Quiz 23: Sole Proprietorships, Partnerships, and Limited Liability Companies
Business
Q 1Q 1
Darnell and Eliana are partners in D E Designs, an architectural firm. When Darnell dies, his widow claims that as Darnell's heir, she is entitled to take his place as Eliana's partner or to receive a share of the firm's assets. Is she right? Why or why not? (See Partnerships.)
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The Uniform Partnership Act (UPA) provides that upon the death of a partner their shares are transferred to the remaining partners through specific partnership property rationale. Also, the UPA sets forth that partners can only become a partner with the unanimous consent of all partners. The partnership is required to account to the estate for the value of the deceased partner's interest. It is well settled that upon the death of a partner a remaining spouse does not receive a share of the ongoing partnerships assets. Therefore, D's widow would not be eligible to get the firm's assets or become a partner with E. However, if it is consented by E or if the partnership agreement has a similar condition mentioned in it, she may become eligible for the same.
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Below mentioned are the advantages of sole proprietorship: • Corporate tax is not applicable in case of sole proprietorship. • Business requirements are very formal. • Very minimal legal cost is involved in forming sole proprietorship. • Sole proprietor has the discretion over sale and transfer of the business. • Sole proprietor has decision making power and complete control over the business. Below mentioned are the disadvantages of sole proprietorship: • Sole proprietor is personally liable for debts and business obligations. • Risk off wrongdoing of employees must also be bared by the sole proprietor. • Investors generally do not invest in sole proprietorship. • Sole proprietors have to finance their business through personal assets and loans.
Q 3Q 3
The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions:
What advantages and disadvantages are associated with the sole proprietorship?
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Sole entrepreneurship: Any person who establishes a business without creating separating business organizations is known as sole entrepreneurship. It is one of the simplest forms of business organizations. The sole person is held liable for entire obligations or debts which are incurred by the company. Advantages of sole proprietorship: 1. Easy formation: Sole proprietorship is very easy to establish as compared to other business form as less legal formalities are required. There is no need to file documents to government in order to start an entrepreneur. Thus such less cumbersome legal formalities made the establishment of sole entrepreneurship easy. 2. less expensive and profitable: The major advantage of sole proprietorship is that it is very easy and less expensive to establish as compared to other form of business. It is profitable as the entire profit earned belongs to the owner. 3. Flexible: This form of proprietorship is provides most flexibility than any other form of business as sole proprietor has freedom to take any decision regarding business. Disadvantages of sole proprietorship: 1. Unlimited liability: The major disadvantage of sole proprietorship is unlimited liability which means that sole proprietor is solely held personally responsible for the losses. 2. Lack of continuity: The other disadvantage of sole proprietorship is that business cannot be continued after the death of business thus business dies with owner.
Q 4Q 4
The LLC Operating Agreement. John, Lesa, and Trevor form a limited liability company. John contributes 60 percent of the capital, and Lesa and Trevor each contribute 20 percent. Nothing is decided about how profits will be divided. John assumes that he will be entitled to 60 percent of the profits, in accordance with his contribution. Lesa and Trevor, however, assume that the profits will be divided equally. A dispute over the profits arises, and ultimately a court has to decide the issue. What law will the court apply? In most states, what will result? How could this dispute have been avoided in the first place? Discuss fully. (See Limited Liability Companies.)
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Q 5Q 5
A bridge on a prominent public roadway in the city of Papagos, Arizona, was deteriorating and in need of repair. The city posted notices seeking proposals for an artistic bridge design and reconstruction. Davidson Masonry, LLC, which was owned and managed by Carl Davidson and his wife, Marilyn Rowe, submitted a bid for a decorative concrete project that incorporated artistic metalwork. They contacted Shana Lafayette, a local sculptor who specialized in large-scale metal forms, to help them design the bridge. The city selected their bridge design and awarded them the contract for a commission of $184,000. Davidson Masonry and Lafayette then entered into an agreement to work together on the bridge project. Davidson Masonry agreed to install and pay for concrete and structural work, and Lafayette agreed to install the metalwork at her expense. They agreed that overall profits would be split, with 25 percent going to Lafayette and 75 percent going to Davidson Masonry. Lafayette designed numerous metal sculptures of salmon that were incorporated into colorful decorative concrete forms designed by Rowe, while Davidson performed the structural engineering. Using the information presented in the chapter, answer the following question.
