Chapter 21 Forms of Business Organization 2013 The

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 Wedding bells have been replaced by divorce attorneys.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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 GT 500 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 Mc. Graw-Hill Companies, Inc. All rights reserved. 6

Chapter 21 Case Hypothetical and Ethical Dilemma Harris, Pendleton, and Mc. Rae, certified public accountants, have operated their general partnership accounting firm since the “disco ball and polyester” years of the 1970 s. Harris is 68 years old, Pendleton is 66, and Mc. Rae 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 1970 s 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 Mc. Rae 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 Mc. Rae of their legal rights, as well as their ethical responsibilities. © 2013 The Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-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 Mc. Graw-Hill Companies, Inc. All rights reserved. 25

Types of Franchises • “Chain-Style” Business Operation -Franchisor helps franchisee establish a business (using franchisor’s business name, and franchisor’s standard “methods and practices”) • Distributorship -Franchisor licenses franchisee to sell franchisor’s product in specific area • Manufacturing Arrangement -Franchisor provides franchisee with technical knowledge to manufacture franchisor’s product © 2013 The Mc. Graw-Hill Companies, Inc. All rights reserved. 26