Partnership Flashcards
Partnership Definition
A partnership is an association of two or more persons to carry on as co-owners a business for profit. It’s formed as soon as that happens, regardless of whether the parties subjectively intend to form a partnership
Factors For Deciding Whether Partnership Exists
- Sharing of profits raises a presumption of partnership unless the share was received as payment of a debt, as wages or compensation for services rendered, as rent payment, as an annuity or other retirement benefit, as interest on a loan, or for the sale of goodwill of a business.
- Right to participate in control
- Title to property is held in joint tenancy or in common
- The parties designate their relationship as a partnership
- The venture undertaken by the parties requires extensive activity
- Sharing of gross returns
Partnership by Estoppel
If no partnership was formed in fact, parties may still be liable as if they were partners to protect reasonable reliance by third parties
Partnership Agreement
No agreement is required to form a partnership. Nevertheless, you should be on the lookout for the existence of a partnership agreement because partnership law allows the partners to contract around almost all of the statutory provisions. Look for an agreement first, and then fall back on the statutory default rules in the absence of an agreement. Note also that a partnership agreement may be written, oral, or implied (for example, by conduct)
Revised Uniform Partnership Act (“R.U.P.A.”)
Provides default rules. Partners are free to agree— through a partnership agreement—to abide by different rules for governing the relationships among themselves, and the R.U.P.A. will govern only those issues not provided for in the partnership agreement. Note, however, that certain R.U.P.A. provisions cannot be waived (for example, the duty of loyalty, the right of a court to expel a partner).
Partnership Voting
Unless otherwise agreed, all partners have equal rights in the management of the business and equal votes (that is, one partner, one vote). Decisions regarding matters within the ordinary course of the partnership business require a majority vote of the partners. Matters outside of the ordinary course of business require the unanimous consent of all partners
Partnership Profits and Losses
Unless otherwise agreed, profits are shared equally among the partners (by number). Unless otherwise agreed, losses are shared in the same manner as profits
Partnership Liability to Third Parties
R.U.P.A. generally provides that each partner is an agent of the partnership for the purpose of its business. The authority of a partner to bind the partnership when dealing with third parties roughly follows agency law
Partnership Actual Authority in Real Estate
Grants of and restrictions on partner authority to transfer partnership real property in the statement are binding on third parties if the statement is also recorded in the county where the property is located. In other words, third parties are deemed to have constructive knowledge of the statement if secretary of state and county filings are made. Third parties are benefitted by filed grants of authority (unless they have actual knowledge that the partner lacked authority) and burdened by filed restrictions on authority.
Liability of Partners
A defining characteristic of the general partnership is that each partner is jointly and severally liable (so, one or more partners may be sued) for all obligations of the partnership, whether arising in tort or contract.
But the plaintiff must first exhaust partnership resources before seeking to collect from an individual partner’s assets.
Extent of Partner Liability
Each partner is personally and individually liable for the entire amount of partnership obligations
Liability of Newly Admitted Partners
A newly admitted partner is not personally liable for partnership obligations that arose before their admission. They can only lose the amount of their investment in the partnership
Liability of Dissociating Partners
An outgoing or dissociated partner remains liable for obligations arising while they were a partner unless there has been payment, release, or novation.
A dissociated partner can be liable for post-dissociation partnership liabilities incurred within two years after the dissociation (assuming that dissolution has not occurred) if (1) when entering the transaction the other party reasonably believed the dissociated partner was still a partner, and (2) did not have notice of the partner’s dissociation. Note that a dissociated partner can protect themselves (meaning, cut short this period of liability) by notifying creditors directly of their dissociation (effective immediately) or by filing a public notice of dissociation (becomes effective 90 days after filing). The partnership can make the filing as well
Partners’ Criminal Liability
Partners will not be criminally liable for the crimes of other partners committed within the scope of the partnership business, unless the other partners participated in the commission of the crime either as principals or accessories
Partnership Fiduciary Duties
- Duty of Loyalty
- Duty of Care
- Duty of Disclosure
- Duty of Obedience
Partnership Duty of Loyalty
Essentially each partner must deal with the partnership with utmost fairness: requires each partner
- Duty to account: to account to the partnership for any benefit derived by the partner in conducting the partnership business, using the partnership’s property, or appropriating a partnership opportunity;
- No acting adverse to partnership interests: to refrain from dealing with the partnership in the conduct of its business as (or on behalf of) a party having an interest adverse to the partnership; and
- Duty to not compete with partnership: to refrain from competing with the partnership in the conduct of its business.
