5


Business Associations - Outline
Overview Notes
I. Business:
A. Broad term describing all kinds of profit-making conduct;
II. Business Associations:
A. The legal means, devices, and entities that exist for the conduct of business individually or collectively;
III. Two Broad Categories of Business Associations:
A. Closely Held:
1. Businesses with one or very few owners;
2. Ownership interest is not publicly traded on an established market;
3. Examples (not exhaustive list, there are more):
a. Sole Proprietor
(1) The default business position;
(2) Owner is fully liable for all of the business’s torts and financial liabilities;
(3) Advantage:  Can quit and close the business at any time or sell the business without any input or filings; can hire and fire at will; all profits are the owner’s alone;
(4) If you have co-owners, can no longer be a Sole Proprietorship;
b. Corporation
(1) Liability is limited;
(2) Owners are:  Shareholders
(3) Closely Held Corporation:  meaning that no ready market exists for the trading of shares, so the shares are owned by a small group of shareholders which privately may sell and trade, but do not do so on a public exchange.
c. Limited Liability Company (LLC)
(1) Liability is limited;
(2) Owners are:  Members
d. Partnerships:
(1) General Partnership (GP)
(a) The is the default co-ownership business association;
(2) Limited Liability Partnership (LLP)
(3) Limited Partnership (LP)
(4) Limited Liability Limited Partnership (LLLP)
B. Publicly Held:
1. Businesses with a large number of owners;
2. Ownership interest is routinely publicly traded on an established market;
3. Examples:
a. Corporation
IV. Type of Business & Risk:
A. Closely Held = More Risk / Publicly Held = Less Risk: The closer held the business, often the more the risk;
1. +Risk=More Profit: The more the risk, the more profit can be made by the owner;
a. Example:  A Sole Proprietor takes all of the risk, and therefore should gain the profits;  employees not taking any risk should therefore be paid less than the owner who is assuming the risk;
b. Example:  A landowner who leases their land to a winemaker, for example, is essentially selling all their risk to the winemaker who will profit from the winemaking business and the landowner only receives a fixed amount for the use of the land (thus, less profit);
2. -Risk=Less Profit:  The less risk, potentially the less profit can be made by the owner(s), shareholders, or members;
B. Managing Risk:
1. Advising clients on the kind of business association to form can help manage liability risk;
2. Employee loyalty, honesty, and work ethic can be managed in other ways and should be considered when advising (incentivizing employees, monitoring employees, et al.);
3. Financial risks can be managed by setting up lines of credit, purchasing proper insurance, et al.;
V. The Law Governing Business Associations:
A. Largely statutes;
B. Based, often, on the model or uniform statutes;
C. Controlled at the state statutory level;
D. ***Note:  The Law that Governs in Business Association disputes:  The determination of whether the Law of Partnerships, Agency Law, Contract Law, or some other law is the governing law in a dispute is fact dependent.
VI. Business Associations I:
A. Deals, primarily with Closely Held, private businesses;
1. Private firms are the biggest part of the economy;
2. They pay 44% of the entire U.S. payroll in the economy;
3. They constitute approximately 50% of the private economic output (as opposed to large corporations);
B. Business Associations II, deals with Publicly Held businesses.

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I. Agency Law (Accomplish Results by Using Others)
A. Agency in General
1. Overview:
a. The law governing relationships between principals, agents, and third parties.
b. Agency Law is Common Law;
c. Agency forms do not create business forms, rather they are the “glue” that holds the business together;
d. Agency law defines the rights and responsibilities of individuals who work for or on behalf of businesses.
e. Most common agency relationship = Employment Relationship.
f. Agency is a consensual relationship;  but not necessarily contractual;
g. Principal sources of agency law:  Second & Third Restatements of Agency (persuasive, not binding).
2. Elements of Agency:  As long as the legal definition of Agency is met, Agency exists legally whether the parties intended it to or not.  The elements:
a. Manifestation by the principal that the agent shall act for him;
b. Agent’s acceptance of the undertaking;
c. Understanding of the parties that the principal is to be in control of the undertaking;
d. An agreement, not necessarily a K, is all that is required.
B. Roles/Actors
1. Agency Defined, R. 2d. of Agency:
a. Agency = The fiduciary relationship which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.
