Legal Issues and Legal Structure

Legal Issues and Legal Structure of Starting and Operating Anyname Fitness Center, LP

There are some interesting dynamics at work in determining the feasibility of creating any new enterprise in the current economic climate, but these issues are particularly pronounced as they relate to the establishment of a public gymnasium or other fitness-related business. On the one hand, fitness awareness has significantly increased through the American demographic, but on the other hand, the nation is faced with a virtual epidemic in obesity due in large part to the increasingly sedentary lifestyle that characterizes modern society. Despite these latter constraints, it is apparent that there are numerous examples of well-operated fitness-related facilities that are enjoying healthy profits, making the creation of such a facility a timely and relevant enterprise that also forms the focus of this study. The purpose of this paper was to provide a review of the relevant literature to identify and describe the legal structure of a gymnasium and some of the typical contractual arrangements that will be encountered during its establishment and as part of its day-to-day operation. To this end, an analysis of pertinent issues that should be taken into account that relate to the type of facility that is involved and corresponding management and marketing concerns is followed by a background of the activities involved in a typical gymnasium operated as a limited partnership, and a proposed business model for the partnership. A discussion of the various legal issues and documentary requirements that are involved in creating and operating a limited partnership is followed by a recommendation concerning how the enterprise should proceed and a summary of the research in the conclusion.

A.

WHY DOES a GYM FIT a NEED? Gymnasiums (hereinafter alternatively "gyms," "fitness centers" or "fitness facilities") serve a wide range of needs in contemporary American society, ranging from meeting the purely physical fitness-related needs of people to those that are more related to socialization and, by extension, romance and dating (Cruz-George, 2007. Therefore, the type of gym structure that is used and the specific corresponding legal factors that are involved will depend on the market being targeted. For example, gymnasiums providing services for single-sex gym classes in a private school setting will have very different legal considerations than a public co-ed facility that is targeting young, unmarried and affluent members of the community. Targeting this segment of the demographic would appear to be a good place to start for a new enterprise as well. For instance, Mealey (1997) examined the reasons why most people sought out a public gymnasium and the types of exercise equipment they used during their visits and found some interesting relationships between the two variables. The gym clientele that was found to be more interested in establishing relationships used exercise equipment that maximized their opportunities for communication with members of the opposite sex as well as those that accentuated the physical attributes the respondents believed were most attractive (Mealey, 1997). According to Mealey, "Many men and women who use athletic training equipment do so in an attempt to increase their physical attractiveness to potential mating partners and thus use athletic equipment in ways that would exaggerate physical, biological gender signals" (Mealy, 1997, p. 224).

These behaviors even extended to more recent innovations in physical fitness training equipment that are specifically intended to reduce gender-related disparities. In this regard, Mealy notes that, "Men tailored their workouts in ways that would enhance the musculature of the upper body, and women tailored their workouts in ways that would enhance leg and hip muscle" (p. 224). These findings held consistent for three independent samples of analyzed for both males and females, but were most pronounced among the younger, college-aged samples who reported that "appearance to opposite sex was one of the most important reasons for working out" (quoted in Mealey, 1997 at p. 224). Therefore, the age and gender(s) of the market being targeted will have some influence over what type of physical fitness equipment is used and what type of training regimens will be offered. In addition, the levels of privacy that a gym offers will directly relate to what type of market is being targeted.

B.

BACKGROUND. With a history dating to the ancient Greeks who were fond of using the facilities for socialization besides physical fitness activities, gymnasia have served as meeting places and exercise venues for humankind for thousands of years (Rahe, 1993). While the basic purposes of gyms have not changed that much since the days of the ancient Greeks, the equipment and methods used have changed in fundamental ways. Although most gyms today offer a variety of exercise equipment and classes, a weight room, a locker room, and qualified trainers, they differ in many ways depending on these factors and how they relate to the fitness goals of existing and potential clientele. In order to ensure that the facility meets the changing needs its clientele, the features outlined in Appendix a must be taken into account. There are also some environmental issues such as temperature and noise levels that must be taken into consideration when operating a public gymnasium. According to West (2006), "The temperature should be what is comfortable for your clients. It will be different for each of your classes. I suggest that the issue be resolved at the management level since they will be responsible for the overheated client in a room that is set too warm for regular aerobics classes. I consider 70 degrees too high for regular aerobic classes. It would probably be fine for the over 60 crowd. For an aerobics class, a room temperature of no higher than 68 degrees and 50% humidity is recommended" (p. 17). Gym operators who are in doubt concerning optimum temperature levels should consult with their clientele as well as the relevant Occupational Safety and Health Administration (OSHA) guidelines which recommend a workplace temperature control in the range of 68-76 degrees F. And humidity control in the range of 20%-60% as set forth in the OSHA Manual which also provides corresponding allowable noise ranges depending on the activities that are involved (West, 2006; Temperature, 2007). In addition, some upscale gym operators have even recruiting the services of feng shui experts to help them provide an atmosphere that is conducive to promoting harmonious environmental conditions for their clients (Wu, 2005). The private gym enterprise targeting middle-class young adults discussed herein, though, will not require a feng shui expert but it will require a viable business model that can be used to help guide its activities in the short-term and provide the basis for growth in the long-term and this model is discussed further below.

C.