Partnership 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.
Partnership Duty of Disclosure
A partner also has a duty to provide complete and accurate information concerning the partnership. The duty of disclosure is a statutory duty rather than a fiduciary one (although some judicial opinions treat it as fiduciary in nature).
Partnership Duty of Obedience
The duty of obedience requires the partner to obey all reasonable directions of the partnership and not act outside the scope of his or her authority.
Partner’s Ownership Interest in the Partnership
A partner’s ownership interest in a partnership is called his “partnership interest”. The partnership interest is the personal property of the partner.
A partnership interest is comprised of (1) management rights (that is, a partner’s right to participate in the management of the business, to obtain information about the partnership, and to be recognized as a “partner”); and (2) financial rights (that is, the partner’s right to receive his share of any profit distributions made by the partnership).
Unless otherwise agreed, a partner cannot unilaterally transfer his management rights and thereby make the transferee a “partner.” The default rule for the admission of a new partner is that it requires a unanimous vote of the existing partners
Unless otherwise agreed, a partner can unilaterally transfer his financial rights. The transferee merely has the right to receive profit distributions from the partnership that would have otherwise gone to the partner
Partnership: Events of Dissociation
A partner becomes dissociated from the partnership by:
- oral or written notice of the partner’s express will to withdraw (automatically triggers dissolution of the partnership)
- happening of an agreed event;
- valid expulsion of the partner;
- the partner’s bankruptcy or the appointment of a receiver for a partner;
- the partner’s death or incapacity to perform partnership duties;
- the decision of a court that the partner is incapable of performing a partner’s duties; or
- termination of a business entity that is a partner.
Partnership: Wrongful Dissociation
A partner will be deemed to have wrongfully dissociated if the dissociation is in breach of an express term in the partnership agreement. A dissociation is also wrongful in a term partnership if the partner withdraws, is expelled, or becomes bankrupt before the end of the term. A partner who wrongfully dissociates is liable to the partnership for any damages caused by the dissociation
Consequences of Dissociation for Partnership
When a partner dissociates from a partnership, one of two statutory avenues is implicated:
The first avenue provides that the partnership is dissolved and that its business must be wound up. This means that the partnership business will be liquidated (that is, “sold off”).
The second avenue provides that the partnership continues in existence with the dissociated partner becoming entitled to a buyout of their partnership interest.
Dissolution of a Partnership at Will
When a partnership is formed with no particular undertaking or definite term, it is said to be a partnership at will. A partnership at will can be dissolved at any time by the express will (for example, notice of dissolution) of any partner without penalty.
RUPA Events of Dissolution
- In a partnership at will, notification by any partner of an express will to withdraw as a partner;
- b. In a partnership for a definite term or particular undertaking: (1) expiration of the term or completion of the undertaking, (2) consent of all of the partners to dissolve, or (3) within 90 days after a partner’s death, bankruptcy, or wrongful dissociation, at least half of the remaining partners wish to dissolve;
- c. The happening of an event agreed to in the partnership agreement that requires winding up the partnership business;
- d. The happening of an event that makes it unlawful for the partnership to continue;
- e. Issuance of a judicial decree on application by a partner that (1) the economic purpose of the partnership is likely to be frustrated, (2) a partner has engaged in conduct making it not reasonably practicable to carry on the business, or (3) the business cannot practicably be carried on in conformity with the partnership agreement;
- f. Issuance of a judicial decree on application by a transferee of a partner’s interest that it is equitable to wind up the partnership (1) after the term expires or the undertaking is completed in a partnership for a definite term or particular undertaking, or (2) at any time in a partnership at will; and
- The passage of 90 consecutive days during which the partnership does not have at least two partners
Partnership Priority of Distribution
- First, the partnership must pay all creditors. Creditors include “outside creditors” (for example, trade creditors, lenders, suppliers) and “inside creditors” (for example, partners who loaned money).
