Partnerships and LLCs

Question 1

Partnership

Answer 1

A partnership is an association of two or more persons to carry on as co-owners a business for profit. (the partnership is a legal entity distinct from its partners)

–A “person” may be an individual, trust, corporation, partnership or other entity.

–To determine whether a partnership exists, courts generally look to the intent of the parties. If they intended to carry on a business as co-owners, there is a partnership even if they did not subjectively intend to be partners.

–Sharing of profits raises a presumption of partnership unless the share was received as payment for something (e.g., debt, wages, compensation for services rendered, as rent payment, as an annuity or retirement benefit, etc)

–Right to participate in control of the business is another important factor.

–Other additional evidence: title to property held as JTs or TIC; parties designation; venture undertaken requires extensive activity; sharing of gross returns

Question 2

Partnership Agreement

Answer 2

No agreement is required to form a partnership. But partnership law allows the partners to contract around almost all of the statutory provisions, so be on the lookout for a partnership agreement. (may be written, oral, or implied)

–Note: B/c of the Statute of Frauds, if partners wish to have an enforceable agreement to remain partners for more than one year, they generally must execute a writing reflecting their agreement.

Question 3

Rights of Partners

Answer 3

Management: All partners have an equal right to participate in the management of the partnership unless the partnership agreement provides otherwise.

Distributions: Partners have whatever rights are granted in the partnership agreement as to distribution of profits. If the agreement is silent, partners share profits (and losses) equally.

Remuneration: Partners have no right to remuneration for their services to the partnership except for winding up the partnership business.

Indemnification: A partner has a right to be indemnified by fellow partners for expenses incurred on behalf of the partnership.

Contribution: A partner has a right to contribution from fellow partners where the partner has paid more than his fair share of a partnership liability.

Inspection: A partner has a right to inspect and copy the partnership books.

Lawsuits: Generally, a partner may sue his partnership and the partnership may sue a partner in an action at law or in equity.

Question 4

Governing Law of Partnership

Answer 4

Generally, the Revised Uniform Partnership Act (“RUPA”) provides a default set of rules.

Partners are free to agree - through a partnership agreement - to abide by a different set of rules for governing the relationships among themselves, and RUPA will govern only those issues not provided for in the partnership agreement. (some RUPA provisions cannot be waived, e.g., the duty of loyalty and the right of a court to expel a partner)

Question 5

Voting Rights in Partnership

Answer 5

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 all the partners.

Matters outside the ordinary course of business require the unanimous consent of all partners.

Question 6

Liability of the Partnership in Contract

Answer 6

A partnership is liable for all contracts entered into by a partner in the scope of partnership business or with actual or apparent authority of the partnership.

–Actual Authority: Is the authority a partner reasonably believes they have based on the communications between the partnership and the partner. It can come from the partnership agreement or a vote of the partnership. (A majority vote of the partners is required to authorize ordinary business; a unanimous vote is required for extraordinary acts)

–Apparent Authority: The RUPA provides that a partner is an agent of the partnership, and that a partner has apparent authority to bind the partnership to transactions within the ordinary course of the partnership’s business or business of the kind carried out by the partnership (unless the third party is aware that the partner lacks actual authority to act).

Question 7

Statement of Partnership Authority

Answer 7

Actual authority can also be created by the partnership’s filing of a statement of partnership authority w/ the secretary of state (for real property transfers, this must also be filed w/ the county recorder). A statement of authority grants or limits a partner’s authority to enter into transactions on behalf of the partnership. The effect differs whether the transaction involves a transfer of real property.

Question 8

Statement of Partnership Authority’s Effect on Transactions

Answer 8

Transactions Involving Real Property: 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.

–The third parties are deemed to have constructive knowledge of the statement if the secretary of state and county filings are made.

Transactions Not Involving Real Property: Grants of partnership authority in the statement are binding on the partnership (unless the third party has actual knowledge that the partner lacked authority). Restrictions on partner authority in the statement, however, are not binding on third parties.

–In other words, third parties are deemed to have constructive knowledge only of filed grants of authority, NOT filed restrictions. (this effectively states that no other transaction (outside of real property) involving the partnership can cut off the partners’ apparent authority)

Question 9

Limitation of Partner’s Apparent Authority

Answer 9

A partnership will not be bound by a partner’s act if the partner lacked actual authority and the person with whom the partner dealt either knew or received notification of such fact.

–Under RUPA, knowledge means subjective knowledge (i.e., what the person actually knew).

