General Partnerships Flashcards
Partnership
Definition
A partnership is
- an association of two or more persons
- to carry on as co-owners of a business
- for profit.
Note: The association between or among the partners must be voluntary, although it does not need to be with the knowledge or intent to form a partnership.
The association does not need to be in the form of a contract.
The association can be an understanding between or among two or more people who are working together. There is no requirement that the “persons” be two individuals. The association may involve any two entities that are considered “persons” under law.
Characteristics of a Typical Partnership
- A partnership cannot be another entity (such as an LLC).
- Owners in a partnership generally make some contribution (which need not be monetary) in exchange for their share in the partnership.
- Partners generally share the profits of the business.
- Partners generally share the risk of financial loss.
- Partners jointly share the management, but equal votes or control is not necessary.
- Note, other individuals can be hired who are not partners (e.g., associates).
There are also features that might be present but do not necessarily create a partnership.
For example:
- Joint ownership alone does NOT automatically mean that a partnership exists.
- Neither sharing gross returns nor giving capital to an enterprise, independently, is sufficient to create a partnership.
- Sharing profits in a business is prima facie evidence that a partnership exists, EXCEPT where those profits are received as
- (a) debt service,
- (b) wages,
- (c) rent, or
- (d) annuity.
- (Note that prima facie evidence creates a rebuttable presumption, not a conclusive presumption.)
What questions do courts ask to determine if a relationship is a partnership or an employer-employee relationship?
- The intent of the parties (although this is not definitive);
- The language of the agreement, if any;
- The conduct of the parties toward third parties;
- The treatment of the returns of the business (evaluating whether there is a sharing of profits and losses)—As discussed above, sharing profits in a business is prima facie evidence that a partnership exists, rather than an employer-employee relationship, EXCEPT where those profits are received as wages (e.g., a commission); and
- Who bears the risk of financial loss.
Attributes of a Partnership
Liabilities—Each partner is jointly and severally liable for the debts of the partnership. This feature of general partnerships means that if the partnership’s assets are not sufficient to cover a debt, the partners are personally liable for that debt. In addition, each partner has the power to independently create obligations and liabilities for the partnership.
Control—Each partner has the ability to participate in the control and management of the partnership. Under the revised Uniform Partnership Act (1997) (“RUPA”), each partner is entitled to one vote, regardless of how much capital he or she contributed. Alternative voting standards may be established by agreement among the partners.
Returns—In a partnership, profits are shared equally among partners. When a partnership is dissolved, the money is divided up among the partners. Most states provide that profits are allocated evenly among the partners, regardless of how much money was contributed by each partner. The partners can also change this feature by an agreement to allocate profits based on the amount contributed to the partnership or using some other measure they might determine appropriate.
Tax treatment—Partnerships are not taxed on their income. Instead, the tax responsibility (or credit, as the case may be) for the profits or losses of the partnership is “passed through” to the partners to include on their respective “personal” tax returns.
Fiduciary duties—Partners owe fiduciary duties to each other and to the partnership.
General Partnership Default Rules
RUPA
A partnership agreement may NOT:
- Unreasonably restrict a partner’s access to books and records of the partnership;
- Eliminate the general duty of loyalty (although specific exceptions may be approved) (Note that Delaware permits the elimination of liability for breach of fiduciary duties, including the duty of loyalty, if specified in the partnership agreement. However the actions of the partners are still subject to the obligation of good faith and fair dealing, and few other states allow such complete limitation of the duty of loyalty.)
- Unreasonably reduce the duty of care;
- Eliminate the obligation of good faith and fair dealing (although certain reasonable standards by which the performance of this duty is measured may be established);
- Vary the power of a partner to dissociate;
- Vary the right of a court to expel a partner under specific circumstances;
- Vary the requirement to wind up the partnership business in certain circumstances; or
- Restrict the rights of third parties under RUPA.
Note: Default rules apply in the absence of a partnership agreement.
Joint Ventures
A joint venture is a business endeavor undertaken by two or more parties. Joint ventures typically have a limited scope and are usually for a limited time. For these reasons, some people will distinguish joint ventures from traditional partnerships.
However, to the extent that any joint endeavor, whether it is called a “joint venture,” “partnership” or something else, represents an association of two or more persons to carry on as co-owners a business for profit, then it will be treated as a partnership.
Merely calling an endeavor a “joint venture” does not make it a partnership. The factual circumstances surrounding the undertaking will determine whether a joint venture meets the standards to be treated as a partnership.
PARTNERSHIP BY ESTOPPEL
Definition
In partnership by estoppel, if A, B, and C are partners, and X is not a partner, X still can be held liable as a partner IF X acts (or fails to act) in a way that leads third parties to reasonably believe X is a partner. In order to be responsible under partnership by estoppel, X must make some manifestation that creates an impression that allows others outside the partnership to reasonably believe that X is a partner, AND the third party, claiming partnership by estoppel, must rely on that impression to his or her detriment.