- Second, the partnership must repay all capital contributions paid into the partnership by partners.
- Third, profits or losses, if any.
Limited Partnerships
A limited partnership (“LP”) is a partnership with at least one general partner and at least one limited partner. Because it’s a partnership, general partnership principles typically apply unless displaced by LP-specific provisions. The general partner(s) is personally liable for partnership obligations, while the limited partner(s) generally does not have any liability beyond the liability to make agreed-upon contributions
Formation of LP
Certificate of Limited Partnership: A certificate of limited partnership must be filed with the secretary of state. The certificate must be signed by all general partners. The information required in the certificate is minimal. It includes, among other items: (1) the name of the partnership, (2) the names and addresses of the agent for service of process, and (3) the names and addresses of each general partner.
LP General Partners
The LP is managed by the general partner(s).
- Each general partner has equal rights in the management and conduct of the LP’s activities.
- Generally, any matter relating to the limited partnership’s ordinary business activities may be exclusively decided by the general partner or, if there is more than one general partner, by a majority of the general partners.
LP Limited Partners
Limited partners usually have no management rights unless the partnership agreement grants them rights. Unless otherwise agreed, the vote of all partners (general and limited) is necessary for certain extraordinary activities, including to:
- (1) amend the partnership agreement;
- (2) convert the partnership to a limited liability limited partnership;
- (3) dispose of all or substantially all of the limited partnership’s property outside the usual and regular course of the partnership’s activities;
- (4) admit a new partner; or
- (5) compromise a partner’s obligation to make a contribution or to return an improper distribution
LP Financial Rights
Uniform Limited Partnership Act(U.L.P.A.): Unless otherwise agreed, distributions from an LP are made on the basis of the partners’ contributions (that is, in proportion to the value of each partners’ contribution) rather than the R.U.P.A’s default equal split for general partnerships.
Also, like a corporation, a limited partnership may not make a distribution if after making the distribution the limited partnership would be unable to pay its debts as they become due or the limited partnership’s total assets would be less than the sum of its total liabilities, including sums needed to satisfy superior preferential rights upon dissolution.
LP Liability: General Partners
General partners are jointly and severally liable for all obligations of the LP, just as they are in a general partnership. Note: A general partner may also be a limited partner and have the rights of a limited partner, but such a dual capacity does not relieve the general partner of his duties as a general partner
LP Liability: Limited Partners
A limited partner is not personally liable for an obligation of the LP solely by reason of being a limited partner. Limited partners have limited liability, meaning that they can only lose the value of their investments.
LP Fiduciary Duties: GPs
A general partner owes the LP and the other partners the same fiduciary duties of loyalty and care that general partners owe in a general partnership. However, a general partner does not automatically violate the duty of loyalty merely because the general partner’s conduct furthers his own interests.
LP Fiduciary Duties: LPs
Generally, a limited partner owes no fiduciary duty to the partnership or any other partner solely by reason of being a limited partner. Thus, they’re free to compete with the partnership and have interests adverse to those of the partnership, unless the partnership agreement provides otherwise.
Admission of Additional General and Limited Partners
A person may be admitted to the limited partnership as a general or limited partner as provided in the partnership agreement, as a result of a merger or conversion, or on the consent of all partners.
LP Conversion and Merger
A limited partnership may convert to or merge with another form of business entity upon the consent of all partners and filing of a certificate (of conversion or merger) with the secretary of state.
Dissociation of Partners in an LP
The events that will cause dissociation of a partner in a general partnership (see 4.1.1, supra) will also cause dissociation of a partner (general or limited) in a limited partnership.
