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Ahmad and his friend, A.G. Pennypacker, have come up with a great idea: they have developed a fluoroelastomer liner (a rubber lining) for oil tankers. With this innovation, they believe they can eliminate most oil spills that result from tanker accidents. The liner is highly resistant to fluctuations in temperature as well as physical punctures.
Ahmad wants to set up a company, but is unsure of his options and has come to you for advice for the type of business entity formation he should select. He has the following concerns:
- He does not want his other business concerns being held liable should there be a lawsuit arising from use/sale of this product.
- He wants an entity form that will minimize his tax liability.
Based on the entity forms detailed in Chapter 35, select one you feel satisfies his concerns. Make sure to explain why it is the best for Ahmad and Pennypacker.
Action Items
- Read the case study above.
- By the due date, submit your answers to the case study questions. Justify your answers.
Chapter 35
Forms of Business
Organizations
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 35 Ethical Dilemma
As this chapter indicates, a corporation is a legal construct with an identity
separate and apart from its owner(s). The primary legal advantage to converting
one’s business from an unincorporated enterprise to the corporate form is the
ability to avoid personal liability for the business’s financial obligations. Since the
corporation is distinguishable from its owner, the owner’s personal assets cannot
be seized to satisfy business indebtedness. This effectively means that an owner
can “crash and burn” a corporation financially, bankrupt the business, and walk
away from the “flaming wreckage” of the corporation without personal obligation
for business debts.
Is it ethical for an owner to use the corporate entity to avoid personal obligation for
business debts?
35-2
Chapter 35 Case Hypothetical
Allison Seizer has a very wealthy father, entrepreneur Warren Seizer of “Chimichonga Chime” restaurant
fame, although her family pedigree was not what attracted Blake Patterson to his girlfriend of three years;
instead, it was “love at first sight.” Blake proposes to Allison, and the two are married with the blessing of
Warren Seizer.
Warren wants the best for his daughter and son-in-law, so he offers a “Chimichonga Chime” franchise to
Blake, with a prime location in the center of the Elmwood business district. After one year, it is clear that
the newest “Chimichonga Chime” is and will be a tremendous business success. In fact, sales, revenue
and profit goals for the restaurant are shattered in its first year of operation, and Blake would like to think
that his “hands-on” ownership and operation of the restaurant was an important part of the store’s
success.
Unfortunately, the couple’s relationship has suffered over the year, and the term “irreconciliable
differences” creeps into marriage conversations. Blake asks for his freedom, and Allison obliges.
Wedding bells have been replaced by divorce attorneys.
Warren Seizer is furious. He is firmly convinced that Blake Patterson is to blame for the marriage’s
dissolution, because there is no conceivable way (at least in his mind) that his “darling angel,” his
“precious daughter,” could be responsible for the divorce. The creative genius behind “Chimichonga
Chime” plots justice for his daughter and himself, although some may call it revenge.
On September 1, Warren Seizer personally delivers a Notice of Termination of Franchise to Blake
Patterson. The document states that Patterson’s franchise agreement has been terminated for cause, and
that he must either close the restaurant, or cease and desist from using the name “Chimichonga Chime,”
advertising the franchise chime logo, and selling all franchise-related products, within 30 days.
Who wins: The “ex-father-in-law,” or the “ex-son-in-law?”
