General Partnerships

Question 1

What is a general partnership?

Question 2

How is a general partnership formed? Is an agreement or filing required?

Question 3

What are the sources of the law governing general partnerships?

Question 4

Are the legal rules applying to general partnerships mandatory or alterable by contract?

Question 5

What are some of the key legal characteristics of general partnerships?

Question 6

What factors affect a court’s determination of whether a general partnership has been formed?

Question 7

Under the default rules, what partnership vote is required for ordinary course and non-ordinary course transactions and amendments to the partnership agreement, if any?

Question 8

How are profits divided if there is no written partnership agreement?

Question 9

What was the basis for the court’s decision in favor of NABISCO in the Stroud case?

Question 10

What fiduciary duties does a partner owe the partnership? How are they defined by statute?

Question 11

How does Judge Cardozo describe the duty of loyalty in Meinhard v. Salmon?

Question 12

When are partnerships liable to third party for acts or omissions of a partner?

Question 13

When are partners liable for liabilities of the partnership? What is the extent of a partner’s liability?

Question 14

Are partners co-owners of property owned by the partnership?

Question 15

What kind of interest in the partnership can a partner transfer to a third party without the consent of the other partners?

Question 16

By acquiring a transferable interest in a partnership does a creditor become a partner in the partnership?

Question 17

What happens upon dissociation of a partner?

Question 18

What happens upon dissolution of a general partnership?

Question 19

What happens upon winding up of a general partnership?

Question 20

What are the legal requirements for the formation of a partnership?

Answer 20

Legally, a partnership is formed by the association of two or more people to carry on as co-owners of a business for profit, regardless of whether the people intend to form a partnership. The partnership must be for a legal purpose.

Question 21

If a person receives a share of the profits of a business, is she a partner?

Answer 21

Yes. Generally, any person who receives a share of the profits and has contractual capacity is presumed to be a partner of the business, unless the receipt of the share of profits is payment for another specified purpose.

However, even if a presumption arises that a person is a partner, this is just a presumption. Courts will look at other factors before making a final determination about the person’s status.

Question 22

What are the factors courts consider in determining whether a person is a partner in a partnership?

Answer 22

In determining whether a person is a partner in a partnership, courts consider:

–whether person shares in the profits and losses,
–whether he person has contractual capacity on behalf of the partnership,
–the intention of the parties,
–whether the person has ownership and affirmative control of the partnership property and business,
–the language of any applicable partnership agreement,
–the parties’ conduct toward third parties, and
–the rights of the parties upon dissolution.

Joint or common ownership of property does not by itself establish a partnership, even if the co-owners share profits from the property.

Question 23

What is a partnership at will?

Answer 23

A partnership at will is a partnership in which the duration of the partnership is not fixed by the terms of the partnership agreement. Unless otherwise restricted by agreement, a partner may leave this type of partnership without facing any liability.

Question 24

A general partnership sought to borrow money from one of its partner’s wealthy neighbors. The neighbor loaned $100,000 to the partnership in exchange for 20 percent of the partnership’s monthly profits until the neighbor was repaid. Unfortunately, the partnership’s business began to experience significant financial distress, and the partnership was unable to pay its creditors. Some unpaid creditors learned that the neighbor received 20 percent of the monthly profits. These creditors then claimed that the neighbor was a partner and, thus, was jointly and severally liable for the partnership’s obligations.

Is the neighbor likely to be considered a partner?

Answer 24

No. The neighbor is not likely to be considered a partner. Generally, any individual who receives a share of a partnership’s profits is presumed to be a partner. However, this presumption does not apply if the person is receiving a share of the profits based on:

–a debt,
–services rendered (either as an independent contractor or an employee),
–rent,
–an annuity or other benefit to a deceased or retired partner,
–a loan, or
–the sale of the business’s goodwill or other property.

Here, the neighbor was receiving profits and, thus, could be presumed to be a partner. However, the neighbor loaned the partnership money and was being given a share of the profits merely to repay that loan. Thus, the profit presumption does not apply to the neighbor. Because there is no other basis to find that the neighbor is a partner, it is unlikely that the neighbor will be considered a partner.