Note that a limited partner has no right to dissociate before termination of the limited partnership. A general partner’s right to dissociate is similar to the right of a partner to dissociate in a general partnership
LP Dissolution in General
A limited partnership may be judicially dissolved upon application of a partner if it is no longer reasonably practicable to carry on the limited partnership in conformity with the limited partnership agreement. A limited partnership may also be administratively dissolved by the secretary of state for failure to pay fees or file an annual report, but the partnership may apply for reinstatement by curing the defect within two years of the dissolution. Otherwise, a limited partnership may be dissolved only upon the occurrence of one of the following:
- The happening of an event specified in the partnership agreement
- The consent of all general partners and limited partners holding a majority of the right to receive distributions (“majority in interest”)
- After dissociation of a general partner, upon consent of partners owning a majority in interest if another general partner remains; if no general partner remains, after 90 days unless the partners admit a new general partner
- Ninety days after dissociation of the last limited partner, unless a new limited partner is admitted within the 90 days
LP Distribution of Assets on Winding Up
Upon winding up a limited partnership, the assets are distributed in the following order:
- First, to creditors (including partners who made loans to the limited partnership)
- Second, any surplus must be paid in cash as a distribution
- Distribution Where Assets Are Insufficient to Satisfy Debts: If limited partnership assets are insufficient to satisfy all obligations to creditors, each person who was a general partner when the obligation was incurred must contribute to the partnership to satisfy the obligation. The contribution due is in proportion to the right to receive distributions in effect when the obligation was incurred.
Formation of an LLP
To become an LLP, a partnership must file a statement of qualification with the secretary of state. The statement must be executed by at least two partners. The required minimal information includes:
- (1) the name and address of the partnership;
- (2) a statement that the partnership elects to be an LLP; and
- (3) a deferred effective date, if any. The partnership becomes an LLP at the time of the filing of the statement or on the date specified in the statement, whichever is later. (There is no LLP unless this statement is filed.)
The terms and conditions on which a partnership becomes an LLP must be approved by whatever vote is necessary to amend the partnership agreement or, if specified, the vote necessary to amend the contribution obligations of the partners. If the partnership agreement is silent as to how it may be amended, all partners must approve the terms and conditions of the partnership becoming an LLP.
LLP Partner Liability
A partner in an LLP is not personally liable (directly, indirectly, or by way of contribution) for the obligations of the LLP, whether arising in tort, contract, or otherwise. As always, however, a partner remains personally liable for their own wrongful acts. If partnership assets are insufficient to indemnify them for an obligation they incurred on behalf of the LLP, they forfeit the right to receive contributions from other partners in exchange for being relieved of the obligation to contribute to their personal liability.
Limited Liability Company (LLC)
A limited liability company (“LLC”) is a hybrid business organization between a corporation and a partnership that (1) is taxed like a partnership (except for a single-member LLC), (2) offers its owners (called members) the limited liability of shareholders of a corporation, and (3) can be run like either a corporation or a partnership
LLC Formation
An LLC is formed by filing a certificate of organization (or, in some states, articles of organization) with the secretary of state. The LLC must have at least one member
The information required in the certificate is minimal. It must include the following:
- a. The name of the LLC
- b. The address of the LLC’s registered office AND
- c. The name and address of its registered agent
LLC Operating Agerement: Altering Duties
The operating agreement may alter duties owed by members (for more on these duties, see below). For example, the agreement may eliminate the duty of loyalty and alter the duty of care (except to authorize intentional misconduct or knowing violations of law) if doing so is not manifestly unreasonable. Similarly, the operating agreement may not eliminate the contractual obligation of good faith and fair dealing, but it may prescribe standards for measuring the performance of the obligation if doing so is not manifestly unreasonable.
LLC Management and Operation
Management of the LLC is presumed to be by all members. Other management arrangements can be made (for example, management by outside managers), but they must be specified in the operating agreement. Each member (or manager, if the LLC is manager-managed) has equal rights in the LLC’s management. A majority vote of the members (or managers) is required to approve most (that is, ordinary business) decisions. Thus, consistent with general agency law principles, each member of a member-managed LLC has authority to bind the company to contracts apparently carrying on the ordinary business of the company, unless the member lacks actual authority to do so and the other party to the contract has notice that the member lacks such authority. In a manager-managed LLC, only the manager(s) has (have) such authority. A unanimous vote of members (or managers if manager-managed) is required to approve extraordinary business decisions, including amending the operating agreement.
