Environmental Engineering Chapter 19 Management Duties Partners Have Fiduciary Duty The

Unlock access to all the studying documents.

View Full Document

Chapter 19

STARTING A BUSINESS: LLCs AND

OTHER OPTIONS

Suggested Additional Assignments

Interview: Entrepreneur

Student could interview an entrepreneur to ask why he or she chose a particular form of business. Did the

selections? Or did they “fall into” a choice such as sole proprietorship or corporation without thinking?

Research: Costs of Forming a Business Organization

Ask students to find out how much it costs in your state to form different types of organizations. They

Research: Close Corporation Statutes

Ask students to find out whether your state has a close corporation statute. Must a corporation elect to be

treated as a close corporation, or can any corporation take advantage of the special provisions if it meets

the statutory requirements?

Research: Franchise Offering Circulars

Ask students to obtain an offering circular for a franchise. They can order one from a franchisor that

Research: Joint Ventures

Have students prepare a list of three to five recently-announced joint ventures. They may be surprised to

learn how common they are.

Research and Drafting Exercise: Choosing a Form of Business Organization

Divide students into nine groups. Give each group a piece of paper with one form of organization written

at the top: Sole Proprietorship; General Partnership; Limited Liability Partnership (LLP); Professional

Chapter Overview

Chapter Theme

No one form of organization is right for every business. The proper choice depends upon factors such as

sources of financing, tax issues, liability concerns, and the entrepreneur’s goals (to go public, for

2 Unit 4 Business Organizations

instance). In choosing a form of organization, it is important for the entrepreneur to consider all of these

issues.

Quote of the Day

General Concepts

Taxable versus Non-Taxable Entity

Tax treatment under the Internal Revenue Code is often a primary consideration in choosing a form of

organization. Business organizations are taxed either as partnerships or as corporations. To be “taxed as a

Question: To say that an organization is “taxed as a partnership” or “not a taxable entity” is simply a

euphemism for saying that it is not taxed at all. Some commentators argue that organizations receive

valuable privileges— such as limited liability—and should, in return, pay taxes. Do you agree?

Answer: A fair division of the country’s tax burden is always a controversial topic. Some argue that

Indeed, some politicians have long argued against the double taxation of corporations.

Question: But does it make sense for some forms of organizations, such as C corporations, to pay

taxes while S corporations and LLCs do not?

standard for large businesses as well as small.

Question: Traditionally, law firms and accounting firms were partnerships in which each partner

faced unlimited liability for the partnership’s debts. The partnerships themselves were not taxable

entities. With LLCs and LLPs, the liability burden is much lighter but the tax burden is no heavier. Is

this fair?

Answer: There is no reason why liability issues and tax burden should necessarily be linked. Should

simply eliminate taxation on all organizations?

Limited Liability versus Unlimited Liability

Unlimited liability means that an owner of a business is personally liable for the business’s financial

obligations to the full extent of the owner’s personal assets. In other words, a business creditor may be

able to seize and sell any of the owner’s personal assets to satisfy business debts.

Limited liability means that an owner is liable for the debts of the business only to the extent of the

Note: There is a chart in the text that lists the characteristics of each type of business organization.

Chapter 19 Starting a Business: LLCs and Other Options 3

Sole Proprietorships

A sole proprietorship is easy and inexpensive to form, but the entrepreneur is personally liable for all

debts of the organization. Debt or personal assets are the only sources of financing.

Question: Why do 76 percent of all small businesses choose to operate as sole proprietorships?

Corporations

Corporations in General

As is the case for all forms of organization, corporations have their advantages and disadvantages.

Limited Liability

Although employees and individual shareholders have no personal liability for corporate debts, it is

important to remind students that individuals are always liable for their own negligence. An entrepreneur

who incorporates her business will still be liable if she commits a tort.

Question: Suppose that Loretta opens a candy shop on Main Street. Wary about her potential

liability serving food to the public, she incorporates her business. However, she fails to follow the

manufacturer’s suggestions and refrigerate her fudge. As a result, every mother in town falls ill after

eating gifts of fudge on Mother‘s Day. The business has a bank account with a few thousand dollars.

Loretta has $100,000 in savings in a mutual fund account. Will the injured mothers have a right to

the mutual funds, or only the bank account?

