Start Here: 5 Things You MUST Know
A sole proprietorship is the simplest entity — no filing required, but the owner has unlimited personal liability
In a general partnership, every partner has unlimited liability for all partnership debts — even for other partners' negligence
Partners owe each other fiduciary duties of trust, loyalty, and good faith — like agents and trustees
Upon dissolution, assets are distributed in a specific order: outside creditors first, then partner loans, then capital, then surplus
A joint venture is a partnership for a single project — same liability rules, but limited in scope
1. Sole Proprietorships
Sole Proprietorship
The simplest form of business entity. One person owns and operates the business. There is no legal separation between the owner and the business — they are the same legal person.
Advantages
- No state filing required to form
- Complete control over all decisions
- Simple tax reporting (Schedule C)
- Easy to start and dissolve
Disadvantages
- UNLIMITED personal liability
- Difficult to raise capital
- Business dies with the owner
- All risk falls on one person
Real-World Scenario: Unlimited Liability in Action
The Setup: Mike runs a landscaping business as a sole proprietor. He has $20,000 in business equipment and $150,000 in personal savings.
What Happens: An employee driving a company truck causes a major accident, injuring three people. The judgment is $500,000.
The Result: Mike is personally liable for the entire $500,000. Creditors can seize his business equipment AND his personal savings, car, and even put a lien on his house. There is NO separation between Mike and his business.
2. Partnership Formation
Partnership
An association of two or more persons who carry on as co-owners of a business for profit. No state filing is required — a partnership can be formed by a simple handshake. Governed by the Uniform Partnership Act (UPA).
Key Characteristics
Shared Profits
Partners share profits AND losses equally (unless agreed otherwise)
Mutual Agency
Each partner is an agent of the partnership and can bind it in ordinary business
Unlimited Liability
Each partner has unlimited personal liability for all partnership debts
Partnership by Estoppel
When someone represents themselves as a partner (or allows it) and a third party relies on that representation to their detriment, that person may be treated as a partner — even if no formal partnership exists.
Example: Dan tells a bank, "My partner Steve and I need a $100,000 loan." Steve is NOT actually a partner but does not correct Dan. The bank lends the money based on both of their credit. If the loan defaults, Steve can be held liable as a "partner by estoppel" because he allowed the bank to rely on the representation.
Common Name Statute
A law requiring partnerships doing business under a trade name (like "Sunrise Plumbing" instead of "Smith & Jones") to register that name with the state. This lets the public know who actually owns the business.
3. Partnership Liability
The Big Risk of General Partnerships
Every partner is jointly and severally liable for torts committed by ANY partner acting in the ordinary course of partnership business. This means a creditor can go after any one partner for the entire debt.
Tort Liability
ALL partners are jointly and severally liable for torts by any partner in the ordinary course of business. You are personally on the hook even if you did nothing wrong.
Criminal Liability
Partners are generally NOT liable for crimes committed by other partners — unless they participated in or authorized the criminal act.
Real-World Scenario: Why Partnerships Are Risky
The Setup: Alice and Bob are partners in a delivery business. Alice is careful and responsible. Bob sometimes drives recklessly.
What Happens: While making a delivery, Bob runs a red light and injures a pedestrian. The pedestrian sues for $300,000.
The Result: Both the partnership AND Alice personally can be held liable for the full $300,000. Even though Alice was not driving and did nothing wrong, she is personally liable because Bob's negligence occurred in the ordinary course of partnership business. This is the HUGE risk of general partnerships.
4. Partners' Relationships to Each Other
Fiduciary Relationship
Every partner owes fiduciary duties to the other partners and the partnership. This means duties of mutual trust, loyalty (no competing with the partnership), and good faith — similar to duties of an agent or trustee.
Financial Relationship
Each partner shares equally in profits and in any surplus remaining on dissolution after all liabilities are paid (unless the agreement says otherwise).
Right to Inspect Books
The partnership must maintain books. All partners have the right to inspect them at any time.
Assignment of Partner's Interest
A partner CAN assign their financial interest (right to receive profits) to someone else. However, they CANNOT transfer their right to participate in management without the other partners' consent.
Example: Partner A assigns their share of profits to their spouse. The spouse receives A's share of profits but has NO right to vote on partnership decisions, inspect books, or participate in management.
Decision Making
Ordinary Business Matters
Majority vote of partners decides. Day-to-day decisions like purchasing supplies, hiring staff, setting prices.
Extraordinary Matters
Unanimous consent usually required. Major decisions like changing the nature of the business, admitting new partners, or selling all assets.
