CHAPTER 12
BUSINESS ORGANIZATIONS
Forms of business organization used most frequently are sole proprietorships, partnerships,
limited partnerships, limited liability companies, and corporations. Less frequently used are joint
ventures, cooperatives, and syndicates. Business organizations are governed largely by state
laws. Statistically, sole proprietorships predominate in terms of numbers but represent 4% of all
business receipts (but 20% of profits). Corporations, about 20% of the businesses, take in about
87% of all receipts. Partnerships are 8% of all businesses and take in 11% of receipts.
SOLE PROPRIETORSHIPS—Sole proprietorships, the oldest form of business organization,
may begin without formality in businesses that do not require a license or permit. Some states
require that the business name be registered. Since the “owner is the business” capital must come
from the owner’s own resources. Profits are taxed to the owner, so no specific tax return may be
required for the business. (Note: Due to complexity, little attention is given to tax treatment of
business forms in this text.)
Add. Case: Holberg & Co. v. Citizens National (Ct. App., Tx., 1993)–Holberg & Co. was a
sole proprietorship owned by Robert Holberg. He sold insurance for Citizens and paid Citizens
the premiums less his commission. The two got into a dispute. The court awarded Citizens
$94,305 plus costs against Holberg & Co. and Holberg personally. Holberg appealed, arguing
that he could not be bound by a judgment against the proprietorship.
Decision: Affirmed. Holberg’s attorney represented Robert Holberg and Holberg & Co. because,
Add. Case: C&J Builders, LLC v. Geisenheimer (Sup. Ct., Conn., 1999)–Defendant had a
construction contract with Pageau, who did business as C&J, a sole proprietor. The contract
contained an arbitration agreement. A few months later, while work was ongoing, Pageau
converted C&J into an LLC. Months later, a dispute between C&J and defendant arose. Pageau
submitted his claim to the arbitrator specified in the contract. Defendant refused to cooperate, so
Pageau sued. Defendant claimed that since the contract was with a sole proprietorship, the
arbitration clause was no longer effective once C&J became an LLC. The trial court held for
C&J to compel arbitration. Defendants appealed.
Decision: Affirmed. Statutes on business organizations clearly show intent to “facilitate
seamless transition” between one form of business organization and another, such as a change
from a sole proprietorship to an LLC. “We conclude, therefore, that where a sole proprietorship
PARTNERSHIPS—A general partnership is a business formed by two or more persons who
enter into an agreement (implicitly or explicitly) to carry on a business venture for a profit. The
persons are referred to as partners or general partners. At common law, a partnership was not
considered an independent entity. Thus, the partners had to be sued, not the business. But most
states now provide that the business can be an independent entity. Partnership had its origins in
the common law, but many aspects are now codified in the Uniform Partnership Act.
Forming a Partnership—Although usually created by written agreement, an oral agreement or
a tacit agreement based on the conduct of the parties may form a partnership. A written
agreement generally includes the business name, the ownership interests of the partners, partner
responsibilities, method of accounting, duration of the partnership, and procedures for the
partnership’s dissolution.
CASE: Zhou v. Bickley (Ct. App., KS 2012)—Bickley wanted to run a motorcycle repair shop.
He got Zhou and Zhang to help him rent space, fix it up, and buy inventory. Then he refused to
give them keys to the business or see the books. They asked for their money back and he refused,
saying they were partners and were in breach. The trial court held that Bickely was a proprietor
who borrowed money from Zhou and Zhang and owed it to them. Bickley appealed.
Decision: Affirmed. While the parties worked together for a while, they did not act as partners.
There never was a written agreement and Bickley seemed unclear as to what he was doing in
Questions: 1. The appeals court affirmed that no partnership was ever created; what would have
been necessary for that to happen? Did they need a signed document?
They needed something more. No signed agreement was required, but the fact that Bickley took
money, would never sign an agreement, or even let Zhou and Zhang do anything (except give
2. Suppose they had signed an agreement and the facts were the same. Would Bickley owe
anything then?
Yes; had there been an agreement, his behavior would have breached his fiduciary obligation to
Add. Case: Brown v. Swett and Crawford of Texas (Ct. App., Tex., 2005)—Brown was an
insurance broker who worked with Galtney in a partnership. IBS, a Dallas company, asked
Galtney to start a Houston office for it. He wanted Brown to work with him, so both were hired
to form “Houston Team One” for IBS; they had a formula to split commissions they earned. IBS
later fired Brown. He sued, contending he had been wrongfully expelled from a partnership. The
district court held for IBS; Brown appealed.
