chapter 27 - partnerships

Introduction; Although the concept of partnerships is an ancient one, today the common law of partnerships has been largely supplanted by

statutory law

Each state has its own partnership

statute.

However, most states have modeled their legislation after the

However, most states have modeled their legislation after the

This model partnership act, an attempt to codify partnership law into a single document, has now replaced the

Uniform Partnership Act (UPA) as the dominant source of partnership rules. Accordingly, the RUPA provides the framework for this chapter.

**Creation of a Partnership;** Most people are surprised to discover that there are amazingly few legal formalities involved in creating a partnership. In fact, a court may find two persons to be partners even though

neither had the specific intent to create a partnership.

his is so because no express agreement is necessary to create a partnership. All that is required is

his is so because no express agreement is necessary to create a partnership. All that is required is

The RUPA simply describes a partnership as

“an association of two or more persons to carry on as co-owners of a business for profit.”

**An Association of Two or More Persons;** A partnership is a

voluntary and consensual association involving two or more persons.

Nobody can be forced to become a partner, although one can engage unwittingly in behavior that

gives rise to the creation of a partnership. The RUPA is extremely liberal in that it permits individuals, partnerships, and corporations to qualify as persons that can form a partnership.

**Carrying on a Business for Profit;** The RUPA definition of a partnership applies only to instances in which two or more persons

The RUPA definition of a partnership applies only to instances in which two or more persons

However, any trade, occupation, or profession is treated as a business in

determining the existence of a partnership.

The key element in this definition is the fact that the objective must be to make a

**profit**. People who are involved in a nonprofit association are not partners

**Co-ownership;** For there to be a partnership there must be **co-ownership**, which means

ownership of the business as such

It does not require that the property used in the business be

wned by the partnership or in equal shares by the

partners. In fact, the property and capital used in the business of a partnership can be supplied entirely by a single partner, or the property may be leased from others and the working capital borrowed.

**Disputes on the Existence of a Partnership;** Disputes often arise over whether or not a

partnership has been created.

When this occurs, courts generally look at all the facts, paying particular attention to

whether there appears to be a community of interest.

Perhaps the two most important factors in determining whether such co-ownership exists are the

**sharing of profits** and the **sharing of management** of the business.

The RUPA states that,

unless other evidence clearly disproves that individuals are partners, the sharing of profits is presumptive evidence that they are.

However, the RUPA then lists certain factors that can overcome this presumption. For instance,

if one receives a share of profits in payment of a debt, wages, or rent or for the sale of the goodwill of a business, no presumption of partnership exists.

While the sharing of management provides some evidence that a partnership exists, participation in management alone does not

create a partnership.

For instance, sometimes creditors are given

substantial control over business operations, but they are not necessarily partners. In the case of creditors, a court may refuse to find the existence of a partnership even though the creditor shares in profits as well as management. Further, many businesses hire people to manage their businesses, but without a sharing of profits, the manager is unlikely to be treated as a partner by the courts.

**Purported Partnerships;** You can be liable as a partner without

being a partner.

If you go with a friend to a bank to borrow money and tell the banker that you and the friend are partners in a business, the banker can

hold you liable as a partner.

The same result would occur if the friend stated that you were his partner and

you failed to correct the statement. However, if the friend went alone to the bank and told the banker you were his partner, you would not be liable.

As with the concept of *estoppel*, the person who seeks to hold another liable as a partner must prove

that she relied on the holding out of consent.

The reliance must be justifiable and must result in loss to

the person who sold goods or otherwise relied on the credit of the person held out as a partner. If reliance is justifiable, the defendant is estopped from claiming that there was, in fact, no partnership.

**Articles of Partnership;** Although generally not required, it is highly desirable to have

written articles of partnership. (Partnership agreements may need to be in writing when they create an interest in real property or have a term in excess of one year.)

A written contract tends to minimize

misunderstanding and disagreement.

The process of preparing such an agreement is likely to cause the parties to provide for

contingencies they might not otherwise consider. This is especially true if a lawyer is called on who is experienced in drafting partnership agreements.

It should be noted that lawsuits raising the question of whether or not there is a partnership usually arise where

arrangements among the partners have been casual. Disputes are more likely when there are no written articles of partnership.

Articles of partnership usually state how

profits and losses are to be shared.

They should provide a means for continuing the business on the

death or disability of a partner.