35-3
Major Forms of Business Organizations
◼ Sole Proprietorship
◼ General Partnership
◼ Limited Partnership
◼ Corporation
35-4
Sole Proprietorship
◼
Definition: Unincorporated business owned by one person
◼
Owner has total control
◼
Owner has unlimited liability
◼
Profits taxed directly as income to sole proprietor
35-5
Advantages and Disadvantages of Sole
Proprietorship
◼
◼
Advantages
◼
Ease of creation (“start-up”)
◼
Owner has total managerial control
◼
Owner retains profits
Disadvantages
◼
Personal liability for all business debts/obligations
◼
Funding limited to personal contributions and loans
35-6
General Partnership
◼
Definition: Unincorporated business owned and operated by
two or more persons
◼
Each partner has equal control of business
◼
Each partner has unlimited, personal liability for business
debts/obligations
◼
Profits taxed as income to partners
35-7
Advantages and Disadvantages of Partnership
◼
◼
Advantages
◼
Ease of creation (“start-up”)
◼
Partnership income is partner income
◼
Business losses qualify for tax deduction
Disadvantages
◼
Personal liability for all business debts/obligations, including those
incurred by other partners on behalf of partnership
35-8
Limited Partnership
◼
Definition: Unincorporated business with at least one general
partner, and one limited partner
◼
General partner in limited partnership has
managerial/operational control over business
◼
Limited partner’s liability limited to extent of his/her capital
contributions
◼
Limited partner has no managerial/operational control over
business
35-9
Corporation
◼
Definition: State-sanctioned business with legal identity separate
and apart from its owners (shareholders)
◼
Owners’ (shareholders’) liability limited to amount of investment
in corporation
◼
Profits taxed as income to corporation, plus income to
owners/shareholders (“double-taxation”)
◼
“S” Corporation can avoid double-taxation
35-10
Advantages and Disadvantages of Corporation
◼
◼
Advantages
◼
Limited liability for shareholders
◼
Ease of raising capital by issuing (selling) stock
Disadvantages
◼
“Double-taxation”
◼
Formalities required in establishing and maintaining corporate existence
35-11
“S” Corporation
◼
Definition: Business organization formed under federal tax law
that is considered corporation, yet taxed like a partnership
◼
Formed under federal law
◼
No more than seventy-five shareholders
◼
Shareholders must report income on their personal income tax
forms
35-12
Limited Liability Company (LLC)
◼
Definition: Business organization with limited liability of a
corporation, yet taxed like partnership
◼
Formed under state law
◼
Owners of LLC (“members”) pay personal income taxes on
shares they report
◼
No limitation on number of owners permitted in LLC
35-13
Specialized Forms of Business Organizations
◼
Cooperative—Organization formed by individuals to market products
◼
Joint stock company—Partnership agreement in which company members hold
transferable shares, while all company goods are held in names of partners
◼
Business Trust—Business organization governed by group of trustees, who operate
trust for beneficiaries
◼
Syndicate—Investment group that forms for purpose of financing specific large
project
◼
Joint Venture—Relationship between two or more persons/corporations created for
specific business undertaking
◼
Franchise—Agreement between “franchisor” (owner of trade name/trademark) and
“franchisee” (person who, by specific terms of agreement, sells goods/services under
trade name/trademark)
35-14
Advantages and Disadvantages of Franchise
(To Franchisee)
◼
◼
Advantages
◼
Assistance from franchisor in starting franchise
◼
Trade name/trademark recognition
◼
Franchisor advertising
Disadvantages
◼
Must meet contractual requirements, or possibly lose franchise
◼
Little/no creative control over business
35-15
Advantages and Disadvantages of Franchise (To
Franchisor)
◼
◼
Advantages
◼
Low risk in starting franchise
◼
Increased income from franchises
Disadvantages
◼
Little control (except contractually) over individual franchise
◼
Can become liable for franchise, if franchisor exerts too much control
35-16
Types of Franchises
◼
“Chain-Style” Business Operation
◼
◼
Distributorship
◼
◼
Franchisor helps franchisee establish a business (using franchisor’s
business name, and franchisor’s standard “methods and practices”)
Franchisor licenses franchisee to sell franchisor’s product in specific area
Manufacturing Arrangement
◼
Franchisor provides franchisee with technical knowledge to manufacture
franchisor’s product
35-17
Top Ten Global Franchises (2009)
◼
Subway
◼
Ace Hardware Corp.
◼
McDonald’s
◼
Pizza Hut
◼
Liberty Tax Service
◼
UPS Store
◼
Sonic Drive In Restaurants
◼
Circle K
◼
Intercontinental Hotels
Group
◼
Papa John’s International,
Inc.
35-18
Chapter 35
Forms of Business
Organizations
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 35 Ethical Dilemma
As this chapter indicates, a corporation is a legal construct with an identity
separate and apart from its owner(s). The primary legal advantage to converting
one’s business from an unincorporated enterprise to the corporate form is the
ability to avoid personal liability for the business’s financial obligations. Since the
corporation is distinguishable from its owner, the owner’s personal assets cannot
be seized to satisfy business indebtedness. This effectively means that an owner
can “crash and burn” a corporation financially, bankrupt the business, and walk
away from the “flaming wreckage” of the corporation without personal obligation
for business debts.
