Business Entity Basics

• Year: 2025
• Citation: Vol. 29 No. 02

Business Entity Basics

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by Joseph A. Dane and Ryan M. Hamaguchi

I. Introduction.

Helping a client determine the right entity structure for their business can often be a difficult task. There are a number of factors that one may consider, including liability exposure of the entity's owners and managers, tax implications, the number of owners and the rights of each owner, management structure, the nature of the business, type of assets being held, distributions and allocation of profits and losses, and much more. Selecting the right entity may also require input and consultation with the client's tax advisors, estate planning counsel, and business advisors. While a client may able to convert their newly formed business into a different entity structure in the future as their business grows, this may result in additional administrative costs, legal fees and expenses, tax consequences, and/or may be impermissible under current third-party agreements, such as loan documents.

This article is intended to provide a primer on some of the common business structures used in Hawaii, along with some of the advantages, restrictions, and other considerations for each type of entity.

II. Survey of Entity Types

1. The Sole Proprietorship

The simplest form of business ownership is the sole proprietorship. A sole proprietorship is an unincorporated business, in which the sole owner of the business operates the business for him or herself. A sole proprietorship is not a separate entity, but an extension of the sole owner. The owner is personally liable for all debts and obligations of the business. While a sole proprietorship can operate under a trade name or doing business as (dba) name different from the owner, doing so does not create a separate entity. The principal advantages of the sole proprietorship are the low set up cost and tax simplicity, since profits and losses of the business are reported on the owner's personal income tax return. However, because a sole proprietorship does not offer any separate liability protection, it may not be the right choice for your client.

2. Partnerships

Next up is the partnership. A partnership, sometimes referred to as a "general partnership" to distinguish it from

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other partnership-like forms, is the next most simple business entity type. It is also, for the reasons touched on below, unlikely to be the right choice of entity in all but the most special circumstances.

Unlike a sole proprietorship, a partnership is an entity distinct from its partners. Hawaii Revised Statutes (HRS) § 425-108(a). Still, historically (and the partnership is by far the oldest of the various business organization types) partnerships were treated as a hybrid, characterized sometimes as a separate entity (e.g., partners have no direct interest in property owned by the partnership, HRS § 425-110) and sometimes as an aggregate of individual partners. The most notable reflection of the "aggregate" theory, and the main reason why general partnerships are unlikely to be the best choice of entity today, is the imposition of joint and several liability on each of the partners. Generally, all partners are jointly and severally liable for all partnership obligations. HRS § 425-117(a). Furthermore, each partner acts as an agent for the partnership and can generally bind the partnership to obligations incurred in the carrying on of the ordinary course of the partnership's business. HRS § 425-112.

a. Joint and Several Liability for Partners

The general partnership being the ancestral form of all other species of partnership, one can sometimes find authority from the Territorial period, or even earlier, to illustrate these points. For example, in a case before the Supreme Court of the Republic of Hawaii, Lea Bow v. Young Yung, 11 Haw. 772 (1899), a promissory note for $70 was given in the name of a partnership by one of its two partners, brothers who carried on a rice planting business. After payment of $6 had been made on the note, there was apparently a payment default on which the holder of the note sued both partners. The Court's brief opinion begins with a statement of the general principle that strongly echoes the current statutory language: "each partner is an agent of the partnership with implied authority to act for the firm in all matters within the scope of its business." Id. The Court then considered the nature of the business of the partnership (rice planting), and whether the giving of notes would typically be within the authority of a partner engaged in that business. Since there had been "no evidence to show that the giving of notes by one partner in the partnership name is usual in the business of rice planting or had become a practice of this particular firm, or was necessary to the successful conduct of its business," the court below must have concluded as a matter of law that any act of a partner purportedly carried out in the name of the partnership must in all cases bind the partnership. The Court ruled that this conclusion was in error, and remanded for a new trial to consider this question.

The co-partner fared worse in the case of H. Hackfield & Co., Ltd., v. Tamamoto, 22 Haw. 455 (1915), which involved a partnership between Yamamoto and Eichner to operate a boarding house, billiard room, and cigar store at "Castner Station," near Schofield Barracks. The partners had set forth their understandings, including the responsibilities of each of the partners, in a written agreement, which provided that Yamamoto alone would be responsible for placing orders for goods to be used in the cigar store and billiard room. Despite this understanding and agreement, Eicher apparently purchased goods from the plaintiff in this case without telling Yamamoto. Eichner then died, and the plaintiff sued Yamamoto for the unpaid goods. Although the evidence referred to in the Court's opinion seems somewhat scanty, it was enough to uphold the judgment against Yamamoto. The plaintiff had knowledge of the partnership and Yamamoto's involvement, and did not have knowledge of the restrictions on Eicher's authority set forth in the partnership agreement.

b. "Inadvertent" Partnerships

Under Hawaii law, a general partnership is formed by "the association of two or more persons to carry on as co-owners a business for profit . . . whether

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or not the persons intend to form a partnership." HRS § 425-109(a). Notably absent is any requirement that the partners file a document with a government agency such as the State of Hawaii Department of Commerce and Consumer Affairs, Business Registration Division (the "DCCA"), and indeed no filing with the DCCA or other government agency, or even any written agreement among the partners, is required to form a partnership. The statute exempts any "association formed under a statue other than this part," so that persons forming, for example, a corporation (Chapter 414), limited partnership (Chapter 425E), or limited liability company (Chapter 428) do not simultaneously form a partnership. A partnership can file a registration statement with the DCCA setting forth information about the partnership, but a registration statement is not required to form a partnership.

Because no filings are required, it is entirely possible to form a partnership, and become a partner, inadvertently, without expressly intending to do so. A comment to the Uniform Partnership Act, on which Hawaii's Chapter 425 is based, explains that a person "may inadvertently create a partnership despite their expressed subjective intention not to do so," and that even "a disclaimer of partnership status is ineffective to the extent the parties' intended arrangements meet the criteria stated in [the statute]." The statute sets forth certain presumptions, including that a person who receives a share of the profits of a business is presumed to be a partner in the business, unless the payment is for one of a limited number of exceptions (e.g., payment of a debt, for services rendered, etc.). HRS § 425-109(c).

A search does not reveal any reported Hawaii case in which the issue of an "inadvertent partnership" has arisen, but the concept was applied in a fairly recent Texas case, Energy Transfer Partners. L.P. v. Enter. Prods. Partners, L.P., 593

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S.W.3d 732 (Tex. 2020), involving two competing oil pipeline companies. The two competitors had signed a series of letter agreements concerning a possible joint venture involving an investment in a pipeline project. The documents included language disclaiming any binding commitments until "definitive agreements" had been negotiated and the approvals of the companies' respective boards of directors had been obtained. The discussions eventually broke down, after which one of the potential partners entered into a similar transaction with a third competitor. The disappointed competitor sued, asserting that despite the waivers in the preliminary agreements, the parties had formed a partnership to "market and pursue" the joint venture, and that the transaction ultimately entered into constituted a breach of the duty of loyalty. Astonishingly, this theory was successful in a jury trial, resulting in a judgment of over $535 million. This judgment was ultimately reversed by the Texas Court of Appeals, and on further appeal to the Texas Supreme Court, which stated that the Court had "never squarely addressed" the question presented. The Court held that "an agreement not to be partners unless certain conditions are met will ordinarily be conclusive on the issue of partnership formation as between the parties." Id. at 741. Because the preliminary agreements included certain express conditions precedent to the formation of a partnership (specifically, agreements on the form of "definitive agreements" and board approval) which had not been satisfied, there was no "unintentional formation" of a partnership.

The decision of the Texas Supreme...