Sole Proprietorships, Partnerships,

and Limited Liability Companies

“It has been uniformly laid down in this Court, as far back as we can
remember, that good faith is the basis of all mercantile transactions.”
-J. Buller

I. Chapter Objectives

 Define a sole proprietorship and describe the liability of a sole proprietor.

 Define a general partnership and explain the contract and tort liability of owners.
 Define limited partnership and describe the liability of general and limited partners
 Define limited liability partnership (LLP) and limited liability company (LLC), and
describe the limited liability of their owners.
 Define limited liability partnership (LLP) and limited liability company (LLC), and
describe the limited liability of their owners.
 Define franchise and license.

II. Text Materials

Sole Proprietorship

The simplest form of a business organization is a sole proprietorship. They are easy and
inexpensive, and the owner has the right to make all business decisions.

Creation of a Sole Proprietorship – This form of business requires no formalities other than a
license to do business, if the municipality requires one.

d.b.a. - “Doing Business As” - Sole proprietorships can operate under fictitious names, or trade
names.

Personal Liability of Sole Proprietors – The owner bears all of the risk of loss and has unlimited
personal liability.
General Partnership

General or ordinary partnerships are a voluntary association of two or more persons for the
purpose of conduction business. The general partners are liable personally for all debts and
obligations.
There are four key issues in partnership law. They are the formation of a partnership, the
operation of a partnership, the dissolution of a partnership, and an overview of limited

178
 Sole Proprietorships, Partnerships, and Limited Liability Companies

partnerships. First consider the phrase: “For better or worse.” These words are used in most
major religious ceremonies involving the rite of marriage. The bonds of marriage are expected to
run long and deep as evidenced by the absolute terms used in the ceremony. Partnership is, in
many ways, akin to marriage. Persons entering into a partnership arrangement must do so
voluntarily and with their legal eyes open to the ramifications of their bonding. Just as in
marriage, the law attaches great significance to the act of casting one’s fate with another person in
the formation of a partnership.

Uniform Partnership Act (UPA) – The UPA codifies partnership law and has been adopted in
whole or part by almost every state. It adopted an entity theory of partnership, allowing
partnerships to hold personal and real property and transact business in the partnership name.

Partnership Name – The partnership can operate under the names of the partners or under a
fictitious name.

Formation of a Partnership – To be a partnership under UPA, the business must be an

association of 2 or more people, who carry on a business for profit as co-owners. The partnership
can be formal or informal, but the co-ownership is essential. Receipt of a share of the business
profit is considered to be prima facie evidence of the partnership.

The Partnership Agreement - The agreement can be oral, written, or implied. If it is written, it is
termed the articles of partnership or the partnership agreement. If the written agreement fails to
provide any essential terms or contingencies, the provisions of the UPA will be applied.

Right to Participate in Management – Absent an agreement to the contrary, all partners have
equal rights.

Right to an Accounting – Partners cannot sue each other or the partnership. Instead, they can
bring an action for an accounting against the other partners, asking the court to review
transactions and award each partner their share of the partnership assets.

Partners’ Rights to Share in Profits – Unless otherwise stated, all partners have a right to an
equal share in the profits and losses.

Tort Liability – Partnerships are liable for tortuous acts committed within the ordinary course of
business, and the partners will be held jointly and severally liable.

Contract Liability – Partners are jointly liable for the contracts and debts of the partnership. Any
partner who pays more than their proportionate share can seek indemnification from the
partnership and the partners who did not pay their share.

Dissolution of Partnerships – Partnerships can be for a fixed term, and are designated as
partnerships for a term. If no fixed duration is given, it is a partnership at will.
A partner can withdraw and dissolve the partnership at any time, but they will be liable for any
damages caused by a wrongful dissolution.
As for the dissolution of a partnership, compare its existence with that of a corporation,
which will be covered in the next chapter. One of the key distinctions between the partnership
form of doing business and corporate format is the corporation’s ability to have an indefinite or
perpetual existence. Under state laws of incorporation, a corporation is allowed to continue its

179
Chapter 16

juristic existence in spite of the death of its key players. This is not so with partnerships.
Partnerships are literally much more personal.

