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Patricia Garcia and Bernardo Lucero were in a romantic relationship. While they were seeing each other, Garcia and Lucero acquired an electronics service center, paying $30,000 apiece. Patricia took care of the service center and Bernardo was the chief salesman. Two years later, they purchased an apartment complex. The property was deeded to Lucero, but neither Garcia nor Lucero were required to make a down payment. They were required to make timely monthly payments, which they did, each paying half. The couple considered both properties to be owned “50/50” and they agreed to share profits, losses, and management rights. When the couple’s romantic relationship ended, Garcia asked a court to declare that she had a partnership with Lucero as to both projects. In court, Lucero argued that the couple did not have a written partnership agreement and hence he was the sole owner of the apartment complex. Did they have a partnership as to both properties? Why or why not.
A partnership arises from an agreement, express or implied, between two or more persons to carry on a business for a profit. Partners are co-owners of the business and have joint control over its operation and the right to share in its profits. The traditional form of partnership discussed in this chapter is commonly referred to as a general partnership to distinguish it from existing limited liability forms of partnership.Basic Partnership Concepts
Partnerships are governed both by common law concepts—in particular, those relating to agency—and by statutory law. As in so many other areas of business law, the National Conference of Commissioners on Uniform State Laws has drafted uniform laws for partnerships, and these have been widely adopted by the states.
Agency Concepts and Partnership Law
When two or more persons agree to do business as partners, they enter into a special relationship with one another. To an extent, their relationship is similar to an agency relationship (to be discussed in a later chapter), because each partner is deemed to be the agent of the other partners and of the partnership. Thus, concepts of agency law apply—specifically, the individuals (agents) are charged with knowledge of, and responsibility for, acts carried out within the scope of the partnership relationship. In their relationships with one another, partners, like agents, are bound by fiduciary duties, meaning they are required to act primarily in the best interests of one another.
In one important way, however, partnership law differs from agency law. The partners in a partnership agree to commit funds or other assets, labor, and skills to the business with the understanding that profits and losses will be shared. Thus, each partner has an ownership interest in the firm. In a nonpartnership agency relationship, the agent usually does not have an ownership interest in the business and is not obligated to bear a portion of ordinary business losses.
The Uniform Partnership Act
The Uniform Partnership Act (UPA) governs the operation of partnerships in the absence of express agreement and has done much to reduce controversies in the law relating to partnerships. A majority of the states have enacted the amended version of the UPA.
Definition of a Partnership
The UPA defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit” [UPA 101(6)]. Note that the UPA’s definition of person includes corporations, so a corporation can be a partner in a partnership [UPA 101(10)]. The intent to associate is a key element of a partnership, and one cannot join a partnership unless all other partners consent [UPA 401(i)].
Essential Elements of a Partnership
Questions may sometimes arise as to whether a business enterprise is a legal partnership, especially when there is no formal, written partnership agreement. To determine whether a partnership exists, courts usually look for the following three essential elements, which are implicit in the UPA’s definition:
A sharing of profits or losses.
A joint ownership of the business.
An equal right to be involved in the management of the business.
If the evidence in a particular case is insufficient to establish all three factors, the UPA provides a set of guidelines to be used.
The court in the following case considered these and other factors to determine whether a partnership existed between two participants in a new restaurant venture.
Harun v. Rashid
Court of Appeals of Texas, Dallas, 2018 WL 329292 (2018).
Background and Facts Mohammed Harun was interested in opening a new restaurant, Spice-N-Rice, in Irving, Texas, but he lacked the financial resources to do so. He asked Sharif Rashid if Rashid was interested in financing the venture. Rashid was interested and provided about $60,000 in funding. In addition, he helped negotiate a lease for the restaurant, was a signatory on its bank account, paid for advertising, and bought furniture, equipment, and supplies.
Rashid also hired a bookkeeper to handle the restaurant’s accounting. The bookkeeper later expressed concern about Harun’s reporting of Spice-N-Rice’s income on his personal tax return. Shortly thereafter, Harun removed Rashid from the bank account and locked him out of the restaurant’s premises. Rashid filed a suit in a Texas state court against Harun and Spice-N-Rice, alleging the existence of a partnership and a breach of fiduciary duty. Harun denied that he and Rashid had ever been partners. The court ruled that a partnership existed and awarded damages to Rashid. The defendants appealed.
In the Language of the Court
Opinion by Justice SCHENCK.
* * * *
In determining whether a partnership was created, we consider several factors, including
the parties’ receipt or right to receive a share of profits of the business;
any expression of an intent to be partners in the business;
participation or right to participate in control of the business;
any agreement to share or sharing losses of the business or liability for claims by third parties against the business; and
any agreement to contribute or contributing money or property to the business.
