Chapter 31: All Forms of Partnership 1
Chapter 31
All Forms of Partnerships
Introduction
The most common forms of business organization are the sole proprietorship and, when two or more persons are involved, the partnership and the corporation, with the limited liability company becoming increasingly popular. In this chapter, the basic features of partnerships are explained, and some of their advantages and disadvantages are spelled out.
Additional Background—Partnership Law
Partnerships can be traced to the earliest records of history. The Code of Hammurabi, from 2300 B.C., includes references to partnerships. Around 2000 B.C., the Jews developed a form of partnership, known as a shutolin, for agricultural purposes. Commercial Jewish partnerships developed later.
In the Roman Code of Jusitinian, there were provisions for partnerships that resemble current American partnership law. The Romans also developed the rules of agency, which serve as the basis for much partnership law. Under Roman law, the essence of a partnership was the choosing of partners.
As with other commercial law, English partnership law developed form the Law Merchant, according to the realities of how merchants did business. In 1353, the Statute of the Staple provided that law was to be administered in the Court Staple (the law merchant courts) from “day to day and hour to hour,” which meant quickly. Eventually, the English equity courts began to hear partnership cases, and by the time of the American Revolution, partnership law was being administered in the law courts.
In civil law countries, partnership law is similar to partnership law in common law countries, because in civil law countries, partnership law also developed from the customs of the merchants.
Chapter Outline
I.Basic Partnership Concepts
A.Agency Concepts and Partnership Law
Partnership law is based on agency law: the fiduciary ties that bind agent and principal also bind partners. In a non-partnership agency relationship, the agent usually does not have an ownership interest in the business nor is the agent obligated to bear a portion of the ordinary business losses.
B.The Uniform Partnership Act
The Uniform Partnership Act (UPA), as adopted by the states, governs the operation of partnerships in the absence of an express agreement among the partners to the contrary.
C.Definition of a Partnership
Under the UPA, a partnershipis “an association of two or more persons to carry on as co-owners a business for profit” [UPA 101(6)]. Intent is a key element [UPA 401(g)]. The Revised Model Business Corporation Act and the UPA permit a corporation to be a partner.
D.Essential Elements of a Partnership
Sharing profits alone does not qualify, but sharing both profits and losses might. The three essential elements implicit in the definition of partnership are—
•A sharing of profits or losses.
•A joint ownership of the business.
•An equal right in the management of the business.
1.The Sharing of Profits and Losses
Sharing both profits and losses creates a presumption that a partnership existsunless the profits are received as payment of[UPA 202(c)(3)]—
•A debt by installments or interest on a loan.
•Wages of an employer or for the services of an independent contractor.
•Rent to a landlord.
•An annuity to a surviving spouse or representative of a deceased partner.
•A sale of the goodwill of a business or property.
2.Joint Property Ownership
Joint ownership of propertydoes not alone create a partnership. The parties’ intentions are key.
E.Entity v. Aggregate
A partnership is sometimes called a firm or a company, terms that connote an entity separate and apart from its aggregate members. Generally, the law treats a partnership as an independent entity.
F.Tax Treatment of Partnerships
For at least one purpose—federal income taxes—a partnership is regarded as an aggregate of individual partners.
II.Formation and Operation
Partners may agree to virtually any terms, as long as they are not illegal or contrary to public policy. A partnership statement may (or may not) be filed with the appropriate state office.
A.Duration of the Partnership
A partnership for a term ends on a specific date or the completion of a particular project. Dissolution without consent of all partners before the end of the term is a breach of the agreement. If there is no fixed term, a partnership is at will, and any partner can dissolve the firm at any time.
B.Partnership by Estoppel
1.Liability Imposed
A person who represents himself or herself to be a partner in an actual or alleged partnership is liable to any third person who acts in good faith reliance.
2.Nonpartner Agents
When a partner represents that a nonpartner is a member of the firm, the nonpartner is regarded as an agent of the firm.
C.Rights of Partners
1.Management Rights
•All partners have equal rights in management [UPA 401(f)]. Each partner has one vote, and the majority rules in ordinary matters.