–Under RUPA, a notification is effective either when it comes to the person’s attention or when it is duly delivered. Thus, if a notification limiting a partner’s authority is duly delivered to a third party (e.g., at the third party’s place of business), the third party cannot rely on apparent authority w/ regard to the limitation even if the third party has not actually read the notification.

Question 10

Liability of the Partners

Answer 10

A defining characteristic of the general partnership is that each partner is jointly and severally liable for all obligations of the partnership, whether arising in tort or contract. But P must first exhaust partnership resources before seeking to collect from an individual partner’s assets. (so the partners are essentially guarantors)

–A judgment is not personally binding on a partner unless they have been served and the creditor has exhausted partnership assets, or exhaustion is excused by agreement or court order or b/c the partnership is bankrupt.

Question 11

Liabilities of Admitted Partners

Answer 11

If the partnership admits a new partner (unless otherwise agreed, this requires a unanimous partner vote), that 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.

Question 12

Liabilities of Dissociating Partners

Answer 12

An outgoing or dissociated partner remains liable for obligations arising while they were a partner unless there has been payment, release, or novation. An outgoing partner can also be liable for acts done after dissociation.

Question 13

Partner’s Duty of Loyalty

Answer 13

This duty requires the partner to place the success and interests of the partnership above the partner’s own personal or business interests.

Requires each partner to:
(1) 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:

(2) refrain from dealing w/ the partnership in the conduct of its business as (or on behalf of) a party having an interest adverse to the partnership; and
(3) refrain from competing w/ the partnership in the conduct of its business.

—-A partnership agreement may NOT eliminate the duties of loyalty or care.

Question 14

Partner’s Duty of Care

Answer 14

The duty of care requires each partner to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.

–Ordinary negligence is excused.

–A partnership agreement may NOT eliminate the duties of loyalty or care.

Question 15

Partner’s Duty of Disclosure

Answer 15

A partner has a duty to provide complete and accurate info concerning the partnership.

RUPA provides that each partner and the partnership shall furnish to a partner (1) w/o demand, and info concerning the partnership’s business and affairs reasonably required for the proper exercise of the partner’s rights and duties; and (2) on demand, any other info concerning the partnership’s business and affairs (except if info demanded is unreasonable or improper)

Question 16

Partner’s Duty of Obedience

Answer 16

This requires the partner to obey all reasonable directions of the partnership and not act outside the scope of his authority.

Question 17

Partnership Capital

Answer 17

Is the property or money contributed by each partner for the purpose of carrying on the partnership’s business.

Question 18

Partnership Property

Answer 18

Is everything the partnership owns, including both capital and property subsequently acquired in partnership transactions.

Question 19

Property Deemed to Be Partnership Property

Answer 19

Titled property is partnership property if it is acquired in the partnership’s name where it is apparent from the document that they are acting for a partnership. (e.g., it mentions a partnership or says they’re a partner)

Question 20

Property Presumed to Be Partnership Property

Answer 20

Under RUPA, property is rebuttably presumed to be partnership property if it was purchased w/ partnership funds, regardless of in whose name title is held. “Partnership funds” include not only the partnership’s cash, but also the partnership’s credit.

Question 21

Property Presumed to Be Partner’s Separate Property

Answer 21

Under RUPA, property is rebuttably presumed to be a partner’s property if:

(1) it’s held in the name of one or more partners;
(2) the instrument transferring title gives no sign that they’re acting for a partnership; and
(3) partnership funds were not used to acquire the property.

Question 22

The Partner’s Ownership Interest in the Partnership

Answer 22

A partner’s ownership interest in a partnership is called his “partnership interest.” This is the personal property of the partner, however, it’s subject to a few restrictions regarding what a partner can do with it.

(1) A partnership interest is comprised of (a) management rights [that is, a partner’s right to participate in the management of the business, to obtain info about the partnership, and to be recognized as a “partner”], and (b) financial rights [that is, the partner’s right to receive his share of any profit distributions made by the partnership].

(2) No unilateral transfer of management rights allowed. The default rule for the admission of a new partner requires a unanimous vote of existing partners. (unless otherwise agreed)
(3) Unilateral transfer of financial rights is permitted. (unless otherwise agreed)

Question 23

Dissociation from the Partnership

Answer 23

Dissociation is a change in the relationship of the partners caused by a partner ceasing to be associated in the carrying on of the business. It does not necessarily cause a dissolution and winding up of the business.

