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Chapter 21

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Law and Business
LAW 603
George Ellinidis

Sept. 11 2012 Chapter 21: Basic Forms of Business Organizations Introduction  Business organizations law determines the extent to which individual entrepreneurs benefit and to what extent they are responsible for the losses o Also addresses risk that other stakeholder groups experience un their relationships with the business (only to a limited extent) o Ex: for creditors of a business organization the law governs when a business is bound by the contract that creates the obligation to the creditor o Provides structure for the operation of the business, focusing on relationships o Establishes rights and obligations by owners to manage business and monitor and control those who manage on their behalf o Addresses the risks that business owners face as a result of actions by managers Sole Proprietorships  Sole Proprietorships – exists when a person carries on business on their own, without adopting any other form of business organization o If you enter into a contract to employ someone, you are still the only person responsible for the business’s obligations o There is no separation between the sole proprietorship business organization and the individual who is the sole proprietor o You cannot be an employee of the business because you cannot contract with yourself  The SP is exclusively responsible for performing all contracts  The SP is exclusively responsible for all torts committed personally in connection with the business and vicariously liable for all torts committed by employees  The income or loss from the SP is included with the income or loss from other sources in calculating the sole proprietor’s personal tax liability  Main advantage: easy to set-up and dissolve  In order to dissolve, simply stop carrying on the business o However, this does not excuse you from any obligations made during business  Main disadvantage: unlimited personal liability o Unlimited Personal Liability – third parties may take all of the sole proprietor’s personal assets to satisfy the business’s obligations  Many try to manage liability risk through contracts and insurance, but usually incorporation is a less expensive and more effective strategy o Limited financing options - raising funds is also difficult since money must be borrowed directly by the SP Legal Requirements for Sole Proprietorships  Name must be registered if it is something other than the proprietor’s personal name o Must be done in every province where the company conducts business o Does not create any ownership interest in the business name  Business license is necessary for some types of activities  Business License – government permission to operate a certain kind of business o Ex: taxi drivers, restaurants, real estate, car dealerships, securities brokers etc. [Type text] General Partnerships  General Partnership – a form of business organization that comes into existence when two or more persons carry on business together with a view to a profit o Arises automatically by operation of law, when a relationship meeting these criteria begins o No formalities are required, but may have to register name and obtain a license Characteristics of General Partnerships  Partnerships not legally separate from the partners o A partner cannot be employed by the partnership o All benefits of the partnership accrue directly to the partners o All partners are personally liable for all of the obligations of the business, even if they did not personally consent to them  Including torts committed by a partner or employee  Liable to the full extent of the obligation – all of a partner’s personal assets may be seized to satisfy a partnership debt (unlimited personal liability) o Creditworthiness of partnership is based on creditworthiness of partners  Share of income (or loss) is allocated to each partner according to the partner’s entitlement to share in the profits of the business o Must be included in personal income, even if profits were re-invested in business Partnership Legislation and Partnership Agreements  Based on English Partnership Act of 1890 in all provinces except Quebec o Does not provide a satisfactory set of rules  Many use a Partnership Agreement – a contract between partners regarding the operation of the partnership o Legal issues usually resolved on the basis of the legislation and partnership agreement Creating a Partnership  When two or more persons carry on business together with a view to a profit  Hard to tell when if a partnership relation exists; many factors: o Most important: sharing of profits  When you have a financial stake in the management of the business though sharing profits, a court is likely to find that the business carried on for your benefit and that you are a partner in the business  Can share profits without carrying on business  Loan is to be repaid out of profits  Employee’s remuneration varies with employer’s profits (profit-sharing arrangement)  Purchaser of a business agrees to pay some of business’s profits to seller o Carrying on business together suggests the existence of an enduring relationship  May arise even in relation to a single, time-limited activity o Less likely if people involved were merely passive investors  Ex: jointly own an apartment building and collect rent o A person who describes themselves as a partner or allows someone else to do so  Permits their name to be used as part of the firm name o Sharing responsibility for losses, including guaranteeing partnership debt o Jointly owning property o Participating in management, including having signing authority for contracts and bank accounts, and enjoying access to information regarding the business [Type text] Risk and Liability in General Partnerships  Provincial partnership statutes determine when a partnership incurs liabilities  Each partner is an agent of the partnership when acting in the usual course of the partnership business o An exception exists if a partner did not have the authority to act in a particular way and the other party knew that the partner lacked authority  Places risk of unauthorized behaviour by one partner on all partners o Partners also liable for torts (including negligence) Managing the Risk that a Business Relationship Will Be Found to Be a Partnership  Partners have unlimited personal liability for the obligations of the firm, including liability for unauthorized acts and torts of the partners that bind the firm o Entrepreneurs risk it because they share in profits and write off losses o Lenders will want to avoid these risks  Insist that the contract governing the relationship states that the relationship is not a partnership  Not enough - Courts will consider how parties actually acted  Negotiate to restructure the business organization so it’s not a partnership  Insist upon sufficient compensation to reflect any residual risk that you will be found to be a partner  Do not enter the relationship without consulting with a lawyer Managing Liability Risk if You Are a Partner a) Each partner owes a fiduciary duty to the others o Fiduciary Duty – requires a partner to act honestly and in good faith with a view to the best interests of the partnership o Partners must never put their personal interests ahead of the partnership’s o A partner is prohibited from competing with the partnership or using the name, property or business reputation to obtain a personal benefit o A partner who breaches fiduciary duty must pay any resulting profits to the partnership b) Partnership agreement can be used to manage the risk of liability o Authority of partners can be limited and subject to control and monitoring o Note: when a partner fails to follow the rules and creates a liability to a third party, the firm may still be liable o Right of Indemnification – when a liability is created by a partner in breach of the partnership agreement requirements, the agreement may require the offending partner to compensate the others for any amount that they must oat to a third party  Minimize risk by holding the partnership interest in a corporation, limiting liability through contract or insurance c) Practical steps o Natural relationship of trust and confidence – small number of people who know each other very well o Informal monitoring through daily interaction  Protection breaks down as business expands o Limited Liability Partnerships – individual partners are not personally liable for the professional negligence of their partners and some other obligations if certain requirements are met  Accountants and lawyers  Partnership remains liable for all obligations [Type text] Managing Liability Risk When You Are Not a Partner  Not liable for liabilities that occurred before you joined or after you left o May be liable if you hold yourself out or allow someone else to do so o Holding Out – when you represent yourself as a partner or allow someone else to do so o Ex: bank can seek repayment from you if it relied on your apparent membership in the firm when deciding to make the loan o Allowing your name to appear on letterheads, invoices or business signs makes you liable  However, cannot be held liable if you carelessly failed to realize that your name was associated with the firm  Issues of holding out usually arise after a partner leaves a firm. Concerned about: o Clients who dealt with the firm prior to your departure – you will continue to be liable to them until they learn of your departure  Give them actual notice of departure  Ensure your name is removed from partnership registration filed with provincial government  Notice published in local newspaper (if notice to each client is impractical) o Clients who deal with the firm for the first time after your departure or who never knew you were a member of the firm – cannot hold you liable unless you were held out to be a partner at the time of business  Publishing your departure in the Ontario Gazette is enough to avoid liability  You should allow the firm to continue using your name only if the partnership agrees to indemnify you for any liabilities as a result Internal Organization of the Partnership  Default Rules – kind of standard form agreement in partnership statutes for the internal organization of a partnership that apply unless the partners agree to some other agreement o What each partner will do for the business, what their entitlement to profits will be etc. o Default rules give partners great flexibility to c
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