Question 24

What are the six reasons a person may receive a share of a general partnership’s profits that do not give rise to a presumption that the person is a partner in that general partnership?

Answer 24

Any person who receives a share of a general partnership’s profits is presumed to be a partner in a general partnership—unless the person is receiving a share of the profits for:

–a debt,
–services rendered (by an independent contractor or an employee),
–rent,
–an annuity or other benefit to a deceased or retired partner,
–a loan, or
–the sale of the business’s goodwill or other property.

Question 25

What is a partnership for a definite term?

Answer 25

A partnership for a definite term is a partnership in which the duration is fixed by the terms of the partnership agreement. The partnership terminates upon the expiration of the specified period. Unless altered by agreement, a partner who leaves the partnership prior to the termination of the term faces the prospect of liability for any damages caused by her premature departure.

Question 26

What is a partnership for a particular undertaking?

Answer 26

A partnership for a particular undertaking is a partnership in which the duration of the partnership is determined by a particular undertaking and terminates upon the completion or cessation of that undertaking. As in all partnerships, the undertaking must be a legal one.

Question 27

What is a partnership agreement?

Answer 27

A partnership agreement is a written, oral, or implied contract that governs the partners and the partnership. Although no formalities are typically required, some partnership agreements may need to be in a signed writing under the statute of frauds.

However, a partnership agreement is not required for the formation of a partnership. A partnership can form without an agreement if two or more people associate to carry on as co-owners of a business for profit.

Question 27

What are the three most common types of general partnerships?

Answer 27

The three most common types of general partnerships are:

partnership at will,
partnership for a definite term, and
partnership for a particular undertaking.

Question 28

What is the test for whether a partnership by estoppel has been created?

Answer 28

A partnership by estoppel has been created by operation of law if:

–a person claimed to be a partner through words or conduct or otherwise consented to being represented as a partner, and
–another party relied on the representation to enter into a transaction with the actual or purported partnership.

If the representation about being a partner was made in a nonpublic manner, the purported partner can be liable only to the people to whom the representation was made. However, if the representation was made in a public manner, the purported partner is potentially liable to anyone who relied on the purported partnership, even if the purported partner was unaware of being held out as a partner to that specific claimant.

Question 29

What is a limited partnership?

Answer 29

A limited partnership is a common type of partnership that limits the individual liability of particular partners under statutory law. In most states, the governing law is the Uniform Limited Partnership Act of 2001 (ULPA) or the Revised Uniform Limited Partnership Act (RULPA).

Question 30

Do limited partnerships arise from common law?

Answer 30

No. Limited partnerships, unlike general partnerships, do not arise from common law. Instead, a limited partnership may be formed pursuant to the procedures set forth in a state statute that specifically provides for the creation of limited partnerships.

Typically, states require the filing of a certificate of limited partnership that lists the names of the general partners and may require additional information, such as the type of business and amount of capital contributions. Alternatively, a limited partnership may be formed by converting a general partnership into a limited partnership with the approval of all partners and the filing of a certificate of limited partnership.

Question 31

What is a limited liability limited partnership (LLLP)?

Answer 31

An LLLP functions similarly to a limited partnership in most respects, except that an LLLP provides limited liability to general partners, as well as limited partners. LLLPs are recognized in some states.

Question 32

Does a partner in a limited liability partnership have any personal liability for the partnership’s obligations if the partner takes an active role in managing the partnership?

Answer 32

No. A partner in a limited liability partnership does not have any personal liability for the partnership’s obligations even if the partner takes an active role in managing the partnership.

Partners in a limited liability partnership enjoy limited liability. Unlike partners in general or limited partnerships, a partner in a limited liability partnership is protected from individual liability for the partnership’s obligations of the partnership regardless of the partner’s role in partnership management. Instead, the limited liability partnership itself is liable as an entity for any partnership obligations, whether arising in contract, tort, or otherwise. However, even in a limited liability partnership, partners remain individually liable for their own personal misconduct.

Question 33

May an individual partner bind a partnership?

Answer 33

Yes. An individual partner may bind a partnership in the ordinary course of partnership business. Each partner is considered an agent of the partnership when conducting partnership business.