Other matters usually included in articles of partnership are the

name of the firm, the business to be carried on, the term for which the partnership is to exist, salary and drawing accounts, the authority of the partners to bind the firm, and provisions for withdrawal of partners.

This is because RUPA merely creates default provisions that fill

gaps in partnership agreements. However, where an agreement clearly states the terms and conditions governing the operation and dissolution of the partnership, absent prohibitory provisions dictated by statutory law, those contractual terms prevail.

parties to a partnership agreement generally have the right to contract around a provision of

RUPA, provided they do so in language that is clear, unequivocal and unambiguous.

Joint Venture; Many courts distinguish a **joint venture** from a

partnership.

The elements of a joint venture are

(1) an express or implied agreement to carry on an enterprise; (2) a manifestation of intent by the parties to be associated as joint venturers; (3) a joint interest as reflected in the contribution of property, finances, effort, skill, or knowledge by each party to the joint venture; (4) a measure of proprietorship of joint control of the enterprise; and (5) a provision for the sharing of profits or losses.

The major distinction between a joint venture and partnership is that a

joint venture relates to a single enterprise or transaction, and a partnership relates to a continuing business.

Both require a meeting of the minds and contract formation. However, some courts hold that the requirement for joint

ventures is

less formal and may be implied entirely by conduct.

Further, they state that with joint ventures, any agreement that does exist

need not cover as many terms as are necessary for a partnership. For instance, an agreement to jointly buy, develop, and resell one particular plot of land may be considered a joint venture. On the other hand, an agreement to jointly buy, develop, and resell land on a long-term basis may well be construed as a partnership.

For the purposes of this chapter, the distinction between a partnership and a joint venture is not very important. This is so because courts generally

apply partnership law to joint ventures. Perhaps the only significant difference is that joint venturers sometimes are held to have less implied and apparent authority than partners. This is because of the more limited scope of the joint venture enterprise.

**Management and Authority of Partners;**

**Voice in Management;** Each partner normally has an equal voice in

managing the business.

A vote of the majority prevails if there are

more than two partners. This may be changed by agreement, however. One or a group of partners may, by agreement of the partners, be granted authority to make the day-to-day operating decisions of the business. These might include making usual contracts for goods and services and hiring and firing employees.

Unanimous agreement is required to act contrary to the

partnership agreement or to act outside of the ordinary course of the partnership business.

Assume you are a member of a retail partnership. You decide that it would be a good investment to buy a nearby residence for rental purposes. Approval of all the partners is

necessary. Likewise, unanimity would be required for an agreement to guarantee the debt of another, such as that of a partner, if contracts of surety or indemnity fall outside the scope of the partnership’s usual business. Such approval would also be required to authorize a sale of the store’s entire inventory or the building in which the business is conducted.

When a certain action is proposed and there is an even split among the partners, the action

cannot be taken.

If it is an important matter and the

deadlock continues,

it may be impossible to continue the business. In such a case, any partner may petition a court for dissolution of the partnership.

**Authority**

Authority to act for a partnership may be of three types:

express, implied, and apparent.

These concepts have the same meaning as under agency law, and the tests for implied and apparent authority are the same. Both implied and apparent authority are

influenced by customs and usages of the particular partnership and those of similar businesses in the area.

**Express Authority**

A partner has express authority to do whatever he or she is authorized to

by the articles of partnership. In addition, express authority stems from any other agreement of the partners.

**Implied Authority**

The RUPA gives every partner

implied authority to bind the partnership on contracts that are usually appropriate to that business.

For example, if your partnership runs a women’s ready-to-wear clothing store, any partner has the authority to

dresses for resale. However, this implied authority may be abolished or limited by agreement of the partners.

**Apparent Authority**

When the agency authority of a partner is abolished or limited by agreement, the partner may still have

apparent authority.

Suppose, in a clothing store, that you and your partners, Roger and Jane, have agreed that all merchandise buying will be done by Jane. Suppose further, as is likely, that it is customary for all partners in this type of business to give merchandise orders. A manufacturer takes and fills an order given by Roger. If the manufacturer is unaware of the restriction, the partnership and, ultimately, you are

bound

Laurence Kelly entered into a partnership with Stephen MacKenzie to purchase a parking lot. While Kelly and MacKenzie were searching for investors, MacKenzie approached Russell Glidden, the principal of QAD Investors, and provided him with a copy of Kellys personal financial statement. Kelly, MacKenzie, and Glidden met together repeatedly thereafter. At the meetings, MacKenzie referred to Kelly as a partner in the project. Glidden had committed QAD to providing $20,000 to the venture. MacKenzie gave Glidden a written receipt stating that the money would be paid back pursuant to a note that Glidden would hold. The note had lines for the signatures of Kelly and MacKenzie, but only MacKenzies line contained a witnessed signature; Kellys line was blank. Later, when the partnership defaulted on the loan, QAD sued Kelly for payment. QAD argued that, at a minimum, MacKenzie had apparent authority to act for Kelly as a partner. Did MacKenzie have apparent authority to bind Kelly on the note?