Continuation of a Partnership After Dissolution - When the partner is gone, so is the

partnership. One of the questions students frequently ask is: How is it that multinational
business organizations such as large accounting or law firms stay in business as partnerships
when they frequently lose partners through death or changes in partnership associations?
Technically, with each of these changes, the partnership is ended, and a new one is created. A
well-crafted partnership agreement should have, as one of its key components, an orderly process
of succession in case of death or termination. Where these circumstances are properly planned
for, the transition is seamless, and the life of the new partnership goes on where the old one left
off.
Most partnerships are not, however, large and multinational in scale. Most are created and
operated by individuals who have sought to capitalize on their respective economic or talent
contributions by acting together in the legal sense. These business ventures could be set for a
short term, specific goal, such as erecting a building, or extend to a full professional career as a
licensed practitioner of law, medicine, or accounting. Just like a marriage, sometimes the best
intentions at the legal alter of partnership do not always work out in the strain of living with
someone legally.

Contemporary Environment: Right of Survivorship

Upon the death of a partner, the deceased partner’s property vests in the remaining partner or
partners, not to his or heir heirs of next of kin.

Limited Partnership
The Revised Uniform Limited Partnership Act – Most states have enacted RULPA, which
defines the formation, operation, and dissolution of limited partnerships.

General and Limited Partners – General partners invest capital, manage the business, and are
personally liable for the partnership debts. Limited partners invest capital but do not participate
in management and their liability is limited to their investment. A limited partnership must have
at least one of each.

Formation of Limited Partnerships – RULPA requires that the partners execute a certificate of
limited partnership, which states the name of the partnership, the general character of the
business, the address of the principal place of business, the agent of record’s information, the
names and addresses for each partner, the capital contributed, and the latest date for dissolution.

Limited Partnership Agreement – The articles of limited partnership set forth the rights and
duties of both the general and limited partners, the distribution of profits and losses, and voting
rights.

Liability of General and Limited Partners – The general partners have unlimited liability for the
debts and obligations, while limited partners are liable only for amounts up to the limit of their
capital contributions.

Limited Liability Partnership (LLP)

180
 Sole Proprietorships, Partnerships, and Limited Liability Companies

LLPs do not have any general partners, but all partners are limited partners.

Articles of Partnership – LLPs are created by filing articles of partnership with the secretary of
state in the state where they are organized. LLPs may do business in other states if the register as
a foreign LLP.

Liability Insurance Required – Most states require insurance to guarantee that injured third
parties will be able to recover.

Contemporary Environment: Accounting Firms Operate as LLPs

Prior to the advent of the limited liability partnership form of doing business, accounting firms
operated as general partnerships. As such, the general partners were personally liable for the
debts and obligations of the general partnership. Once LLPs were permitted by law, all of the big
accounting firms changed their legal status from general partnership to LLP.

Limited Liability Company (LLC)

LLCs are unincorporated business entities that are controlled by state law. LLCs are treated as
separate legal entities from the members.

The Uniform Limited Liability Company Act – Many states have adopted all or part of the
Uniform Limited Liability Company Act.

Formation of a LLC – Articles of corporation for the LLC must be filed with the state and
include the LLC’s name, duration, and other information.

Operating Agreement – Operating agreements regulate the affairs of the LLC.

Taxation of LLCs – Like an LLP, a LLC allows the income or losses to flow through to the
member’s individual income tax returns.

Members’ Limited Liability – The owners/members of an LLC are not personally responsible for
the debts, obligations, and liabilities of a LLC beyond their capital contribution.

Case 16.3. Limited Liability Company: Page v. Roscoe, LLC.