–Withdrawal by a partner

Question 24

Wrongful Dissociation of a Partner

Answer 24

A partner will be deemed to have wrongfully dissociated if the dissociation is in breach of an express term in the partnership agreement. It may also be 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 (damages will be offset against the buyout price). They’re also not entitled to payment of the buyout price of their partnership interest until the term expires or the undertaking is completed, unless they can establish that earlier payment will not cause undue hardship of the partnership business.

Question 25

Consequences of Dissociation for the Partnership

Answer 25

When a partner dissociates from a partnership, 1 of 2 statutory avenues is implicated:

(1) The partnership is dissolved and its business must be wound up (e.g., liquidated and sold off); OR
(2) The partnership continues in existence w/ the dissociated partner becoming entitled to a buyout of their partnership interest.

Question 26

Dissolution of Partnership

Answer 26

Dissolution and winding up are required only in limited circumstances. (e.g., event in the agreement requiring winding up, business becomes illegal, issuance of a judicial decree, unanimous consent of partners in a term partnership, expiration of term partnership). Two circumstances are particularly important:

(1) In general, when a partner dissociates by express will in an at-will partnership, the partnership dissolves and its business must be wound up.
(2) In a term partnership, if one partner dissociates wrongfully, or if a dissociation occurs b/c of a partner’s death or bankruptcy, dissolution and winding up of the partnership are required only if, within 90 days after the dissociation, at least 1/2 of the remaining partners agree to wind up the partnership.

Question 27

Liability of a Partner Post-Dissociation

Answer 27

Can still be liable for post-dissociation liabilities incurred within 2 years after the dissociation 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: A dissociated partner can protect himself (cut short this period of liability) by notifying creditors directly of his dissociation (effective immediately) OR by filing a public notice of dissociation (becomes effective 90 days are filing). The partnership can make the filing as well.

–Generally, a dissociated partner remains liable for pre-dissociation partnership obligations.

Question 28

Dissociated Partner’s Power to Bind Partnership

Answer 28

A partnership can be bound by an act of a dissociated partner undertaken within 2 years after dissociation if:

(1) the act would have bound the partnership before dissociation; and
(2) the other party to the transaction (a) reasonably believed the dissociated partner was still a partner and (b) did not have notice of the dissociation.

–Note: The partnership can protect itself by notifying creditors directly of the dissociation (effective immediately) or by filing a public statement of dissociation (becomes effective 90 days after filing).

Question 29

Dissolution of a Partnership at Will

Answer 29

When a partnership is formed w/ no particular undertaking or definite term, it is said to be a partnership at will. This can be dissolved at any time by the express will (e.g., notice of dissolution) of any partner w/o penalty.

Question 30

Partners Waive Dissolution

Answer 30

Any time before the winding up of the partnership business is complete, the partners may decide to waive the dissolution and continue the partnership by unanimous vote of the partners who have not wrongfully dissolved.

–Such waiver does not affect the rights of the persons who have relied on the dissolution before receiving notice of the waiver.

Question 31

Limited Partnerships

Answer 31

A limited partnership (“LP”) is a partnership w/ at least one general partner and at least one limited partner.

–The general partner(s) is personally liable for partnership obligations, while limited partner(s) generally do not have any liability beyond the liability to make agreed-upon contributions.

–This is created by filing a certificate of limited partnership w/ the secretary of state.

Question 32

Formation of Limited Partnership

Answer 32

A certificate of limited partnership must be filed w/ the secretary of state. The certificate must be signed by all general partners. The info required is minimal. It must include: (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.

–It should also include whether it’s a limited partnership or limited liability limited partnership

A limited partnership must maintain in its state of organization an office w/ records of the certificate, any partnership agreements, and the partnership’s tax returns for the 3 most recent years. The partnership agreement or some other record must contain the amount and description of each partner’s contribution, special rights of parter regarding distributions, etc.

The limited partnership name must contain the phrase “limited partnership” or the abbreviation “L.P.” (to alert the public of its limited liability nature of the business) The name may contain the name of any partner (general or limited).

Question 33

General Partners

Answer 33

The LP is managed by general partners. Each general partner has equal rights in the management and conduct of the LP’s activities.

Generally, any matter related to the LP’s ordinary business may be exclusively decided by the general partner, or if there is more than one general partner, by a majority of the general partners.

–Note: A general partner does not automatically violate the duty of loyalty merely b/c the general partner’s conduct furthers his own interests.

—Not entitled to remuneration for sercies performed for the LP; however, LP must indemnify a general partner for liabilities incurred in the ordinary course of the activites of the partnership.