Proof of each of these factors is not necessary to establish a partnership. [Emphasis added.]
* * * *
At trial, Rashid presented evidence through his testimony that:
Harun approached him indicating he had found a good location to open a restaurant and needed a partner to finance the operation;
Harun asked him to be his partner;
he and Harun were equal business partners in the restaurant;
he and Harun agreed to share equally in the profits and losses;
he and Harun met with the leasing agents to negotiate the lease of the restaurant space;
he and Harun had equal access to the restaurant’s bank account;
he hired and communicated with the bookkeeper;
he was very involved in preparing paperwork for the restaurant;
he paid restaurant-related bills, and purchased furniture and equipment for the restaurant;
he was not an employee of the restaurant or Harun, nor did he receive any pay for the work he performed on behalf of the restaurant; and
he invested approximately $60,000 in the business.
We conclude the trial court’s finding a partnership existed between Harun and Rashid is supported by more than a scintilla [speck] of evidence.
Finally, * * * appellants [Harun and Spice-N-Rice] argue Rashid was not entitled to an award of damages because there was no partnership and thus there could be no breach of fiduciary duty. As we have concluded there is sufficient evidence Harun and Rashid were partners in Spice-N-Rice, we overrule appellants’ * * * issue.
Decision and Remedy
A state intermediate appellate court affirmed the lower court’s award to Rashid of actual damages of $36,000 (the difference between his initial investment of $60,000 and the amount repaid by Huran), punitive damages of $36,000, and attorneys’ fees of $79,768.64, plus interest and costs.
Legal Environment Harun’s income tax return and other documents prepared by the bookkeeper on behalf of Spice-N-Rice identified the business as a sole proprietorship. Should the appellate court have reversed the finding of a partnership on this basis? Explain.
What If the Facts Were Different? Suppose that Huran had complained that there was no evidence of an agreement between himself and Rashid to share losses. Would the result have been different? Why or why not?
The Sharing of Profits and Losses
The sharing of both profits and losses from a business creates a presumption that a partnership exists.
Case in Point 16.3
David Tubb, representing Superior Shooting Systems, Inc., entered into an agreement with Aspect International, Inc., to create a business that would make and sell ammunition to the public. Their contract stated that both companies would participate in the business and split the profits equally, but it did not say explicitly that they would share the losses. It also did not specify what type of entity the business would be.
A dispute arose between the two companies, and the matter ended up in court. A Texas appellate court held that the two corporations had created a partnership even though there was no express agreement to share in losses. Because they had agreed to share control and ownership of the business and to split the profits equally, they would also have to share the losses equally.Footnote
A court will not presume that a partnership exists if shared profits were received as payment of any of the following [UPA 202(c)(3)]:
A debt by installments or interest on a loan.
Wages of an employee or payment for the services of an independent contractor.
Rent to a landlord.
An annuity to a surviving spouse or representative of a deceased partner.
A sale of the goodwill (the valuable reputation of a business viewed as an intangible asset) of a business or property.
A debtor, Mason Snopel, owes a creditor, Alice Burns, $5,000 on an unsecured debt. They agree that Snopel will pay 10 percent of his monthly business profits to Burns until the loan with interest has been repaid. Although Snopel and Burns are sharing profits from the business, they are not presumed to be partners.
Joint Property Ownership
Joint ownership of property does not in and of itself create a partnership [UPA 202(c)(1) and (2)]. The parties’ intentions are key.
Chiang and Burke jointly own farmland and lease it to a farmer for a share of the profits from the farming operation in lieu of fixed rental payments. This arrangement normally would not make Chiang, Burke, and the farmer partners.
Entity versus Aggregate
At common law, a partnership was treated only as an aggregate of individuals and never as a separate legal entity. Thus, at common law a lawsuit could never be brought by or against the firm in its own name. Each individual partner had to sue or be sued.
Today, in contrast, a majority of the states follow the UPA and treat a partnership as an entity for most purposes. For instance, a partnership usually can sue or be sued, collect judgments, and have all accounting performed in the name of the partnership entity [UPA 201, 307(a)].
As an entity, a partnership may hold the title to real or personal property in its name rather than in the names of the individual partners. Additionally, federal procedural laws permit the partnership to be treated as an entity in suits in federal courts and bankruptcy proceedings.
Tax Treatment of Partnerships
Modern law does treat a partnership as an aggregate of the individual partners rather than a separate legal entity in one situation—for federal income tax purposes. The partnership is a pass-through entity and not a tax-paying entity. A pass-through entity is a business entity that has no tax liability. The entity’s income is passed through to the owners, who pay income taxes on it.
