although precise requirements vary by state, typically the articles include the name of the business, which must include the words Limited Liability Company or the initials LLC, its principal business address, the name and address of a registered agent for service, the names of the owners, and information about how the company's management will be structured. LLCs typically want to do business in states other than the state in which they are formed, and they usually need to register in every additional state in which they want to operate, a process typically referred to as qualification. Qualification simply entails filing a certificate of authority or a similar document and getting a business license in each additional state in which the business plans to operate. The LLC will usually be referred to as a foreign company in the additional states, and, under most state statutes, the LLC will be governed by the LLC rules of the state in which it was created, regardless of where it is transacting business. When members form an LLC, they typically draft an operating agreement, which is the foundational contract among the entity's owners. It spells out such matters as how the company is to be managed, how the profits and losses will be allocated, how interests may be transferred, and how and when the LLC may be dissolved. Any matter not covered in the operating agreement will be resolved in accordance with the state LLC statute; if a matter is not covered by the relevant statute, the principles of partnership law are generally followed.

Joint Stock Company

A partnership agreement in which company members hold transferable shares while all the goods of the company are held in the names of the partners. Thus, the joint stock company is a mixture of a corporation and a partnership. As with the corporation, the members who hold shares of stock own the joint stock company. As with the partnership, the shareholders have personal liability, and in most cases, the company is not a separate legal entity. The joint stock company is formed by agreement rather than by statute.

Partnership

A voluntary association of two or more persons to act as co-owners of a business for profit. Although there are certain advantages to creating a partnership, there are also disadvantages associated with partnerships. Most important, the partners are personally liable for the debts of the partnership. For instance, suppose you are in a partnership with your best friend, who embezzles $50,000 through your partnership. Because of the partnership, you would likely be held personally liable for the debts of the partnership. In other words, you would likely be responsible for the $50,000. Exhibit 21-2 summarizes the advantages and disadvantages of partnerships

Articles of Partnership

A written agreement that creates a partnership is called the articles of partnership. What kind of information do the articles of partnership usually include? First, the partners' names, as well as the name of the partnership, should be listed on the document. Second, the agreement should address the duration of the partnership. The agreement could include the date or event on which the partnership agreement would expire. Alternatively, the agreement could specify that the term of the partnership is indefinite. Third, the agreement should state the division of profits and losses. Fourth, the articles of partnership should establish the division of management duties. Fifth, the agreement should state exactly what capital contributions will be made by each partner. Creating articles of partnership can prevent legal problems by explicitly establishing the terms of the partnership agreement.

Duties of Partners to One Another

Most of the duties that partners hold to one another involve a duty to be loyal. They include the fiduciary duty to the other partners, the duty of obedience, and the duty of care. Perhaps the most important duty of the partners is their fiduciary duty. They must, in good faith, work for the benefit of the partnership and refrain from taking any kind of action that will undermine the partnership. Consequently, the partners must not engage in any business that competes with the partnership. Partners must disclose any material facts affecting the business. If a partner derives some kind of benefit from the partnership without the consent of the other partners, he or she must notify the partners of this benefit. The second duty that the partners have to each other is the duty of obedience, to obey the partnership agreement. If they do not obey the agreement, they can be held liable for any losses that the partnership incurs. The third duty the partners have is a duty of care to the other partners. Each partner must perform her management functions to the best of her abilities. If a partner makes an honest mistake in fulfilling her responsibilities to the partnership, she will not be held liable for the mistake.

Limited Partnership (LP)

Now imagine that your parents want to invest in your Internet business. Suppose that they want to share in the profits associated with the business, but they do not want to share in the management responsibilities or assume personal liability for the debts of the partnership. Your parents can join your business as limited partners, and your partnership would become a limited partnership. A limited partnership (LP) is an agreement between at least one general partner and at least one limited partner. The general partners, you and your best friend, assume unlimited personal liability for the debts of the partnership. However, your parents, the limited partners, assume no liability for the partnership beyond the capital they have invested in the business. Moreover, the limited partners do not have any part in the management of the company. However, limited partners pay taxes on their share of the business profit.