2. Principal (Master)
a. Principal (Employer): The person for whom the agent is acting on behalf of.
(1) The principal has the right to control the conduct of the agent with respect to matter entrusted to the agent;
(2) Control in this sense is affirmative control;
(3) Master (Employer): Is a principal who employs an agent to perform service in his affairs and who controls or has the right to control the physical conduct of the other in the performance of the service;
(4) Business Associations like corporations, trusts, partnerships, LLCs may act as principals OR agents;
3. Agent (Servant)
a. Agent: The person who is acting for another.  A person employed to do any act for another or to represent another in dealings with third persons.
(1) Servant (Employee):  An agent employed to perform service in his master’s affairs;
(2) Independent Contractor (Non-employee Agent):  A person who contracts with another to do something for him but who is NOT controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking.
(a) An Independent Contractor may or may not be an agent;
(b) ICs agree to do work for the Principal, but are only responsible for the result (not how the work is done);
(c) The degree of control exercised over the work being done by the independent contract determines whether the IC is an agent or not.  Control means AFFIRMATIVE control.
C. Duties of Principals & Agents
1. Principal’s Duties:
a. Principal’s Duties to the Agent
(1) The principal’s duties to the agent are NOT fiduciary;
(2) Principal must perform his contractual commitments to the agent;
(3) Principal must not unreasonably interfere with agent’s work;
(4) Principal must generally act fairly and in good faith toward the agent;
(5) Principal must indemnify the agent for expenses or losses suffered by the agent in carrying out the principal’s instructions.
2. Agent’s Duties:
a. Agent’s Duties to the Principal
(1) The agent, as a fiduciary, is required to act loyally and carefully when acting within the scope of the agency;
(2) Agent is:
(a) Accountable for any profits arising out of transactions conducted for the principal;
(b) Agent must act solely for the benefit of the principal and not himself or someone other than the principal;
(c) Agent must not deal with the principal as an adverse party;
(d) Agent may not use the principal’s property or confidential information for the agent’s own purposes or a third party’s;
(e) Agent has a duty to disclose information to the principal which is relevant to affairs entrusted to him, and to which the principal would have a desire for (without violating a superior duty to a third person);
(f) Agent has a duty to act only as authorized by the principal.
b. Termination of the Agent’s Power
(1) Actual Authority terminates when the Principal revokes it or the Agent renounces it.
(2) Actual Authority terminates when the objective of the relationship has been achieved;
(3) Actual Authority terminates when the principal or agent dies;
(4) If based on a Contract, the termination of actual authority may be a breach of contract if the contract is unfulfilled;
(a) Meaning a principal or agent always has the power to terminate actual authority, but may not contractually have the right to do so (the breach of contract would come into play here).
D. Liability Created by Agency Relationships
1. Tort Liability
a. Servant v. Independent Contractor:  Whether an agent is a Servant or Independent Contractor is key in determining tort liability;
(1) Masters are Liable:  Masters are liable for torts committed by a servant within the scope of his employment;
(a) Tort Theory:  Respondeat Superior (employers are responsible for the torts of their employees)
(b) Liablity:  Vicarious Liability (Liability imposed on one person for the conduct of another)
I. Limited Liability associations mean that the liability that is limited is Vicarious Liability; only the money invested in the business is at risk; not the personal assets of the owners.
(c) Policy: Because the chances that the servant can pay for damages is low; chances the employer can pay are higher; its an allocation of risk as the cost of doing business.
(2) Principals are usually not Liable:  Principals are generally not liable for torts committed by an Independent Contractor in his employ;
(a) Policy:  The principal does not supervise the IC and therefore is not in a position to prevent negligent performance; in an employment relationship, the principal (master) is in such a position.
(b) Exceptions:  Sometimes an IC can be considered an agent in a way that makes the Principal vicariously liable; the test, again is the degree of control OR fraud/misrepresentation;
2. Contract Liability
a. A Contact Relationship may impose liability upon the Principal, the Third-Party, and/or the Agent;
b. Contract Liability is often affected by the type of principal present:
(1) Disclosed Principal:  At the time of the Agent’s transaction, the Third-Party has notice that the agent is acting for a principal and has notice of the principal’s identity;
(2) Partially Disclosed Principal:  At the time of the Agent’s transaction, the third party has notice that the Agent is or may be acting for a principal, but has no notice of the principal’s identity.
