OK, let's let's be honest. If you're a law student staring
down business associations, you know, terms like limited
liability, piercing, the corporate veil, all the
different entity types. It can feel like, well, like
trying to build a skyscraper blindfolded sometimes.
Oh, absolutely. It's that classic law school
fire hose moment, isn't it? Totally.
And, you know, these concepts are just critical for the exam,
but cutting through all that noise to figure out what really
matters, that is the challenge. It really is.
Students often get caught in the weeds, you know, memorizing all
the exceptions before they even really grasp the core rules and
the real test. What makes his stuff tough, but
also honestly pretty fascinating, is understanding
why the rules are there, how they fit together, and
importantly, where those lines get blurry.
Exactly, and that's really our mission here in this deep dive.
You shared some fantastic source materials with us.
Articles, notes even that that really relatable Reddit thread
grappling with these exact issues.
Yeah, that was a good one. So we're going to take all of
that, try to distill it down, clarify the must know rules, the
key distinctions, and really highlight the connections you
absolutely need to get for exam success.
Think of it like building that skyscraper, maybe one floor at a
time, but making sure each floor is solid.
Using those sources as our blueprint.
We should probably just jump right into the foundational
stuff. OK, sounds good.
Let's start with what feels like the, I guess, the promised land
for business owners limited liability.
This is the baseline, right? The default for corporations and
LLCS. That's the one.
It's the starting point. And the core idea here, which is
like a massive shift from older business forms, is that the
owners, shareholders and corporation members in an LLC,
they're generally shielded. Shielded from what exactly?
For personal responsibility for the business's debt.
So contractual debts, tort, liabilities of the business
itself. So OK, the business signs a
lease, can't pay, or maybe it gets sued for negligence.
The creditors? They can't usually come after
the owner's personal bank account or their house.
Precisely. Your risk generally is capped at
whatever you've invested in the company.
The law treats the entity as a separate legal person.
OK. But this is a critical
distinction Pops up right away in your sources, especially
there too that Reddit discussion.
Limited liability for the business's debts doesn't mean
limited liability for the owner's own wrongdoing.
Right, That example someone mentioned, the shareholder who
punches A pedestrian corporation probably isn't liable for the
punch, right? But the shareholder definitely
is personally because they threw the punch.
It's their own tort. Grim example, but yeah, it makes
a point. Clearly the corporate shield
isn't for your own personal misbehavior outside the business
context. Makes sense now, while limited
liability is the general rule for Core and LLC's, it's it's
not bulletproof. And this brings us to probably
one of the most heavily tested and frankly trickiest exception.
Piercing the corporate veil. Just the name sounds dramatic.
It is pretty dramatic piercing the corporate veil or PCV.
That's the court's power to essentially say, OK, we see the
corporate structure, but in this specific situation, we're going
to ignore it. And they hold the shareholders
of the owners personally liable for the business's debts, just
as if that limited liability shield wasn't even there.
So the court is basically pulling back the curtains saying
Nope, this time you're responsible.
Exactly. Pulling back the curtains, a
good way to put it. Now, a really crucial point from
your sources is that PCV is governed by state law here in
the US, OK? And while there isn't one single
perfectly consistent test everywhere, you definitely see
common themes, common factors that courts look at.
It's very much a factors test, not a simple checkbox exercise.
OK, let's dig into those factors then.
What kind of things make a court even consider piercing?
Well, a huge red flag is fraud. Using the corporate form
specifically to commit fraud or some other, you know,
fundamental injustice. If the company was basically set
up or uses a sham just to cheat people, that weighs really
heavily towards piercing. OK, so intentional fraud using
the company structure is factor one.
What else? Another big area often talked
about under the hitting alter ego is where there's a serious
lack of corporate formalities. Like what?
Like mixing personal and business funds, commingling or
maybe never holding board meetings, not keeping any
records, basically treating the company bank account like your
personal Piggy Bank. Right.
Like paying your personal mortgage out of the company
account or something. Exactly that Bob and ABC Corp
example from the Reddit thread. That's spot on.
If Bob is the only owner, he's the CEO, the board, everything.
No other employees use the company money for personal
stuff. Never writes anything down.
A court might just say, look, Bob and ABC court are
effectively the same entity. They're his alter ego.
OK, but what about just being sloppy?
Like forgetting to hold the annual meeting.
That's a really important nuance for exams.
The source is generally emphasized that just lacking
formalities like missing some minutes usually isn't enough on
its own. It typically needs to be
combined with other things like that commingling of funds or the
fraud element or maybe serious undercapitalization.
So forgetting minutes may be OK. Forgetting minutes and paying
for your vacation with the company card?