Answer: Loretta herself was negligent–she failed to follow the manufacturer’s instructions. The

Transferability of Interests

Corporations provide flexibility for enterprises small (with one owner) and large (with thousands of

shareholders). As we will see, partnership interests are not transferable without the permission of the

other partners, whereas corporate stock can be bought and sold easily.

Duration

When a sole proprietor dies, legally so does the business. But corporations have perpetual existence:

they can continue without their founders.

Logistics

Corporations require substantial expense and effort to create and operate. The cost of establishing a

corporation includes legal and filing fees, not to mention the cost of the annual filings that states

require. Corporations must also hold annual meetings for both shareholders and directors. Minutes of

these meetings must be kept indefinitely in the company minute book.

Taxes

Because corporations are taxable entities, they must pay taxes and file returns.

S Corporations

Congress created S corporations (aka “S corps”) to encourage entrepreneurship by offering tax

breaks. The name “S corporation” comes from the provision of the Internal Revenue Code that

created this form of organization. Shareholders of S corps have both the limited liability of a

corporation and the tax status of a partnership. Like a partnership, an S corp is not a taxable entity—

all the company’s profits and losses pass through to the shareholders, who pay tax at their individual

rates. It avoids the double taxation of a regular corporation (called a “C corporation”). If, as is often

the case, the startup loses money, investors can deduct these losses against their other income.

4 Unit 4 Business Organizations

S corps do face some major restrictions:

• There can be only one class of stock (although voting rights can vary within the class).

• There can be no more than 100 shareholders.

Students are often confused about the differences among C corporations, S corporations, and close

corporations. State statutes authorize the creation of a corporation, but the IRS determines its tax

status. Thus, state law determines if an organization is a regular corporation or a close corporation.

IRS regulations determine if the corporation is a taxable entity. Both a close corporation and a

regular corporation can be either an S corporation or a C corporation.

Question: Who establishes the rules to determine if a corporation is an S corporation or a C

corporation?

Answer: Each individual state does.

Question: Are the limitations on S corporations (one class of stock, etc.) serious restraints that

dramatically impede an entrepreneur’s options or minor technicalities?

Limited Liability Companies

Limited liability companies are a relatively new form of organization. They offer the limited liability of a

corporation and the tax status of a partnership, but they avoid the restrictions of an S corporation.

You Be The Judge: Ridgaway v. Silk

Facts: Norman Costello and Joseph Ruggiero were members of Silk, LLC, the owner of Silk Stockings

and Cafe Del Mar, which was a bar and adult entertainment nightclub in Groton, Connecticut. Anthony

Sulls was drinking heavily one night at Silk Stockings and, although he was obviously drunk, employees

at Silk Stockings continued to serve him. Giordano (another member of the LLC) and Costello were

working there that night. They both greeted customers (who numbered in the hundreds), supervised

employees and performed “other PR work.” When Sulls left the nightclub at 1:45 a.m. with two friends,

he drove off the highway at high speed, killing himself and one of his passengers, William Ridgaway.

Ridgaway’s estate sued Costello and Giordano personally. The defendants filed a motion for summary

judgment seeking dismissal of the complaint.

You Be The Judge: Are Costello and Giordano personally liable to Ridgaway’s estate?

Holding: Costello and Giordano’s motion for summary judgment was denied. The claims against

2004 Conn. Super. LEXIS 548 Superior Court of Connecticut, 2004

Chapter 19 Starting a Business: LLCs and Other Options 5

and Costello were both present, supervising other employees. Therefore, this case cannot be resolved on a

motion for summary judgment.

Question: Are members of an LLC personally liable for the debts of the business?

Question: Isn’t it obvious, then, that the court should grant the motion for summary judgment?

Question: Isn’t the whole point of an LLC to protect personal assets from business liabilities? Why

would the court deny the motion for summary judgment?

Question: Were the two defendants negligent that night?

could the court determine if the two defendants had been personally negligent.

Question: What could the defendants have done to protect themselves against suit?

Answer: They should not have been running the nightclub. If they engage in running the business,

there is nothing they can do to protect themselves against claims that they were personally negligent.

Question: Is their status as LLC members useless?

Formation

To organize an LLC, you must have a charter and you should have an operating agreement.