Facts: Dale C. Bone was a member of Roscoe, LLC, a limited liability company organized
in North Carolina. Roscoe purchased two acres of land near Apex, NC, to construct and operate a
propane gas bulk storage and distributing facility. That use was permitted under Apex’s zoning
regulations. Local residents sued Roscoe, claiming the facility would be a nuisance. The
residents lost, and dropped the lawsuit. Bone sued to recover the attorney’s fees he spent to
defend the lawsuit.
Issue: Were the sanctions warranted against the plaintiffs for naming an individual member
of a limited liability company in the lawsuit they brought against the LLC?
Decision: No.
Reason: Bone, as a member of the LLC, was not liable as a matter of law for the acts of the
LLC and was therefore improperly named as a defendant in the lawsuit.

Liability of the LLC – The LLC is liable for any wrongful acts or omissions.

181
Chapter 16

Member-Managed and Manager-Managed LLCs – Member-managed LLCs are managed by the

members, while manager-managed LLCs are managed by a member designated manager.

Agency Authority to Bind an LLC to Contracts – In a member-managed LLC, all members have
agency authority to bind the LLC, but in manager-managed, only the manager can bind the LLC.

No Fiduciary Duty Owed by a Non-manager Member – A nonmanager member of a manager-

managed LLC is treated like a shareholder in a corporation.

Continuation of a LLC – An LLC can be continued beyond its term by a unanimous vote and a
filing of an amendment with the state, or by a majority vote of the members.

Contemporary Environment: Dreamworks SKG, LLC: Script for a Movie Company

This discusses a major LLC, Dreamworks SKG, formed by Steven Spielberg, Jeffrey Katzenberg,
and David Geffen.

Franchise

A franchisor or licensor licenses a franchisee or licensee to use their intellectual property.

Types of Franchises – Distributorship franchises are where the franchisor manufactures a

product and licenses a retailer to distribute it. A franchisor provides a secret formulae to a
franchisee in a processing plant franchise. A chain-style franchise is established when a
franchisee is licensed to make and sell products or services to the public.

The Franchise Agreement – The franchise agreement sets the terms and conditions of the
franchise.

Liability of Franchisors and Franchisees – The franchisor and franchisee are separate legal
entities, and are not liable for the contracts and torts of the other.

Termination “For Cause” – These agreements can be terminated for failure of the franchisee to
pay fees or meet legitimate quality control problems.

Wrongful Termination – If the franchisee is terminated without just cause, the franchisee can sue
the franchisor.

License

A license occurs when one party contracts with another for the use of intellectual property.

III. Terms
 entrepreneur—A person who forms and operates a new business either by him-or
herself or with others.
 sole proprietorship—A form of business where the owner is actually the business;
the business is not a separate legal entity.
 action for an accounting—A formal judicial proceeding in which the court is
authorized to (1) review the partnership and the partners’ transactions and (2)
award each partner his or her share of the partnership assets.