LLC Financial Rights
Although the R.U.L.L.C.A. is silent on the allocation of profits and losses among members (for tax purposes), it does provide that if an LLC makes any distribution to its members, the distribution must be made to the members in equal shares unless the operating agreement provides otherwise. In most states, however, unless otherwise agreed, profits and losses and distributions are allocated on the basis of contributions. A member or transferee does not have a right to demand or receive a distribution from the LLC in any form other than money
LLC Liability
Members and managers generally are not personally liable for the LLC’s obligations. They have limited liability and can lose only the amount of their investments. (As always, though, members are liable for their own torts.) However, courts may pierce the LLC veil of limited liability to reach the members’ and managers’ personal assets to satisfy LLC obligations under circumstances similar to those under which courts would pierce the veil of a corporation
LLC Fiduciary Duties
The fiduciary duties owed by a member (if member-managed) or a manager (if manager-managed) to the LLC and to its other members are the fiduciary duties of care and loyalty.
They must also discharge their duties and exercise any rights consistently with the contractual obligation of good faith and fair dealing.
LLC Duty of Care
Members (or managers if manager-managed) must act with the care that a person in a like position would exercise under similar circumstances, in a manner reasonably believed to be in the best interests of the LLC. Business judgment rule protection is provided, which effectively means that, despite the prior sentence, members (or managers if manager-managed) cannot be held liable for negligent decisions (but can be held liable for decisions tainted by gross negligence or worse).
LLC Duty of Loyalty
Pursuant to the duty of loyalty, a member (or manager if manager-managed) must:
- (1) account to and hold for the LLC any benefit they derive from the LLC’s activities or from the appropriation of an LLC opportunity;
- (2) refrain from dealing with the LLC as, or on behalf of, a person who has an adverse interest to the LLC (unless the transaction is fair to the LLC); and
- (3) refrain from competing with the LLC’s business.
However, after disclosure of all material facts, all of the members may authorize or ratify a specific act by a member (or manager if manager-managed) that would otherwise violate the duty of loyalty
Duties in Manager-managed LLC
Although both members and managers must discharge their duties and exercise their rights in accordance with the contractual obligation of good faith and fair dealing, (1) only the managers are subject to the duties of loyalty and care discussed above; and (2) only the members may authorize or ratify an act by a manager that would otherwise violate the duty of loyalty.
Transferability of LLC Ownership Interest
Essentially, the partnership rule applies with respect to the transferability of ownership interests in an LLC—financial rights are unilaterally transferable, but management rights are not. An assignment of a member’s interest in an LLC transfers only the member’s right to receive distributions. Management rights are not transferred. One can become a member (that is, management rights can be transferred) only with the consent of all members or as provided in the operating agreement
LLC Member Dissociation
A person has the power to dissociate as a member of an LLC at any time, rightfully or wrongfully, by expressly withdrawing as a member. Generally, the events that cause dissociation of a partner in a partnership will also cause dissociation of a member of an LLC. A wrongfully dissociating member may be liable to the LLC for damages
LLC: Events Causing Dissolution
An LLC will be dissolved when any of the following events occurs: (1) an event or circumstance that the operating agreement states causes dissolution; (2) the consent of all the members; or (3) the passage of 90 consecutive days during which the LLC has no members
LLC Judicial Dissolution
A member may also apply for judicial dissolution of the LLC. A court may grant an application for judicial dissolution if:
- a. The conduct of all or substantially all of the LLC’s activities is unlawful.
- b. It is not reasonably practicable to carry on the company’s activities in conformity with the certificate of organization and the operating agreement.
- c. The controlling members have acted, are acting, or will act in a manner that is illegal or fraudulent.
- d. The controlling members have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the member applying for dissolution.
Right to Information: Member-Managed LLC
In a member-managed LLC, a member has a right to inspect and copy any record concerning the LLC’s activities, financial condition, and so on, material to the member’s rights and duties. An LLC and its members must automatically furnish such information that they know is material to the exercise of a member’s rights and duties, unless they reasonably believe the member already knows the information. The LLC and its members must furnish other information on a member’s demand unless the demand is unreasonable or improper.