Case: Wyoming.com, LLC v. Lieberman

Facts: Lieberman was a member of the LLC Wyoming.com. After he withdrew, he and the other

members disagreed about what his membership was worth. Wyoming.com filed suit asking the court to

determine the financial rights and obligations of the parties, if any, upon withdrawal of a member.

The Supreme Court of Wyoming ruled that Lieberman still owned part of the business despite this

Issue: Does Lieberman have a right to any financial data about Wyoming.com?

Holding: No, the trial court’s ruling is affirmed. According to the court, the prior Lieberman case held

that no provision exists in either Wyoming state law or the operating agreement requiring any particular

disposition of a members’ equity interest upon their withdrawal as a member. Thus, Wyoming.com could

not legally force Lieberman to sell his interest at any particular value.

No further proceedings are required to resolve this action. Lieberman retains his equity interest and

nothing further is required of either party as a direct result of Lieberman’s withdrawal.

Question: Does Mr. Lieberman want to be a part of this LLC any longer?

Question: According to the court, why can’t Mr. Lieberman withdraw from Wyoming.com?

2005 WY 42; 109 P.3d 883; 2005 Wyo. LEXIS 48. Supreme Court of Wyoming, 2005.

6 Unit 4 Business Organizations

Answer: According to the court, Mr. Lieberman cannot withdraw from Wyoming.com because the

Question: This seems like a crazy result: forcing a person to remain a member of an LLC but not

allowing that person to receive the value of his equity share. How could this result have been

avoided?

Flexibility

Unlike S corporations, LLCs can have members that are corporations, partnerships, or nonresident aliens.

LLCs can also have different classes of stock. Unlike corporations, LLCs are not required to hold annual

meetings or maintain a minute book.

Transferability of Interests

Duration

It used to be that LLCs automatically dissolved upon the withdrawal of a member (owing to, for example,

Going Public

Once an LLC goes public, it loses its favorable tax status and is taxed as a corporation, not a partnership.

Changing Forms

Some companies that are now corporations might prefer to be LLCs. However, the IRS would consider

Piercing the LLC Veil

Case: BLD Products, LTC v. Technical Plastics of Oregon

Facts: Mark Hardie was the sole member of Technical Plastics of Oregon, LLC (TPO). The company

2006 U.S. Dist. LEXIS 89874, United States District Court for the District of Oregon, 2006.

Chapter 19 Starting a Business: LLCs and Other Options 7

BLD argued that the doctrine of piercing the corporate veil of a corporation to hold its shareholders

personally liable should apply in this case to the LLC, thus making Hardie personally liable for TPO’s

debts.

Issues: Does the corporate doctrine of piercing the corporate veil apply to LLC’s? Should Hardie be

personally liable for TPO’s debts?

Holding: Yes, the doctrine of piercing the corporate veil does apply to LLC’s. Yes, Hardie should be

personally liable for TPO’s debts. The court concluded that the doctrine of piercing the corporate veil

does apply to LLC’s. According to that doctrine, three requirements must be satisfied before a court will

pierce the corporate veil and hold shareholders personally liable for the debts of the corporation.

1. the defendant controlled the debtor corporation;

2. the defendant engaged in improper conduct; and

3. as a result of that improper conduct plaintiff was unable to collect on a debt against the insolvent

corporation.

According to the court, there is no question that Hardie controlled the corporation. Regarding the

The third prong of the test is whether Hardie’s improper conduct resulted in BLD being unable to

collect on its debt. The court could not be determined as a matter of law whether the inability to pay

$120,000 owed to BLD was due to Hardie’s improper conduct over the years. As a result, the court

granted partial summary judgment that BLD is entitled to pierce the corporate veil, making Hardie

personally liable, but that the amount for which Hardie is liable will have to be determined by a jury.

Question: If Hardy was the only member of the LLC, why does it matter that he used LLC money to

pay for his personal expenses?

Answer: It matters that Hardy used LLC money to pay for his personal expenses because LLC’s

General Question: Piercing the corporate veil is a very difficult argument to win and courts usually

warranted in extraordinary circumstances. Why do you think that is so?

Answer: A court may be reluctant to apply the doctrine because generally it is more preferable to

Legal Uncertainty

LLCs are a relatively new form of organization without a consistent and widely developed body of law.