182
 Sole Proprietorships, Partnerships, and Limited Liability Companies

 certificate of partnership—A document that a partnership must file with the

appropriate state government agency in some states to acknowledge that the
partnership exists.
 charging order—A document that the court issues against the debtor-partner’s
partnership interest in order to satisfy a debt.
 Dissolution—“The change in the relation of the partners caused by any partner
ceasing to be associated in the carrying on of the business” [UPA § 29].
 distribution of assets—Upon the winding-up of a dissolved partnership, the assets
of the partnership are distributed in the following order [UPA § 40(b)].
 duty of care—The obligation partners owe to use the same level of care and skill
that a reasonable person in the same position would use in the same
circumstances. A breach of the duty of care is negligence.
 duty of loyalty—A duty that a partner owes not to act adversely to the interests of
the partnership.
 duty of obedience—A duty that partners must adhere to the provisions of the
partnership agreement and the decisions of the partnership.
 duty to inform—A duty a partner owes to inform his or her co-partners of all
information he or she possesses that is relevant to the affairs of the partnership.
 entity theory—A theory that holds that partnerships are separate legal entities that
can hold title to personal and real property, transact business in the partnership
name, sue in the partnership name, and the like.
 express partnership—General partnership created by words, either verbal or
written.
 general partnership—An association of two or more persons to carry on as co-
owners of a business for profit [UPA § 6(1)].
 implied partnership—General partnership implied from the conduct of the parties.
 indemnification—Right of a partner to be reimbursed for expenditures incurred on
behalf of the partnership.
 joint and several liability—Partners are jointly and severally liable for tort
liability of the partnership. This means that the plaintiff can sue one or more of
the partners separately. If successful, the plaintiff can recover the entire amount
of the judgment from any or all of the defendant-partners.
 joint liability—Partners are jointly liable for contracts and debts of the
partnership. This means that a plaintiff must name the partnership and all of the
partners as defendants in a lawsuit.
 judicial decree of dissolution—Order of the court that dissolves a partnership. An
application or petition must be filed by a partner or an assignee of a partnership
interest with the appropriate state court; the court will issue a judicial decree of
dissolution if warranted by the circumstances.
 management—Unless otherwise agreed, each partner has a right to participate in
the management of the partnership and has an equal vote on partnership matters.
 partner’s interest—A partner’s share of profits and surplus of the partnership.
 partnership agreement—A written partnership agreement that the partners sign.
Also called articles of partnership.
 partnership at will—A partnership with no fixed duration.

183
Chapter 16

 partnership capital—Money and property contributed by partners for the

permanent use of the partnership.
 partnership for a term—A partnership with a fixed duration.
 partnership property—Property that is originally brought into the partnership on
account of the partnership and property that is subsequently acquired by purchase
or otherwise on account of the partnership or with partnership funds.
 Uniform Partnership Act (UPA)—Model act that codifies partnership law. Most
states have adopted the UPA in whole or in part.
 winding-up—Process of liquidating the partnership’s assets and distributing the
proceeds to satisfy claims against the partnership.
 wrongful dissolution—When a partner withdraws from a partnership without
having the right to do so at that time.
 wrongful dissolution—When a partner withdraws from a partnership without
having the right to do so at that time.
 certificate of amendment—A document that keeps the certificate of limited partnership
current.
 certificate of limited partnership—A document that two or more persons must execute
and sign that makes the limited partnership legal and binding.
 certificate of registration—A document permitting a foreign limited partnership to
transact business in a foreign state.
 decree of judicial dissolution—A decree of dissolution that is granted to a partner
whenever it is not reasonably practical to carry on the business in conformity with the
limited partnership agreement.
 defective formation—Occurs when (1) a certificate of limited partnership is not properly
filed, (2) there are defects in a certificate that is filed, or (3) some other statutory
requirement for the creation of a limited partnership is not met.
 domestic limited partnership—A limited partnership in the state in which it was formed.
 foreign limited partnership—A limited partnership in all other states than the one in
which it was formed.
 limited liability partnership (LLP)—A special form of partnership where all partners are
limited partners and there are no general partners.
 limited liability partnership (LLP)—A type of partnership that has no general partner.
All partners have limited liability.
 limited partnership agreement—A document that sets forth the rights and duties of the
general and limited partners; the terms and conditions regarding the operation,
termination, and dissolution of the partnership; and so on.
 limited partnership—A special form of partnership that has both limited and general
partners.
 limited partnership—A type of partnership that has two types of partners: (1) general
partners and (2) limited partners.
 revised uniform limited partnership act (RULPA)—A 1976 revision of the ULPA that
provides a more modern comprehensive law for the formation, operation, and dissolution
of limited partnerships.
 agreement of conversion—Document that states the terms for converting an existing
business to an LLC.
 articles of organization—The formal documents that must be filed at the secretary of
state’s office of the state of organization of an LLC to form the LLC.