•Extraordinary matters may require unanimous consent to [UPA 301(2), 401(j)]—
Admit new partners or enter a new business.
Amend partnership articles.
Enter a new line of business.
2.Interest in the Partnership
Unless provided otherwise, profits and losses are shared equally, regardless of the amount of a partner’s capital contribution [UPA 401(b)].
3.Compensation
Conducting partnership business is a partner’s duty and generally not compensable.
4.Inspection of the Books
Books must be kept at the firm’s principal office. Every partner, active or inactive, is entitled to inspect all books and records on demand (and can make copies) [UPA 403]. The personal representative of a deceased partner’s estate has the same right
5.Accounting of Partnership Assets or Profits
An accounting can be called for voluntarily or compelled by a court. Formal accounting occurs by right in connection with dissolution, but a partner also has the right to an accounting in other circumstances, listed in the text, and in UPA 405(b).
6.Property Rights
Property acquired in the name of the partnership or a partner, or with partnership funds, is normally partnership property [UPA 204]. A partner can use partnership property only on the firm’s behalf [UPA 401(g)]. A partner is not a co-owner of this property and has no interest in it that can be transferred [UPA 501].
D.Duties and Liabilities of Partners
Every act of a partner concerning partnership business and every contract signed in the partnership name bind the firm [UPA 301(1)].
1.Fiduciary Duties
A partner owes the firm and its partners duties of care and loyalty [UPA 404].
•Duty of care—a partner must refrain from “grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law” [UPA 404(c)].
•Duty of loyalty—a partner must account to the firm for “any property, profit, or benefit” in the conduct of its business or from a use of its property, and refrain from dealing with the firm as an adverse party or competing with it [UPA 404(b)].
Case Synopsis—Case 31.1: Meinhard v. Salmon
“Walter Salmon negotiated a twenty-year lease for Hotel Bristol in New York City. To pay for the conversion of the building into shops and offices, Salmon entered into an agreement with Morton Meinhard to assume half of the cost. They agreed to share the profits and losses from the venture. Before the end of the lease, the building’s owner Elbridge Gerry approached Salmon about a project to raze the converted structure, clear five adjacent lots, and construct a single building across the whole property. Salmon agreed and signed a new lease in the name of his own business. When Meinhard learned of the deal, he filed a suit in a New York state court against Salmon. From a judgment in Meinhard’s favor, Salmon appealed.
The Court of Appeals of New York held that Salmon breached his fiduciary duty by failing to inform Meinhard of the business opportunity and secretly taking advantage of it himself. “Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. ... Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Thus “a man obtaining [an] ... opportunity ... by the position he occupies as a partner is bound by his obligation to his copartners in such dealings not to separate his interest from theirs, but, if he acquires any benefit, to communicate it to them.” The court granted Meinhard an interest “measured by the value of half of the entire lease.”
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Notes and Questions
Would the reasoning and result in this case have been the same under the principles of agency law? Possibly. An agent, like a partner, owes his or her principal a duty of loyalty. This duty requires the agent to refrain from self-dealing without the principal’s consent. In circumstances similar to the situation in this case, an agent who engaged in the same conduct as Salmon would have violated the agent’s duty of loyalty. The remedy might have been different, however. In the context of an agency relationship, the entire contract might have been awarded to the principal.
2.Breach and Waiver of Fiduciary Duties
These duties cannot be waived and partners must comply with the obligations of good faith and fair dealing, but a partner may pursue his or her own interests without automatically violating these duties [UPA 103(b). 404(d)].
Additional Cases Addressing this Issue —Breach of Fiduciary Duties
Cases in which partners were considered to have breached their fiduciary duties owed to other partners include the following.
•McBeth v. Carpenter, 565 F.3d 171 (5th Cir. 2009): (general partner in partnership formed to buy property falsely assured limited partners that any issues stemming from negotiations with city to secure property’s water entitlements were not significant obstacles to closing the deal).
•Magellan Morada Investments, L.P. v. Miller, __ P.3d __ (Ariz.App. Div. 1 2008) (the finance managers of the general partner of a limited liability partnership that sold condominiums breached their fiduciary duty to the other partners when they invested funds from the sale of partnership assets in violation of the limited partnership agreement).