An important area of legal uncertainty involves managers’ duties to the members of the organization.

Managers do certainly owe a duty to the LLC itself (as opposed to its members), but do members have the

right to enforce this duty?

Case: Tzolis v Wolff

Facts: Soterios Tzolis owned 25% of Smith Pennington Property Co. LLC which owned a Manhattan

hotel. Herbert Wolff managed the LLC. Tzolis alleged that Wolff first leased and then sold the hotel to

884 N.E.2d 1005; 855 N.Y.S.2d 6; 2008 N.Y. LEXIS 226 COURT OF APPEALS OF NEW YORK, 2008.

8 Unit 4 Business Organizations

family and friends at a price below market value. Tzolis filed a derivative suit against Wolff on the

grounds that the man had violated his duties to the LLC.

“no injury the stockholders may sustain by a fraudulent breach of trust, can, upon the general

principles of equity, be suffered to pass without a remedy. I will never determine that a court cannot

lay hold of every such breach of trust. I will never determine that frauds of this kind are out of the

To hold that there is no remedy when corporate fiduciaries use corporate assets to enrich themselves was

unacceptable in 1832, and it is still unacceptable today. Derivative suits are not the only possible remedy,

but they are the one that has been recognized for most of two centuries, and to abolish them in the LLC

context would be a radical step.

Question: Why is there legal uncertainty surrounding LLCs?

Answer: LLCs are a relatively new form of organization without a consistent and widely developed

body of law.

Socially Conscious Organizations

More than a dozen states now permit the formation of socially conscious business organizations. These

hybrids are called flexible-purpose organizations, benefit corporations (B corporations), low-profit

General Partnerships

Few people now affirmatively elect to form a partnership because so many other options are available.

Even professionals such as lawyers and accountants now have other choices. As we will see in the next

Chapter 19 Starting a Business: LLCs and Other Options 9

Question: Why would anyone choose to form a partnership?

Answer: There was a time when lawyers and accountants had no other choice. Now in most states

Management

The management of a partnership can be a significant challenge.

Management Duties

Partners have a fiduciary duty to the partnership.

Case: Marsh v. Gentry

Facts: Tom Gentry and John Marsh were partners in a business that bought and sold racehorses. The

partnership paid $155,000 for Champagne Woman, who subsequently had a foal named Excitable Lady.

The partners decided to sell Champagne Woman at the annual Keeneland auction, the world’s premier

thoroughbred horse auction. On the day of the auction, Gentry decided to bid on the horse personally,

without telling Marsh. Gentry bought Champagne Woman for $135,000. Later, he told Marsh that

someone from California had approached him about buying Excitable Lady. Marsh agreed to the sale.

Although he repeatedly asked Gentry the name of the purchaser, Gentry refused to tell him. Not until 11

months later, when Excitable Lady won a race at Churchill Downs, did Marsh learn that Gentry had been

the purchaser. Marsh became the Excitable Man.

Issue: Did Gentry violate his fiduciary duty when he bought partnership property without telling his

partner?

Excerpts from Justice O’Hara’s Decision: Admittedly, at an auction sale, the specific identity of a

[P]artners, in their relations with other partners, [must] maintain a higher degree of good faith due to

the partnership agreement. The requirement of full disclosure among partners as to partnership business

cannot be escaped. Had Gentry made a full disclosure to his partner of his intentions to purchase the

partnership property, Marsh would not later be heard to complain of the transaction.

would be chaotic.

Reasoning: A partner has an absolute right to know if his partner purchases partnership property.

642 S.W.2d 574, 1982 KY. LEXIS 315, SUPREME COURT OF KENTUCKY, 1982

10 Unit 4 Business Organizations

Question: Why didn’t Gentry tell Marsh he wanted to purchase the two horses?

Question: Marsh agreed to the price for the private sale of Excitable Lady. Why would Marsh care

whether he sold to a partner or to a stranger?

Answer: In a sale to a stranger, Marsh would assume that he knew at least as much, if not more,

Question: What damages would Gentry be required to pay?

Question: How would you measure profits in this case?

Answer: It would be complicated. If Gentry subsequently sold the horses, then the difference

Limited Liability Partnerships

A limited liability partnership (LLP) is a general partnership in which the partners are not liable for the

debts of the partnership. However, partners must file a statement of qualification with state officials and

the LLP must file an annual report.