Would Davidson Masonry automatically be taxed as a partnership or a corporation? Explain.
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Q 6Q 6
ISSUE SPOTTERS
Gomer, Harry, and Ida are members of Jeweled Watches, LLC. What are their options with respect to the management of their firm? (See page 558.)
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Q 7Q 7
What is meant by joint and several liability? Why is this often considered to be a disadvantage of doing business as a general partnership?
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Q 8Q 8
The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions:
What is meant by joint and several liability? Why is this often considered to be a disadvantage of doing business as a general partnership?
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Q 9Q 9
Question with Sample Answer Dorinda, Luis, and Elizabeth form a limited partnership. Dorinda is a general partner, and Luis and Elizabeth are limited partners. Consider each of the separate events below, and discuss fully which would constitute a dissolution of the limited partnership.
1 Luis assigns his partnership interest to Ashley.
2 Elizabeth is petitioned into involuntary bankruptcy.
3 Dorinda dies.
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Q 10Q 10
What advantages do limited liability partnerships offer to entrepreneurs that are not offered by general partnerships?
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Q 11Q 11
The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions:
What advantages do limited liability partnerships offer to entrepreneurs that are not offered by general partnerships?
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Q 12Q 12
Partnership Formation. Daniel is the owner of a chain of shoe stores. He hires Rubya to be the manager of a new store, which is to open in Grand Rapids, Michigan. Daniel, by written contract, agrees to pay Rubya a monthly salary and 20 percent of the profits. Without Daniel's knowledge, Rubya represents himself to Classen as Daniel's partner, showing Classen the agreement to share profits. Classen extends credit to Rubya. Rubya defaults. Discuss whether Classen can hold Daniel liable as a partner. (See Partnerships.)
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Q 13Q 13
What are the key differences between the rights and liabilities of general partners and those of limited partners?
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Q 14Q 14
The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions:
What are the key differences between the rights and liabilities of general partners and those of limited partners?
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Q 15Q 15
Sole Proprietorship Julie Anne Gaskill is an oral and maxillofacial surgeon in Bowling Green, Kentucky. Her medical practice is a sole proprietorship that consists of Gaskill as the sole surgeon and an office staff. She sees every patient, exercises all professional judgment and skill, and manages the business. When Gaskill and her spouse, John Robbins, initiated divorce proceedings in a Kentucky state court, her accountant estimated the value of the practice at $221,610, excluding goodwill. Robbins's accountant estimated the value at $669,075, including goodwill. (Goodwill is the ability or reputation of a business to draw customers, get them to return, and contribute to future profitability.) How can a sole proprietor's reputation, skill, and relationships with customers be valued? Could these qualities be divided into "personal" and "enterprise" goodwill, with some goodwill associated with the business and some solely due to the personal qualities of the proprietor? If so, what might comprise each type? Is this an effective method for valuing Gaskill's practice? Discuss. [ Gaskill v. Robbins , 282 S.W.3d 306 (Ky. 2009)]
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Q 16Q 16
How are limited liability companies formed, and who decides how they will be managed and operated?
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Q 17Q 17
The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions:
How are limited liability companies formed, and who decides how they will be managed and operated?
