Archives
Rise of unincorporated businesses linked to regulatory, ethical issues
Mark Reutter,
Business & Law Editor
217-333-0568; mreutter@illinois.edu
8/22/2005
CHAMPAIGN, Ill. — The rapid expansion of non-incorporated businesses, such as limited
liability companies (LLCs) and limited liability partnerships (LLPs),
raises questions ranging from government regulation to professional
ethics, according to the latest issue of the University of Illinois
Law Review.
Beginning in 1977, many state legislatures have authorized the establishment
of such entities, which are more loosely structured than a shareholder
corporation. They have proven especially popular among lawyers, doctors,
engineers and other professionals.
A primary reason why professionals choose to be unincorporated is flexibility
– a partner can make contracts directly with clients rather than
through the corporation – along with limited liability, a feature
of corporations.
(Stockholders in a corporation are protected from the debts of the corporation,
while partners of a traditional “unlimited” partnership
are personally liable for the firm’s obligations.)
Another advantage of limited liability groups is the avoidance of so-called
double taxation. A corporation is taxed on its income and again when
profits are distributed to stockholders. The income derived from a LLC
or LLP, however, is not taxed; instead the owners pay personal taxes
based on their share of the enterprise. This can lead to significant
tax savings.
Despite their rapid expansion, unincorporated entities have been conspicuously
unexamined by legal scholars, according to Larry E. Ribstein, a professor
at the Illinois College of Law.
“Uncorporations already have gone a long way toward replacing
traditional partnerships and close corporations in closely held and
professional firms,” he wrote, “and raise questions about
the survival of the traditional public corporation form for publicly
held firms.”
A major unexplored issue is the ethical responsibilities of lawyers
who represent unincorporated entities. Is the lawyer retained by an
LLP representing the individual partners or the enterprise itself, asked
Richard W. Painter, an Illinois law professor.
“The little case law that exists is confusing,” Painter
noted. As a result, he recommended that lawyers define their relationship
with partners through “private ordering,” or explicit written
agreements, at the outset of representation. Courts and bar associations
should then enforce these contracts when ruling on lawsuits and other
disputes between parties.
A related question centers on how a lawyer should disclose evidence
of fraud, kickbacks and other criminal behavior in a partnership. The
Securities and Exchange Commission (SEC) has ruled that unincorporated
firms that issue stock to the public are covered under the Sarbanes-Oxley
Act, which set new standards for business ethics following the corporate
scandals of 2001-02.
Because LLCs and LLPs do not have executive officers or boards of directors,
Painter suggested that a lawyer first report the alleged misbehavior
to all partner members or to a special panel of members. If the partners
do not take appropriate action, the lawyer is then obligated –
like his counterpart in corporate America – to report the illegalities
to the SEC.
Outside of SEC fraud provisions, uncorporations are unregulated by the
federal government. Saul Levmore, a law professor at the University
of Chicago, predicted that partnerships will come under federal regulation
“following a shocking scandal” and “the distance between
corporate and uncorporate law (will) narrow.”
Papers by Ribstein, Painter and Levmore were part of a Illinois College
of Law symposium called “Uncorporation: A New Age?”