Decision: Affirmed. Brown was an employee. He was paid a base salary plus commissions; he
Add. Case: Pieretti v. Silk (Super. Ct., Conn., 1993)–Silk approached Pieretti for expertise in
developing property owned. They discussed a partnership but never formalized an agreement.
Soon after, an offer was made on the property and Pieretti demanded to be included in the
transaction as a partner. When Silk refused, Pieretti sued for a decree finding the existence of a
partnership and directing the parties to finalize terms of the partnership agreement, or, if they
could not agree, a decree stating the terms of the agreement.
Decision: No partnership existed. A partnership is a contract. A contract must have an offer and
acceptance based on mutual understanding; it must be definite and certain as to its terms and
International Perspective: Small Is Not So Beautiful in Japan
Regulations in Japan tends to favor large businesses so that, proportionally, many fewer small
businesses are established there compared to the U.S. This stifles innovation and economic
development, which has contributed to the difficulty Japan has encountered in reviving its
economy. There has been a lot of talk about making the rules less difficult for small business, but
little has changed.
Duty of Partners—A partnership is a relationship based on extraordinary trust and loyalty. It is a
fiduciary relationship requires that each partner act in good faith with personal interests placed
below those of the partnership.
Add. Info: Loyalty—In Meinhard v. Salmon, 164 N.E. 545 (1928), Judge Cardozo held:
“Partners owe to one another…the duty of finest loyalty. Many forms of conduct permissible in a
workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties.
A trustee is held to something stricter than the morals of the market place. Not honesty alone,
but the punctilio of an honor the most sensitive, is then the standard of behavior.” That duty
transfers to successors; if it did not, the value of partnerships would be much lower since
partners could loot the share of dead partners.
Control of Partners—Unless otherwise stated, partners have an equal voice (vote) in partnership
affairs and major decisions require unanimous vote. Although most basic decisions require a
majority vote, day-to-day management is normally delegated to one partner normally referred to
as the managing partner.
Add. Case: Clark v. Lubritz (Sup. Ct., Nev., 1997)–Five doctors formed a partnership for their
practices, agreeing to share equally in profits or losses. They later incorporated. After several
years, Lubritz resigned as an officer, but stayed in the practice. The other doctors cut Lubritz’s
share of the profits, something he did not discover for several years. He sued; the jury awarded
him $196,000 for breach of contract and breach of fiduciary duty, $200,000 punitive damages,
plus attorney’s fees. The other doctors appealed.
Decision: Affirmed. Although the partnership incorporated, it failed to follow the requirements
of state corporation law (annual meeting, etc.). In such cases, the corporate form is ignored and
Termination of the Partnership—Termination requires dissolution; the affairs of the
partnership have been wound up. Dissolution occurs when an event, such as the withdrawal,
bankruptcy, or death of a partner, makes it impossible for the partnership to engage in any new
business. Winding up involves competing any unfinished business, and collecting and
distributing the partnership’s assets.
Add. Case: Caines Landing Wildlife Preserve v. Kirkpatrick (Sup. Ct., Del., 1993)–Caines
Landing was a hunt club for its partners, including Kirkpatrick. It had land and built a lodge.
Kirkpatrick withdrew and requested the return of his $41,000 contribution. The partners offered
him $3,579. The partners also imposed a “capital improvement assessment” of $15,000 to be
paid by all partners, including Kirkpatrick, who sued. The lower court awarded him $11,738
plus interest, the value of his partnership interest as of the date on which the partnership
terminated (when the partners met to consider his withdrawal). The partners appealed.
Decision: Affirmed. Upon dissolution, partners have a duty to wind up affairs. Thus, “a
partnership continues after dissolution only for the purpose of winding up the partnership
affairs, unless the partners agree otherwise.” The partners not only failed to take steps to wind
LIMITED PARTNERSHIP—A limited partnership is a special form of a general partnership.
Like a general partnership, it is made up of two or more persons (called partners) who have
entered into an agreement to carry on a business venture for a profit. However, not all partners in
a limited partnership have limited personal liability.
Forming a Limited Partnership—All states but Louisiana use a form of the Uniform Limited
Partnership Act or the Revised Uniform Limited Partnership Act. Partners must provide a written
agreement (certificate of limited partnership) describing who is involved and what they
contributed and their respective rights and file it with the appropriate state official.