(3) Undisclosed Principal:  At the time of the Agent’s transaction, the third party has no notice that the Agent is acting for a principal.
c. Liability of the Principal to a Third Party:
(1) A principal will b liable on a Contract between the agent and a third party when the agent acts with:
(a) Actual Authority Authority:  Manifestation of a Principal to an Agent that the Agent has power to deal with others as representative of the principal. Decisions thus made by the Agent are binding on the Principal.
I. Implied Actual Authority:  Inferred from the principal’s prior acts which grant Actual Authority;
A. Incidental Authority:  Authority to do incidental acts that are related to a transaction that is authorized; sub-category of Implied Actual Authority;
II. Express Actual Authority:  Oral or written statements giving Actual Authority.
(b) Apparent Authority: The manifestation of a principal to a third-party that another person is authorized to act as an agent for the principal. Often arises when a principal creates the impression that broad authorities exists in an agent when in fact it does not.  The idea is that if a third-party relies on the appearance of authority, the third-party may hold the principal liable for the action of the agent (Apparent Authority, therefore, is designed to protect the third party.)
I. Key difference with Actual Authority:  Actual Authority flows from Principal to Agent.  Apparent Authority flows from Principal to Third Party.
A. Example: A seller hires a realtor an sets the sale price floor at $300K.  The seller tells a potential buyer to contact his realtor.  The realtor (agent) has actual authority for $300K, but Apparent Authority to the general buying public of any price.  If the Realtor then enters a K to sell the house for $275K, the seller (principal) is bound to the sale K, because the buyer relied on the Apparent Authority of the realtor.  The realtor, by the way, is liable to the seller for the loss incurred contrary to his instructions.
B. Even if the realtor was fired BEFORE entering into the agreement, if the realtor enters the agreement and the third party relies on the deal, the principal is still responsible for the contract (and can sue the realtor for the loss incurred).
II. Titles creating Apparent Authority:  Sometimes an official title or position can convey Apparent Authority.  Example: A company that appoints a treasurer should expect third parties to reasonably deal with them in typical transactions a treasurer deals in.
III. Requires a showing of reasonable reliance.  Estoppel requires a showing of detrimental reliance.
IV. Estoppel: Similar to Apparent Authority, but Estoppel applies when the principal has made NO manifestations to the third party that an actor has authority as an agent.  The principal is held responsible under Estoppel Doctrine when the principal contributes to the third party’s belief or failed to dispel it.  see p. 27Liberal1
A. Example:  A furniture store advertises a 10% discount for cash sales.  Customer comes, orders furniture from what they think is a salesman and gives him cash.  Furniture never shows (b/c Salesman wasn’t really a salesman an stole the money).  Customer sues store.  Under Estoppel Doctrine, plaintiff may win if circumstances show that the offer created an expectation that could reasonably be relied on to the detriment of a customer.  Typically will have to show negligence on the part of the principal.
(c) Inherent Authority:  The power of an agent which is derived not from actual authority, apparent authority, or estoppel but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.  Requires reasonable reliance by the third party.
I. Stated another way:  It’s inevitable agents will do unauthorized things and harm people.  It would be unfair for the Principal to benefit from the agent’s actions without also making the principal responsible for the excesses of the agent or their failures to act carefully.
II. The 3d Restatement of Agency simply asserts that this is an extension of Apparent Authority;
(2) Ratification (Retroactive Approval):  Even if an agent acts without authority, the principal will be liable to the third party if:
(a) The agent purports to act on the principal’s behalf;
(b) Express Ratification: The principal affirmatively treats the agent’s act as authorized;
(c) Implied Ratification: The principal engages in conduct that is justifiable only if the principal is treating the agent’s act as authorized;
(d) Ratification Does Not Occur, unless:
I. The principal, at the time of ratification, is aware of all the material facts involved in the original transaction.
A. Communication of ratification to the third part is not necessary; only that the principal ratified;
B. When ratification occurs (which is when the principal objectively manifests acceptance of the transaction), the effect is to validate the contract as if it were originally authorized by the principal.
d. Liablity of the Third Party to Principal
(1) When an Agent makes a contract for a disclosed or partially disclosed principal, the third party is liable to the principal if the agent acted with authority;
(2) Except:
(a) An undisclosed principal cannot bind a third party to a contract if the principal’s role in the contact substantially changes the third parties rights or obligations.
e. Liablity of the Agent to the Third Party
(1) General Ω: An agent that contracts with a third party on behalf of a disclosed principal, is not a party to the contract and not liable to the third party.