Real-World Scenario: Fiduciary Duty Breach
The Setup: Tom and Jerry are partners in a real estate firm. Tom learns about a prime commercial property for sale at a great price.
What Happens: Instead of presenting the opportunity to the partnership, Tom buys the property personally and flips it for a $200,000 profit.
The Result: Tom breached his fiduciary duty of loyalty. He took a partnership opportunity for personal gain. Jerry can sue Tom, and the court will likely require Tom to turn over the $200,000 profit to the partnership.
5. Relationship of Partners to Third Parties
Apparent Authority (Estoppel)
If a partner appears to have authority to act and a third party reasonably relies on that appearance, the partnership is bound — even if the partner actually lacked authority.
Example: Partner A orders $50,000 worth of inventory from a supplier, even though the other partners told A not to. The supplier had no way of knowing about this internal restriction. The partnership is bound because ordering inventory is within the ordinary scope of business for that type of partnership.
Conveying Real Property
Under the UPA, if property is held in the partnership's name, any partner can transfer it by signing a deed. The partnership IS bound unless the purchaser knew the partner lacked actual authority.
Spouses' Rights
The UPA does NOT give a partner's spouse any direct rights in partnership property. The spouse has no claim to partnership assets.
6. Dissolution, Winding Up & Termination
Rightful Dissolution
Partners agree to dissolve, the partnership term expires, or a partner gives proper notice of withdrawal.
Wrongful Dissolution
A partner dissolves the partnership in violation of the agreement. The wrongfully dissolving partner may be liable for damages.
Distribution of Assets Upon Dissolution (MEMORIZE THIS ORDER)
Outside Creditors
Pay non-partner debts FIRST
Partner Loans
Repay loans partners made to the firm
Capital Contributions
Return partners' original investment
Surplus
Split any remaining assets equally
Winding Up
The process of settling partnership affairs after dissolution — collecting debts owed to the partnership, paying obligations, and distributing remaining assets to partners.
Effect on Third Parties
Until third parties receive notice of dissolution, they can still hold the partnership liable for new transactions entered into by the partners. Always notify business contacts when dissolving!
Example: Smith & Jones dissolve their partnership but forget to notify their regular supplier. The supplier ships $10,000 of inventory to the partnership based on a new order from Smith. The partnership (and both partners) are liable because the supplier had no notice of dissolution.
Cheat Sheet
Print this page for quick referenceSole Proprietorship
- One owner, no filing, no formalities
- UNLIMITED personal liability
- Taxed on Schedule C (personal return)
General Partnership
- 2+ co-owners, no filing required
- Jointly and severally liable (torts)
- NOT liable for other partners' crimes
- Fiduciary duties: trust, loyalty, good faith
Dissolution Order
- 1. Outside creditors
- 2. Partner loans
- 3. Capital contributions
- 4. Surplus (split equally)
Key Rules
- Can assign profits, NOT management rights
- Ordinary = majority vote; Extraordinary = unanimous
- Third parties bound until notice of dissolution
- Spouse has NO rights in partnership property
Exam Trap Alerts
1. Tort vs. Crime Liability
Partners ARE liable for each other's torts (in ordinary course of business) but generally are NOT liable for each other's crimes. The exam loves testing this distinction.
2. Assignment Does NOT Transfer Management
A partner can assign their right to receive profits, but CANNOT transfer the right to participate in management without the other partners' consent. The assignee gets money, not votes.
3. Dissolution Order Matters
Outside creditors are paid FIRST, then partner loans, then capital, then surplus. The exam tests this order. Partners who also loaned money to the firm get paid before partners who only contributed capital.
4. Partnership by Estoppel
You do NOT need a formal agreement to be liable as a partner. If you allow someone to represent you as a partner and a third party relies on it, you can be treated as one.
5. No Notice = Still Liable
After dissolution, until third parties receive notice, partners are still liable for new transactions. Dissolving is not enough — you must notify everyone.
Quick Reference Summary
Sole Proprietorship
One owner, no filing, unlimited liability, simplest entity form.
General Partnership
2+ co-owners, no filing needed, unlimited liability for all partners.
Joint & Several Liability
Any partner can be sued for the full amount of a partnership tort.
Fiduciary Duties
Trust, loyalty, good faith. Cannot compete or take partnership opportunities.
Dissolution Order
Outside creditors, partner loans, capital contributions, surplus.
Apparent Authority
Partnership bound if partner appears authorized and third party relies.