Business Organizations

16 June

• The Covalt fact situation is like an exam question. If you were the plaintiff what fiduciary duty would you argue was breached, and if you were the judge how would you find?
• RUPA §§ 401(1), 807, 305-8, 301. Those are the RUPAs.
• LLPs are general partnerships that have registered as LLPs. RUPA § 1001.
• Guest speaker on partnership and tax.
  Most of this is issue-spotting, and mostly it's simple. But people often overlook it. This focuses on LLCs, but it holds true for pretty much all partnerships (except maybe general); and also not S-Corps or C-Corps. those are special.

  What's your deal: that is the key question. It determines a lot about taxes.

  All of these entities are flow-through entities for tax purposes. There's a partnership return filed, and the owners get informed about their income or losses, and then they report those on their own returns. Corporations pay tax themselves, generally, on the income that they make, and are therefore less tax-efficient. About 20%, as a rule of thumb, when the entity is sold.

  Every deal has at least three parties: buyer, seller, and Uncle Sam. That's not the end-all/be-all, and in some complex endeavors a C-Corp is a fine thing. They eliminate "friction in the deal," where multiple rounds of finance, for example, make it so hard to explain who is going to get paid what and when. And they make it so that there are fewer lawyer fees setting all that stuff up.

  Allocations of profits and losses can be done any which way, as long as they have "substantial economic effect." That's a heavily laden term, but the short version is that you allocate things according to the deal. Taxes follow the economics of the deal, in other words.

  So what is the deal? Lots of the time we are focused on default rules: what happens if you don't put anything in the agreement. So the question is always: what is in the agreement? Clients come up with all kinds of ideas about how they want their deal to work, and it's the lawyer's task to write up the operating agreement.

  The statutes give you a default for how profits and losses are shared (value of contributions [WI], or equal [RUPA]). But usually clients don't care what the default is, they'll just say what they want, and generally in incomplete terms because they haven't thought it through. So you can put everything in the operating agreement, except the bits that you can't vary. That turns into, like a 40pp document, but it should tell you everything you need to know.

  You still need to know what the default rules are, because often agreements don't end up getting signed. Or they fail to anticipate some circumstance that comes up.

  The four questions:

  • What are the members contributing?
  • What happens if the company breaks even? (i.e. realizes only the value of the contributions; and what is "breaking even," if the contributions are hard to value)
  • What happens if there's not enough to repay all the members? (usually overlooked by clients)
  • How do the profits, if any, get shared?
  People rarely have the answers to all of these, but that's what we need. A private equity firm, e.g., will take a 20% cut, for the value they bring in by organizing everyone. There can be intellectual property contributed, other property, etc.

  So in the break-even case, how do you decide the relative worths of the contribution? The client has to tell you how those things are valued. That will tell you what the break-even point is. Note that getting money in return for services is generally a taxable event.

  Generally partners get paid back in sequence. You can think of it as buckets that get filled up with whatever is left. But this is something that the partners should negotiate in advance.

  Thus, also, with sharing profits. There's a bewildering variety of ways to pay things off. "I want all of the profits first, until I get an 8% return on my investment, and then we share 60-40." That's a "priority return." We're going to split 80-20 until I get 3x my investment. That's a "hurdle." After that, we'll share 20-80.

  Clients usually have detailed ideas of how to split profits, even if they haven't covered break-even or loss scenarios.

  A "preferred return" can be set to get you paid before things are declared to be profits. And that's taxable. If a preferred return "eats into" someone else's capital investment, it's taxable. Anyway, you can prioritize the distribution of profits, but also the return of capital.

  And note that you can have losses beyond just your investment in capital (i.e., a guarantee to a bank for a loan). You should have a plan for how that's going to get handled also.

  A "book up" event: a change in ownership when you bring in a new investor-- that changes the value of the company, and has implications for capital accounts.

  Contributions + Profits - losses - distributions = balance of capital accounts.

  Allocations: how do we track capital accounts, and how do we report on our taxes? Distributions: when money comes out of the company, how is it distributed? Distributions show you how the buckets are set up, and what order folks get paid. Allocations tell you who loses their money last, when there are losses.

  If you know the answers to the Four Questions, you will be able to reach the right answer 95% of the time. If you don't think of these things in advance, you end up in litigation and malpractice.

• You don't have to divide up property equally, or based on contributions, or with the same priority.
• Limited liability partnerships are just general partnerships that have registered. This puts people on notice that the partners are not liable, jointly and severally, for the obligations of the partnership. They're liable for their own acts, and to the extent of their contributions. In WI, you register with the Department of Financial Institutions.
• A general partnership, incidentally, can delegate management to a managing partner, just like a LLP does.
• Dow v. Jones
  RUPA § 306: the partners in an LLP aren't personally liable. So RUPA § 301(1): a partner is an agent, and can bind the partnership, and then § 305: the partnership is liable for torts of the partners.
• The Frode Jensen v Pillbury case
  If this agreement wasn't in the ordinary course of the partnership business, maybe RUPA § 301(1) doesn't apply. But there has presumably been a delegation of authority (these are managing partners). So probably the actions of the partners making the agreement bound the partnership.

  But maybe these weren't the same partners who badmouthed Frode Jensen. But so what? § 305(a) applies. Maybe even if the partner who blabbed was unaware of the agreement (it does, after all, go beyond the firms ordinary duties to a partner). Also, given that it was a partner who was directly involved with the contract, § 404(c): intentional misconduct.

• Dissolution. As usual UPA and RUPA disagree. The aggregate theory (UPA) says there's dissolution every time a partner departs. But dissolution leads to termination, which means all affairs have to be wound up and assets liquidated. And that's horribly inefficient.

