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Business Entity Implications for Contracts

Yuleydis Darrigo
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Business Entity Implications for Contracts

Contract Creation and Negotiation for the Most Common Types of Business Entities

First of all, it should be noted that “the most common types of business are a sole

proprietorship, partnership, corporation, and limited liability company (LLC)” (Internal Revenue

Service, n.d., par. 1). The sole proprietorship is considered to be the simplest type of business

entity (Miller & Cross, 2018). An individual who has started a sole proprietor business negotiates

for contractual issues. Meanwhile, the nature of a partnership business entity implies that one of

the partners, either at the instruction of other partners or in order to run the day-to-day

operations, can initiate contract creation and negotiation. By contrast, the nature of a corporation

implies that a board of directors who are often the owners of a business, besides shareholders,

negotiate for contractual issues thereby, deciding and controlling business operations. Finally,

when it comes to a member-managed LLC, members of this type of business entity are

responsible for contract creation and negotiation (Skripak, 2016).

Contract Approval for the Most Common Types of Business Entities

An individual who has started a sole proprietor business accepts or rejects a contract offer

and signs all contracts associated with running the business (Ibid). When it comes to the

corporation, contract approval is the responsibility of a board of directors while the CEO or the

Vise President sign contracts. In LLC, generally, a contract must be signed by all its members

unless otherwise is stated in an operating agreement (Skripak, 2016). However, the situation is

different in the general partnership type of business. One partner in the general

partnership is free to contract with a legal entity without the need for obtaining a clearly

communicated approval from the other partners (Justia, n.d.). At that, if one partner

contracts with a legal entity, the partnership as a whole, is bound to a contract. Therefore,
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the ability of one partner in the general partnership to decide whether to contract is one of

the drawbacks of this type of business entity (MacBethm, 2021).

Contract Liability for the Most Common Types of Business Entities

An individual who has started a sole proprietor business is solely liable for any contract

signed. In other words, “the proprietor alone bears the burden of liabilities incurred by the

business enterprise” (Miller & Cross, 2018, p. 353). Moreover, in case of a lawsuit against the

sole proprietor's business or staff, the sole proprietor can bear unlimited personal legal liability.

Therefore, the disadvantage of this type of business entity in the context of contract liability is

that the business owner is solely responsible for any contract signed, and creditors can "use"

his/her personal assets (e.g., a real estate) to cover the proprietor's business debts. On the other

hand, the advantage of the sole proprietor business in the context of contract liability is that

business debts can be higher than the cost of the proprietor’s personal assets (Lawrence, n.d.).

Consequently, the business owner cannot lose more than he/she owns.

As regards the partnership, each partner is legally answerable for the breach of

contract. That is to say, a third party sues not an individual partner but all the partners.

Also, if a third party wants to sue only one of the partners, he/she has the legal right to

request the other partners to stand trial for breach of contract with him/her. An individual

partner, however, can bear the responsibility for the full amount. It should be noted that

the disadvantage of this type of entity associated with contract liability is that each of the

partners is personally liable for the financial obligation of the partnership (Miller & Cross,

2018). Importantly, most states impose unlimited liability upon each of the partners

because “the acts of one partner in the ordinary course of business subject the other

partners to personal liability” (Ibid, p. 359). That said, the advantage of the partnership in
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the context of contract liability is that creditors do not pursue the personal assets of the

partners if the partnership has at least some assets.

Meanwhile, individuals that own the corporation are not generally personally liable for

financial obligations/debts of this type of business entity beyond the extent of the amount of their

investment. Therefore, "one of the key advantages of the corporate form is the limited liability of

its owners" (Miller & Cross, 2018, p. 388). However, the disadvantage of the corporate in the

context of contract liability is that in some situations, a court pierces the corporate veil or, in

other words, puts aside limited liability and imposes personal liability on the owners

(shareholders) of the corporation for breaching of contracts by this type of business entity (Ibid).

Finally, members of the LLC do not bear personal liability if the LLC as an entity

breaches a contract. If acts committed by the LLC members lead to a breach of contract,

the LLC, rather than its members, is held liable for that. Consequently, one could state that

"a key advantage of the LLC is the limited liability of its members" in the context of

contract liability (Ibid, p. 373). Furthermore, there are some hidden pitfalls of the limited

liability of the members of this type of business entity, though. If, for example, a member of

the LLC signed a contract but did not include either his/her title (e.g., Chief Financial

Officer) or the name of the LLC, claims against the member individually could be filed

(Hanley & Koo, 2013).

