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Tricky Terms for Business

A glossary of business terminology

Agent: A person (sometimes an entity) who acts on behalf of another person (the principal) in a manner controlled by the principal. A typical agent-principal relationship is that of employee-employer.

Contract: An agreement between two or more parties which is enforceable by law.  There are three key elements to the creation of a contract: (1) offer and acceptance, (2) mutual consideration, which is often money, and (3) an intention to have a binding agreement.  Contracts do not have to be in writing, but there are some exceptional situations which require a written contract, such as the sale of real property.  Many disputes arise over whether or not there was an offer and acceptance of the same terms, and if there was, what the terms required.  Obviously, it is easier to prove a contract that is written, and still easier to prove one that is carefully and clearly written. Writing a contract can be difficult. The recently published “A Manual of Style for Contract Drafting, Second Edition,” by Kenneth A. Adams, runs 450 pages. It is also worth mentioning here that the fact that a party did not read the contract is almost never a valid defense.

Corporation: An entity owned by one or more persons or other entities, and which exists under the authority of a state’s statute.  Typical characteristics of corporations are (1) owners are protected from liability for the corporation’s debts, (2) the entity can exist perpetually, and (3) it can be for profit or not for profit.  For taxation purposes, corporations can be defined as c corporations or s corporations. In a c corporation, the corporation is taxed on its profits and then the earnings are taxed again when profits are paid out in dividends to the owners. In an s corporation, the profits can escape this double taxation by being passed through to the owners, who pay the tax when they file their returns. In some situations, corporations can be an appropriate entity for small businesses.  However, in recent years the LLC has become the more popular choice for small or closely held businesses.

Employee: A person whose principal controls the manner and means of the person’s performance of work for the principal.  Compare this to an independent contractor who works for a principal but works independently of direct control by the principal.  See “Independent Contractor or Employee?” in Tips and Traps to help you determine whether a person who works for you is an employee or an independent contractor.

Fiduciary: A person who has a duty to act primarily for the benefit of another, usually due to the fiduciary being in a position of trust or power over the other person.  Common fiduciaries include trustees, executors or personal representatives, and sometimes majority owners or managers of businesses.

Foreign Limited Liability Company: An entity that is formed under the limited liability company laws of another state or a foreign country.  Foreign LLCs and corporations must register with the proper authority in any state in order to do business in that state as a foreign entity.  So, if you formed your entity in another state and would like to do business in Washington state, you will likely have to register here as a foreign entity.  Different states, however, set their own guidelines regarding when registration is required. So, depending on your level of business activity in a particular state, you may or may not have to register there as a foreign limited liability company.

Independent Contractor: See “Employee” in this glossary of terms and the article “Independent Contractor or Employee?”

Limited Liability Company or LLC: An entity having one or more members that is organized and exists pursuant to a state statute authorizing the entity.  These entities have surpassed all other types of entities for closely held businesses in the United States due to the liability protection they offer and the flexibility of ways to organize the relationship among parties who wish to carry on business or investment together.

Limited Liability Company Agreement: This document is sometimes called an “operating agreement.”  It is any written agreement by the members, or any written statement of the sole member, as to the affairs of a limited liability company and the conduct of its business which is binding upon the member or members.  Note that the definition specifies that the agreement must be “written.”  An LLC agreement is similar to the bylaws of a corporation.  The LLC agreement lays out the details of how the business will be operated.  Most LLC agreements for a closely held business will run from 10 to 50 pages.

Limited Liability Company Interest: A member’s share of the profits and losses of a limited liability company and a member’s right to receive distributions of the LLC’s assets.  This is also known as an ownership interest.  The ownership interest in the LLC can be expressed in terms of a percentage of the entire interest (“I own 49% of the LLC”) or in terms of units (“I own 15,000 units of the LLC”).  Of course, units don’t mean much unless you know how many units the LLC has issued.