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Q 18Q 18
LLC Dissolution. Walter Van Houten and John King formed 1545 Ocean Avenue, LLC, with each managing 50 percent of the business. Its purpose was to renovate an existing building and build a new commercial building. Van Houten and King quarreled over many aspects of the work on the properties. King claimed that Van Houten paid contractors too much for the work performed. As the project neared completion, King demanded that the LLC be dissolved and that Van Houten agree to a buyout. Because the parties could not agree on a buyout, King sued for dissolution. The trial court prevented further work on the project while the dispute was settled. As the ground for dissolution, King cited the fights over management decisions. There was no claim of fraud or frustration of purpose. The trial court ordered that the LLC be dissolved. Van Houten appealed. Should either of the owners be forced to dissolve the LLC before completion of its purpose-that is, finishing the building projects? Discuss. [ In re 1545 Ocean Avenue , LLC , 893 N.Y.S.2d 590 (N.Y.A.D. 2 Dept. 2010)]
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Q 19Q 19
Fiduciary Duties of Partners. Karl Horvath, Hein Rusen, and Carl Thomas formed a partnership, HRT Enterprises, to buy a vacant manufacturing plant and an annex building on eleven acres in Detroit, Michigan. HRT leased the plant to companies owned by the partners, including Horvath's Canadian-American Steel. When Horvath's firm missed three payments under its lease, HRT evicted it from the plant. Horvath objected but remained an HRT partner. Later, Rusen and Thomas leased the entire plant to their company, Merkur Steel. Merkur then sublet the premises to City Steel and Merkur Technical Services-both of which were owned (or substantially owned) by Rusen and Thomas. The rent these companies paid to Merkur was higher than the rent Merkur paid to HRT, which meant that Merkur profited from the arrangement. Rusen and Thomas did not tell Horvath about the subleases. When Horvath learned of the deals, he filed a suit in a Michigan state court against HRT and the other partners for an accounting of their actions. Did Rusen and Thomas breach their fiduciary duty to HRT and Horvath? Discuss. [ Horvath v. HRT Enterprises , 489 Mich. 992, 800 N.W.2d 595 (2011)]
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Q 20Q 20
LLC Operation. After Hurricane Katrina, James Williford, Patricia Mosser, Marquetta Smith, and Michael Floyd formed Bluewater Logistics, LLC, to bid on construction contracts. Under Mississippi law, every member of a member-managed LLC is entitled to participate in managing the business. The operating agreement provided for a "super majority" 75 percent vote to remove a member "under any other circumstances that would jeopardize the company status" as a contractor. After Bluewater had completed more than $5 million in contracts, Smith told Williford that she, Mosser, and Floyd were exercising their "super majority" vote to fire him. No reason was provided. Williford sued Bluewater and the other members. Did Smith, Mosser, and Floyd breach the state LLC statute, their fiduciary duties, or the Bluewater operating agreements? Discuss. [ Bluewater Logistics, LLC v. Williford, 55 So.3d 148 (Miss. 2011)] (See Limited Liability Companies.)
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Q 21Q 21
A Question of Ethics Elliot Willensky and Beverly Moran formed a partnership to renovate and "flip" (resell) some property. According to their agreement, Moran would finance the purchase and renovation of the property, and Willensky would provide labor and oversight of the renovation work. Moran would be reimbursed from the profits of the sale, and the remainder of the profits would be divided evenly. Any losses would also be divided evenly. Moran paid $240,000 for a house and planned to spend $60,000 for its renovation. The parties agreed that the renovation would be completed in six months. Willensky lived in the house during the renovation. More than a year later, the project still was not completed, and the cost was much more than the $60,000 originally planned. Willensky often failed to communicate with Moran, and when she learned that her funds were nearly exhausted and the house nowhere near completion, she became worried. She told Willensky that he would have to pay rent and utility bills if he wished to continue to live in the house. Shortly thereafter, Willensky left for Florida due to a family emergency, saying that heMoran lost touch with him. Moran took over the project and discovered that Willensky had left numerous bills unpaid, spent money on excessive or unnecessary items, and misappropriated funds for his personal use. After completing the project, paying all expenses relating to the renovation (in all, the renovation costs came to $311,222), and selling the property, Moran brought an action in a Tennessee state court to dissolve the partnership and to recover damages from Willensky for breach of contract and wrongful dissociation from the partnership. [ Moran v. Willensky, ___ S.W.3d ___ (Tenn.Ct.App. 2010)]
1 Moran alleged that Willensky had wrongfully dissociated from the partnership. When did this dissociation occur? Why was his dissociation wrongful?