Additional Case: Apcar v. Gaus

Facts. Smith & West, LLP had two partners: Michael L. Gaus and John C. West. The partnership

registered in Texas as a limited liability partnership. The Texas statute requires LLPs to renew their

registrations each year, but Smith & West never did so. Four years after its initial registration, the

motion for summary judgment. The trial court granted Gaus and West’s motions while denying Apcar’s.

Issue: Were Gaus and West personally liable for payments due under Smith & West’s lease?

Holding: Judgment for Gaus and West reversed, case remanded for further proceedings. Under Texas

law, an LLP must renew its registration each year, or its LLP status expires. Smith & West did not renew

their application before the expiration date, therefore, its status as a limited liability partnership expired

one year after the initial filing. Smith & West entered into the lease three years after this expiration.

Therefore, Gaus and West are not protected from individual liability for the lease obligations.

Question: Smith & West registered as an LLP once. Why does it matter that it didn’t continue to

renew its registration?

2005 Tex. App. LEXIS 379 Court of Appeals of Texas, 2005

Chapter 19 Starting a Business: LLCs and Other Options 11

Limited Partnerships and Limited Liability

Limited Partnerships

Limited partnerships are the first of many types of hybrid organizations that combine the limited liability

of a corporation with the tax status of a partnership.

Limited Liability Limited Partnerships

In a limited liability limited partnership, a general partner is not personally liable for partnership debts.

Question: What is the difference between a limited partnership and a limited liability limited

Professional Corporations

For many years, professional corporations (PCs) were the only option for professionals who sought to

avoid the unlimited liability of a partnership. Now, LLCs and LLPs are generally more favorable than

Joint Ventures

A joint venture is a partnership for a limited purpose. Large companies who undertake a limited project

together often use them. The text gives the example on p.787 of the joint venture between Imax Corp. and

cinema operators, whereby Imax would supply its big screens for a share of the box office revenue. If

students completed the joint venture research assignment, ask them to present their results.

General Questions:

• What advantages does a joint venture provide to its partners?

• What difficulties does it create?

Franchises

Franchises are increasingly common, being popular with down-sized executives, women bumping up

owning their own business.

Case: National Franchisee Association v. Burger King Corporation

Facts: The Burger King Corporation (BKC) would not allow franchisees to have it their way. Instead,

BKC forced them to sell the double-cheeseburger (DCB) and, later, the Buck Double (the DCB minus one

2010 U.S. Dist. LEXIS 123065 United States District Court for the Southern District of Florida, 2010

12 Unit 4 Business Organizations

The court dismissed the first claim because the franchise agreement unambiguously permitted BKC to set

whatever prices it wanted. But the court allowed the NFA to proceed with the second claim. BKC filed a

motion to dismiss.

Issue: Was BKC acting in good faith when it forced franchisees to sell items below cost?

Excerpts from Judge Moore’s Decision: The motive of BKC in exercising its discretion to set prices

under the contract is key. [B]ad faith involves a subterfuge or evasion of contractual duties. [T]here are at

least two ways a plaintiff can go about raising a claim of bad faith. Plaintiffs can allege facts identifying

defendant’s improper ulterior motive(s). For example, if a franchisee had evidence that a franchisor had a

The issue is not whether such a strategy was wise or ultimately successful or mistaken. In the absence of

some other evidence of improper motive, the question is whether it was so irrational and capricious that

no reasonable person would have made such a decision. There is nothing about the pricing decision that

suggests BKC was doing anything other than seeking to promote the performance of its franchisees.

Nothing about this action suggests bad faith.

Note: The franchisees agreed to dismiss the lawsuit and entered into an agreement giving the

franchisees more input on the price of items on its value menu and on how long special deals run.

Question: Were BKC’s action done in bad faith?

Chapter 19 Starting a Business: LLCs and Other Options 13

Additional Case: Kieland v. Rocky Mountain Chocolate Factory

Facts: Rocky Mountain is a franchisor of stores that sell chocolate and other candies. Kristine and Scott

Kieland’s Rocky Mountain store failed four years after they purchased it. Kathleen and Stanford

Evavold’s franchise was not as profitable as they thought it would be. Rocky Mountain had given both

the Kielands and the Evavolds a uniform franchise offering circular (UFOC) before they signed their

franchise agreements.