  RUPA creates the concept of "dissociation" to cover the departure of a partner. Not all dissociations trigger a dissolution. So the question is when does a dissociation trigger a dissolution, and how can you continue business?

• For Thursday, RUPA §§ 601, 602, 701(a-d), 801(1-3), 802. Make a little decision tree.

18 June

	601 - Dissociation (notice of withdrawal, event, expulsion, etc.)
	602 - Wrongful dissociation (breach of agreement, etc): liable
	701 - Purchase of dissociated partner's interest
	      (a) if not a winding up, the partnership buys out 
	      (b) for the partner's current share as of dissociation
	      (c) damages due for wrongful dissociation
	      (d) bought-out dissociated partner indemnified, except against
	          own acts
	801 - Events causing dissolution and winding up
	      (1) Withdrawal of a partner via express notice (p-ship at will)
	      (2) Death of a partner, expiration, or unanimous (for term)
	      (3) Agreed-upon event
	802 - Partnership continues after dissolution
	      (a) only to wind up its business
	      (b) unless the partners waive dissolution

• Newly revised syllabus.
• So LLPs are still bound by the acts of partners (and this makes troubles for very large partnerships), but the individual partners themselves are not liable.
• Terms:
  • Dissociation: may or may not cause a dissolution. Here are the main ways this happens.
    • (1) Voluntary withdrawal
    • (2) An event agreed to in the partnership agreement
    • (3) Expulsion by the partnership agreement
    • (4) Expulsion by unanimous vote of the other partners
    • (7) Death or incapacity
  • Dissolution: may or may not trigger a termination
  • Termination: of the partnership or of the business of the partnership (partnership could terminate, but the partners could continue the business as a new entity; even though there has been an event of dissolution, the partners can elect to continue the partnership)
  • Winding up/Liquidation: if the partnership terminates
• So here's how we roll:

     Dissociation            
         |       \            Rightful
    (801)|        \          /
    Dissolution?   Withdrawal           Damages? 602(c)
    (No)/ \ (Yes)     |     \         /
    Ch.7   Ch.8       |      Wrongful? 602(b)
  	            |
                Term or Special Purpose?
  
  	

• Questions we ask:
  1. Is there a dissociation?
  2. Is the withdrawal wrongful?
  3. Is the partnership for term or a special purpose?
  4. Does the dissociation lead to dissolution? (801)
     • Partnership at will: withdrawal
     • Partnership for term or particular undertaking:
       • wrongful withdrawal
       • death or incapacity and more than 50% of remaining partners vote to dissolve
       • unanimous decision to dissolve
       • expiration of the term
     • All: event agreed to in the partnership agreement
  5. Does the partnership continue after dissolution? (802) Know §§ 802(a) and (b)(1)
  6. If the withdrawal didn't lead to a dissolution, then what do we do with the withdrawing partner? (701)
• Note that a withdrawing partner still gets their stuff back, by default, even if it's wrongful (if their contributions exceed their liability for the wrongful withdrawal).
• Note also that by default (701) withdrawing partners get bought out. That can be crippling to the partnership, so it is often varied in the agreement. Exception is 701 (h): withdrawing from a partnership for term or specific undertaking means you don't get paid until the thing winds up.
• Typical question: what happens on the death of a partner under the default rules? or a wrongful dissociation?
• Either way, when the partner gets paid off, it's to the tune of the valuation of their contributions at the time of the withdrawal.
• Fischer v. Fischer
  So the question is whether the partnership was dissolved or not a the time of his death. So does he get his share of the value of the partnership, or does he get what the agreement says? So was there a dissociation? Was it wrongful? Did it cause dissolution?

  The notice of dissociation strategy is kind of a manufactured argument.

• Problem 2-5. Note that they were only able to expel her because the partnership agreed upon; RUPA § 601(3) would not allow that by default. And note that RUPA § 404 doesn't specify a fiduciary duty that the partners breached here.
• Limited Liability Companies. If we were following historical or logical order, we'd talk about corporations first. First we had Corporations (C Corporations), then S Corporations (come with limits: 1 class of stock, max 75 shareholders, US shareholders only), but have some more partnership-esque tax properties. So then we got LPs: two classes of partners (general-- liable for the obligations, and limited-- uninvolved in management). Used to see those a lot in real-estate tax shelters. Then we got LLCs and finally LLPs and LLLPs.

  And LLCs seem to work the best for getting partnership tax, and corporate liability shielding. The only problem with them is that they're not traded on the market. And they're maybe cumbersome when they get to be too big-- sometimes corporate tax makes things simpler. Also, there are some countries that don't believe in LLCs, and then there are tax treaties that deal with how they're taxed when they do business internationally.

• We have ULLCA, not RULLCA, but that's OK. § 201: this is an entity. You organize by delivering articles of organization to the state: § 202. Note that you can have a 1-person LLC. That's pretty interesting, in terms of the justification for limiting liability. Members are the owners of LLCs.

  Member-managed is like a general partnership. If management is delegated to a manager, it's manager-managed. That's sort of like a corporation, where the shareholders are the owners, but they elect the directors who actually manage the thing.

  § 105: the name has to include LLC. § 112: you do pay attention to the purpose for which you organize, because it can affect if/when you can cash out. That'll all be handled in an operating agreement as defined in § 103, along with the things that can't be waived (b).

  A manager, note, does not need to be a member of the company (i.e., an owner).

• Stone v. Jetmar
  The moral: file the LLC papers if you want them to be recognized. It's against public policy to create limitations of liability without filing.

  Also, try to know whether you're dealing with a real LLC.