However, a partnership agreement may limit individual partners’ authority to act for the partnership on specific matters. If a partner does not have the authority to act for the partnership in a particular matter, and the other party knows that the partner lacks authority, the partnership will not be bound. Additionally, a partner’s actions outside the ordinary course of business bind the partnership only if authorized by the other partners.

Question 34

Are partners liable for the obligations of the partnership?

Answer 34

Yes. All partners are jointly and severally liable for the obligations of the partnership, unless otherwise agreed by a claimant or provided by law. This means that a judgment against a partner or the partnership—e.g., a judgment finding tort or contract liability—may be enforced against any of the partners.

Question 35

If a partner is personally liable for a judgment against a partnership, must a judgment creditor first attempt to satisfy a judgment from the partnership’s assets before attempting to satisfy the judgment from the partner’s personal assets?

Answer 35

Yes. If a partner is personally liable for a judgment against the partnership, creditors must first attempt to satisfy the judgment from the partnership’s assets before attempting to satisfy the judgment from the partner’s personal assets. This is sometimes referred to as the exhaustion requirement.

This rule means that, even if a partner has personal liability for a judgment against the partnership, the creditor must exhaust efforts to get the partnership itself to pay the judgment against the partnership before the creditor can pursue the partners’ personal assets to satisfy the judgment.

Question 36

A supplier had been providing raw materials to a general partnership’s business. Generally, the supplier delivered materials on the first of every month, and the partnership would pay for the delivery within 90 days. The supplier accepted this arrangement, because he knew one of the partners was wealthy. Unfortunately, the partnership was experiencing significant financial distress and suddenly filed for bankruptcy. The supplier’s last three deliveries remained unpaid. The jurisdiction follows the RUPA.

Can the supplier immediately try to recover from the wealthy partner’s personal assets for the unpaid deliveries?

Answer 36

Yes. The supplier can immediately try to recover from the wealthy partner’s personal assets for the unpaid deliveries. Generally, in a general partnership, all partners are jointly and severally liable for the partnership’s obligations, meaning they are personally liable for the partnership’s debts. In most cases, creditors must attempt to satisfy claims from the partnership’s assets before pursuing a partner’s personal assets. This exhaustion requirement does not apply, however, if the partnership has filed for bankruptcy.

Here, the wealthy partner is personally liable for the general partnership’s debt. Usually, the supplier would have to try to recover the debt from the partnership first. However, because the partnership has filed for bankruptcy, the exhaustion requirement does not apply, and the supplier may go directly after the partner’s personal assets.

Question 37

Under the Revised Uniform Partnership Act (RUPA), what are the five exceptions to the exhaustion requirement?

Answer 37

Under the RUPA, the five exceptions to the exhaustion requirement are:

–a judgment against the partnership based on the same claim already exists, but a writ of execution was returned unsatisfied;
–the partnership is a debtor in bankruptcy;
–the partner agrees that the creditor need not exhaust partnership assets first;
–a court gives the creditor permission to pursue a partner’s personal assets after finding that: (1) partnership assets are insufficient to satisfy the judgment, (2) exhaustion of partnership assets is excessively burdensome, or (3) equitable principles support giving permission; or
–the partner is liable independently of the partnership.

If a partner is personally liability for a judgment against the partnership and an exception applies, the judgment creditor may go after that partner’s personal assets without exhausting all efforts to recover from the partnership.

Question 38

A failing general partnership owned an oil well in a foreign country. The oil well was valuable, though none of the partners were quite sure how to sell it, and there were many regulations involved with selling it. This made liquidating the well excessively burdensome. The partnership had owed a key creditor $100,000 for several months without making any payments. The creditor intended to go after the partners’ personal assets to satisfy this debt. The partners argued that the creditor could not go after their personal assets to satisfy this partnership debt until all of the partnership’s assets had been exhausted. The partnership’s only real remaining asset was the foreign oil well. The jurisdiction follows the RUPA.

What does the creditor need to do to go after the partners’ personal assets directly to satisfy the partnership’s debt?