Much riskier. Much riskier, yeah.
You mentioned under capitalization, what's that?
Right. Under capitalization, yeah.
That just means the business wasn't set up with enough money
in the 1st place to reasonably cover its likely debts or
potential liabilities from its operations.
It's another factor courts might throw into the mix.
And does it matter who is trying to Pierce The Veil?
Like does the type of creditor make a difference?
It often does, yeah. You'll hear it said that
piercing is maybe more likely in tort cases compared to contract
cases. Why is that?
Well, the thinking is tort creditors are usually
involuntary. They didn't choose to interact
with the company, they got hit by the company truck, for
example. Contract creditors, on the other
hand, they voluntarily chose to do business with the company.
They had a chance, arguably, to check the company's finances,
maybe ask for a personal guarantee from the owner if they
were worried. Makes sense.
So if the veil does get pierced, Bottom line.
The shield is gone, the owners
become personally liable for that business debt, and yeah,
their personal assets are potentially on the line.
That's what could happen to Bob in that Reddit example.
But it's also worth noting, like the Wikipedia source mentions,
with that Adam Z Cape Industries case from English law actually
winning a piercing case, especially against a big parent
company for what its subsidiary did, it can be really tough.
In practice, courts do respect the corporate form unless
there's pretty clear abuse like fraud.
OK, so that covers the world where limited liability is the
norm and piercing is the big exception.
But what about those business types where personal liability
is? Well, the default setting.
Right, that takes us straight into general partnerships here.
Flip the script. The partners are typically
personally on the hook for the business's obligations.
OK, personally liable is the starting point.
Exactly. And to really understand why,
you have to understand a fundamental concept that
underpins partnerships agency. Agency.
How does that connect? Well, as one of your sources,
Law Shelf explains really clearly, partnerships basically
grew out of agency law. Their governing principles come
from agency theory. In a general partnership, every
single partner is considered an agent for all the other
partners, and also an agent for the partnership itself.
OK, so each partner can act for the whole group?
Precisely. And that agency relationship,
that's the direct cause of partnership liability because
each partner is an agent agent, their actions, as long as
they're acting within the scope of the partnership business, can
bind the entire partnership. Bind them how?
Like signing contracts. Signing contracts, yes, but also
committing torts in the course of business.
And crucially, those actions don't just bind the partnership
entity, they make the other partners personally liable too.
Whoa, like that Nadia and Colby design firm example.
Nadia signs some huge, maybe risky contract for the firm
while Colby's away. Colby is personally on the hook
for that debt, even if he knew nothing about it.
Absolutely. If Nadia had the authority or a
parent authority to sign it for the partnership, Colby's liable.
And it gets even more potentially impactful because of
something called joint and several liability.
Joint and several. Yeah, Brady Ware mentioned this.
It means each partner can be held individually responsible
for the entire amount of a partnership debt, not just their
proportional share. Wait the entire amount.
The entire amount a creditor can choose to sue just one partner,
maybe the one with the deepest pockets for the full debt.
That partner would then have to try and get contributions from
the others, but the creditor gets paid first.
Wow, OK, that is that's a stark contrast to limited liability.
That's genuinely scary. It's a fundamental risk you take
on in a general partnership. It's why people often opt for
LLC's or corporations if they can.
Is there any exception to this broad liability?
There's one key exception, typically criminal liability.
Generally, one partner isn't criminally liable for another
partner's crime just because they're partners, unless of
course they participated in the crime somehow.
OK, that makes sense. You don't go to jail because
your partner did something illegal without you knowing,
right? Civil liability is broad, but
criminal liability usually requires personal involvement.
OK. So major personal liability
risk, how do you actually, how do you form one of these
partnerships? Do you need lawyers and filings?
This is another absolutely critical point for exams, and
one where people sometimes get tripped up, while having a
formal written partnership agreement is incredibly smart.
Highly recommended. As TC Group notes, it's not
always legally required to form a general partnership.
Really, the most basic legal requirement to be a partner is
simply having the capacity to contract.
Just standard contract law stuff like being an adult mentally
competent. Exactly that John and Evan
example is good. John's 23, he has capacity.
Evan, the 16 year old computer whiz.
Brilliant maybe, but lacks capacity to form a binding
partnership. His agreements would be
voidable. OK, but no written agreement
required. That sounds inherently risky.
Could you like, accidentally become someone's partner?
You absolutely could. This is the key insight.
A partnership can be implied by law just based on how people
act, even without a formal document, or even without them
fully intending. The legal consequences if two or
more people start carrying on a business together, sharing
profits, acting like partners, the law might just say looks
like a partnership, smells like a partnership.