Yes. Kellys conduct would lead a reasonable third party to believe that MacKenzie was acting as the agent of the partnership and with the requisite authority. Kelly attended meetings with Glidden and MacKenzie during which they discussed the possibility of obtaining money from Glidden for the partnership. MacKenzie gave Kellys personal financial statement to Glidden before negotiating with him. These facts adequately support the legal conclusion that MacKenzie was at least apparently authorized to bind the partnership.

**Ratification;** Generally, the partnership will not be liable for contracts created by a partner acting

outside the scope of her authority.

An exception to this rule arises when the other partners

ratify the unauthorized action.

It occurs when the partners, either expressly or implicitly, demonstrate the inten

to accept the action of the partner who was lacking actual or apparent authority. Any act that the partnership could have authorized at the time it was done may be ratified.

Ratification releases the partner from liability for having exceeded her authority and

binds the partnership to the contract as if it had been authorized all along.

**Property of Partnerships What Is Partnership Property?;** Disputes often arise among both partners and creditors over what property actually belongs to the partnership and

what property belongs to individual partners.

Partnership property includes all

property that originally was contributed to the partnership as well as anything purchased then or later for the partnership.

In addition, any property

acquired with partnership funds is partnership property unless a contrary intent is clearly shown

The fact that property is used in the business does not

make it partnership property; however, assets that appear on the account books of the partnership are presumed to be partnership property.

Payment by the partnership of taxes or insurance on property is presumptive but not conclusive evidence that the

property is owned by the partnership. The same is true if improvements are made on the property by the partnership.

The RUPA provides several rules for determining if property belongs to the partnership.

It holds that property belongs to the partnership if it was transferred (1) to the partnership in its name, (2) to any partner acting as a partner by a transfer document that specifically names the partnership, or (3) to any partner by a transfer document indicating the partner’s status as a partner or otherwise indicating that a partnership exists.

**Ownership and Possession;** A partner’s ownership of partnership property is called a

partnership interest.

Partners have no separate interest in

partnership property.

They have no right to

sell, mortgage, or devise to an heir any individual item of the firm’s property.

A partner has a right to

take possession of the firms property for partnership purposes but not for personal use.

For example, if you are a partner, you have no right to use the firms automobile for

your vacation. Permission of a majority of the partners would be required. You may, however, without special permission, drive the car to the bank to deposit the firms receipts.

**Creditors of Partners**

A creditor of a partner may not

attach any of the property owned by the partnership; however, a partner may assign her partnership interest to a creditor or to anyone else

This entitles the assignee to

eceive that partner’s share of the profits. It does not give the assignee a right to any information about partnership affairs or a right to look at its books.

A creditor who gets a judgment against a partner may

obtain from the court a *charging order* against the partner’s interest in the firm.

he court may appoint a receiver to look after the creditor’s interests. If profits are insufficient to pay off the creditor, the court may order that the

partner’s interest be sold.

The purchaser may dissolve the partnership if it is to

exist for an indefinite time. If it is for a term of years that has not expired, the partnership will continue as originally agreed. The purchaser will not be a partner, nor can she exercise any of the partner’s rights except to receive that share of the profits. The partnership or any partner may purchase the debtor’s partnership interest by paying the debt.

**Partners’ Rights and Duties Right to Compensation;** A partner is not ordinarily entitled to

salary or wages

The compensation is presumed to be the

partner’s share of profits

This is true even if one partner spends

much more time than another on partnership business

The same principle applies to rent to a partner for

se of the partner’s property and to interest on a capital contribution. An exception is made by the RUPA when a partner dies. Then any surviving partner is entitled to reasonable compensation for winding up partnership affairs.

However, the partners may agree that

ne or more of them is to be paid salary, rent, interest, or wages in addition to sharing in profits.

Often, drawing accounts for

all partners are agreed on, or perhaps regular monthly payments are made

These are then deducted from the partner’s share of profits when

year-end settlements are made.