Answer 38

To go after the partners’ personal assets directly, the creditor needs to get a court’s permission. Generally, in a general partnership, all partners are personally liable for the partnership’s debts (jointly and severally). In most cases, creditors must try to satisfy a partnership’s debt from the partnership’s assets before pursuing the partners’ personal assets. This exhaustion requirement does not apply if a court grants permission to go after the partners’ personal assets, because exhausting the partnership’s assets would be excessively burdensome.

Here, the partners are personally liable for the partnership’s debt. The creditor can avoid the exhaustion requirement by getting a court’s permission to pursue the partners’ personal assets. Because it would be excessively burdensome to get cash from the partnership’s one asset, the oil well, the court will likely give permission.

Question 38

May a liable partner seek contribution from other partners?

Answer 38

Yes. A liable partner may seek contribution from other partners. Additionally, the partnership itself is liable for loss or injury resulting from a wrongful act or omission, or other actionable conduct, by a partner acting in the ordinary course of business or with the authority of the partnership.

Question 39

What is partnership by estoppel?

Answer 39

Partnership by estoppel is a partnership created by law when a person holds himself or herself out as a partner in an existing or apparent partnership, and a third party relies on the person’s representation. This can create a legally binding partnership in the absence of a formal partnership agreement.

If a partnership by estoppel exists, a purported partner is subject to the same liability as an actual partner and may be held jointly and severally liable to a person who relies upon the purported partnership to enter into a transaction with the actual or purported partnership.

Question 40

Is an incoming partner who joins an existing partnership personally liable for all partnership obligations?

Answer 40

No. An incoming partner who joins an existing partnership is not personally liable for partnership obligations that were incurred before the partner’s admission into the partnership. Once having joined the partnership, the partner will be jointly and severally liable for the partnership’s subsequent obligations.

Question 41

Is a dissociating partner who leaves an existing partnership personally liable for partnership obligations incurred before dissociation?

Answer 41

Yes. A dissociating partner who leaves an existing partnership remains personally liable for partnership obligations that were incurred before dissociation. A dissociating partner is not personally liable for partnership obligations incurred after dissociation, unless the obligee:

–believes the dissociated partner is a current partner,
–did not have notice of the partner’s dissociation, and
–is not deemed to have knowledge or notice of the dissociation under the RUPA.

A dissociated partner may be released from liability for a partnership obligation by agreement.

Question 42

May a partnership own property in its own name?

Answer 42

Yes. A partnership may own property in its own name. Each partner may use or possess partnership property on behalf of the partnership. Typically, property may also be transferred to or from a partnership and its partners.

Question 43

May a partnership own property that is not owned by the individual partners?

Answer 43

Yes. A partnership may own property that is not owned by the individual partners. Property belongs to a partnership and not the individual partners if the property was acquired by a transfer to:

–the partnership in its name or
–one or more partners in their capacity as partners in the partnership, if the title instrument indicates the name of the partnership.

Property purchased with partnership assets is presumed to be partnership property. Otherwise, property is assumed to be each individual partner’s property, even if it is used for partnership purposes.

Question 44

May an individual partner transfer partnership property held in the individual partner’s name?

Answer 44

Yes. An individual partner may transfer partnership property held in the name of the individual partner if there is no indication that the property is held in the name of the partnership. Partnership property held in the name of any person may be transferred by that person if there is no indication that the property is held in his capacity as a partner in the partnership.

Question 45

Does a partner have the right to dissociate from the partnership?

Answer 45

Yes. A partner has the right to dissociate from the partnership at any time by giving notice to the partnership of her express will to withdraw.

Question 45

Several friends formed a general partnership to manage rental properties. The partnership was highly successful and regularly issued distributions to the partners. One partner was experiencing some financial distress. An investor was willing to give this partner a one-time, lump-sum payment for the partner’s interest in future distributions issued by the partnership. The partner wanted to maintain her partnership interest but sell her right to future distributions to the investor. The partnership agreement is silent on the issue of the transferability of distributions. The jurisdiction follows the RUPA.

Can the partner sell her interest in future distributions?

Answer 45

Yes. The partner can sell her interest in future distributions. Partnership agreements often address issues about how to distribute profits and losses. However, if a general-partnership agreement does not fully cover the issue or does not exist at all, under the RUPA, each partner is entitled to an equal share of partnership profits and has the right to receive distributions from the partnership. In addition, unless otherwise restricted by the partnership agreement, a partner’s interest in profits and distributions is transferable as personal property.