•Farber v. Breslin, 47 A.D.3d 873, 850 N.Y.S.2d 604 (2 Dept. 2008) (general partner’s failure to disclose that he was negotiating a lease with a retailer that would stop foreclosure proceedings on partnership property, before the limited partner she sold her interest in the property for substantially less than its actual worth, stated a cause of action against the general partner for breach of fiduciary duty).
•Ederer v. Gursky, 9 N.Y.3d 514, 881 N.E.2d 204 (2007) (in withdrawing law-firm partner’s action against other members of the limited liability partnership for an accounting, the general partner was not shielded from personal liability for breaches of the partnership's or partners' obligations to each other).
3.Authority of Partners
Each partner is a general agent of the partnership in carrying out the usual business of the firm, unless designated otherwise.
a.Limitations on Authority
A partnership may limit a partner’s capacity to act as the firm’s agent by filing a “statement of partnership authority”in a designated state office—though this is normally effective only with respect to third parties who know of it.
b.The Scope of Implied Powers
Partners can exercise all implied powers reasonably necessary and customary to carry on partnership business, including the power to contract on its behalf.
4.Liability of Partners
a.Joint Liability
At one time, partners were jointly liable for partnership obligations. A creditor had to sue all of the partners as a group, but each could be liable for the entire judgment. Partnership assets had to be exhausted before individual partners’ assets could be reached.
b.Joint and Several Liability
Partners are jointly liable and severally liable for partnership obligations, including contracts, torts, and breaches of trust [UPA 306(a)]. But a creditor cannot collect a partnership debt from the partner of a non-bankrupt partnership without first attempting to collect from the partnership [UPA 307(d)].
c.Liability of Incoming Partners
A new partner to an existing partnership is liable only to the extent of his or her capital contribution for preexisting partnership debts and obligations [UPA 306(b)].
Additional Cases Addressing this Issue —Liability of Partners
Cases considering the liability of partnersinclude the following.
•Peter v. GC Services L.P.,310 F.3d 344 (5th Cir. 2002) (a collection agency’s general partners were jointly and severally liable for the agency’s violations of law in attempting to collect a student loan debt).
•In re Tsurukawa, __ Bankr. __,2002 WL 31941454 (9th Cir. BAP 2002) (a business partnership existed between a debtor and her husband, in connection with a company that the debtor formed and to which the husband channeled most of his corporate employer’s repair work at prices exceeding those of vendors to which the work was farmed out, and thus, it was appropriate to impute the husband’s fraud to the debtor).
•Action Mechanical, Inc. v. Deadwood Historic Preservation Commission, 2002 SD 121, 652 N.W.2d 742 (2002) (in a plumbing subcontractor’s suit to foreclose a mechanic’s lien and for unjust enrichment, seeking recovery for work performed on a hotel and casino for a lessee that lost possession of the hotel and casino to the lessor, the lessor’s partners were jointly and severally liable for the debts of their partnership).
III.Dissociation and Termination
When a partner ceases to be associated in the carrying on of the partnership business, he or she can have his or her interest bought by the firm, which otherwise continues to do business.
A.Events That Cause Dissociation
Under UPA 601—
•A partner may give notice and withdraw.
•The occurrence of an event specified in the partnership agreement can cause dissociation.
•A partner might be expelled by the firm.
•A partner might be expelled by a court.
•A partner dissociates by declaring bankruptcy, assigning his or her interest, or through death or incapacity.
B.Wrongful Dissociation
This can occur if dissociation is in breach of a partnership agreement, before the expiration of its term or completion of its undertaking [UPA 602]. A partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociation
C.Effects of Dissociation
1.Rights and Duties
On dissociation, a partner’s right to participate in the firm’s business ends [UPA 603]. The duty of loyalty also ends, and the duty of care continues only with respect to events that occurred before dissociation, unless the partner participates in winding up.
2.Buyouts
The partner’s interest in the firm must be purchased according to the rules in UPA 701.