It's a partnership that Bush V Taylor case highlights courts
looking at the party's intent and actions.
And this leads to that idea of partnership by estoppel.
Precisely. Estoppel means you're prevented
or is stopped from denying something.
So here you can be treated as a partner with all the liability
that entails, even if you didn't technically agree to be 1
because of how you acted or what you allowed others to believe.
How would that happen? Well, if you share profits and
losses, that's strong evidence. Or like in the O'Brien and Jerry
Engineers case mentioned. Or that Tony and Linda ski lodge
example. If Linda keeps telling
suppliers, Oh yeah, Tony's my partner in the lodge, and Tony
knows she's saying this and doesn't correct her, A supplier
who relies on that statement might be able to hold Tony
personally liable as a partner by estoppel if the partnership
doesn't pay its bills, even if Tony and Linda never signed a
piece of paper. And the massive danger there is
suddenly being on the hook for debts or taxes you had no idea
you were responsible for. Exactly right.
Which just hammers home why having that written partnership
agreement is so vital. It forces you to think through
and define the relationship. Who does what?
How are profits and losses split?
Who manages things? It avoids those nasty surprises.
OK, so let's say you have a partnership, maybe even a
written agreement. How does the day-to-day stuff
work? Like who owns the computers?
The desks. Generally, the ownership and
operation rest with the partners themselves.
Property that's bought for the business or contributed to it is
usually considered partnership property.
And you mentioned a difference between contributing something
versus just letting the partnership use it.
Yes, the partners intent when property comes into the business
is key. Remember Leon's desk?
If Leon formally contributes his desk as capital to the
partnership, it becomes partnership property.
OK. But if he just says, hey, you
guys can use my spare desk for a while, it probably remains his
personal property just being loaned or licensed to the
partnership. And why does that distinction
matter? It matters mainly for creditors.
A partner's personal creditor can usually go after the
partners interest in the partnership, like their share of
profits or their capital account balance, but that personal
creditor generally cannot seize specific items of partnership
property like that Des Leon contributed as capital.
Got it. What about default rules if the
agreement doesn't say anything about how decisions are made or
how profits are shared? Good question.
If the agreement is silent, the Uniform Partnership Act, the UPA
reference by law shelf kicks in with default rules and the main
ones are first. Each partner gets an equal vote
in managing the partnerships business. 2nd profits are split
equally among the partners regardless of capital
contributions or effort. Equally, even if one partner
does way more work, even. Then yes, that's the default.
If partners want something different like profit split 7030
or maybe only managing partners get a vote, they absolutely must
put that explicitly in their agreement and everyone has to
agree to it. OK.
That equal split default is definitely something to remember
for exams. Now.
Taxes. How does the IRS treat
partnerships? Partnerships generally get
what's called pass through taxation.
This is a big advantage. Pass through.
Yeah, the partnership entity itself doesn't pay federal
income tax. Instead, all the profits or
losses are passed through directly to the individual
partners. They then report their share of
the income or loss on their personal tax returns.
Brady Ware, Law Shelf, TC Group all highlight this.
So it's tax like you're self-employed basically.
Pretty much, yeah. It avoids the potential double
taxation you can sometimes see with corporations where the
corporation pays tax on its profits and then shareholders
pay tax again when they receive dividends.
That sounds simpler, maybe better.
It often is simpler, but there's a really important catch, a
potential pitfall here that catches students out.
Partners are taxed on their share of the partnership's
income, whether or not they actually receive that money in
cash. Wait, say that again.
You pay tax on money you didn't get.
Potentially, yes. That Law Shelf P partnership
example illustrates it perfectly.
The partnership made operating profits, but instead of
distributing the cash, they used it all to buy a building.
The partners still had taxable income allocated to them based
on their share of those profits. Even though their bank accounts
didn't see a dime for the partnership that year, they
still owed taxes on that phantom income.
Ouch, that's a major point to flag.
You could have a big tax bill with no cash distribution to pay
it with. Exactly, That's why well run
partnerships usually make regular tax distributions to the
partners specifically to cover their estimated tax liabilities
arising from the partnership income.
And partners also pay self-employment taxes on that
income. Yes, that's the other piece.
Partnership income pass through to partners is generally subject
to self-employment, taxes, Social Security and Medicare
here in the US. Similar concept to the National
Insurance mentioned in the UK. Sources from TC Group.
OK. And TC Group also mentioned that
things like getting sick pay from the partnership doesn't
automatically make you an employee for tax purposes.