Relationship of the Parties — A limited partnership has at least one general partner and one or
more limited partners. General partners are treated much the same way as a partner in a general
partnership and have the responsibility for management of the business and are personally liable
to partnership creditors. Limited partners do not, and cannot, participate in the day-to-day
management of the limited partnership. They have access to books of the business and participate
in the dissolution of the business. However, they are not liable for the debts or torts of the
business beyond their contributions. Limited partners lose their liability shield and become
general partners by taking an active role in the management of the company, including taking
control of the business, contributing services, or allowing their names to appear in the name of
the business.
CASE: Eagles Landing Development v. Eagles Landing Apartments (Ct. App., TN 2012)—
ELD contracted to build apartments for ELA, a partnership with a general partner and two
limited partners. The general partner’s contribution would not exceed the net cash flow from
apartment rentals, but the deal was a mess with little cash but unpaid construction costs. ELD
sued the limited partners to cover the unpaid costs and the trial court held for ELD. ELA
appealed.
Decision: Reversed. Under the Uniform Partnership Act and the Limited Liability Partnership
Questions: 1. Does this decision mean Eagles will collect none of the $931,000 it is owed?
We don’t know. It is still owed that amount by ELA, the limited partnership. But the general
partner, Bluff City, cleverly restricted its liability, in the contract with Eagles, only to net cash
2. How could Eagles have protected itself better regarding PNC and Columbia?
Even though they are limited liability partners, either one could have agreed to serve as surety on
the deal, but they did not, so regardless of how much those entities are worth, they owe nothing.
Add. Case: Carella v. Scholet (App. Div., NY, 2004)–The Scholets owned a building they used
for a furniture store. To raise cash, they set up a limited partnership with the building as the
asset, which was leased back to the furniture business. The Scholets, as managing general
partners of the limited partnership, sold the building for a bargain price to their son. The limited
partners essentially got nothing. They sued for breach of fiduciary duty. Trial court held for the
Scholets; partners appealed.
Decision: Affirmed. The LP agreement specifically stated that the partners consented to “any
sale” of the building that the general partners wanted. That was what happened. The agreement
Add. Case: Northampton Valley Const. v. Horne-Lang (Super. Ct., Pa., 1983)–Northampton
installed a sewer system Horne’s land, but Horne was unable to pay. Northampton sued Horne
for breach of contract for nonpayment. Horne was a limited partnership with a general partner
and 18 limited partners. Northampton alleged that the limited partners were actually general
partners and were personally liable. Court dismissed the suit and Northampton appealed.
Decision: Affirmed. A creditor may pursue a claim against a limited partner as a general partner
only in limited circumstances, such as when the limited partner takes part in control of the
Add. Case: Remenchik v. Whittington (Ct. App., Tx., 1988)–Remenchik and others were
limited partners in an office building. The LPs contributed $48,000 in exchange for a 48% of the
profits of the building. General partner Whittington contributed services in exchange for 52%.
His services included getting the building built and leasing or selling it. The building was built
by a contractor, Evans, a friend of Whittington. After years of no profits, the limited partners
audited the books and discovered that Whittington overpaid Evans by $275,000. Evans had paid
$150,000 of that to Whittington. The limited partners sued Evans for fraud and Whittington for
fraud and for breach of fiduciary duty.
Decision: The court held Evans and Whittington jointly and severely liable for the $275,000.
Whittington violated his fiduciary duty to the limited partners and was personally liable to them
Add. Case: Dixon v. Trinity Joint Venture (Ct. App., Md., 1981)–Dixon was general partner
and manager of a limited partnership, Trinity. He bought a parcel of land for himself, earning a
profit of $60,000 on the deal that would have been a natural to have been bought for Trinity,
given the location of the land and the purpose of Trinity. The LPs sued Dixon for breach of
fiduciary duty and won at trial. Dixon appealed.
Decision: Affirmed. As general partner, he had a duty to inform the LPs of the business
opportunity. If they did not care about the opportunity and had no objection to Dixon’s purchase,
it would have been ok. “Every partner must account to the partnership for any benefit, and hold
Issue Spotter: Brotherly Love?
You have a general partnership. This was never discussed, but that is what it is. You have a
fiduciary duty to each other, so your brother should not have taken money for personal use
without permission. He can tell you to make it even by taking a similar amount of money. Time
to think about how to handle finances. Legal status aside (you don’t want to sue each other, you
need to hash out how to handle the money, etc.). Since it is a joint account, he could clean it out
and there would not be much you could do, so perhaps two signatures should be required on the
checks. A client could get hurt and sue–you have potentially unlimited personal liability, so better
think about insurance. Perhaps you should consider another legal form of business, such as an
LLC. Indeed, the judo and yoga could each be handled apart from each other. Many family
businesses float along until something blows up, at which point it can be too late to undo the
damage.