Here, the partner has a right to receive future distributions from the partnership. The general-partnership agreement does not restrict the transferability of the partners’ interests in future distributions. Thus, the partner’s interest is treated as her personal property, and she can sell her right to future distributions.

Question 46

Are partners entitled to inspect the partnership’s books and records?

Answer 46

Yes. Partners are entitled to access, inspect, and copy the partnership’s books and records. This is permissible at any time and for any reason; a partner’s right to access, inspect, and copy the partnership’s books and records is not conditioned on the partner’s purpose or motive.

The partnership’s books and records must be kept at the partnership’s chief executive office, if any.

Question 47

May a dissociated partner bind her former partnership?

Answer 47

Yes. A dissociated partner may bind her former partnership with respect to a third party for two years after dissociation if the other party:

–reasonably believes that the dissociated partner is still a partner,
–does not have notice of the partner’s dissociation, and
–is not deemed to have knowledge or notice under the RUPA.

To extinguish any lingering liability, a dissociated partner or the partnership itself may file a statement of dissociation that provides constructive notice of the partner’s dissociation.

Question 47

Under what circumstances is a partner’s dissociation from a partnership wrongful?

Answer 47

A partner’s dissociation from a partnership is wrongful if the dissociation:

–breaches an express provision in the partnership agreement or
–results from a judicial determination of wrongful conduct.

If the partner’s dissociation is wrongful, the partner is liable to the partnership and other partners for any damages caused by the dissociation.

Question 48

If a partnership agreement does not include any provisions about fiduciary duties, do the partners owe each other or the partnership any fiduciary duties?

Answer 48

Yes. If a partnership agreement does not include any provisions about fiduciary duties, then, by default, the partners owe fiduciary duties of loyalty and care to the partnership and each other. Generally, this means partners are obligated to act on behalf of the partnership rather than in their own interests. Further, all partners are required to fulfill their fiduciary duties with good faith and fair dealing.

The duty of loyalty requires, among other things, that each partner avoid self-dealing. The duty of care requires that each partner refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law related to partnership business.

Question 49

May a partnership be bound by a partner’s actions that occur after the partnership has been dissolved?

Answer 49

Yes. A partnership may be bound by a partner’s actions that occur after the partnership has been dissolved. This can occur if the partner’s actions:

–are appropriate for winding up the partnership’s business or
–would have bound the partnership before dissolution, if the other party to the transaction did not have notice of the dissolution.

Each partner is liable to the other partners for the appropriate share of any partnership liability that was incurred after dissolution.

Question 50

Do partners have an obligation to act on behalf of the partnership rather than in their own interests?

Answer 50

Yes. Unless the partnership agreement specifies otherwise, partners have an obligation to act on behalf of the partnership rather than in their own interests. Each partner owes the fiduciary duties of loyalty and care to the partnership and other partners. Partners are required to fulfill their fiduciary duties with good faith and fair dealing.

If a partner breaches a fiduciary duty or otherwise causes harm to the partnership, another partner or the partnership itself may bring an action against the breaching partner for legal or equitable relief.

Question 51

What is the duty of care that partners owe the other partners and the partnership?

Answer 51

The duty of care that partners owe the other partners and the partnership requires each partner to refrain from engaging in:

–grossly negligent or reckless conduct,
–intentional misconduct, or
–a knowing violation of law related to partnership business.

Ordinary negligence, defined as the failure to use the care a reasonably prudent and careful person would use under similar circumstances, does not constitute a breach of the duty of care.

Question 52

Unless the partnership agreement itself provides otherwise, is the unanimous consent of all partners required to amend a partnership agreement?

Answer 52

Yes. Unless the partnership agreement provides otherwise, the unanimous consent of all partners is required to amend a partnership agreement. Similarly, unless the default rule is modified by the partnership agreement, the unanimous consent of all partners is also required for:

–an act that is outside the ordinary course of partnership business or
–the acceptance of a new partner to the partnership.