Is it ethical for an owner to use the corporate entity to avoid personal obligation for
business debts?
35-2
Chapter 35 Case Hypothetical
Allison Seizer has a very wealthy father, entrepreneur Warren Seizer of “Chimichonga Chime” restaurant
fame, although her family pedigree was not what attracted Blake Patterson to his girlfriend of three years;
instead, it was “love at first sight.” Blake proposes to Allison, and the two are married with the blessing of
Warren Seizer.
Warren wants the best for his daughter and son-in-law, so he offers a “Chimichonga Chime” franchise to
Blake, with a prime location in the center of the Elmwood business district. After one year, it is clear that
the newest “Chimichonga Chime” is and will be a tremendous business success. In fact, sales, revenue
and profit goals for the restaurant are shattered in its first year of operation, and Blake would like to think
that his “hands-on” ownership and operation of the restaurant was an important part of the store’s
success.
Unfortunately, the couple’s relationship has suffered over the year, and the term “irreconciliable
differences” creeps into marriage conversations. Blake asks for his freedom, and Allison obliges.
Wedding bells have been replaced by divorce attorneys.
Warren Seizer is furious. He is firmly convinced that Blake Patterson is to blame for the marriage’s
dissolution, because there is no conceivable way (at least in his mind) that his “darling angel,” his
“precious daughter,” could be responsible for the divorce. The creative genius behind “Chimichonga
Chime” plots justice for his daughter and himself, although some may call it revenge.
On September 1, Warren Seizer personally delivers a Notice of Termination of Franchise to Blake
Patterson. The document states that Patterson’s franchise agreement has been terminated for cause, and
that he must either close the restaurant, or cease and desist from using the name “Chimichonga Chime,”
advertising the franchise chime logo, and selling all franchise-related products, within 30 days.
Who wins: The “ex-father-in-law,” or the “ex-son-in-law?”
35-3
Major Forms of Business Organizations
◼ Sole Proprietorship
◼ General Partnership
◼ Limited Partnership
◼ Corporation
35-4
Sole Proprietorship
◼
Definition: Unincorporated business owned by one person
◼
Owner has total control
◼
Owner has unlimited liability
◼
Profits taxed directly as income to sole proprietor
35-5
Advantages and Disadvantages of Sole
Proprietorship
◼
◼
Advantages
◼
Ease of creation (“start-up”)
◼
Owner has total managerial control
◼
Owner retains profits
Disadvantages
◼
Personal liability for all business debts/obligations
◼
Funding limited to personal contributions and loans
35-6
General Partnership
◼
Definition: Unincorporated business owned and operated by
two or more persons
◼
Each partner has equal control of business
◼
Each partner has unlimited, personal liability for business
debts/obligations
◼
Profits taxed as income to partners
35-7
Advantages and Disadvantages of Partnership
◼
◼
Advantages
◼
Ease of creation (“start-up”)
◼
Partnership income is partner income
◼
Business losses qualify for tax deduction
Disadvantages
◼
Personal liability for all business debts/obligations, including those
incurred by other partners on behalf of partnership
35-8
Limited Partnership
◼
Definition: Unincorporated business with at least one general
partner, and one limited partner
◼
General partner in limited partnership has
managerial/operational control over business
◼
Limited partner’s liability limited to extent of his/her capital
contributions
◼
Limited partner has no managerial/operational control over
business
35-9
Corporation
◼
Definition: State-sanctioned business with legal identity separate
and apart from its owners (shareholders)
◼
Owners’ (shareholders’) liability limited to amount of investment
in corporation
◼
Profits taxed as income to corporation, plus income to
owners/shareholders (“double-taxation”)
◼
“S” Corporation can avoid double-taxation
35-10
Advantages and Disadvantages of Corporation
◼
◼
Advantages
◼
Limited liability for shareholders
◼
Ease of raising capital by issuing (selling) stock
Disadvantages
◼
“Double-taxation”
◼
Formalities required in establishing and maintaining corporate existence
35-11
“S” Corporation
◼