184
 Sole Proprietorships, Partnerships, and Limited Liability Companies

 articles of termination—Document that is filed with the secretary of state that terminates
the LLC as of the date of filing or upon a later effective date specified in the document.
 at-will LLC—An LLC that has no specified term of duration.
 certificate of interest—Document that evidences a member’s ownership interest in an
LLC.
 derivative action—A lawsuit that a member may bring against an offending third party on
behalf of his or her LLC when the LLC fails to bring the lawsuit or a request of the LLC
to do so is excused.
 direct lawsuit—A lawsuit that a member can bring against an LLC to enforce his or her
personal rights as a member.
 distributional interest—A member’s ownership interest in an LLC that entitles the
member to receive distributions of money and property from the LLC.
 distributional interest—The ownership interest that a member has in an LLC.
 duty of care—A duty owned by a member of a member-managed LLC and a manager of
a manager-managed LLC to not engage in (1) a known violation of law, (2) Intentional
conduct, (3) reckless conduct, or (4) grossly negligent conduct that injures the LLC.
 duty of loyalty—A duty owned by a member of a member-managed LLC and a manager
of a manager-managed LLC to be honest in his or her dealings with the LLC and to not
act adversely to the interests of the LLC.
 legal entity—An LLC is a separate legal entity – an artificial person – that can own
property, sue and be sued, enter into and enforce contracts, and such.
 limited liability company (LLC)—An unincorporated business entity that combines the
most favorable attributes of general partnerships, limited partnerships, and corporations.
 limited liability company codes—State statutes that regulate the formation, operation, and
dissolution of LLCs.
 limited liability—Members are liable for the LLC’s debts, obligations, and liabilities only
to the extent of their capital contributions.
 manager-managed LLC—An LLC that has designated in its articles of organization that it
is a manager-managed LLC.
 Member—An owner of an LLC.
 member-managed LLC—An LLC that has not designated that it is a manager-managed
LLC in its articles of organization.
 operating agreement—An agreement entered into among members that governs the
affairs and business of the LLC and the relations among members, managers, and the
LLC.
 statement of disassociation—A document filed with the secretary of state that given
constructive notice that a member has disassociated from an LLC.
 term LLC—An LLC that has a specified term of duration.
 Uniform Limited Liability Company Act (ULLCA)—A model act that provides
comprehensive and uniform laws for the formation, operation, and dissolution of LLCs.
 winding-up—The process of preserving and selling the assets of the LLC and distributing
the money and property to creditors and members.
 wrongful disassociation—Occurs when a member withdraws from (1) a term LLC prior
to the expiration of the term or (2) an at-will LLC when the operating agreement
eliminates a member’s power to withdraw.
 apparent agency—Agency that arises when a franchisor creates the appearance that a
franchisee is its agent when in fact an actual agency does not exist.

185
Chapter 16

 chain-style franchise—The franchisor licenses the franchisee to make and sell its
products or distribute services to the public from a retail outlet serving an exclusive
territory.
 distributorship franchise—The franchisor manufactures a product and licenses a retail
franchisee to distribute the product to the public.
 Federal Trade Commission (FTC)—Federal government agency empowered to enforce
federal franchising rules.
 franchise agreement—An agreement that the franchisor and the franchisee enter into that
sets forth the terms and conditions of the franchise.
 franchise—Established when one party licenses another party to use the franchisor’s
trade name, trademarks, commercial symbols, patents, copyrights, and other property in
the distribution and selling of good and services.
 FTC franchise rule—A rule set out by the FTC that requires franchisors to make full
presale disclosures to prospective franchisees.
 processing plant franchise—The franchisor provides a secret formula or process to the
franchisee, and the franchisee manufactures the product and distributes it to retail dealers.
 trademarks and service marks—A distinctive mark, symbol, name, word, motto, or
device that identifies the goods or services of a particular franchisor.
 uniform franchise offering circular (UFOC)—A uniform disclosure document that
requires the franchisor to make specific presale disclosures to prospective franchisees.
 wrongful termination—Termination of a franchise without just cause.

186