The default rule of unanimous consent for all three of these partnership events may be changed by a provision in the partnership agreement itself allowing for fewer votes (e.g., a majority vote).

Question 53

Six people formed a general partnership to develop real property. After a number of setbacks, some of the partners realized that the project needed a dedicated administrative advisor. After an extensive search, the partners identified an administrator, but she would join the partnership only as a partner. The partnership agreement was silent about the addition of new partners. The partners had a meeting, and five of the six partners voted to make the administrator a partner.

Was this vote sufficient to make the administrator a partner?

Answer 53

No. A nonunanimous vote was not sufficient to make the administrator a new partner. Unless the partnership agreement provides otherwise, the unanimous consent of all partners is required for:

–an act that is outside the ordinary course of partnership business,
–an amendment to a partnership agreement, or
–the acceptance of a new partner to the partnership.

Here, the partnership agreement is silent about admitting new partners. Thus, the unanimous consent of the partners was required to accept the administrator into the partnership as a new partner. Because only five of the six partners voted in favor of adding the new partner, the vote was insufficient to add the administrator as a new partner in the partnership.

Question 54

Three friends formed a general partnership for landscaping services. The company’s profits were far higher than any of the partners had expected. One day, two of the partners were discussing profit distributions and decide to expel the third partner to seize his share of the company’s profits before the next distribution. These two partners reviewed the partnership agreement and followed all the procedures in the agreement to expel the third partner without cause. The agreement contained no provisions regarding fiduciary obligations among the partners.

Did the two remaining partners violate any fiduciary duties by expelling the third partner without cause?

Answer 54

Yes. The two remaining partners violated fiduciary duties to the third partner. Unless modified by the partnership agreement, partners are obligated to act on behalf of the partnership rather than in their own interests. All partners owe the fiduciary duties of loyalty and care to the partnership and are required to fulfill their fiduciary duties with good faith and fair dealing. Generally, expelling a partner without cause does not violate these duties. However, the duty of loyalty requires, among other things, that each partner avoid self-dealing.

Here, due to the agreement’s silence, the default rule imposing fiduciary duties on all partners applied. Although the two partners could have expelled the third for no reason, they had a reason: self-gain. Because the two partners put their own interests ahead of the partnership’s interests, they breached the fiduciary duty of loyalty.

Question 55

Under the Revised Uniform Partnership Act (RUPA), if a general-partnership agreement does not address how to distribute profits among partners, how are profits distributed among the partners?

Answer 55

Under the RUPA, if a general-partnership agreement does not address how to distribute profits among partners, profits are distributed among the partners in equal shares. Partnership agreements frequently address how to distribute profits and losses. However, if a general-partnership agreement fails to address this issue fully or an agreement does not exist, the default rule under the RUPA provides that each partner is entitled to an equal share of the partnership profits.

This rule is for general partnerships only. Under both the Uniform Limited Partnership Act (ULPA) and the Revised Uniform Limited Partnership Act (RULPA), the default rule is different for limited partnerships. If a limited-partnership agreement does not address how profits are distributed, the profits will be distributed based on the partners’ contributions to the partnership.

Question 56

A general partnership had three partners. The first partner contributed $200,000 to start the venture. The second partner contributed $75,000. The third partner contributed only $25,000 but managed the partnership. The partners all signed a general-partnership agreement. When it came time to distribute profits, the partners discovered that the partnership agreement did not have a provision setting out how the profits should be distributed among the partners. The partnership had $30,000 available to distribute to the partners. The jurisdiction applies the RUPA.

What is the profit distribution to the third partner?

Answer 56

The third partner will received one-third of the profits, or $10,000 each. Partnership agreements frequently address the issue of how to distribute profits and losses. However, if a general-partnership agreement fails to fully address the issue, under the RUPA, the default rule is that each partner is entitled to an equal share of the partnership’s profits and losses.

Here, the partnership agreement does not provide a method for profit distribution. Thus, the default rule applies. Because this is a general partnership, each partner will get an equal share of the profits regardless of what that partner contributed to the partnership. There are three partners. Thus, each partner will be entitled to one-third of the total profits, or $10,000 each.

Question 56

How are partnership profits and losses distributed under the RUPA?

