Legal Issues and Legal Structure Term Paper

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LEGAL ISSUE, STRUCTURE, and ANALYSIS

A.

LEGAL ISSUES-LIMITED PARTNERSHIP. According to Black's Law Dictionary (1991), a limited partnership is a "type of partnership of one or more general partners who manage business and who are personally liable for partnership debts, and one or more limited partners, who contribute capital and share in profits but who take no part in running business and incur no liability with respect to partnership obligations beyond contribution" (p. 928). This definition of a limited partnership is congruent with the provisions of the Uniform Limited Partnership Act that stipulates such a partnership is comprised of one or more general partners and one or more limited partners who are not bound by the obligations of the partnership (Black's, 1991). A limited partnership represents an effective operational structure for asset protection because limited partners are generally liable only for their partnership contributions and not for any partnership debts if they do not participate in the control of the day-to-day partnership business; by contrast, general partners control the partnership and are completely liable for partnership debts (Dedon, 1999).

Although laws concerning limited partnerships vary from state to state, the aforementioned Uniform Limited Partnership Act sets forth general requirements for their creation and operation. For instance, the Secretary of State (2010) reports that in Texas, "The limited partnership operates in accordance with a partnership agreement, written or oral, of the partners as to the affairs of the limited partnership and the conduct of its business. While the partnership agreement is not filed for public record, the limited partnership must file a certificate of formation with the Texas Secretary of State. The Secretary of State provides a form that meets minimum state law requirements" (Selecting a business structure, 2010, para. 2).

1. EASE of FORMATION. In Missouri, forming a limited partnership involves only the filing of a certificate of limited partnership with the state's Corporations Division and the payment of all required fees; however, there are a variety of other issues that must be considered during the formation that will contribute to its success -- or failure -- in the future and these issues are discussed further below.

2. TAXATION. The ultimate goal of any limited partnership is to provide a framework in which there is limited personal liability as to taxation for all owners (Cleveland, Wells & Yashimoto, 1996). According to Gutterman (1994), "For tax purposes, profits and losses from the limited partnership are "passed through" to each of the general and limited partners in the proportions provided for in the limited partnership agreement" (p. 259). In this area, the general partners enjoy a great deal of latitude concerning the allocation of profits and losses. In this regard, Gutterman advises, "As a general rule, the partners are free to allocate profits and losses in any manner they decide, even if the allocations are disproportionate to the capital contributed to the partnership, provided that the allocations have 'substantial economic effect' under Section 704(b) of the Internal Revenue Code of 1986, as amended" (1994, p. 259).

In addition, in those cases where there are family relationships between the partners such as a married couple, there also some worthwhile income and estate planning reasons why assets should be transferred to a family limited partnership:

1. It allows a couple to shift income to children or other relatives through gifts of limited partnership interests. Income from these limited partnership interests is then taxed to the limited partners. If the parents together own 10% of the partnership and the partnership's income is $100, the parents would be taxed on only $10 of income.

2. Once the interests have been given away, they generally no longer are in the couple's gross estate.

3. Couples can take advantage of the gift tax provisions by giving $20,000 worth of limited partnership interests each year to a limited partner. These independent reasons for forming a limited partnership may help demonstrate there is no fraudulent intent on asset transfers to the partnership if this strategy subsequently is challenged in court (Dedon, 1999, p. 61)

3. EXTERNAL LIABILITY.

According to Dedon (1999), partnerships are confronted with certain special risks that can doom a business to failure because partnerships are liable for potential claims against their partners (Dedon, 1999). According to this authority, "General partners may be liable for against their personal assets resulting from engagements performed in distant cities of which he or she had no knowledge. Failure to adopt a plan that protects assets from creditors can have tragic consequences for those who are sued" (Dedon, 1999, p. 61). There are some limits as to what and how much can be assessed against partnership assets. In this regard, the same type of affirmative asset partitioning that is applied to corporations, typically termed "priority with liquidation protection" is also used with limited partnerships which assigns creditors a prior claim on assets as well as providing that if a partner becomes insolvent, the partner's personal creditors cannot force liquidation of partnership assets to satisfy their claims upon exhausting the partner's personal assets (Hansmann & Kraakman, 2000). The most severe tactic that a creditor can use in these cases is to have the partner's creditors assume the partner's role as an owner that can encourage the liquidation of firm assets but this requires at least a majority agreement among the partnership's limited partners (Hansmann & Kraakman, 2000).

4. Management and CONTROL. The general partner of a limited partnership has full authority to manage the affairs of the limited partnership and is subject to unlimited liability for debts and obligations incurred by the limited partnership. Limited partners have no rights to participate in the management and control of the business of the limited partnership; however, they also are not liable for any of the debts or obligations of the limited partnership in excess of the amount of capital they contributed to the partnership (Gutterman, 1994, p. 258). In practice, the management structure of a limited partnership ranges between full or partially participatory (Cleveland, Wells & Yashimoto, 1996).

5. TRANSFERABILITY and CONTINUITY. Both partnerships and corporations share some common characteristics as they apply to transferability and continuity. Although partnerships and corporation must both have associates as well as a stated objective in order to conduct their businesses, partnerships do not typically posses four of the remaining characteristics that define corporations, to-wit: (a) limited liability, (b) centralized management, (c) continuity of life, and (d) free transferability of interests (Cleveland et al., 1996). Current IRS regulations require that in order to be properly formed for federal income tax purposes, a partnership is not allowed to possess more than two of these four corporate characteristics (Cleveland et al., 1996). Because limited liability is one of the primary features that the limited partnership provides its stakeholders, companies seeking to operate as limited partnerships must ensure that they do not posses more than one of the other three remaining corporate characteristics: (a) continuity of life, (b) centralized management, or (c) free transferability of ownership (Cleveland et al., 1996).

B.

LEGAL STRUCTURE: FORMATION and FILING of CERTIFICATE. The Missouri Secretary of State (201) reports that in Missouri, the formation of a limited partnership requires the filing of a certificate of limited partnership with the Corporations Division pursuant to Section 359.091, RSMo; likewise, all foreign limited partnerships seeking to do business in Missouri are also required to register with the Corporations Division per Section 359.501, RSMo; the fee for filing both an original certificate of limited partnership and for registering a foreign limited partnership is currently $105 (Starting a business, 2010).

C.

LEGAL ANALYSIS:

1.

CONTRACT and TORT LIABILITY. The extent of liability for contractual obligations as well as exposure to tort liability will depend on the stakeholders' status within the limited partnership. "An entity has "limited liability" if under local law no member is personally liable for the debts or claims against the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization, to the extent that the assets of the organization are insufficient to satisfy the creditor's claim" (Cleveland et al., 1996, p. 27). The law of partnership solves the problem of granting creditors a prior claim on the assets of the firm, and hence permits the weak form of affirmative asset partitioning, by creating a special form of concurrent tenancy for all assets held in partnership name. (a partner is said to hold partnership assets as a "tenant in partnership" under the old Uniform Partnership Act.(34) the rules of creditors' rights and bankruptcy applied to partnership provide that creditors of the partnership have a claim on these partnership assets, in case of the partnership's insolvency, that is prior to the claims of the partners' personal creditors (Hansmann & Kraakman, 2000,…

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