Business Associations

Exam 1

Partnerships

• Historically two people entering into a business together were considered a partnership.

• A partnership arises from an agreement, express or implied, between two or more persons to carry on a business for profit (or specifically, to split profits)

• Partnerships are primarily governed by common law, particularly agency law.

  • Each partner is deemed to be an agent and principal of the other.

• A partnership is NOT a distinct legal entity. Instead it is an aggregate of the individuals belonging to the partnership.

  • No filing with the state is needed to create a partnership

  • An “agreement” to form partnerships can be written, oral, or implied.

  • “if two or more individuals or entities begin conducting business without organizing as another entity, then the law treats that joint enterprise as a general partnership, whether the parties consciously chose to create a general partnership… or merely if the parties had not organized as a different entity yet out of ignorance, neglect, or deliberate choice

Essentials of a Partnership - Factors

Factors:

• A sharing of profits and losses (creates a presumption of a partnership)

• A joint ownership of the business

• An equal right to be involved in the management of the business

Essentials of a Partnership - Tax Treatment

Tax Treatment: Partnerships are considered aggregates of its members. Thus a partner is taxed regularly for their profits. This is called “pass through taxation”

Essentials of a Partnership - Duration

Duration: unless otherwise specified, partnerships are at will meaning that may always be terminated.

Essentials of a Partnership - Rights of Partners

Rights of Partners:

• unless otherwise specified, all partners have equal rights to manage.

• Majority rules unless it is a significant decision. Then unanimously.

• Each partner is entitled to the partnership's profits equal to their interest.

Fiduciary Duties and Liability

• Each partner is an agent of each other. Each partner is also an agent of the partnership. As a result:

  • each partner is a FIDUCIARY of the partnership with the DUTY OF LOYALTY and DUTY OF CARE (agency law)

  • Liability: PARTNERS ARE PERSONALLY LIABLE FOR THE DEBTS OF THE PARTNERSHIP. LIABILITY IS ESSENTIALLY UNLIMITED. A third party may sue Partner A for the acts of Partner B.

• “The hallmarks of a general partnership are as follows: partners owe fiduciary duties to the entity and each other; parties retain personal liability for partnership obligations; the partners have the right to co-manage the business of the partnership; the partners have the right to an equal share of the profits of the partnership; and the partnership has vicarious liability for the torts of the partners.”

• Conflicts often arise whether a business arrangement constitutes a partnership when there’s no written document.

  • Common disputes: does a partnership exist, partner v. partner, partners v. third party (often occurring at the same time)

Meinhard v. Salmon - Facts, Issue, and Conflict

• Facts: Walter Salmon negotiated a twenty year lease for a hotel in NYC. To pay for its conversion into shops, he brought in a partner, Morton Meinhard, to pay half the costs. Salmon would exclusively manage the venture. They agreed to share profits. Four months before the lease was to end, the building’s owner approached Salmon alone about the chance to lease the building, who then leased the building without telling Meinhard. Meinhard sued.

• Issue: was Walter Salmon obligated to include his partner, Meinhard, into the deal? Or could Salmon make plans for a post-partnership life?

• Conflict: Typically, there is typicallyno problem accepting a deal without a friend or colleague. The issue was whether Salmon’s general partnership imposed a duty of loyalty, via agency law, onto Salmon, requiring him to include his partner Meinhard in the deal?

Meinhard v. Salmon - Court and Holding

• Court

  • “Many forms of conduct permissible in the work world are forbidden to those bound by fiduciary duties.”

  • The trouble about Salmon’s conduct is that he excluded his coadventurer from any chance to compete, from any chance to enjoy the opportunity for benefit.”

  • A man obtaining an opportunity by the position he occupies as a partner is bound by his obligation to his copartners in such dealings not to separate his interests from theirs, but, if he acquires any benefit, to communicate it to them.

• Breach of loyalty: “Salmon assumed in all good faith that with the approaching end of the venture he might ignore his coadvernturer and take the extension for himself… For him the rule of undivided loyalty is relentless and supreme”

  • That is, the general partnership imposed a duty of loyalty on Salmon, requiring him to include Meinhard so long as the partnership was intact

• Holding: Salmon breached the duty of loyalty

United States v. Atlas Lederer - Facts and Issue

• Facts:

  • The Department of Justice sued the company, Caldwell, which was responsible for environmental pollution in Troy, OH. Caldwell was originally organized as a general partnership between a father and uncle. In essence, the partnership disposed of car batteries at a dump site, causing environmental damage. The father retired, then the son took on the duties of his father. The son neither invested money nor signed a partnership agreement. Profits were divided between the son and uncle.

  • The U.S. government sought to sue Caldwell, which is now out of business. The Uncle is also deceased. As such, the government is pursuing the son for damages occurring in Troy, OH.

• Issue: is the son liable for Caldwell’s damages as a general partner, given that no partnership agreement was ever signed?

United States v. Atlas Lederer - Ruling and Holding

• General rule:

  • a partner of a general partnership is responsible for the debts the partnership incurs while he is a partner

  • This derives from agency law (i.e. a principal is liable for an agent’s torts)

• Test: “a partnership exists where there is ‘[1] an express or implied partnership contract between the parties; [2] the sharing of profits and losses; [3] mutuality of agency; [4] mutuality of control; and [5] co-ownership of the business and of the property used for partnership purposes or acquired with partnership funds.’”…

• Ruling: The agreement to share profits, as well as bind each other to contracts, establishes a general partnership. Even if the son had never personally delivered toxic batteries to the waste site, he was vicariously liable for Caldwell’s damage as a principal/agent of the general partnership.

• Holding: the son is liable to the government for the environmental pollution by virtue of being a partner in the culpable partnership

General Partnerships Recap

• General partnerships follow agency law.

• Each partner is a principal and agent of each other, allowing each partner to bind the other partner but also subject other partners to tort and contract liability

  • Partners owe fiduciary duties to each as principal/agents

• No written agreement (or agreement at all) is needed. A general partnership is imputed when, especially, an agreement to share profits is present

• A partnership is not a distinct legal entity, requiring no filing with the state

• There is no separate tax rate for a partnership, but the partners pay individual taxes on their profits.

• These rules are very different than the classic CORPORATION

  • The limited liability aspects of corporations makes them much more appealing than being apart of a general partnership

History of Corporations

• A corporation was historically a special grant from government, which often gave the charter’s recipient a monopoly

• Corporations were detested due to their inherit unfairness as well as the traditional ills of monopolies (e.g., high prices).

• An early example was the British East India Company, which pillaged foreign lands.

• To raise investment and minimize risk, boats sold portions of their haul, and then company, which was an early version of “stock”—e.g., a part ownership of a company.

• In the 1800s, states would begin to issue corp charters to anyone, rather than granting special privileges, which would become the modern corporation.

Modern Day Corporation

• Anyone can form a corporation by filing documents with a state (as opposed to a general partnership).

• Corporations entail both large and small companies.

• Ownership of a corporation is called stock or shares (if you own 1 share out of 100, you own 1% of the company).

• You can incorporate in any state, making you subject to the laws of that state—even if the company has zero ties to that state.

• The power to direct a corporation belongs to the board of directors ( as opposed to partnerships).

• Agency law directs much of the duties and liabilities of corporations