PARTNERSHIP BY ESTOPPEL
Elements
Partnership by estoppel requires:
Actual reliance—The party claiming partnership by estoppel needs to actually rely on the manifestation. It is not enough for the party to claim that he, she or it would have relied on the manifestation;
The reliance must have been reasonable—The third party may not assert that partnership by estoppel exists because (for example) the third party thought X looked like A, B, or C, so the third party assumed they were partners, EVEN IF the third party truly did make that assumption; and
Some manifestation by the alleged partner—The alleged partner must act or fail to act in some way, which conveys the (albeit incorrect) message that such individual or entity is a partner. Even if the manifestation is not made directly to the third party, it must be traceable back to some action or inaction of the alleged partner.
Apparent Authority of a Purported Partner
A partnership that creates the (albeit incorrect) appearance that an outside non-partner is in fact a partner may be held liable for the actions of that non-partner taken on behalf of the partnership if the third party dealing with the non-partner reasonably believes that the non-partner is a partner
In order for an apparent partner to be able to bind the partnership, the partnership must have done (or failed to do) something to make it appear that there was a partnership with the non-partner, and a third party must have reasonably believed that the “non-partner” had the authority to act on behalf of the partnership in the transaction in question.
There is no requirement that the party claiming apparent authority show detrimental reliance, as is the case with partnership by estoppel.
FIDUCIARY OBLIGATIONS OF PARTNERS
(“THE PUNCTILIO OF AN HONOR THE MOST SENSITIVE …”)
Each partner has fiduciary obligations to the partnership itself and to the other partners in the partnership. These fiduciary obligations fall within the two general duties, the duty of loyalty and the duty of care. (See RUPA § 404.)
Partnership Duty of Loyalty
The duty of loyalty encompasses the obligation of each partner:
- To account to the partnership for-profits, property, or benefits from the conduct (or winding up) of partnership businesses or the use of partnership property;
- To refrain from acting as or on behalf of a party with an adverse interest to the partnership (e.g., avoiding conflicts of interest);
- To refrain from competing with the partnership in the subject matter of the partnership business;
- To perform all duties to the partnership and the other partners consistent with the obligation of good faith and fair dealing.
Partnership Opportunities
Partners also have a duty (as part of their duty of loyalty) to not take opportunities that belong to the partnership for their personal benefit. With regard to an opportunity presented to the partnership, often the question is what is the nature of the opportunity. Is the “opportunity” just information about the potential to profit in an enterprise outside the scope of the partnership business? If so, disclosure alone might be sufficient.
However, if the business opportunity falls within the scope of the partnership business, disclosure alone is probably NOT enough. If the opportunity belongs to the partnership, no partner may take the partnership opportunity for him or herself. When faced with a new opportunity that arises out of, or relates to, the partnership business, the managing partner must:
- First, disclose the business opportunity to the other partners;
- Second, decide whether or not to act on behalf of the partnership and take the opportunity. (The partners owe a fiduciary obligation to the partnership, and a decision by any partner whether or not to take advantage of the opportunity must be made in good faith.)
Partnership Duty of Care
The duty of care encompasses the standard by which a partner must evaluate and make partnership decisions. A partner typically does not violate his duty of care for mere negligence.
Under the duty of care standards articulated in section 404(c) of RUPA, a partner must not engage in:
- gross negligence;
- reckless conduct;
- intentional misconduct; or
- a knowing violation of the law.
In addition, every partner has the obligation to discharge his or her duties to the partnership and other partners (and to exercise any rights that he or she might have under partnership law or the partnership agreement) consistent with the obligations of good faith and fair dealing.
The Ability to Waive Fiduciary Duties in a Partnership
In general, partners are permitted to waive specific duties, but not general duties, such as the duty of loyalty.
Even when permitted by statute, courts tend to frown upon blanket waivers of rights, such as the duty of care and the duty of loyalty.
However, partners can waive specific actions that would otherwise fall under the duty of loyalty, such as the right to start a competing business. In addition, many states will require that the waiver of the duty not be “manifestly unreasonable.”
Attorneys and Their Duties to Their Firms
With regard to best practices when a lawyer leaves a firm, the ABA has guidelines that include:
- Notice must be mailed to each client with whom the lawyer had an active attorney-client relationship.
- The notice should not encourage the client to sever relations with the firm
- The notice should be brief, dignified, and not disparage the former firm.
In many of these cases involving lawyers leaving their firms, there are certain actions that are improper, which may get the departing lawyer in trouble.
These include:
- Communicating with clients before giving notice to the firm that they are leaving;
- Taking client files;
- Lying; and
- Not letting clients know they have a choice about whether to stay with the firm or move with the departing attorney.
Actions that are acceptable include:
- Looking for and obtaining office space;
- Setting up a merger or an affiliation with another firm;
- Negotiating with partners (this is distinct from negotiating with associates to join the departing group which might be questionable and is listed below); and
- Reminding clients that they have a right to choose their lawyer.
The gray areas that might get attorneys into trouble, but are not per se improper, are:
- Contacting clients after notice to the firm, but before leaving; and
- Talking to associates about accompanying the lawyer.
Remember, when evaluating a partner’s actions, simply planning to do something improper (i.e., planning to breach a duty) is not actually a breach of duty.
