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dynamic business law essentials 3e 2016 chapter 21

Chapter 21
Forms of Business Organization

© 2013
The McGraw-Hill
Companies,
Inc. All rights
reserved. All
Copyright
© 2016
McGraw-Hill
Education. 

rights reserved.

1


Chapter 21 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 “irreconcilable 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 Wedding bells have been replaced by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?”
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

2


Chapter 21 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?

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.


3


Chapter 21 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?
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

4


Chapter 21 Case Hypothetical
The year 2010 was a nightmare for James Littleton. In January 2010, 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?
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

5


Chapter 21 Case Hypothetical
Morrison, Manzarek and Huxley is a general partnership law firm located in Los Angeles, California.
The partnership was formed in 1967, the year Robbie Morrison, John Manzarek and Raymond
Huxley graduated from the University of California at Los Angeles (UCLA) School of Law.
Robbie Morrison’s desk had sat empty for the past two (2) weeks. John and Raymond had no idea
where he was. The day before he left, Robbie had told his fellow partners he was tired of the practice
of law, and wanted to do something else with his life. Concerned about their partner, especially since
he had never “disappeared” like this before, John and Raymond drove to Robbie’s house on Love
Street, where he lived with his common-law wife, Pamela Kennealy.
Pamela answered the door. When asked of Robbie’s whereabouts, Pamela responded that she did
not know where he was. She did say that he had said something about going to the desert, and had
left in his 1967 Shelby GT500 Mustang. He had not returned home in the past two (2) weeks, nor
had she seen him since he left.
John and Raymond consider Robbie’s disappearance strange, and given the fact that he had, by
Pamela’s account, chosen to leave, they considered his absence inexcusable. They are considering
partnership dissolution.
Do John Manzarek and Raymond Huxley have the legal right to dissolve the Morrison, Manzarek and
Huxley general partnership?
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

6


Chapter 21 Case Hypothetical and Ethical Dilemma
Harris, Pendleton, and McRae, certified public accountants, have operated their general partnership
accounting firm since the “disco ball and polyester” years of the 1970s. Harris is 68 years old, Pendleton is 66,
and McRae is 65. They have operated their partnership by way of an “old-school” approach, a “handshake”
agreement, since their professional association was first formed (in spite of strong advice from legal counsel
to the contrary.)
Harris has been acting rather strange in recent months. Clients and support staff have been asking questions.
Six weeks ago, Harris was discovered standing on top of his desk singing the 1970s Rick Dees tune, “Disco
Duck,” interspersing quacking sounds throughout his rendition of the disco classic. Harris no longer wears
conservative business attire; instead, he has opted for a light blue leisure suit with white patent leather shoes.
Currently, he can be found again standing on his desk, this time offering up his version of the 1979 Sister
Sledge anthem, “We Are Family.”
Pendleton and McRae are in the conference room, considering their options and the future of their accounting
business. They would like to terminate Harris’ partnership, but they are unsure whether they have the legal
right to do so. They are also struggling with the notion of an ethical obligation to “try to work things out” with
Harris; after all, he has been their partner for over thirty years. Finally, they wonder whether they could end
their professional relationship with Harris, without being required to dissolve the existing partnership and “wind
up” the financial affairs of the business.
Advise Pendleton and McRae of their legal rights, as well as their ethical responsibilities.

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

7


Major Forms of Business Organizations
• Sole Proprietorship

• Corporation

• General Partnership

• S Corporation

• Limited Partnership

• Limited Liability Company

• Limited Liability
Partnership

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

8


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

9


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/losses
-Funding limited to personal funds and loans

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

10


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/losses
•Profits taxed as income to partners
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

11


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/losses, including those incurred
by other partners on behalf of partnership
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

12


Termination of Partnership
Occurs through
•“Dissolution” Stage and
•“Winding Up” Stage
•Dissolution (Definition): Change in relation of
partners caused by any partner’s ceasing to be
associated with carrying on of business
•Winding Up (Definition): Completing unfinished
partnership business, collecting and paying debts,
collecting partnership assets, and taking inventory
of business
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

13


Reasons for Rightful Dissolution of a
Partnership
•The term established in the partnership
agreement expires
•The partnership meets its established objectives
•A partner withdraws from the partnership at will
•A partner withdraws in accordance with the
partnership agreement
•A partner is expelled from the partnership in
accordance with the partnership agreement
•A partner dies
•A partner is adjudicated bankrupt

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

14


Reasons for Rightful Dissolution of a
Partnership (Continued)
•The business of the partnership becomes illegal
•A partner is adjudicated insane
•A partner becomes incapable of performing the
duties as established by the partnership
agreement
•The business of the partnership can be carried
on only at a loss of profits
•A disagreement between the partners is such
that it undermines the nature of the partnership
•Other circumstances of the partnership
necessitate the dissolution

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

15


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

16


Limited Liability Partnership
•Definition: Partnership in which all partners assume
liability for any partner’s professional malpractice to the
extent of the partnership’s assets
•If one LLP partner is guilty of malpractice, other
partners’ personal assets cannot be seized
•Business name must include phrase “Limited Liability
Partnership” or abbreviation “LLP”
•Parties must file form with Secretary of State to create
LLP
•Each partner pays taxes on his/her share of business
income
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

17


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 (“doubletaxation”)
•“S” Corporation can avoid double-taxation
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

18


Advantages and Disadvantages of
Corporation
•Advantages
-Limited liability for shareholders
-Ease of raising capital by issuing (selling)
stock
-Profits taxed as income to shareholders (not
partners)
•Disadvantages
-“Double-taxation”
-Formalities required in establishing and
maintaining corporate existence
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

19


“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 one hundred shareholders
•Shareholders must report income on their
personal income tax forms
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

20


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

21


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

22


Specialized Forms of Business
Organizations (Continued)
•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)
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

23


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

24


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
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

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