Right. The overall test still looks at
whether your income is tied to the firm's profits and if you
share in the economic risk, not just whether you get certain
benefits. It's about the substance of the
relationship. So we started the section
talking about how partnerships are rooted in agency theory.
But agency itself is way broader than just partnerships, isn't
it? Oh, absolutely fundamental.
Think about it. A corporation is just a legal
construct, right? A piece of paper, essentially.
It can't physically do anything on its own.
It has to act through human beings.
It's agents. These could be officers,
directors, employees, even outside lawyers or accountants
acting on its behalf. Agency is the legal mechanism by
which any business entity, corporation, LLC, whatever
interacts with the outside world and creates legal rights and
responsibilities for itself. So agency is really the bedrock
for how all businesses operate legally.
Who are the key players involved in an agency relationship?
Women Learning outlines the three main parties clearly.
You have the principal, that's the person or entity the agent
is acting for. You have the agent, the one
doing the acting, and you have the third party.
That's the person or entity the agent is dealing with on the
principal's behalf. OK, Principal agent, third
party. And the law governs the
relationships between all of them, Principal and agent,
Principal and 3rd party and agent third party.
And the sources mentioned different kinds of agents.
They do. It's useful to know the main
types. A general agent has pretty broad
authority to handle a series of transactions for the principal
over time. Think of a store manager who
hires employees, orders inventory, deals with customers.
Broad authority. OK, General Agent.
What else? Then there's a special agent.
Their authority is much narrower, usually limited to a
single transaction or a specific task, like hiring a real estate
agent just to sell one particular house.
Makes sense. What about a sub agent?
A sub agent is basically an agent hired by another agent.
If the principal gives the first agent permission to delegate
tasks, the person they hire becomes a sub agent.
Interestingly, the sub agent usually owes duties to both the
original agent and the principal.
Okay. And agency coupled with an
interest that sounds a bit more complex.
It is a bit specific. This happens when the agent
doesn't just have authority, but also has some kind of ownership
or security interest in the subject matter of the agency
itself. Like what Maybe a lender who is
also given the authority to sell the property if the borrower
defaults. The key legal effect is that the
principal often can't easily terminate this type of agency if
it would harm the agents interest.
That literary agent example who gets a Commission and collects
the money might also fit here. They have a direct financial
stake. Got it.
Now, a distinction that feels like it comes up everywhere in
business law and definitely on exams, employee versus
independent contractor. Absolutely critical distinction,
and Lumen explains the core test well.
The fundamental difference boils down to the principal's right to
control the manner and means by which the agent performs the
work. Control.
Yes, with an employee, sometimes called a servant in older cases.
The employer has the right to control not just the result, but
also how the work gets done, the physical conduct, the hours, the
methods. Think of your typical office
worker. OK.
And an independent contractor. With an independent contractor
or IC, the principle controls or directs only the final result of
the work, not the specific methods used to get there.
The IC is generally autonomous in how they erform the task.
Think of hiring a plumber to fix a leak.
You care that the leak is fixed, not how they hold the wrench.
And why is nailing this down so incredibly important?
Huge legal consequences hinge on this classification.
For the principal employer, it impacts things like do they have
to withhold income taxes? Do they have to pay payroll
taxes like Social Security, Medicare, employer portions?
Are they liable for state unemployment insurance?
Do they need to provide workers compensation coverage?
Wow OK. And also crucially, vicarious
liability. Is the principal automatically
liable if the agent commits A tort while working?
Generally yes for employees acting within the scope of
employment. Much less likely for ICS.
So employers might want to classify workers as ICS to save
money. Sometimes, yes.
There's definitely an incentive to misclassify employees as ICS
to avoid those costs and liabilities, but the key thing
to remember is that the law determines the status based on
the facts of the relationship, not just what the contract
labels the person. You can't just slap an
independent contractor label on someone and call it a day.
Courts look behind the label at the reality of the control
exerted. They use a multi factor test
looking at things like who supplies the tools in workplace?
Is the payment by the hour or by the job?
Is the work part of the principal's regular business?
How much skill is required? The duration of the
relationship? Those case examples, like
Robinson the salesman in General accident the golf ball shagger,
show courts digging into these facts.
So how do these agency relationships actually get
started? Most commonly by agreement
between the principal and the agent.
This agreement can be expressed, written or spoken, or can be
implied just by their conduct. Does the agent have to be paid?
No, actually an agency relationship can be gratuitous,
meaning the agent isn't compensated.
That Abe and Byron errand example.
Abe asks Byron to run an errand. Byron agrees.
Even if Byron isn't paid, an agency relationship is formed
and Byron owes Abe duties like loyalty and care.