Rocky Mountain required that its franchisees purchase a point of sale cash register system (POS

$2,000.

Stanford Evavold e-mailed a pro forma budget to Kraig Carlson, a Rocky Mountain salesperson. The

The Kielands and the Evavolds sued Rocky Mountain for violating the Minnesota Franchise Act by

failing to disclose the cost of the new AIM system and by approving Evavold’s earnings estimate. Had

they known all the relevant facts, the Kielands and the Evavolds would not have purchased a Rocky

Mountain franchise. Rocky Mountain filed a motion for summary judgment.

Issue: Did Rocky Mountain violate Minnesota franchise law?

Holding: No, Rocky Mountain’s motion for summary judgment is granted. According to the court, the

Kieland’s claim that Rocky Mountain failed to disclose the cost of the new AIM system fails as a matter

of law. Pursuant to the UFOC singed by the Kielands, Rocky Mountain had the right to require

franchisees to “upgrade or update” the POS system. Although the expense of the AIM system was

approximately $13,000 more that the [old] system, and the maintenance fee was approximately $1,200

more, the UFOC authorized Rocky Mountain to require the Kielands to make such an upgrade.

Similarly, the Evavolds claim that Carlson gave them an earnings claim by replying to their email that

the numbers “did not raise any issues” fails as a matter of law. The UFOC signed by the Evavolds clearly

states that Rocky Mountain does not authorize its sales personnel to make any oral projections regarding a

franchisee’s potential success.

Question: If the purpose of the offering circular is to ensure that the franchisor discloses all relevant

facts, was that purpose achieved with the Rocky Mountain offering circular?

Answer: Not according to the Keilands and Evavolds. According to them, the circular did not state

Question: Why did Stanford Evavold ask the Rocky Mountain sales person his opinion about their

budget?

Answer: Probably because he was worried that his franchise was not making as much money as he

Question: What is wrong with that?

2006 U.S. Dist. LEXIS 76057, United States District Court for the District of Minnesota, 2006.

14 Unit 4 Business Organizations

Answer: It may not be wrong to ask, but the court made it clear that it was wrong to rely on any

Suggested Additional Assignment

If your students obtained a copy of a franchise offering circular, this would be a good time to discuss it.

Question: In examining a franchise circular, what factors should a potential purchaser look at most

closely?

make an investment without reading the offering circular carefully!

Multiple Choice Questions

1. A sole proprietorship:

(a) Must file a tax return

(b) Requires no formal steps for its creation

(d) May sell stock

(e) Provides limited liability to the owner

2. CPA QUESTION Assuming all other requirements are met, a corporation may elect to be treated as

an S corporation under the Internal Revenue Code if it has:

(a) Both common and preferred stockholders

(b) A partnership as a stockholder

(d) The consent of a majority of the stockholders

3. A limited liability company:

(a) Is regulated by a well-established body of law

(b) Pays taxes on its income

(d) Must register with state authorities

(e) Protects the owners from personal liability for their own misdeeds

Chapter 19 Starting a Business: LLCs and Other Options 15

4. CPA QUESTION A joint venture is a(n):

(a) Association limited to no more than two persons in business for profit

(b) Enterprise of numerous co-owners in a nonprofit undertaking

(d) Association of persons engaged as co-owners in a single undertaking for profit

5. A limited liability partnership:

(a) Has ownership interests that cannot be transferred

(b) Protects the partners from liability for the debts of the partnership

(d) Requires no formal steps for its creation

(e) Permits a limited number of partners

6. CPA QUESTION Cobb, Inc., a partner in TLC Partnership, assigns its partnership interest to Bean,

who is not made a partner. After the assignment, Bean asserts the right to (1) participate in the

management of TLC and (2) take Cobb’s share of TLC’s partnership profits. Bean is correct as to

which of these rights?

(a) 1 only

(b) 2 only

(d) (Neither 1 nor 2

Essay Questions

1. Alan Dershowitz, a law professor famous for his wealthy clients (O. J. Simpson among others), joined

with other lawyers to open a kosher delicatessen, Maven’s Court. Dershowitz met with greater

success at the bar than in the kitchen—the deli failed after barely a year in business. One supplier

sued for overdue bills. What form of organization would have been the best choice for Maven’s

Court?