Answer 56

The RUPA provides that each partner is entitled to an equal share of the partnership profits and has the right to receive distributions from the partnership. The RUPA provides that losses are shared in proportion to each partner’s share of the profits.

A partner’s interest in the share of profits and distributions is transferable as personal property. Additionally, each partner has the right to obtain from the partnership reimbursement for payments made and indemnification for liabilities incurred in the ordinary course of partnership business. However, partners are not generally entitled to compensation for services that are performed for the partnership.

Question 57

Two individuals agreed to start a term general partnership to build and sell a new apartment building. The first partner contributed $100,000 to the partnership. The second partner did not contribute any capital to the partnership but agreed to serve as a general contractor and manage the entire building process. The partnership agreement did not say anything about how losses would be allocated. Unfortunately, the real estate market declined. When the building finally sold, the partnership suffered a $100,000 loss, meaning the first partner had lost his entire investment. The jurisdiction applies the RUPA.

Is the second partner obligated to reimburse the first partner for any part of this loss?

Answer 57

Yes. The second partner must reimburse the first partner for an equal share of the loss. If a general-partnership agreement fails to fully address how losses are allocated, under the RUPA, the default rule is that each partner is entitled to an equal share of the partnership’s profits and losses. To calculate the losses, only capital contributions are considered. Unless the partnership agreement says otherwise, a partner’s labor is not given any value when allocating losses.

Here, the partnership agreement did not address how losses would be allocated. Under the RUPA, this means the two partners share any losses equally. The first partner contributed and lost $100,000. The second partner’s labor does not count, meaning the second partner contributed and lost nothing. To make the partners’ losses equal, the second partner owes the first partner $50,000 for his share of the loss.

Question 58

A general partnership was considering the following two proposals: (1) an amendment to the partnership agreement altering the required vote for partner expulsion and (2) the hiring of three professionals from a competing firm as new partners. The partnership agreement was silent about how many votes were needed for these transactions.

Is a unanimous vote from the partners needed to approve either of these proposals?

Answer 58

Yes. Because the partnership agreement is silent on the issue, the partners’ unanimous consent is required to approve both proposals. Unless the partnership agreement provides otherwise, the consent of all partners is required for:

–an act that is outside the ordinary course of partnership business,
–an amendment to a partnership agreement, or
–the acceptance of a new partner to the partnership.

Here, the partnership agreement is silent about the voting requirements. Thus, the default rules apply. The proposals are to amend the partnership agreement and accept new partners. These two proposals both fit squarely in categories requiring unanimous consent. Thus, unanimous consent will be necessary to enact either proposal.

Question 59

Do partners have rights in the management of the partnership business?

Answer 59

Yes. Each partner has equal rights in the management and conduct of the partnership business. These rights may be altered by the partnership agreement.

Question 60

Can a partnership agreement modify the duty of care?

Answer 60

Yes. A partnership agreement can materially modify the duty of care, including reducing a partner’s obligations under the duty of care, as long as the provision is not manifestly unreasonable. However, a partnership agreement cannot eliminate the duty of care entirely.

Question 61

A company was interested in buying a storage facility. The company’s general partners decided to purchase the first facility they looked at. The purchase price for this facility was $100,000. The partners did not look at any of the other six facilities that are available, nor did they consult with an expert in the valuation of real estate regarding the purchase price. After the sale closed, the partnership’s business began to fail. The partnership became insolvent, and creditors discovered that the facility was actually worth only $20,000. The company’s general-partnership agreement provided that partners were not subject to the duty of care.

Did the partners owe a duty of care when they purchased the facility?

Answer 61

Yes. The partners owed a duty of care when they purchased the facility. Unless modified by the partnership agreement, all partners owe the fiduciary duties of loyalty and care to the partnership and are required to fulfill their fiduciary duties with good faith and fair dealing. The duty of care requires each partner to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law related to partnership business. Although a partnership agreement may modify these duties, it may not eliminate them.

Here, the partnership agreement attempted to eliminate the partners’ duty of care completely. This provision is unenforceable. Thus, the default rules apply. This means the partners still owed a duty of care and could face personal liability for their uninformed decision to purchase the storage facility.