Business MODEL

The business model to be used in this private gym enterprise will be based on a goal of providing physical fitness activities and equipment that can be used by the young adults with or without children in the home by offering a family-friendly environment that features on-site childcare. The business model calls for the company's clientele to receive a personalized training regimen and attention from the training staff so that clientele can pursue their physical fitness goals in effective ways. The private gym will have a target market of members who are aged 45 years or under and who have young children in the family. Initially, onsite childcare facilities operated by the gym will accommodate 25 children (including five infants) with plans to expand this service depending on the level of demand. The combination of state-of-the-art exercise equipment, facilities, expert trainers and on-site childcare will be the primary competitive advantage for this business. Initial staffing requirements are set forth in Table 1 below as well as projected salary ranges for these positions.

Table 1

Staffing requirements and projected salaries for a private gym

Personnel

2010

2011

2012

Center Manager (general partner)

$48,000

$50,000

$52,000

Assistant Manager (general partner)

$36,000

$38,000

$40,000

Center Staff

$240,000

$270,000

$300,000

Childcare Manager (general partner)

$30,000

$32,000

$34,000

Childcare Staff

$147,000

$170,000

$200,000

Tennis Manager

$30,000

$32,000

$34,000

Source: Workout Gym Business Plan for Mountain Brook Fitness Center (2007) at http://www.bplans.com/workout_gym_business_plan/management_summary_fc.cfm

D.

MISSION STATEMENT. The mission statement will be included as part of the partnership agreement (discussed further below) and will state that, "It is the mission of Anyname Fitness Center, LP to provide that high-quality physical fitness services in an affordable environment that is conducive to physical fitness activities using the best equipment and trainers available to grow the business for the mutual profitability of its general and limited partners and the physical fitness of the clientele it serves."

E.

STATEMENT of PERTINENT POINTS in PAPER. The following issues are discussed to varying degrees as they relate to their implications for the general and limited partners in a limited partnership in general and for one operating in the State of Missouri in particular. The topics so discussed concern the legal issues involved in creating and operating a limited partnership, its structure and an analysis of its suitability for the gymnasium enterprise outlined herein, the ease of its formation and taxation issues, an examination of external liability for the two types of partners, a general discussion of management and control, transfer and continuity considerations, and the legal structure of the limited partnership.

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, p. 381).

2.

DISSOLUTION. The limited partnership should have the steps by which the partnership will be dissolved set forth in the partnership agreement (discussed further below). According to Truskowski and Thorne-Thomsen (1999), "The partnership agreement should allow for dissolution by a partner vote and should specify the procedure to be followed and the exact vote required. A dissolution provision also might set a specified partnership termination date, describe an event that would make it impracticable or illegal to continue or determine that the failure to reach certain performance levels would trigger termination. The agreement also should specify how the partnership's assets are to be liquidated and distributed" (p. 93).

APPLICABLE LAW and CONTRACTS

A.

SIX ELEMENTS of a CONTRACT. According to Black's, a contract is "an agreement between two or more persons which creates an obligation to do or not to do a particular thing. To satisfy the terms of a contract and have it held as authentic in a court of relevant jurisdiction, the six elements of a contract must be considered, which are (a) intention (did the parties to the contract make their respective intentions evident?); (b) agreement (there is concordance between the parties as to the terms of the contract); (c) consideration (something of value changed hands pursuant to the contract); (d) capacity (the legal standing of the parties to contract with each other); (e) consent (affirmative consent was demonstrated by the parties) and (e) legality (the enterprise outlined in the contract is not illegal).

Part of the contractual requirements for the general and limited partners will involve entering into a mutual nondisclosure agreement concerning the operations and business plan used by the private gym enterprise outlined herein, as well as a non-competing employment agreement for a period to be determined for all general partners of the limited partnership ("two time periods must be considered when drafting them: the partner's tenure in the partnership and the period afterward" (Truskowski & Thorne-Thomsen, 1999, p. 92). A partnership agreement will also be crafted by a lawyer hired for the purpose that is specifically tailored to the partners and their mutual and individual goals and management styles. This approach is congruent with the guidance provided by Truskowski and Thorne-Thomsen (1999) that emphasize, "Because a partnership is intimately involved with the partners' personalities, no two partnerships are exactly the same. Thus, no model partnership agreement can cover the many concerns, goals and management styles and practices of every accounting practice. Nevertheless, all partnership agreements should address certain matters" (p. 92). All partnership agreements should address the issues described in Table 2 below:

Table 2

Elements of a partnership agreement

Element

Description

Statement of purpose.

Although the statement of purposes may seem to be a rather straightforward provision, it is important the agreement set forth the specific businesses in which the partnership will engage

Noncompetition.

Probably one of the most difficult provisions to negotiate, as well as to enforce, is a noncompetition provision. The agreement should specify each partner's obligations to bring all business opportunities to the partnership and refrain from diverting partnership business to his or her own account. It also may describe situations in which a partner can engage in an economic activity for his or her own benefit such as outside training. Even in these circumstances, however, the agreement should include some guidance to prevent partners from devoting excessive time to outside activities.

Capital contributions.

Partners frequently either lend or contribute money to the partnership. Although it is not always easy to distinguish between debt and equity, the distinction does not result in significant differences in tax treatment, so the issue has not been a crucial one for many partnerships. Between the two ends of the partner debt-equity spectrum are numerous variations that focus on repayment terms and the interim charge for the use of funds. The documentation for all of these arrangements may be included either in the partnership agreement or in the form of an independent loan contract and promissory note. When partners make equity contributions to the firm, the tax allocation and partnership distribution sections of the partnership agreement should ensure a proper priority return to the contributing partner and proper capital account maintenance