Answer: A sole proprietorship would not have worked, because there was more than one owner. A

2. Mrs. Meadows opened a biscuit shop called The Biscuit Bakery. The business was not incorporated.

Whenever she ordered supplies, she was careful to sign the contract in the name of the business, not

16 Unit 4 Business Organizations

personally: The Biscuit Bakery by Daisy Meadows. Unfortunately, she had no money to pay her flour

bill. When the vendor threatened to sue her, Mrs. Meadows told him that he could only sue the

business, because all the contracts were in the business’s name. Will Mrs. Meadows lose her dough?

3. You Be the Judge: WRITING PROBLEM Cellwave was a limited partnership that applied

to the Federal Communications Commission (FCC) for a license to operate cellular telephone

systems. After the FCC awarded the license it discovered that, although all the limited partners had

signed the limited partnership agreement, Cellwave had never filed its limited partnership certificate

with the Secretary of State in Delaware. The FCC dismissed Cellwave’s application on the grounds

that the partnership did not exist when the application was filed. Did the FCC have the right to

dismiss Cellwave’s application? Argument for Cellwave: The limited partnership was effectively in

existence as soon as the limited partners signed the agreement. The Secretary of State could not refuse

to accept the certificate for filing; that was a mere formality. Argument for the FCC: When

Cellwave applied for a license, it did not exist legally. Formalities matter.

4. Kristine bought a Rocky Mountain Chocolate Factory franchise. Her franchise agreement required her

to purchase a cash register that cost $3,000, with an annual maintenance fee of $773. The agreement

also provided that Rocky Mountain could change to a more expensive system. Within a few months

after signing the agreement, Kristine learned that she would have to buy a new cash register that cost

$20,000, with annual maintenance fees of $2,000. Does Kristine have to buy this new cash register?

Did Rocky Mountain act in bad faith?

5. What is the difference between close corporations and S corporations?

Answer: S corporations are created by the IRS and are not a taxable entity. Close corporations are

6. Pedro and Juan have a business selling ties with fraternity insignia. Pedro finds out that an online shirt

business is for sale. It sounds like a great idea—customers send in their measurements and get back a

custom-made shirt at a price no higher than off-the-rack shirts at the local department store. Does

Pedro have to let Juan in on the great opportunity?

Discussion Questions

1. ETHICS Lee McNeely told Hardee’s officials that he was interested in purchasing multiple

restaurants in Arkansas. A Hardee’s officer assured him that any of the company-owned stores in

Arkansas would be available for purchase. However, the company urged him to open a new store in

Maumelle and sent him a letter estimating first-year sales at around $800,000. McNeely built the

Chapter 19 Starting a Business: LLCs and Other Options 17

Maumelle restaurant, but gross sales the first year were only $508,000. When McNeely asked to buy

an existing restaurant, a Hardee’s officer refused, informing him that Hardee’s rarely sold company–

owned restaurants. The disclosure document contained no misstatements, but McNeely brought suit

alleging fraud in the sale of the Maumelle franchise. Does McNeely have a valid claim against

Hardee’s? Apart from the legal issues, did Hardee’s officers behave ethically? Is all fair in love, war,

and franchising?

Answer: The court found for Hardee’s. Although the court felt that Hardee’s personnel were

2. Leonard, an attorney, was negligent in his representation of Anthony. In settlement of Anthony’s

claim against him, Leonard signed a promissory note for $10,400 on behalf of his law firm, an LLC.

When the law firm did not pay, Anthony filed suit against Leonard personally for payment of the

note. Is a member personally liable for the debt of an LLC that was caused by his own negligence?

3. Think of a business concept that would be appropriate for each of: a sole proprietorship, a

corporation, and a limited liability company.

4. As you will see in Chapter 33, Facebook, Inc. began life as a corporation, not an LLC. Why did the

founder, Mark Zuckerberg make that decision?

5. Corporations developed to encourage investors to contribute the capital needed to create large-scale

manufacturing enterprises. But LLCs are often start-ups or other small businesses. Why do their

members deserve limited liability? And is it fair that LLCs do not have to pay income taxes?