MANAGING THE LAW

(4TH EDITION)

Chapter 21: Basic Forms of Business Organizations

 Chapter 21 Overview

Sole proprietorships
General partnerships
Limited partnerships
Corporations

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 Types of Business Organizations

Business organizations were discussed in Chapter 20

This chapter focuses on four other ways, namely
Sole proprietorships
General partnerships
Limited partnerships
Corporations
Liability and benefits of entrepreneurs and other
stakeholders differ depending on type used

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 Sole Proprietorship

Created once person begins to conduct business

eg start cutting someones lawn for money
No separation between business and proprietor
(owner)
proprietor entitled to all income
proprietor liable for all obligations
proprietors assets available for business debts
business income (loss) on personal income
proprietor cannot be employee of business

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 Advantages and Disadvantages

Advantage
simple to set up & dissolve
Disadvantages
unlimited personal liability
money raised only by personal borrowing
both problems grow as business grows
Result
suitable for small businesses

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 Legal Requirements for
Sole Proprietorships
Laws generally applicable to businesses apply to sole
proprietors, such as
provincial registration for business name
only if name other than personal name
business licence may be required
requirements vary with type of business
requirements exist for every form of business
eg sole proprietorship, partnership, corporation

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 Partnerships

Three main types of partnerships

partnership (sometimes called general partnership)
limited liability partnership (or LLP)
limited partnership

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 General Partnerships

A partnership exists when two or more people carry on

business together with a view to a profit
Not all profits sharing creates partnership
loan repaid out of profits
employee profit sharing
purchaser of business paying price from profits
Partnership creation automatic when relationship
begins: no formalities are required

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 Factors Indicating Partnerships

Sharing profits (not just revenues) or losses

Jointly owning property or jointly contributing capital
Involvement in business especially management
Joint authority for contracts and bank accounts
Equal access to business information
Holding each other out as partners or acquiescing
Engaging in ongoing activity rather than one project

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 Risks of Unintended Partnership

Examine any proposed relationship carefully to

determine if it is a partnership
Insist contract states relationship is not a partnership
Restructure relationship if it conforms to partnership
definition
Insist upon compensation for risk of partnership
Seek advice from a lawyer

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 Partnership Characteristics

No separation between partner and partnership

partner cannot be employed by partnership
all benefits of partnership accrue to partners
each partner responsible for all partnership debts
Partners have unlimited personal liability
personal assets available to satisfy partnership debt
creditworthy partners make a creditworthy partnership
Income to partnership is personal income to partners

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 Partnership Legislation and
Partnership Agreements
English Partnership Act 1890
model followed across Canada
statutes provide default rules for partnerships
Contracts (partnership agreements) may be used to
modify statutory rules
consider addressing key issues in partnership agreement
e.g., name, criteria for admission of partners, capitalization,
profit division, management, and dissolution procedure

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 Consequence of Partnership

Each partner is an agent of the partnership

can commit the partnership to obligations
extends risk of unauthorized obligations and torts to all
partners

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 Risk Management Strategies

Legal strategies to reduce risk

a partner owes fiduciary duty to other partners
restrict partnership to trusted individuals
monitor partners
partnership agreement
restrict authority (not liable on external parties unless notice)
require indemnity for unauthorized obligations
using a limited liability partnership if allowed

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 Limited Liability Partnership (LLP)

In some jurisdictions, some professionals may not

provide professional services through a corporation
They can use a special form of general partnership
called limited liability partnership
individual partners are not personally responsible for
negligence and sometimes other liabilities of their partners

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 Liability as a Partner
Based on Holding Out
You are liable as a partner if you:
hold yourself out to be a partner or
allow another to hold you out to be a partner
You remain liable as a partner:
after you have left the partnership,
to people who believe you are a partner,
unless they have been given notice

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 Risk Management
When Leaving Partnership
Give notice to all existing clients
Remove name from partnership
Remove name from partnership registration
Document instructions regarding departure
Obtain indemnity for subsequent liabilities

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 Internal Organization

Statutory default rules

equality amongst partners for financial interests
equality amongst partners for management
Rules in practice
equality rarely exists
default rules varied by agreement

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 Dissolution

Consider contracting out of default termination rules

any partner may terminate partnership on notice
termination on death or insolvency of partner
Claims paid upon dissolution
debts and liabilities to non-partners
debts to partners
invested capital to partners
remainder to partners in accord with right to profits

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 Limited Partnerships

Created upon filing with provincial agency

Requirements
at least one limited partner with limited liability
at least one general partner with unlimited liability
may be individual or corporation
limited partners lose limited status if they control business,
but not if they merely advise management
limited partners can be employees of limited partnership

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 Corporations:
Incorporation Process
Created upon filing with government agency
Governed by laws of jurisdiction of incorporation
provincial or federal
Canada Business Corporations Act requirements
articles of incorporation
name search report (unless numbered company)
fee

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 Post-Incorporation Organization
Directors meeting
issue shares
adopt general by-laws
designation of officers
Shareholders meeting
approve bylaws
Shareholders agreement to customize relationship
Prepare minute book

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 Separate Legal Existence

Corporation is a separate legal person

eg corporation (not shareholder) carries on business
eg corporation (not shareholder) incurs liabilities
Implications
shareholder can be employee or creditor of corporation
corporation and shareholder are separate taxpayers
shareholders taxed only when paid dividend
corporation unaffected if shareholder dies

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 Liability of Shareholders

Shareholders have limited liability

no direct liability for obligations of corporation
can lose investment but no more
Rare exception: piercing the corporate veil
serious fraud, wrongdoing, or unfairness
court willing to impose liability on true culprit
court pierces corporate veil
court imposes liability on shareholder

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 Separation of
Ownership and Management
Shareholders elect directors to manage
directors may delegate to officers
shareholders never manage
Roles may be blurred in small company
Will revisit this in Chapter 22

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 Corporate Finance

Debt: loan to corporation. Claim for fixed amount

creditors rights if non-repayment
sue for breach of contract or put corporation into bankruptcy
Equity: shareholders investment
claim on corporations residual value after other claims paid
value therefore depends on value of business
cannot sue to enforce obligations or put corporation into
bankruptcy if not paid

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 Shares

Corporation can have different classes (set in articles)

Shares must have three basic rights
vote for the election of directors
receive dividends
receive property on dissolution after debts paid
Common shares usually have all basic rights
Preferred shares may also exist

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 Preferred Shares

Typical characteristics
non-voting & no claim to the residual value on dissolution
entitled to
fixed dividend
receive amount invested on dissolution
right to payment before common shares
Wide variety of characteristics possible
Created to be attractive to prospective investors

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