In the absence of a contrary agreement, profits are

shared equally even if capital contributions are unequal. The sharing of losses is the same as the sharing of profits unless there is a different agreement.

The relative ease with which a partnership may be formed often results in

creation of this form of business organization without any real planning by the partners

Consequently, a partner who contributes considerably more time and money to the business than the other partners often is

shocked to discover that, in the absence of agreement, she is not entitled to a salary or a greater share of the profits. Is it ethical for the other partners to oppose compensation for such a partner merely because of the failure to draft a more comprehensive agreement?

**Duty of Loyalty and Good Faith**

Partners not only must be honest, but also must not

permit self-interest to come before duty to the partnership.

Partners may buy from or sell to the partnership. However, if they do, they must

make full disclosure of any facts relevant to the deal that are not known to the other partners. Partners may not make secret profits from their position as members of a partnership.

Omar Leal and Kevin Mokhabery entered into a general partnership doing business under the name “All American Auto Glass.” The purpose of the business was the installation of automotive glass, and each party owned a 50 percent interest in the partnership. Mokhabery provide the capital for the business, while Leal operated the business and received a salary. During the period when he was handling the partnership’s bills, Mokhabery took $34,000 out of the partnership account and used the money for another business he owned. Mokhabery admits that he took the money without Leal’s approval but argues that he was owed at least that much in profits that should have been dispensed to him pursuant to his 50 percent stake in the partnership. Has Mokhabery breached a partnership duty?

Yes. Partners owe to the partnership and to each other fiduciary duties, including a duty of loyalty and care. A partner’s duties also include a strict duty of good faith and candor. Thus, the partnership relation imposes upon all partners an obligation of the utmost good faith, fairness, and honesty in their dealings with each other with respect to matters pertaining to the partnership business. Whether or not Mokhabery was entitled to partnership profits at the time he withdrew the money, he had a duty not to use partnership property for his own benefit. Mokhabery breached his duty of loyalty when he arbitrarily removed the money and failed to hold it for the partnership or account to the partnership for the withdrawal. Accordingly, the partnership is entitled to recover $34,000 from Mokhabery.

In the absence of a contrary understanding, each partner owes a

duty to devote full time and his or her best efforts to the affairs of the partnership. A partner must not engage in activities that are in competition with or otherwise likely to injure the partnership. For example, suppose you join with a friend in forming a real estate brokerage partnership. If your partner accepts commissions for arranging sales of property not listed with the firm, the partnership is entitled to those commissions. A partner is also liable to the partnership for the value of partnership property that he or she uses for individual purposes.

**Duty of Care in Partnership Business;** Partners have a

duty to exercise reasonable care and skill in transacting business for the partnership. A further duty is not to exceed the authority granted to them by the partnership.

Partners are

liable for their negligence while acting for the partnership but not for honest errors of judgment.

Duty to inform; Partners owe a

duty to pass on to the other partners all information coming to them that may be important to the operation of the partnership. This is because a notice by a third person to any partner is treated as having been given to the partnership. This rule stems from the agency relationship arising among partners.

It is presumed that an agent will disclose to the principals all matters that it is his or her duty to disclose to them. Outsiders dealing with the agent are

entitled to rely on this presumption, whether or not the agent in fact communicates the knowledge to the principals. Of course, this is not true if the third person has been told that all notices must be given to a certain partner.

**Duty to Account**

Partners have a duty to account for any expenditure of partnership funds they make. They must also

ccount for the sale or other disposal of partnership property. The same is true for any benefit or profit coming to them as partners. They also have a right to be reimbursed by the partnership for expenses on its behalf.

The duty of keeping the account books is usually

assigned to one partner. He then has a duty to keep them accurately. If the records do not properly show the application of the funds coming to the firm, the partner will be liable.

**Enforcement of Partnership Rights and Liabilities**

**Liability on Contracts**

Partnerships were not

considered legal entities at common law

They could not

sue or be sued in the firm name; rather, all partners had to be joined as plaintiffs or defendants.

This requirement of joinder (naming and serving all parties as defendants or naming all as plaintiffs) made it hard for creditors to sue on partnership contracts. Today, under the RUPA, the firm is

primarily liable if a contract is made by a partner or other agent who has express, implied, or apparent authority.

If the partnership does not pay off the liability, then the partners become

**jointly liable**.

When liability is joint,

all those liable must be sued in the same suit at common law.