Interesting. Are there formal requirements
like needing a written contract? Usually, no.
Oral agency agreements are perfectly valid for most
purposes. However, there's a big exception
called the Statute of Frauds. Ah, the Statute of Frauds,
right? Certain types of contracts must
be in writing to be enforceable. If an agent is being authorized
to enter into one of those contracts on behalf of the
principal, like a contract for the sale of land in most states,
or a contract that can't possibly be performed within one
year, then the agents authority often also needs to be in
writing. This is sometimes called the
equal dignity rule. OK, so if the underlying
contract needs writing, the agents authority might need
writing too. Generally, yes.
Also, contracts for the sale of goods over $500 under the UCC
need some writing, so that could impact an agent's need for
written authority too. And what about capacity?
Do both the principal and agent need to be legally competent?
Yes, capacity matters. The principal must have
contractual capacity. If the principal is a minor, for
example, any contract the agent makes on their behalf is
typically voidable by that minor principal.
The agent also needs sufficient capacity to act on behalf of the
principal. They don't necessarily need full
contractual capacity themselves for all purposes, but
critically, someone who is legally incompetent, like due to
severe mental illness, generally cannot act as an agent to bind
the principal. OK, that makes sense.
We've covered a lot of the core ground, the different entities,
the liability spectrum from partnerships to corporations,
the huge exception of piercing the veil, and the fundamental
role of agency. Your sources also briefly
touched on a few other points about the corporate life cycle.
Right, just to round things out, there's the whole area of
corporate governance that really looks at the internal power
structure, the relationships and rules governing the executives,
the board of directors and the shareholders.
Key concepts there. Director duties are huge,
especially the duty of loyalty, the duty to act in the best
interest of the corporation and avoid conflicts of interest.
That Old Aberdeen Railway case is a classic illustration of how
strictly courts can view potential conflicts.
Shareholders also have key rights like voting for directors
and approving major corporate changes.
Like selling the whole company. Exactly.
Selling all or substantially all of the corporation's assets
usually requires shareholder approval.
Defining what substantially all means has led to case law like
gimbal and cats. Corporate finance also got a
quick mention. Yeah, it's the basics.
Companies need money. 2 main ways to get it Equity financing,
which means selling ownership stake shares to investors, and
debt financing, which means borrowing money through loans or
bonds. Debt often has tax advantages
because interest payments are usually deductible.
And lastly, dissolution, the end game.
Right. When a company ceases
operations, especially if it's insolvent, can't pay its debts,
it goes through dissolution and winding up or liquidation.
This can be compulsory, forced by creditors or regulators, or
voluntary, initiated by the owner shareholders.
What happens then? A liquidator is appointed.
Their job is to gather all the company's assets, sell them off,
pay off the company's debts according to a specific priority
order set by law, and then, if there's anything leftover,
distribute the surplus to the owners.
OK. That really covers a huge amount
of ground pulling together all those different sources you
shared, we've traced the liability line from, you know,
the deep personal risk in general partnerships all the way
to the protective shield of limited liability in
corporations and LLC. 'S and crucially, that major
exception, piercing the corporate veil when that shield
fails. Right.
And we also saw how agency isn't just a partnership thing.
It's the engine that makes all businesses run, how they make
contracts, how they become liable through the actions of
their their people. Exactly, it connects everything.
So for anyone listening who's prepping for that business
association's exam, really nailing these core concepts is
just non negotiable, isn't it? You have to know the default
rules for each entity. You have to know those specific
factors for piercing the veil, the different types of agents,
the liability consequences. Definitely those distinctions,
limited versus personal liability, employee versus IC,
implied versus formal partnership, those are the
pressure points where exam questions love to live.
Being able to spot those issues in a fact pattern and apply the
right rules is key. Absolutely practice applying
them to hypos. And maybe as you're reviewing
all this, step back for a second and think about this bigger
picture theme running through it all.
Business law is always doing this balancing act, isn't it?
How so? Well, on one side, it's trying
to encourage business, encourage risk taking by offering ways to
limit personal financial disaster.
That's limited liability. That's the different entity
choices. Right, promoting commerce.
But on the other side, the the law has to provide
accountability when businesses mess up or owners abuse the
system. That's where piercing the veil
comes in. That's agency liability holding
principles responsible. Promoting commerce versus
ensuring justice or accountability.
Exactly. So how do courts and
legislatures strike that balance?
It shifts over time. It differs by jurisdiction.
Thinking about that constant tension between encouraging
enterprise and demanding responsibility, what does that
tell us about what society values and how the law shapes
our economy? It's definitely something
interesting to keep mulling over.