–A general partner’s right to dissociate, the effects of dissociation and his right to information are all the same as in a general partnership.

Question 34

Limited Partners

Answer 34

Limited partners usually have no management rights unless the partnership agreement grants them rights. Participation in the management does NOT cause a limited partner to become personally liable for an obligation of the LP.

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 LLLP; (3) dispose of all or substantially all of the LP’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.

–Note: Generally, a limited partner owes NO fiduciary duties to the LP or any other partner solely by reason of being a limited partner. Thus, they’re free to compete w/ the partnership and have interests adverse to those of the partnership, unless the partnership agreement states otherwise.

–Each limited partner has the right to inspect and copy any partnership records required to be maintained.

–A limited partner has NO right to dissociate before termination of the LP. After dissociation, a limited partner is treated as a transferee of the limited partner’s transferable interest.

Question 35

Financial Rights in a Limited Partnership

Answer 35

Unless otherwise agreed, distributions from an LP are made on the basis of the partners’ contributions (e.g., in proportion to the value of each partners’ contribution).

Also, a LP would not be able to make a distribution if, after making the distribution, the LP would be unable to pay its debts as they become due or the LP’s total assets would be less than the sum of its total liabilities, including sums needed to satisfy superior preferential rights upon dissociation.

–Note: A partner’s contribution may be in the form of any benefit to the partnership. (e.g., money, property, services, and promises to make such contributions).

Question 36

Limited Liability Partnership

Answer 36

RUPA allows the creation of LLPs, which differ from LPs in that ALL of the partners have limited liability (that is, no partner is personally liable for a partnership obligation beyond their contribution to the partnership).

To become an LLP, a partnership must file a statement of qualification w/ the secretary of state. The required minimum info 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 filing of the statement or on the date specified in the statement, whichever is later.

The name must indicate it’s an LLP.

Question 37

Limited Liability Companies

Answer 37

A LLC is a hybrid business organization between a corporation and partnership that (1) is taxed like a partnership, (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.

This is not a corporation or a partnership. It is its own business form. An LLC is treated as a separate legal entity distinct from its owners. There is no limit on the number of members. Although LLCs are governed by statute, LLC members may adopt operating agreements to control most aspects of the LLC’s business and management.

Question 38

Formation of an LLC

Answer 38

An LLC is formed by filing a certificate of organization w/ the secretary of state. The LLC must have at least one member.

The info required in the certificate is minimal. It must include: (1) the name of the LLC; (2) the address of the LLC’s registered office; AND (3) the name and address of its registered agent.

–The LLC’s name must also include an indication that it’s an LLC

Question 39

Management and Operation of an LLC

Answer 39

Management of the LLC is presumed to be by all members. Other management arrangements can be made, 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, 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) 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.

–Note: Those who have management rights also owe fiduciary duties of care and loyalty to the LLC and its other members. They must also discharge their duties and exercise any rights consistently w/ the contractual obligation of good faith and fair dealing.

Question 40

Operating Agreement

Answer 40

The real detail on the operation and governance of an LLC is typically found here. It can displace almost all of the statutory provisions from the Revised Uniform Limited Liability Act (“RULLCA”). (e.g., it may eliminate the duty of loyalty and alter the duty of care [except to authorize intentional misconduct or knowing violations of the law] if doing so is not manifestly unreasonable)

Similarly, the operating agreement may not eliminate the contractual obligations of good faith and fair dealing, but it may prescribe standards for measuring the performance of the obligation is doing so is not manifestly unreasonable.

Question 41

Duty of Care in LLC

Answer 41

Members (or managers if manager-managed) must act w/ 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 judgement rule protection is provided, which effectively means that, members (or managers if manger-managed) cannot be held liable for negligent decisions (but can be held liable for decisions tainted by gross negligence or worse).

Question 42

When does a partner have apparent authority to bind the partnership?

Answer 42

The act of any partner apparently carrying on in the ordinary course of the partnership business or business of the kind carried out by the partnership will bind the partnership unless the partner had no authority to act for the partnership and the third party with whom the partner dealt knew that the partner lacked authority.

Question 43

Describe a partner’s ability to enter into transactions regarding matters within the ordinary course of business vs. matters outside the ordinary course of business?

Answer 43

Actual authority to enter into transactions regarding matters within the ordinary course of business requires a majority vote of the partners.

Actual authority to enter into matters outside the ordinary course of business requires unanimous consent of all partners.