Terminating a Limited Partnership—Like a general partnership, a limited partnership is
terminated through the dissolution and winding up process. It is terminated by the death,
bankruptcy, or withdrawal of the general partner but not a limited partner. Upon the distribution
of assets, the creditors are first, then the limited partners receive their capital contributions, and
finally the general partners.
CORPORATIONS—Although businesses have produced and traded goods for thousands of
years, the modern corporation is a more recent development, arising in the U.S. during the 1700s.
State legislatures issued corporate charters to selected businesses. A charter might give a business
an exclusive privilege of having the only bank in a town. In this way, monopoly power became
associated with early corporate charters. It was not until the late 1800s that the first “liberal”
general incorporation act was enacted. The statutes established a simple and standardized
procedure to be followed for a business to become incorporated. Incorporation was made
available to virtually all businesses regardless of their field of operation or size. No special
privileges attached to charters.
Creating a Corporation—The requirements for incorporation are relatively simple. The articles
of incorporation, along with an application, must first be filed with the appropriate officer of the
state, usually the secretary of state. The articles of incorporation must generally provide the
following:
1. Name of the corporation.
2. Address of the corporation and name of its registered agent at that address.
3. Purpose of the business.
4. The class(es) of stock to be issued and their par value.
5. Names and mailing addresses of the incorporators.
After reviewing the application for completeness, the state issues a certificate of incorporation or
corporate charter. Incorporators often wait until the state issues the charter before holding their
first organizational meeting at which they elect the first board of directors, enact the
corporation’s bylaws, and issue the corporation’s stock. The shareholders, directors, and officers
of the corporation are required to abide by the bylaws in conducting corporate business activities.
Add. Case: Boyer v. Jones (Ct. App., Calif., 2001)– Lone Star was incorporated in California.
In 1996, the Secretary of State suspended the corporation for failure to file annual statements
and to file tax returns. In 1999, the owners of the corporation filed annual statements, tax
returns, and paid all penalties. The owners were informed that because the corporation had been
suspended, it was not a legal entity and the Secretary had granted the name Lone Star to another
party. The owners sued the Secretary to restore the name to them and to revoke the use of the
name by the other party. The court held the Secretary acted properly. The owners appealed.
Decision: Affirmed. The name of a suspended corporation may be adopted by another
corporation at the discretion of the Secretary of State. Consent of the suspended corporation is
Legal Entity Status—Unlike proprietorships and, in most instances, partnerships, the corporation
is recognized under federal and state law as a legal entity–a “person” that enjoys many of the
same rights accorded citizens. Corporations are entitled to many constitutional protections.
However, although the officers and employees of a corporation enjoy the privilege against
self-incrimination under the Fifth Amendment, the corporation itself does not.
Add. Case: Safiedine v. City of Ferndale (Ct. App., Mich., 2008)– Jamal Safiedine, of Arabic
origin, manages a gas station in Ferndale, Michigan. The station is owned by a corporation
owned by Safiedine and members of his family. He sued the City of Ferndale for violating the
Michigan Civil Rights Act (CRA). He claimed that Ferndale police officers made discriminatory
comments to Safiedine and dissuaded customers from patronizing his gas station. He contended
that the discrimination was based on is Arabic national origin and his Islamic religion. The trial
court dismissed the suit; Safiedine appealed.
Decision: Affirmed. The CRA’s antidiscrimination provisions protect natural persons, not
juridical persons such as corporations. Since the discrimination was alleged to have been
Close and Public Corporations—A close or closely held corporation is one that has a limited
number of shareholders and the stock is not publicly traded; this may be to satisfy SEC rules,
discussed in Chapter 20, or may be for purposes of controlling who ends up with stock in their
possession. Public corporations are those that allow corporate stock to be openly exchanged,
whether or not it is traded on a stock exchange.
Add. Case: Ironite Products Co. v. Samuels (Ct. App., Mo., 1998)—Irwin Fox and Alvin
Samuels founded Ironite. There were bylaws, but in practice they shared control equally. Years
later, they invited their sons, Richard Fox and Mark Samuels, to join them. Richard drafted new
bylaws. Alvin made some changes and approved. Later, Irwin died and Richard took his place.
They invited an independent director to join the board so votes could not be split 50-50. Fights
broke out. The board now voted to pay Richard more than Mark. The Samuels sued, contending
the original agreement from the founding should govern the company with 50-50 control, no
outside board member could control the outcome of split decisions. The trial court held for the
Samuels. Richard appealed.