The Effects of the Type of Business Entity on the Ability to Contract for the Sale of

the Business

An individual who has started a sole proprietor business has the legal right to sell his/her

business to another party whenever he/she deems appropriate. At that, there is no need for the

sole proprietor to seek approval for his/her decision from anyone else (Miller & Cross, 2018).
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It is important to note that because the sole proprietorship is neither separated from its

owner nor has its own separate identity, this type of business cannot be simply sold or

transferred. However, because the sole proprietor personally owns his/her assets, he/she

has the right to sell all assets to another person or legal entity (Bodniowycz, n.d.).

When it comes to the partnership, the partnership, like the sole proprietorship, is

the entity that is not separated from its owners. There are two forms of selling the partnership

business. All the partners decide to sell their partnership interests as an integral whole to another

party. One of the partners decides to dissociate, and the partnership purchases his/her interest. In

other words, the partner who decides to dissociate sells his/her share to the partnership. It

should be pointed out that a partnership interest is a separate intangible asset that can be

viewed as corporate stock. By selling his/her partnership interest, the partner sells his/her

share of the profits and material losses of the partnership (Nitti, n.d.)

It must be said that if one of the partners decides to dissociate, there is no need for

him/her to see approval for his/her decision from the other partners unless otherwise is stated in

the partnership agreement (Wolf, n.d).

Meanwhile, owners of the corporation have the ability to sell their share in the company

(stock) at any time. No one else's approval for their decision is needed. Finally, the sale process

of the LLC is almost the same as the sale process of the partnership. The only difference is that

the members of the LLC must refer to Operating Agreement (Miller & Cross, 2018)
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References

Bodniowycz, J. (n.d.). How to sell a sole proprietorship. LegalZoom.com, Inc. Retrieved from

https://info.legalzoom.com/article/how-sell-sole-proprietorship#:~:text=Because%20a

%20sole%20proprietorship%20only,to%20another%20person%20or%20entit

DuBoff, L. D. (2004). The law (in plain English) for small business. Naperville, IL: Sphinx

Publishing.

Justia (n.d.) Business ownership structures. Partnerships. Retrieved from

https://www.justia.com/business-operations/starting-your-own-business/business-

ownership-structures/partnerships/

Hanley, J., & Koo, J. (2013). Limited liability company considerations for conducting

business: A top five list. Carter Ledyard & Milburn LLP. Retrieved from

https://www.clm.com/publication.cfm?ID=386

from https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

Internal Revenue Service (n.d.). Business structures. The Internal Revenue Service. Retrieved

Lawrence, G. (n.d.). What kind of liability does the owner of a sole proprietorship have? The

Houston Chronicle. Retrieved from

https://smallbusiness.chron.com/kind-liability-owner-sole-proprietorship-have-

20636.html

MacBeth, L. (2021). Capella University. BUS-FP3021 Fundamentals of Business Law. Business

entity implications for contracts. Instructor feedback.

Miller, R. L., & Cross, F. B. (2018). The legal environment of business: Text and cases (10th

ed.). Boston, MA: Cengage.

Nitti, A. (n.d.). Sale and purchase of a partnership interest. Wolters Kluwer. Retrieved from
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https://answerconnect.cch.com/topic/5596d3087c6b1000b5bb90b11c2ac4f102/sale-and-

purchase-of-a-partnership-interest

Skripak, S.J. (2016). Fundamentals of business. Pamplin College of Business and Virginia Tech

Libraries. Retrieved from

https://vtechworks.lib.vt.edu/bitstream/handle/10919/70961/Chapter%205%20Forms

%20of%20Business%20Ownership.pdf?sequence=10&isAllowed=y

Wolf, K. (n.d.). Selling a Partnership or LLC business. Wolters Kluwer. Retrieved from

https://answerconnect.cch.com/topic/bad7f5b07d171000a13190b11c18c902012/selling-

a-partnership-or-llc-business#:~:text=Analyst%2C%20Wolters

%20Kluwer-,Overview,remaining%20property%20to%20the%20partners.