Definition: Business organization formed under federal tax law
that is considered corporation, yet taxed like a partnership
◼
Formed under federal law
◼
No more than seventy-five shareholders
◼
Shareholders must report income on their personal income tax
forms
35-12
Limited Liability Company (LLC)
◼
Definition: Business organization with limited liability of a
corporation, yet taxed like partnership
◼
Formed under state law
◼
Owners of LLC (“members”) pay personal income taxes on
shares they report
◼
No limitation on number of owners permitted in LLC
35-13
Specialized Forms of Business Organizations
◼
Cooperative—Organization formed by individuals to market products
◼
Joint stock company—Partnership agreement in which company members hold
transferable shares, while all company goods are held in names of partners
◼
Business Trust—Business organization governed by group of trustees, who operate
trust for beneficiaries
◼
Syndicate—Investment group that forms for purpose of financing specific large
project
◼
Joint Venture—Relationship between two or more persons/corporations created for
specific business undertaking
◼
Franchise—Agreement between “franchisor” (owner of trade name/trademark) and
“franchisee” (person who, by specific terms of agreement, sells goods/services under
trade name/trademark)
35-14
Advantages and Disadvantages of Franchise
(To Franchisee)
◼
◼
Advantages
◼
Assistance from franchisor in starting franchise
◼
Trade name/trademark recognition
◼
Franchisor advertising
Disadvantages
◼
Must meet contractual requirements, or possibly lose franchise
◼
Little/no creative control over business
35-15
Advantages and Disadvantages of Franchise (To
Franchisor)
◼
◼
Advantages
◼
Low risk in starting franchise
◼
Increased income from franchises
Disadvantages
◼
Little control (except contractually) over individual franchise
◼
Can become liable for franchise, if franchisor exerts too much control
35-16
Types of Franchises
◼
“Chain-Style” Business Operation
◼
◼
Distributorship
◼
◼
Franchisor helps franchisee establish a business (using franchisor’s
business name, and franchisor’s standard “methods and practices”)
Franchisor licenses franchisee to sell franchisor’s product in specific area
Manufacturing Arrangement
◼
Franchisor provides franchisee with technical knowledge to manufacture
franchisor’s product
35-17
Top Ten Global Franchises (2009)
◼
Subway
◼
Ace Hardware Corp.
◼
McDonald’s
◼
Pizza Hut
◼
Liberty Tax Service
◼
UPS Store
◼
Sonic Drive In Restaurants
◼
Circle K
◼
Intercontinental Hotels
Group
◼
Papa John’s International,
Inc.
35-18
Chapter 36
Partnerships: Nature,
Formation, and
Operation
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 36 Case Hypothetical
The accounting firm of Cooper, Anderson and Young had fallen on “hard times” in recent
months. Several clients had left the firm, and in a slow economy, it was difficult to generate
new clients. Cooper, Anderson and Young was a general partnership with three (3) partners
(Andrew Cooper, Thomas Anderson, and Marvin Young), and six (6) employees (four
associate accountants, an office manager, and a secretary/receptionist).
Meeting payroll was especially challenging for the partnership this month. In order to
compensate the firm’s employees, Marvin Young went to The Bank of the Americas and
obtained a $23,000 business loan, signing his name to the loan agreement as well as the name
of the partnership. Marvin used the proceeds of the loan to compensate the employees their
full monthly salaries.
Upon discovering what Marvin had done, Andrew and Thomas were furious. Both felt that
since the firm had experienced a financial downturn, the employees should have to take a
substantial reduction in their salaries for the month, or forego their salaries for the month
altogether (Andrew, Thomas, and Marvin had not received any profit distribution for the
current month; their partnership agreement did not provide for partner salaries, and even if it
had, there were no other monies to distribute). Further, Andrew and Thomas were
concerned about partnership liability for the $23,000 loan, as well as their own personal
liabilities for the loan.
Is the general partnership Cooper, Anderson and Young responsible for the $23,000 loan? Are
Andrew Cooper and Thomas Anderson personally liable for the loan?