2 Which of Willensky's actions simply represent unethical behavior or bad management, and which constitute a breach of the agreement?
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Q 22Q 22
Critical Thinking Managerial Question Sandra Lerner and Patricia Holmes were friends. One evening, while applying nail polish to Lerner, Holmes layered a raspberry color over black to produce a new color, which Lerner liked. Later, the two created other colors with names like "Bruise," "Smog," and "Oil Slick," and titled their concept "Urban Decay." Lerner and Holmes started a firm to produce and market the polishes but never discussed the sharing of profits and losses. They agreed to build the business and then sell it. Together, they did market research, worked on a logo and advertising, obtained capital, and hired employees. Then Lerner began working to edge Holmes out of the firm. Did Lerner violate her fiduciary duty? Why or why not?
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Q 23Q 23
FACTS Walter Salmon negotiated a twenty-year lease for the Hotel Bristol in New York City. To pay for the conversion of the building into shops and offices, Salmon entered into an agreement with Morton Meinhard to assume half of the cost. They agreed to share the profits and losses from the joint venture (a joint venture is similar to a partnership but typically is created for a single project, whereas a partnership usually involves an ongoing business), but Salmon was to have the sole power to manage the building.
Less than four months before the end of the lease term, the building's owner approached Salmon about a project to raze the converted structure and construct a new building. Salmon agreed and signed a new lease in the name of his own business, Midpoint Realty Company, without telling Meinhard. When Meinhard learned of the deal, he filed a suit against Salmon. From a judgment in Meinhard's favor, Salmon appealed.
ISSUE Did Salmon breach his fiduciary duty of loyalty to Meinhard?
DECISION Yes. The Court of Appeals of New York held that Salmon had breached his fiduciary duty by failing to inform Meinhard of the business opportunity and secretly taking advantage of it for himself. The court therefore granted Meinhard an interest "measured by the value of half of the entire lease."
REASON The court stated, "Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty." Salmon's conduct excluded Meinhard from any chance to compete and from any chance to enjoy the opportunity for benefit. As a partner, Salmon was bound by his "obligation to his copartners in such dealings not to separate his interest from theirs, but, if he acquires any benefit, to communiand thus the court found that "for him and for those like him the rule of undivided loyalty is relentless and supreme."
WHAT IF THE FACTS WERE DIFFERENT? Suppose that Salmon had disclosed the proposed deal to Meinhard, who had said that he was not interested. Would the result in this case have been different ? Explain.
IMPACT OF THIS CASE ON TODAY 'S LAW This landmark case involved a joint venture, not a partnership. At the time, a member of a joint venture had only the duty to refrain from actively subverting the rights of the other members. The decision in this case imposed the highest standard of loyalty on joint-venture members. The duty is now the same in both joint ventures and partnerships. The eloquent language in this case that describes the standard of loyalty is frequently quoted approvingly by courts in cases involving partnerships.
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Q 24Q 24
Craton Capital, LP v. Natural Pork Production II, LLP
Court of Appeals of Iowa, 797 N.W.2d 623 (2011).
www.iowacourts.gov/Court_of_Appeals
FACTS Natural Pork Production II, LLP (NPP), an Iowa limited partnership, raises hogs. Under a partnership buy-sell agreement, NPP was obligated to buy a dissociating partner's interests (units) but could defer the purchase payment if, in the judgment of the managing partners, it would "adversely affect the working capital, cash flow or other financial means, condition or operation of the Partnership." Once this "Impairment Circumstance" was "no longer applicable," NPP was to make the purchase payment within thirty days. Craton Capital, LP, and Kruse Investment Company were among NPP's limited partners. When they notified NPP of their dissociation, a wave of similar notices from other partners followed. NPP declared an impairment circumstance. Craton and Kruse filed a suit in an Iowa state court against NPP, asking the court to order the partnership to buy their units. NPP responded that the impairment circumstance still existed. Both parties filed motions for summary judgment on the issue of whether NPP was obligated to buy. The court issued a summary judgment in NPP's favor. Craton and Kruse appealed.
