10.1 Selection, Formation, Operation, and Termination

10.1 Selection, Formation, Operation, and Termination

REG Blueprint Area II, Group E, Topic 1 is state business law. It asks which entity exists, how it was formed, what legal characteristics it has, and how it ends. Federal tax classification — check-the-box, disregarded entities, partnership versus association — belongs in LLC tax classification. Do not import IRC §§351 or 721 into this chapter. A Delaware LLC is still an LLC under state law even if it elects to be taxed as a C corporation.

State law decides who is liable, who may bind the firm, whether a filing is required, and how the business dies. Tax rates, basis, and pass-through character sit in later chapters. REG will give facts and ask you to classify the entity or pick the consequence of that classification.

Sole proprietorship

One natural person owns the business. No filing is required to exist (local licenses and assumed-name certificates are not formation of a new legal person). The owner and the business are the same legal person. The owner has unlimited personal liability for business debts. Transfer is a sale of assets, not of an interest in a separate entity. The business ends when the owner dies, retires, or stops operating. There are no partners, members, or shareholders.

General partnership (RUPA)

Under the Revised Uniform Partnership Act (RUPA), a partnership is an association of two or more persons to carry on as co-owners a business for profit. No filing is required. Sharing profits is prima facie evidence of partnership unless the share is wages, rent, interest, or a similar return. A GP is a separate legal entity for many purposes (it can own property and sue in its own name), but partners remain jointly and severally liable for partnership obligations. Default management is equal rights. Duration is at will unless the partners agree to a term or undertaking.

Limited partnership (RULPA)

Formed under the Revised Uniform Limited Partnership Act (RULPA) by filing a certificate of limited partnership with the state. At least one general partner (unlimited liability; manages) and at least one limited partner (liability generally limited to the contribution, provided the limited partner does not take on a general-partner role under a control-rule statute). The certificate, not a private agreement, is what creates the LP vis-à-vis the world. Rights of limited partners who participate in control are developed in 10.2.

Limited liability partnership (LLP)

A general partnership that registers as an LLP. The registration is the formation filing. The hallmark is a liability shield for partners' malpractice of others. Partial-shield statutes typically protect a partner from vicarious liability for another partner's professional negligence, while leaving the partner on the hook for ordinary contract debts. Full-shield statutes extend the shield to most partnership obligations, leaving the partner liable for the partner's own misconduct and for obligations the partner personally guarantees. REG tests the concept, not a particular state's citation: an LLP partner is not automatically liable for another partner's malpractice, but is liable for the partner's own torts and for debts the partner guaranteed.

Limited liability company (LLC)

Formed by filing articles of organization (sometimes called a certificate of formation). The operating agreement governs internal affairs; it is not the public formation document. Members have limited liability. Default management in many acts is member-managed; the articles or operating agreement may elect manager-managed. An LLC is a separate legal entity. Transfer of a membership interest typically transfers economic rights, not automatically the right to participate in management, unless the statute or agreement says otherwise. How the IRS classifies the same LLC is chapter 20, not a state-law formation question.

Corporation (RMBCA)

Under the Revised Model Business Corporation Act (RMBCA), a corporation is formed by filing articles of incorporation (name, authorized shares, registered agent, incorporators). Bylaws are internal rules; they are not filed to create the entity. Promoters who make preincorporation contracts are personally liable on those contracts unless the third party agrees to look only to the corporation-to-be, or the corporation later adopts the contract. Adoption makes the corporation a party; it does not, by itself, let the promoter off. Only a novation — the third party's agreement to substitute the corporation and release the promoter — discharges the promoter. Shareholders have limited liability. A corporation has perpetual duration unless the articles provide otherwise.

Legal characteristics at a glance

Termination: partnership versus corporation

Partnership (RUPA). Three different events; REG will name them.

1. Dissociation. A partner leaves — withdrawal, expulsion, death, or bankruptcy of the partner. Dissociation does not always dissolve the firm. In a partnership at will, a partner's notice of withdrawal typically causes dissolution. In a term partnership, dissociation of one partner often leaves the others free to continue, with a buyout of the dissociated partner.
2. Dissolution. The partnership begins to wind up. Causes include the end of a definite term, express will of all remaining partners, events making the business unlawful, and judicial decree.
3. Winding up. Liquidation of assets, payment of creditors, and distribution of any surplus to partners. After winding up, the partnership is terminated.

A dissociated partner's actual authority to bind the firm ends, but apparent authority can linger as to third parties who lack notice — the same notice problem as in agency.

Corporation. Voluntary dissolution is a shareholder (and, typically, board) decision, followed by filing articles of dissolution and winding up. Administrative dissolution is a state action for failure to file annual reports or pay franchise taxes; many statutes allow reinstatement. Judicial dissolution is a court order — deadlock, oppression of minority shareholders, or illegality. After dissolution the corporation continues for the limited purpose of winding up: collecting assets, discharging liabilities, and distributing the remainder to shareholders. Claims against a dissolved corporation are handled under statutory notice-and-bar procedures; dissolution is not a magic wand that erases creditors.

An LLC dissolves under the operating agreement and the statute (often on consent of members, or on a specified event). A sole proprietorship ends when the owner stops; there is no entity to dissolve.

Worked scenario: two co-owners, no filing

Facts. Jordan and Riley agree to run a catering business together, share profits 50/50, and jointly decide menus and hires. They never file anything with the state. Riley orders $18,000 of ovens from a supplier on the firm's credit. A year later they disagree and Jordan wants out.

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