3.Liability to Third Parties
To avoid liability for obligations under a theory of apparent authority, a partnership should notify its creditors of a partner’s dissociation and file a statement of dissociation in the appropriate state office [UPA 704].
D.Partnership Termination
1.Dissolution
•A partnership may be dissolved by the partners’ agreement or dissociation of a partner [UPA 801, 802].
•A partnership for a definite term or undertaking is dissolved when the term expires or the undertaking is accomplished.
•A partnership is dissolved if an event occurs that makes it impossible to continue lawfully [UPA 801(4)].
Case Synopsis—Case 31.2: Estate of Webster v. Thomas
Clyde Webster, James Theis, and Larry Thomas formed T&T Agri-Partners to own and farm 180 acres in Christian County, Illinois. Under the partnership agreement, the firm was to continue until 2010 unless it was dissolved, any withdrawing partner was to sell his interest to the firm according to specific terms, and the death of any partner would dissolve the partnership. Webster died in 2002, but when Theis and Thomas did not liquidate T&T and distribute its assets, Webster’s estate filed a complaint in an Illinois state court. The trial occurred in 2011. The court ordered the liquidation and distribution of the assets, to be valued at the time of liquidation, with payment of attorneys’ fees to the estate. The defendants appealed.
A state intermediate appellate court affirmed. “The circuit court properly determined that the defendants had failed to liquidate and distribute the partnership assets pursuant to agreement and court order.”
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Notes and Questions
What did the partnership agreement at the center of this case require on the death of a partner and the dissolution of the firm?The parties to the partnership agreement at the center of this case were Clyde Webster, James Theis, and Larry Thomas, who formed T&T Agri-Partners Company to own and farm 180 acres in Christian County, Illinois. Under the partnership agreement, the firm was to continue until January 31, 2010 unless it was dissolved, and the death of any partner would dissolve the partnership. Partners owning at least 120 “Partnership units” could, by “written consent,” or by vote in the case of a partner’s death, continue the partnership. In the event of a partner's death, the vote had to occur within 120 days of the date of the death.
On the dissolution of the firm, the partnership assets were to be “liquidated and distributed.”
What conduct by which parties triggered this litigation?There were a number of events that led to the litigation in this case. Initially, the death of Clyde Webster triggered the provision in the partnership agreement that required the firm’s dissolution or a vote by certain remaining partners to continue the partnership.
The failure of the surviving partners James Theis and Larry Thomas to either vote to continue the business of the firm or to dissolve the partnership, as per the partnership agreement, led to the complaint by Webster’s estate, seeking the liquidation and distribution of the firm’s assets. The continuing failure of the surviving partners to take a vote or to dissolve the firm according to the partnership agreement, and those partners’ failure to act on a court’s order to dissolve the firm, triggered the trial, which led to a second court order to dissolve the firm and pay the plaintiff’s attorney fees.
On what did the court base its order regarding attorneys’ fees?After a trial, the court in the Webster case based its order regarding attorney fees on the provision in the partnership agreement that stated “Any Partner who shall violate any of the terms of this Agreement *** shall indemnify and hold harmless the Partnership, and all other Partners from any and all *** losses, *** including but not limited to attorneys' fees.”
Does the judicial power to dissolve partnerships encourage partners to be more respectful toward each other? Why or why not? Most people do not want courts to dissolve their businesses. If partners honor their enterprise and each other, the partnership is more likely to succeed. And if the partnership succeeds, a court is very unlikely to dissolve it. Thus, the courts’ power to judicially dissolve partnerships should encourage partners to be more respectful toward each other.
What might the defendants have done to avoid the dispute that arose from the circumstances of this case?To avoid the dispute that arose from the circumstances of this case, partners James Theis and Larry Thompson, with the personal representative of Webster’s estate, could have voted to continue the partnership after the death of Clyde Webster. A vote taken in accord with the partnership agreement could have averted the dispute and avoided the litigation. Alternatively, the surviving partners could have liquidated the partnership assets and distributed the proceeds. In the facts of the case, of course, the partners did neither, which prompted Webster’s estate to file a complaint against the other partners and the firm to liquidate and distribute its assets.
1.Illegality or Impracticality