ISSUE Was NPP required to buy the dissociating partners' interests under the buy-sell agreement?
DECISION Yes. A state intermediate appellate court reversed the lower court's judgment in favor of NPP and remanded the case for the entry of a summary judgment in favor of Craton and Kruse.
REASON The "Dissociation Notice" provision of the partnership agreement stated that NPP shall buy a dissociating partner's units. This is mandatory. The only restriction is set out in the "impairment circumstance" provision. This provision applies when NPP is obligated to buy a dissociating partner's units and an impairment circumstance arises. Payment is then postponed, but the partnership is still obligated to buy the units. That is what occurred in this case. NPP argued that under the impairment circumstance provision, an obligation to buy a partner's units would never arise if it would materially impair or adversely affect the financial condition of the partnership. But this interpretation, the court reasoned, was not consistent with "the actual wording." The word "shall" is mandatory. Thus, once Craton and Kruse gave their dissociation notice, NPP was obligated to buy their units. The declaration of an impairment circumstance only deferred the purchase payment.
WHAT IF THE FACTS WERE DIFFERENT? Suppose that Craton and Kruse had been general partners rather than limited partners. In that circumstance, what might their dissociation have meant for NPP?
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Q 25Q 25
Polk v. Polk
Court of Civil Appeals of Alabama, __ So.3d __ (2011).
FACTS Leslie Polk and his children, Yurii and Dusty Polk and Lezanne Proctor, formed Polk Plumbing, LLC, in Alabama. Leslie, Dusty, and Yurii performed commercial plumbing work, and Lezanne, an accountant, maintained the financial records and served as the office manager. After a couple of years, Yurii quit the firm. Eighteen months later, Leslie "fired" Dusty and Lezanne. He denied them access to the LLC's books and offices but continued to operate the business. Dusty and Lezanne filed a suit in an Alabama state court against Leslie, claiming breach of fiduciary duty. The court submitted the claim to a jury with the instruction that in Alabama employment relationships are "at will" (see Chapter 22). The court also told the jury that it could not consider the plaintiffs' "firing" as part of their claim. The jury awarded Dusty and Lezanne one dollar each in damages. They appealed, arguing that the judge's instructions to the jury were prejudicial-that is, that the instructions had substantially affected the outcome of the trial.
ISSUE Did the trial court properly instruct the jury on which evidence could be considered in Dusty and Lezanne's breach of fiduciary duty claim?
DECISION No. A state intermediate appellate court reversed the lower court's judgment on the claim for breach of fiduciary duty and remanded the case for a new trial. The lower court committed reversible error by instructing the jury that Dusty and Lezanne's employment as managers was at will and by failing to instruct the jury that it could consider their "firing" as evidence in support of their claim.
REASON The court reasoned that the lower court had committed reversible errors that had "probably injuriously affected substantial rights of Dusty and Lezanne." Dusty and Lezanne served as managers of the LLC. The operating agreement provided that managers served until replaced or recalled by a vote of the majority of the members. Therefore, their employment as managers was not at will. Because no vote had been taken to recall or replace Dusty and Lezanne, their father did not have the authority to terminate their employment. His attempted "firing" of them was in violation of the LLC's operating agreement. If the jury had considered all of this evidence, the amount of damages might have been higher.
WHAT IF THE FACTS WERE DIFFERENT? Suppose that Leslie owned a majority of the shares in Polk Plumbing. Could his "firing" of Dusty and Lezanne still be considered as evidence of a breach of fiduciary duty? Explain.
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