Winding Up

Once a partnership is liquidated, the partners begin the process of winding up, the activity of completing unfinished partnership business, collecting and paying debts, collecting partnership assets, and taking inventory. During the winding up, the partners must still fulfill their fiduciary duty to one another, in the sense that they must disclose all information about the partnership assets. However, during the winding-up process, the partners can now engage in business that competes with the partnership business.

Limited Liability Company (LLC)

One of the newest forms of business organization in the United States is the limited liability company (LLC), an unincorporated form of business organization that many people see as combining the most advantageous features of partnerships and corporations. It combines the tax advantages and management flexibility of a partnership with the limited liability of a corporation.

S corporation

One way that a corporation can avoid this double taxation is by forming an S corporation, a business organization formed under federal tax law that is considered a corporation yet is taxed like a partnership as long as it follows certain regulations. For example, the S corporation cannot have more than 100 shareholders. Any income of the corporation is taxed when it is distributed to the shareholders, who must report the income on their personal income tax forms. S corporations are always formed under federal law. S corporations cannot be formed under state law, whereas other forms of corporations are created under state law.

In some cases, parties who are not named in partnership agreements can be considered partners. How?

Suppose you create a partnership agreement with your best friend. When you interact with your first potential customer, you tell this customer that your parents are also partners in this business. On the basis of your parents' participation in the partnership, the customer decides to place an order to purchase certain goods from you. Your parents discover that you have reported that they are your partners, but they do not contact the customer to tell her that they are not your partners. When your business cannot afford to purchase these goods to sell them to the customer, the customer sues you as well as your parents. Because your parents were aware of the misrepresentation but did not correct it, they will be estopped from denying they are your partners. Although they will not be able to claim the rights associated with being a partner (e.g., sharing the profits), in many states they could be held liable for the costs of the damages to the customer. Most states recognize two situations in which a partnership by estoppel exists. First, as in the preceding example, if a third party is aware of a misrepresentation of partnership and consents to the misrepresentation, a partnership by estoppel is present. Second, if a nonpartner has represented himself or herself as a partner, and a third party reasonably relies on this information to his or her detriment, the nonpartner can be held liable for the third party's damages.

Advantage and Disadvantage of Franchises

What are the advantages and disadvantages for the franchisor and the franchisee? Exhibits 21-6 and 21-7 summarize these advantages and disadvantages. First, the franchisee enjoys the franchisor's help in opening the franchise. Second, think about how many times you have driven through a strange town and felt relieved when you saw a Burger King. Even though you may have never been to that town before and did not know who controlled that particular business, you know Burger King. Before you walk into the restaurant, you know almost exactly what will be on the menu. Thus, on the one hand, the franchisee benefits from the franchisor's strong trade name or trademark. Moreover, the franchisee benefits from the franchisor's worldwide advertising of the trade name or trademark. The franchisor, on the other hand, does not take a large risk in creating the franchise, yet it can greatly benefit from the income it receives from the franchisee. It should be noted that a franchise is not a legal entity itself by default. For example, a franchisee can choose to incorporate their franchise or register their franchise as an LLC while operating under a franchise agreement.

Franchise

When you go into McDonald's to eat lunch, what type of business are you patronizing? You are likely eating at a franchise, a business that exists because of an arrangement between the franchisor, an owner of a trade name or trademark, and the franchisee, a person who sells goods or services under the trade name or trademark.

Corporation

When you hear the word business, you probably think about businesses such as Walmart, Kmart, McDonald's, and Nike. Perhaps the most dominant form of business organization is the corporation, a legal entity formed by issuing stock to investors, who are the owners of the corporation. The investor-owners are called shareholders. These shareholders elect a board of directors, which is responsible for managing the business. The board of directors, in turn, hires officers to run the day-to-day business. What are the consequences of a corporation's status as a separate legal entity? First, although the corporation can be held liable, shareholders cannot be held personally liable for the debts of the corporation. Their liability is usually limited to the amount they have invested. Second, the corporation is not dissolved when the shareholders die. Third, the corporation must pay taxes on its profits. In addition, the shareholders must pay taxes on the dividends they receive from the corporation.