II. Business Entities
A. Sole Proprietorship
1. The default business position;
2. Owner is fully liable for all of the business’s torts and financial liabilities;
3. Advantage:  Can quit and close the business at any time or sell the business without any input or filings; can hire and fire at will; all profits are the owner’s alone;
4. If you have co-owners, can no longer be a Sole Proprietorship;
B. Partnerships
1. Partnership (aka General Partnership)
a. Nature of a Partnership
(1) RUPA §101 - Partnership:  “Partnership” means an association of two or more persons to carry on as co-owners a business for profit formed under UPA §202, predecessor law, or comparable law of another jurisdiction.
(a) Note: Corporations, Partnerships, & other associations may be in Partnership (not just individuals);
(2) RUPA §202 - Partnership Formation:
(a) Does not require a public filing with the state to exist;
I. The Partnership exists simply by falling within the statutory definition; (even if the partners do not know they are forming a General Partnership);
(b) Sharing Profits (a key partnership element):  A person who receives a share of the profits of a business is presumed to be a partner in the business;
I. Unless the payment was received for:
A. Payment of a debt;
B. Payment as wages;
C. Payment for services as an independent contractor;
D. For rent;
E. Payment as an annuity, retirement plan, or health benefit;
F. For interest on a loan.
(c) Characteristics of a Partner:
I. Unlimited liability; (see §306 below);
II. The right to share in the profits;
III. The right and duty to act as an agent of the other partners;
IV. Shared ownership;
V. Shared (equal) management rights; §401(f)
VI. Fiduciary relationships among partners.
(d) RUPA §306 - Partner’s Liability:  Except as provided in subsections b) and c), all partners are liability jointly and severally for all obligation of the partnership, unless otherwise agreed by the claimant or provided by law;
I. b)  A person admitted to an existing partnership is not personally liable for any partnership obligations incurred before the person’s admission as a partner;
II. c)  An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or others, is solely the obligation of the partnership.
(3) §103 - Partnership Agreements:
(a) Once formed the partnership is governed by the relevant state statute (the characteristics as noted above);
(b) The state statutory provisions are merely the default rules of partnership governance and can be altered by agreement of the partners;
I. But certain things cannot be waived (e.g. partnership cannot unreasonably restrict right of access to books and records of the partnership), and if you waive too much, you may move your partnership out of partnership law and into the law of contracts or some other governing law;
A. Liability to third parties cannot be waived (you cannot waive third-party rights);
(c) Partnership agreements may be oral, implied, or written;
I. It is HIGHLY recommended they be written; lawyers who do not recommend this can face malpractice;
(4) Partnership as an Aggregate of Individuals (UPA) or as a Separate Legal Entity (RUPA)
(a) UPA View: The UPA adopts the view that Partnerships are an aggregation of individuals;
I. Partnerships are not separate legal entities (like Corps.) that can own property, be sued, or sue on its own;
II. Whenever a partner leaves the partnership, it is dissolved;
A. A dissolution occurs when ANY partner leaves; if there are three partners and one leaves, the remaining two are thought to form a NEW partnership separate and distinct from the first;
B. Note:  Legal entities like corporations do not dissolve when a member leaves;
(b) RUPA View:  The RUPA adopts the view that Partnerships are separate legal entities distinct from its partners;
I. A partnership may sue and be sued in the name of the partnership;
II. Property acquired by a partnership is property of the partnership and not of the partners individually;
III. Whenever a partner leaves the partnership, it is NOT dissolved;
A. The partnership is considered to continue with the remaining partners;
(5) RUPA § 308 - Liability of Purported Partner: (aka Partnership by Estoppel)
(a) A partnership may arise by estoppel;
(b) This provision protects third parties (not a non-partner who claims to be one);
(c) If someone who is NOT a partner is held out publicly to be one, a partnership obligation is created if a third party relies upon such a representation; (detrimental reliance);
(d) If a partnership liability results, the creditor must exhaust the partnership assets before seeking to satisfy the claim from the partners themselves;
(6) Partnership vs. Joint Venture:
(a) Joint ventures are only for a limited purpose;
(b) Parnterships are for ongoing businesses;
(c) Joint ventures are also governed by the rules of partnership.  Because they are a special species of partnership and are treated under the UPA and RUPA as such.