Question 62

Does an act of ordinary negligence breach a partner’s duty of care?

Answer 62

No. An act of ordinary negligence does not breach a partner’s duty of care. Unless the partnership agreement modifies the duty of care, the duty of care requires each partner to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law related to partnership business. By itself, an act of ordinary negligence is not enough to meet any of these standards.

Question 63

A partner was tasked with making decisions about how to invest some partnership assets. The partner talked to a variety of financial advisors and decided to invest in a group of high-risk, long-term investments. Unfortunately, many of the investments wound up failing. A few of the other partners were furious and retained a law firm to evaluate the partner’s decision-making process. The law firm concluded that the partner failed to use the care a reasonably prudent and careful person would use under similar circumstances and, therefore, was negligent. The partnership agreement did not modify the general duty of care.

Did the partner breach the duty of care when she negligently purchased these poor investments?

Answer 63

No. The partner did not breach the duty of care when she negligently purchased the poor investments. Unless modified by the partnership agreement, the duty of care requires each partner to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law related to partnership business. However, by itself, an act of ordinary negligence (i.e., a failure to use the care a reasonably prudent and careful person would use under similar circumstances) is not enough to breach the duty of care.

Here, the partnership agreement did not modify the duty of care, and the default duty of care applied to the partner. However, the partner’s poor decision was only ordinary negligence. Without more, an act of ordinary negligence does not breach of the duty of care.

Question 64

What is the duty of loyalty owed by partners?

Answer 64

The duty of loyalty partners owe to their partners and partnership requires each partner to:

–avoid self-dealing;
–account to the partnership and hold all partnership property, profits, and benefits as trustee for the partnership;
–refrain from dealing with the partnership as or on behalf of a party with an interest adverse to the partnership; and
–refrain from competing with the partnership before dissolution.

A partner’s breach of her duty of loyalty can result in the partnership or other partners bringing an action against the breaching partner for legal or equitable relief.

Question 65

Can a partnership agreement eliminate the duty of loyalty?

Answer 65

No. A partnership agreement cannot eliminate the duty of loyalty. However, the partnership agreement may materially modify a partner’s obligations under the duty of loyalty, as long as the provision is not manifestly unreasonable (e.g., the partnership agreement may identify specific types or categories of activities that do not violate the duty).

Question 66

A company’s general partnership agreement provided that the partners were allowed to compete with the partnership in buying commercial real estate. A vacant, commercially zoned lot in an extremely desirable part of town was suddenly listed for sale. The partnership was extremely interested in making a bid. However, during the assessment process, the owner of the warehouse accepted a bid from one of the partnership’s senior partners. The other partners were furious.

Did the senior partner breach his duty of loyalty by competing directly with the partnership in buying this commercial lot?

Answer 66

No. The senior partner did not breach his duty of loyalty. Unless modified by a partnership agreement, all partners owe the fiduciary duty of loyalty to the partnership. The duty of loyalty requires, among other things, that each partner refrain from competing with the partnership in the conduct of the partnership’s business. A partnership agreement cannot eliminate the duty of loyalty entirely, but it may materially modify a partner’s obligations under the duty of loyalty, as long as the provision is not manifestly unreasonable.

Here, the partnership agreement allows only one exception to the duty of loyalty: buying commercial real estate. This one specific exception is not manifestly unreasonable. Thus, the provision is enforceable, and the senior partner did not violate his duty of loyalty when he engaged in that specifically permitted activity.

Question 67

A general partnership was interested in acquiring a local manufacturing facility. The partnership was unaware that the facility was owned by one of the partnership’s junior partners. The junior partner was present during partner discussions regarding the facility but did not comment on the potential purchase. The partnership voted unanimously to buy the facility for the listed sale price.

Did the junior partner violate a fiduciary duty?

Answer 67

Yes. The junior partner violated the duty of loyalty. The duty of loyalty requires each partner to:

–avoid self-dealing;
–account to the partnership and hold all partnership property, profits, and benefits as a trustee for the partnership;
–refrain from dealing with the partnership as or on behalf of a party with an adverse interest to the partnership; and
–refrain from competing with the partnership in the conduct of the partnership’s business.