Manager: With respect to an LLC, the manager is the person (or entity) who manages an LLC which has chosen to be managed by a manager rather than by its members, and which has set forth in its certificate of formation that it is to be managed by a manager.  Often, an LLC will designate one or more of its members to act as a manager for convenience. But in this case, the LLC is still technically managed by members (those members who assign among themselves various managerial duties.)

Master: This is an old legal term which still surfaces often enough to make it worth defining here.  The word applies to an employer (master) who employs an agent (employee).  The employee is sometimes called the “servant” and the two used to be referred to as “master and servant.”  These days, you usually see the terms employer and employee.  The employer controls the location and means by which the employee works.  It can be important to know if a relationship is one of employer and employee because the employer is vicariously liable for the torts of the employee.  See the discussion in “Independent Contractor or Employee?” in Tips and Traps.

Member: A person or entity who has been admitted to a limited liability company as an owner and who has not been dissociated from the limited liability company.  Members are sometimes called partners or owners, but the correct term according to the LLC statutes is “member.”

Partnership: An association of two or more persons to carry on as co-owners a business for profit.  A partnership offers no liability protection to its partners, so relatively few partnerships are formed relative to limited liability companies, which do offer liability protection to the owners.  Partners can be people or entities, such as corporations or LLCs.  A partnership can be formed unintentionally, and have unintended consequences, when people do business together.

Partnership Types: LLCs, although they offer liability protection, are classified as a type of partnership by the IRS because they are usually taxed as partnerships.  For IRS purposes, partnerships are divided into six entity types: domestic general partnership, domestic limited partnership, domestic limited liability company, domestic limited liability partnership, foreign partnership, or “other” partnership.  In 2005, LLCs represented the most common type of partnership, according to the IRS statistics. See the IRS site at http://www.irs.gov/pub/irs-soi/05partnr.pdf for more information on the types of partnerships, as defined by the IRS.

Person: Although this term usually refers to an individual, it can sometimes mean an entity.  For example, in the Washington LLC statutes the term “person” includes a corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government, governmental subdivision, agency, or instrumentality, or a separate legal entity comprised of two or more of these entities, or any other legal or commercial entity.  So, when referring to a “person” be aware of these multiple definitions.

Professional LLC: A limited liability company which is organized for the purpose of rendering “professional service” and whose certificate of formation sets forth that it is a professional limited liability company subject to RCW 25.15.045.  “Professional service” is defined at RCW 18.100.030 which says “professional service” means any type of personal service to the public which requires as a condition precedent to the rendering of such service the obtaining of a license or other legal authorization and which prior to the passage of this chapter and by reason of law could not be performed by a corporation, including, but not by way of limitation, certified public accountants, chiropractors, dentists, osteopaths, physicians, podiatric physicians and surgeons, chiropodists, architects, veterinarians, and attorneys-at-law.  If you are confused about whether you should organize as a Professional LLC, the examples in the statutes are a helpful guide and cover most instances.

Servant: See “Master.”

Tort: A wrongful act which causes damages or injury and for which a civil lawsuit may be brought to recover compensation for the damage or injury.  Examples of torts include car accidents where fault can be proven, a punch in the nose, embezzlement, leaving a banana peal on the floor which causes someone to fall, or a doctor practicing below the standard of care and causing injury.  Two major classifications of claims should be differentiated: (1) tort claims and (2) breach of contract claims.  A major difference between a tort and contract claim is that in a contract matter the two parties willingly enter into an agreement and can agree in advance how they will handle any losses arising out of the contract.

Vicarious Liability: This term describes the situation where one person is liable for the wrongs of another.  Usually this happens when a principal is liable for an agent’s wrongs.  In other words, when an employer is liable for an employee’s wrongs or torts.  The possibility of vicarious liability is one reason it can be important to clarify whether a person who works for you is an employee or an independent contractor.  If the person is an independent contractor, there should be no vicarious liability.