b. Management & Operation of Partnerships
(1) RUPA §301 - Partner Agent of Partnership:
(a) Each partner is considered an agent of the partnership;
(b) Any act of a partner which is in the ordinary business of the partnership binds the partnership; (Actual Authority)
I. Unless:  The partner had no authority to act for the partnership; AND
II. The person or business the partner was dealing with knew or received notice that the partner lacked authority .
A. Note:  In a partnership of only two, authority can only be restricted with a majority vote which in a two-person partnership has to be unanimous.
(c) Any act which is NOT in the ordinary course of business of the partnership is only binding if the act was authorized by the partners;
(2) RUPA §303 - Statement of Partnership Authority:
(a) This provides an optional statement of partnership authority specifying the names of the partners authorized to execute instruments transferring real property held in the name of the partnership;
(b) Grants of Authority:  It may also grant supplementary authority to partners; or
I. Limit their authority;
A. These do not invalidate, however, actions by partners with third parties relying upon apparent authority, except:
1. For Real Estate Transactions - such limitations of authority will invalidate a real estate transaction improperly entered into;
II. To enter into transactions on behalf of the partnership;
III. Grants of Authority are typically created to give to a third party to help the third party feel comfortable in doing business with specific agents or partners;
(3) RUPA §305 - Partnership Liable for Partner’s Actionable Conduct
(a) Partners acting in the ordinary course of business of the partnership or with authority of the partnership;
I. Are liable for any actionable conduct (torts, et al.);
II. This cannot be waived or disclaimed;
(b) If a partner receives money or property from a non-partner in the course of the partnership’s business or while acting with authority of the partnership and misapplies (loses it);
I. The partnership is liable for the loss.
(4) RUPA §401(f) & (j) - Partner’s Rights & Duties:
(a) (f) Each partner has equal rights in the management and conduct of the the partnership business;
I. Unless contracted differently between the parties;
(b) (j) In absence of an agreement to the contrary, matter arising in the ordinary course of the business may be decided by a majority of the partners;
I. Amendments to the partnership agreement and matters outside the ordinary course of the partnership business require unanimous consent of the partners.
II. Extraordinary Decisions require a unanimous vote, by default;
c. Partnership Accounting
(1) Generally: The business of the the partnership is distinct from the financial affairs of the individual partners;
(a) Financial statements are not certain;
(b) The Bible of Accounting is the GAAP = Generally Accepted Accounting Principles
(2) Capital Accounts of Partners:
(a) The interests of the partners are reflected in Capital Accounts (which set forth the partner’s ownership interest in the partnership);
I. Capital Accounts are adjusted periodically for:
A. Income;
B. Draws;
C. Contributions of Capital;
D. Withdrawals of Capital;
(b) RUPA §401 - Partner’s Rights and Duties:
I. Describes how each partner’s Capital Account is constructed and maintained:
A. Capital Contributed by Partner - Any Distributions to Partner + Partner’s Share of Profits - Partner’s Share of the Losses = Capital Account
B. A capital partner’s capital account can go negative from time to time;
1. Upon termination of partnership, if a partner’s capital account is negative, the partner must pay the partnership that amount to bring the balance to zero;
II. Capital Accounts are NOT essential;
A. But all but the most informal partnerships do so;
(3) Financial Accounting for Partnerships:
(a) Method Used:  Accrual Accounting
I. Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
(b) In most respects, closely resembles corporate accounting for profits, losses, assets, and liabilities;
I. Equity = Assets - Liabilities [or] Assets = Liabilities + Owners Equity
A. “Equity” means ownership or net worth (net worth of the business);  also called the “Book Value”
1. Owners Equity is the leftover if the business were liquidated, assets sold, and creditors paid off; the remainder is the Owners Equity; also called the “Book Value”
2. This concept came from mortgages;
B. Assets:  Assets means money on hand (cash), inventory, physical plant, vehicles, patents, et al.;
1. Cash:
a. Most new businesses fail, like 96%;
b. Most fail because they don’t have enough cash on hand;