Decision: Reversed. The original bylaws were contrary to the way the parties apparently ran the
company before the new bylaws were drafted. The oral agreement that Irwin and Alvin
Relationship of the Parties—A corporation legally consists of three primary groups: the
shareholders, the board of directors, and the managers.
Shareholders—The owners of the corporation. They have a limited right to inspect the
corporation’s books and records. Unless stated to the contrary on the stock certificate,
shareholders are not restricted from transferring the stock to someone else. Shareholders do not
have the legal authority for day-to-day management of the corporation, but they elect the board
of directors and vote on matters that may affect a change in the corporation’s structure or
existence. Elections take place at the shareholder meeting, which generally must be held
annually. Shareholders have no legal relationship with creditors of the corporation. A
shareholder’s obligation to creditors is limited to the capital contribution made, usually the
amount paid to buy the stock.
Board of Directors—The initial board is specified in the articles of incorporation or designated
by the incorporators at the first meeting. Then the selection of directors is a shareholder
responsibility. Board functions include making basic corporate policy, such as the sale of
corporate assets, entrance into new product lines, major financing decisions, appointment and
compensation of corporate officers, and approving labor-management agreements.
Directors are the principals of a corporation; hired managers are their agents. Elected by
shareholders, directors are not instructed by the shareholders. Directors are under a duty of care
to conduct themselves in the same manner as a reasonably prudent person in the conduct of
personal business affairs. Directors are subject to a fiduciary duty of loyalty.
Business Judgment Rule–Honest mistakes in judgment that do not result from negligence do not
result in personal liability. Courts give directors and managers the benefit of the doubt, and not
impose liability, by applying the business judgment rule to honest mistakes in judgment.
Fiduciary Duty—Directors must place the interests of the corporation before personal interests.
They are expected to make decisions purely on the merits for the business itself, not taking into
account other business interests.
CASE: Storetrax.com v. Gurland Ct. App., Mary., 2007)—Gurland founded Storetrax.com. He
became president and member of the board. His agreement said that if he was fired, he received
one year’s pay. Two years later he was fired. The board would not pay the severance because it
would be a conflict of interest given his duties as board member. Gurland sued and won. The
company appealed.
Decision: Directors have a fiduciary relation to the corporation to perform their duties in good
faith, in the best interest of the company, and with the care of a prudent person. They work for
the benefit of the company, not their personal interest. When there is a conflict of interest, such
Questions: 1. The Maryland high court held that a director did not breach his fiduciary duty by
suing his own company board to fulfill a contractual obligation. Would it be good to have a rule
that directors cannot do business with companies when they are board members?
That is not realistic. Most corporations are small and people play more than one role in them.
2. Is there some way Gurland could cheat the company in this situation that he could not if he
had not been on the board?
That should make no difference. The board should treat him like any other contracting party, and
Add. Case: Alessi v. Beracha (Chan. Ct., Del., 2004)– Earthgrains made an offer to
shareholders of less than 100 shares to buy them without the usual high commissions on such
odd lots. While the buying occurred, Earthgrains was negotiating to be sold to Sara Lee, which
happened right after the stock buy back was finished. The price of the stock went from $25 to
$40, so the small sellers lost out on the premium and sued the board for breach of fiduciary duty
for not explaining about the possible merger. The directors moved to dismiss the case.
Decision: The case will proceed. The fact that negotiations are often secret does not mean the
directors were not aware of how it would affect stock prices and the shareholders. There is no
Add. Case: McCall v. Scott (6th Cir., 2001) Background: Shareholders sued directors of a
corporation for breach of fiduciary duty for insider trading. The court dismissed their suit. The
appeals court reversed and remanded to the lower court. Here the appeals court clarified the
law regarding shareholders’ complaints about disregard of known risks by directors.
Decision: Under Delaware law, liability on the part of a director for breach of duty to exercise
appropriate attention to potentially illegal corporate activities may arise 1) from a board
decision that resulted in a loss because the decision was ill-advised, or 2) from an unconsidered
Add. Case: Shlensky v. Wrigley (App. Ct., Ill., 1968) Background: Phil Wrigley, majority
owner and president of the Chicago Cubs refused to install lights at Wrigley Field, which forced
the Cubs to play all games during the day. A minority shareholder sued, contending that Wrigley
breached his duty to maximize the profitability and success of the club, which, he contended,
would be enhanced by lights that would allow night baseball as existed in all other cities. Trial
court dismissed; Shlensky appealed.