36-2
Chapter 36 Case Hypothetical
The year 2002 was a nightmare for James Littleton. In January 2002, Littleton was diagnosed with “Type
2” (adult onset) diabetes; in June, Littleton’s physician expressed concern with the lack of circulation in
his left leg, and in October, a circulatory specialist recommended that the left leg be amputated to the
knee; reluctantly but resigned to his fate, James agreed.
On November 1, Littleton was admitted to Pinecrest General Hospital for surgery. In what can only be
described as a horrible and catastrophic mistake, the surgeon misreads the diagnosis and surgical
instructions, and amputates Littleton’s right leg by mistake. Littleton’s left leg is amputated the next day.
Confined to a wheelchair, but supported by the love, care and concern of his family, Littleton is taken to a
local Pinecrest law firm, Stephenson, Gordon, and Ratcliff, a general partnership. Stephenson and Gordon
agree to represent Littleton in the medical malpractice lawsuit, and sign a contract of representation with
Littleton, agreeing to represent him for the standard one-third contingency fee, plus associated expenses.
The statute of limitations for medical malpractice actions in the state is three years. Due to oversight and
neglect (rumor has it that both Stephenson and Gordon have substance abuse problems,) the firm fails to
file a complaint against the attending surgeon and Pinecrest General Hospital within the three-year
period. Even though he lacks legal training, Littleton knows he will be forever barred from bringing a
lawsuit against the doctor and the hospital. Having experienced catastrophic neglect from two professions
he once respected, Littleton focuses his remaining “life energy” on bringing Stephenson, Gordon, and
Ratcliff to justice. He sues the general partnership, as well as individual attorneys Stephenson, Gordon,
and Ratcliff for legal malpractice. Ratcliff’s attorney moves for dismissal of the claim against his client
individually, arguing that Ratcliff was not an “attorney of record” for Littleton, and as a result, should be
dismissed personally from the lawsuit.
Will Ratcliff succeed in his motion for dismissal?
36-3
Partnership (Uniform
Partnership Act Definition):
“Association of two or more persons to
carry on as co-owners a business for profit”
36-4
Characteristics of Partnership
◼
Voluntary and consensual relationship
◼
Between two or more individuals, partnerships, corporations, or
other forms of business organization
◼
Engaged in numerous business transactions over period of time
◼
Partners share profits and management of business
36-5
Situations Where No Partnership:
◼
Employer shares profits with employee as payment for work
◼
Landlord accepts share of profits for payment of rent
◼
Party receives share of profits for payment of debt
◼
Party receives share of profits for payment of annuity to
widow/representative of deceased partner
◼
Party receives share of profits for payment from sale of goodwill of
business/other property
◼
Party receives share of profits for payment of interest on a loan
36-6
Formation of Partnership
Partnership agreement (“articles of partnership”)
should include:
◼ Name of each partner
◼ Name of partnership
◼ Duration of partnership
◼ How profits divided
◼ Division of management responsibilities
◼ Contributions from each partner
36-7
Partnership Duties
◼ Duty of Loyalty
◼ Duty of Obedience
◼ Duty of Care
36-8
Partnership Rights
◼
Right to Share in Management
◼
Right to Share in Profits
◼
Right to Compensation
◼
Rights to Partnership Property
◼
Right to Inspect Books
◼
Right to an Accounting
36-9
Circumstances “Triggering” Partner’s Right to an
Accounting
◼
Whenever partnership agreement provides for an accounting
◼
Whenever co-partners wrongfully exclude partner from partnership/from
access to partnership books
◼
Whenever partner fails to disclose profit/benefit from partnership (breach of
“fiduciary duty”)
◼
Whenever circumstances render accounting “just and reasonable”
36-10
Interactions Between Partners and Third Parties
◼
If partnership has liability, each partner has unlimited personal liability (“joint
and several” liability)
◼
“Joint and several” liability: Third party can choose to sue partners
separately, or all partners jointly in one action; partners are collectively, as
well as individually, liable for partnership debts
◼
All partners jointly and severally liable for commission of tort by any partner
◼
Implied liability of partners when purchases made to perpetuate partnership’s
business
36-11
The Revised Uniform
Partnership Act (RUPA)
Revised version of Uniform Partnership Act
(UPA); use of RUPA varies from state to
state
36-12