c. Cash Flow = Just the amount of cash coming in and going out as measured during a specific time frame;
2. Inventory Valuation:  Usually the lower of either the market value or what was paid for the items;
a. Two methods of Calculation:  FIFO (First In, First Out) or LIFO (Last In, First Out)
b. Depending on the method used, you can easily get wildly different values for the inventory number;
(1) This is important because it can affect substantially tax liability;
(2) Ex.  Some oil companies, use LIFO to calculate their profits from sales of some inventory; LIFO keeps the profit number low as long as they don’t sell their really old inventory;
c. Third method of Calculation:  Average
d. Method used is discretionary, but must be disclosed up front (and tax law requires the method has to be used for a specific period of time- which we don’t need to know for this class);
3. Long-Term Assets:
a. GAAP recommends that these kinds of assets are kept on the books “at cost” rather than market value;
b. Fair Value methodology is sometimes used instead of cost;
c. They are depreciated over time;
d. Some long-term assets appreciate over time and some depreciate over time;
C. Liabilities:
1. Liabilities means claims against the enterprise by creditors;
2. Typically, liabilities are things that must be paid within a year’s time;
3. Long-term debt paid over several years can be here as well;
4. Accounts Payable;
D. Working Capital:
1. Current Assets - Current Liabilities = Working Capital
a. Alternative measure:  Liquidity Ratio (aka Quick Assets):
(1) Current Assets - Inventory / Current Liabilities = Liquidity Ratio
II. Income Statement (aka Profit & Loss Statement):
A. Income = Revenues - Expenses
B. Income statements describe results of operations over time;
C. Income statements are more important in financial analysis, typically;
D. Income statements tell you whether the company is making money or not;
E. Accounting Methods for Income Statements:  GAAP requires the use of the Accrual Method instead of Cash Method of accounting in Income Statements;
1. Cash Accounting Method:  Is like what we use in our personal life (when cash comes in, that’s when you have it and account for it)
2. Accrual Accounting Method:
a. Revenue:  As soon as an item is sold, it’s recorded as revenue (even though the cash has not yet been received);
b. Expenses:  Same thing for Expenses, as soon as the company creates an obligation, it’s recorded as an expense;
F. Revenue Ω:  Revenues are realized only when the business becomes unconditionally entitled to their receipt, not when payment is received; (e.g. a K for sale of goods is realized when the goods are shipped, not when payment is made);
1. Related Ω:  Property of a business that increased in market value does not I’ve rise to revenue until the gain in value is realized by sale or disposition of the property;
III. Balance Sheet:
A. Balance sheets describe is a snapshot of the business at a particular moment in time (the only financial statement which is);
B. The balance sheet MUST balance or something is wrong;
C. The some of the left-hand side must be precisely equal to the right-hand side;
D. Every transaction, for the balance sheet to balance, must be recorded in two ways;
1. This is known as double-entry bookkeeping; see p. 59
2. Example:  New business has started.  The owner invests $10K.
a. Assets = $10K
b. Liablities  = $10K
E. “Goodwill” on a Balance Sheet = The amount paid above the fair-market value to obtain the business;
IV. Nomenclature:
A. Left-Hand Side of the Balance Sheet = Assets;
B. Right-Hand Side of the Balance Sheet = Liabilities/Equity;
C. Profit-and-Loss & Income are synonymous;
(c) Business Valuation:
I. The First Question you should ask is, “Who is asking?”
A. Because the person who wants to know may be a buyer or may be the IRS.  The valuation given to each can determine how much profit you may make from a sale or how much tax you will owe.
II. Capitalization Rate:  Capitalization rate (or “cap rate”) is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value.  Capitalization Rate = annual net operating income / cost (or value)
A. Example:  For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then: $100,000 / $1,000,000 = 0.10 = 10%
B. Exam note:  We’ll not be asked to do this on the exam.
III. Cash Flow:
A. A revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities - financing, operations or investing - although this also occurs as a result of donations or gifts in the case of personal finance. Cash outflows result from expenses or investments. This holds true for both business and personal finance.
B. An accounting statement called the “statement of cash flows”, which shows the amount of cash generated and used by a company in a given period. It is calculated by adding noncash charges (such as depreciation) to net income after taxes. Cash flow can be attributed to a specific project, or to a business as a whole. Cash flow can be used as an indication of a company’s financial strength.
d. Sharing Profits & Losses
(1) RUPA §401 - Partner’s Rights and Duties:
(a) (a) Capital Accounts:  Describes how each partner’s Capital Account is constructed and maintained:
I. Capital Contributed by Partner - Any Distributions to Partner + Partner’s Share of Profits - Partner’s Share of the Losses = Capital Account
II. A capital partner’s capital account can go negative from time to time;
A. Upon termination of partnership, if a partner’s capital account is negative, the partner must pay the partnership that amount to bring the balance to zero;
(b) (b) Equal Shares:  Each partner is entitled to an equal share of the partnership profits and chargeable for losses in proportion to the partner’s share of the profits;
I. This, as most provisions, is modifiable by contractual agreement (default rule is equal shares);
(c) (c) Reimbursement/Indemnification: The partnership shall reimburse a partner for payments made and indemnify a partner for liabilities incurred in in the ordinary course of business;
(d) (f) Management:  Each partner has equal rights in the management and conduct of partnership business (unless modified by contractual agreement);
(e) (h) Services Payments Not Allowed:  A partner is NOT entitled to payment for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership;
I. Need clarification on this one...
(2) RUPA §807 - Settlement of Accounts and Contributions Among Partners
(a) (b) Settling Accounts:  Each partner is entitled to an equal share of any leftover monies as a distribution after all liabilities of the partnership are settled; any losses require each partner to contribute an equal share to cover any losses;
I. Except:  §306 - Partner’s Liability releases partners who joined the partnership at a later date from liability for debt incurred before that partner joined.
II. Except: §401(h) exempts payment for services explicitly for the reason outlined in Kessler;
(3) Class Notes:
(a) Capital Contribution doesn’t matter - Share by Default Still Equal:
I. If partners contribute unequal amounts of capital in a partnership, they still share equally in the profits and losses by default.
(b) Partnership Agreement Modifications to Shares:
I. Flat percentage:  Some agreements specify a flat, constant percentage;
II. Partnership Units:  Some partnerships issue partnership units; the determination of profit or loss for each partner is determined by dividing the number of units owned by the partner by the total number of units outstanding;  this method enables new partners to be added and old ones to leave without having to change the partnership agreement; also permits incentive plans for successful partners to increase their percentage interest in the firm;
III. Salary: Partners may be entitled to fixed salary;
IV. Percentage Basis Recalculated each year:  In this arrangement, partners may agree that profits are divided by amount invested and each year the percentage changes in relationship to the amount invested;
V. Fixed Percentage w/Incentive Portion (Law Firm Model):  In large partnerships, each partner may be entitled to a fixed amount applied against 80% of the income.  The remaining 20% is allocated as incentive pay to the junior partners for which the senior partners are not entitled to receive a share of.
(c) Partnership Agreements that do not address losses:
I. This is common; an agreement may agree to divide up profits but not losses;
II. Money Parnter + Labor Partner:
A. Common in construction projects; one partner fronts the money and the other builds a property;
B. If the agreement only specifies division of the profits, then the losses are what each contributed:  money for one partner and labor for the other; (Kessler) (NOT the default rule, which is that each person is liable for losses equally);
1. The money partner cannot sue the labor partner for a contribution of cash losses (and vice versa) in the absence of a loss provision in the agreement;  (Kessler)
a. This is why gap fillers as noted under §103 are not used in this kind of partnership agreement; also §401(h) applies and exempts payment for services explicitly for the reason outlined in Kessler;
e. Liability to Third Parties
(1) RUPA §306 - Partner’s Liability:
(a) (a) Joint & Several Liability:  Except as provided in subsections b) and c), all partners are liability jointly and severally for all obligation of the partnership, unless otherwise agreed by the claimant or provided by law;
I. π can sue just one partner for the entire liability and then it’s up the partner sued to collect from the rest of the partners;
II. Exhaustion Rule:  A judgment creditor is first required to exhaust the partnership assets before proceeding directly against a partner’s individual assets;
(b) (b) New Partner Obligations:  A person admitted to an existing partnership is not personally liable for any partnership obligations incurred before the person’s admission as a partner;
(c) (c) LLC: An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or others, is solely the obligation of the partnership.
(2) RUPA §305 - Partnership Liable for Partner’s Actionable Conduct:
(a) Partners acting in the ordinary course of business of the partnership or with authority of the partnership;
I. Are liable for any actionable conduct (torts, et al.);
II. This cannot be waived or disclaimed;
(b) If a partner receives money or property from a non-partner in the course of the partnership’s business or while acting with authority of the partnership and misapplies (loses it);
I. The partnership is liable for the loss.
(3) Class Notes:
(a) Judgments against the partnership under the UPA:
I. A judgment creditor is first required to exhaust the partnership assets before proceeding directly against a partner’s individual assets;
(b) Reasonable belief by third party:
I. If a third-party reasonably believes that the services he has requested from a partner in a partnership are given by the partner as part of the ordinary business of the partnership, the partnership is liable for losses, negligence, torts, and other obligations. (Roach v. Mead)
(c) Indemnification & Contribution:
I. Indemnification (obligation of a partnership):  §401(c ) provides that, in the absence of an contrary agreement, a partnership must indemnify a partner for payments made and liabilities incurred by the partner in the ordinary course of business.
A. Contribution (obligation of a partner): Even though on partner may have to pay the entire partnership obligation to a third party, indemnification is a mechanism so that the payment of the obligation is shared among the partners;
B. Indemnification payments reduces profits just like any other partnership payment;
C. Contribution at Dissolution:  If, at dissolution of the partnership, there are insufficient funds to pay obligations like indemnities, partners must contribute to make up the shortfall in accordance with their loss share;
f. Fiduciary Duties
(1) RUPA §404 - General Standards of Partner’s Conduct:
(a) (a) Fiduciary Duties Owed:
I. Duty of Loyalty;
II. Duty of Care;
A. This is less than the duty of trustees (whose fiduciary duty always must put the beneficiary’s interest ahead of their own);
(b) (b) Duty of Loyalty: Limited to the following:
I. Accounting:  To account to the partnership and hold as trustee for it any property, profit, or benefit including appropriation of a partnership opportunity;
II. Conflict of Interest: To refrain from dealing with the partnership on behalf of a party having an interest adverse to the partnership;
III. Non-Compete:  To refrain from competing with the partnership in the conduct of partnership business before the dissolution of the partnership;
(c) (c) Duty of Care:  In the conduct or winding up of the partnership business, refrain from:
I. Grossly negligent or reckless conduct;
II. Intentional misconduct;
III. Knowing violation of the law;
(d) (d) Good Faith & Fair Dealing:  A partner shall discharge the duties of the partnership consistently with the obligation of Good Faith and Fair Dealing;
(e) (e) Self-Interest: A partner does not violate a duty obligation under RUPA or a partnership agreement merely because the partner’s conduct furthers the partner’s own interest;
(f) (f) Loans: A partner may lend money to and transact other business with the partnership, and as to each loan or transaction has the rights and obligations as a person who is NOT a partner;
(g) (g) Applicability:  This section applies to a person winding up the partnership as the personal or legal representative of the last surviving partner as if the person were a partner.
(2) RUPA §103 - Effect of a Partnership Agreement; Nonwaivable Provisions:
(a) (a) Partnership Governance: Except as otherwise provided in (b), relations among the partners are governed by the partnership agreement.  Where the partnership agreement is silent, RUPA governs relations among the partners (gap fillers);
(b) (b) Nonwaivable Provisions (things you can’t contract “around”):  The partnership may NOT:
I. Vary the rights and duties under §105 - Execution, Filing, and Recording of Statements except to eliminate the duty to provide copies f statements to all of the partners;
II. Unreasonably restrict the right of access to books and records under §403(b);
III. Eliminate the duty of loyalty under §404(b) or §603(b)(3), but:
A. Partnership agreements that specify types of activities that do not violate the duty of loyalty may be acceptable if not “manifestly unreasonable”;
IV. Unreasonably reduce the duty of care under §404(c) or §603(b)(3);
V. Eliminate the obligation of good faith and fair dealing under §404(d);
VI. Vary the power to dissociate as a partner under §602(a), except to require the notice under §601(1) to be in writing;