Thus, the income or losses the partnership incurs are “passed through” the entity framework and attributed to the partners on their individual tax returns. The partnership itself pays no taxes and is responsible only for filing an information return with the Internal Revenue Service.
A partner’s profit from the partnership (whether distributed or not) is taxed as individual income to the individual partner. Similarly, partners can deduct a share of the partnership’s losses on their individual tax returns (in proportion to their partnership interests).
Formation and Operation
A partnership is a voluntary association of individuals. As such, it is formed by the agreement of the partners. As a general rule, agreements to form a partnership can be oral, written, or implied by conduct. Some partnership agreements, however, such as one authorizing partners to transfer interests in real property, must be in writing to be legally enforceable.
A partnership agreement, also known as articles of partnership, can include almost any terms that the parties wish, unless they are illegal or contrary to public policy or statute [UPA 103]. The provisions commonly specify the amount of capital that each partner is contributing and the percentage of profits and losses of the business that each partner will receive.
The rights and duties of partners are governed largely by the specific terms of their partnership agreement. In the absence of provisions to the contrary in the partnership agreement, the law imposes certain rights and duties, as discussed in the following subsections. The character and nature of the partnership business generally influence the application of these rights and duties.
Duration of the Partnership
The partnership agreement can specify the duration of the partnership by stating that it will continue until a designated date or until the completion of a particular project. This is called a partnership for a term. Generally, withdrawing from a partnership for a term prematurely (before the expiration date) constitutes a breach of the agreement, and the responsible partner can be held liable for any resulting losses [UPA 602(b)(2)]. If no fixed duration is specified, the partnership is a partnership at will. A partnership at will can be dissolved at any time without liability.
Partnership by Estoppel
When a third person has reasonably and detrimentally relied on the representation that a nonpartner was part of a partnership, a court may conclude that a partnership by estoppel exists.
A partnership by estoppel may arise when a person who is not a partner holds himself or herself out as a partner and makes representations that third parties rely on. In this situation, a court may impose liability—but not partnership rights—on the alleged partner.
Nonpartner as an Agent
A partnership by estoppel may also be imposed when a partner represents, expressly or impliedly, that a nonpartner is a member of the firm. In this situation, the nonpartner may be regarded as an agent whose acts are binding on the partnership [UPA 308].
Case in Point 16.6
Jackson Paper Manufacturing Company made paper used by Stonewall Packaging, LLC. Jackson and Stonewall had officers and directors in common, and they shared employees, property, and equipment. In reliance on Jackson’s business reputation, Best Cartage, Inc., agreed to provide transportation services for Stonewall and bought thirty-seven tractor-trailers to use in fulfilling the contract. Best provided the services until Stonewall terminated the agreement.
Best filed a suit for breach of contract against Stonewall and Jackson, seeking $500,678 in unpaid invoices and consequential damages of $1,315,336 for the tractor-trailers it had purchased. Best argued that Stonewall and Jackson had a partnership by estoppel. The court agreed, finding that the “defendants combined labor, skills, and property to advance their alleged business partnership.” Jackson had negotiated the agreement on Stonewall’s behalf. Jackson also had bought real estate, equipment, and general supplies for Stonewall with no expectation that Stonewall would repay these expenditures. This was sufficient to prove a partnership by estoppel.Footnote
Rights of Partners
The rights of partners in a partnership relate to the following areas: management, interest in the partnership, compensation, inspection of books, accounting, and property.
In a general partnership, all partners have equal rights in managing the partnership [UPA 401(f)]. Unless the partners agree otherwise, each partner has one vote in management matters regardless of the proportional size of his or her interest in the firm. In a large partnership, partners often agree to delegate daily management responsibilities to a management committee made up of one or more of the partners.
A majority vote controls decisions on ordinary matters connected with partnership business, unless otherwise specified in the agreement. Decisions that significantly change the nature of the partnership or that are outside the ordinary course of the partnership business, however, require the unanimous consent of the partners [UPA 301(2), 401(i), 401(j)]. For instance, unanimous consent is likely required for a partnership to admit new partners, to amend the partnership agreement, or to enter a new line of business.
Interest in the Partnership
Each partner is entitled to the proportion of business profits and losses that is specified in the partnership agreement. If the agreement does not apportion profits (indicate how the profits will be shared), the UPA provides that profits will be shared equally. If the agreement does not apportion losses, losses will be shared in the same ratio as profits [UPA 401(b)].
The partnership agreement between Rick and Brett provides for capital contributions of $60,000 from Rick and $40,000 from Brett. If the agreement is silent as to how Rick and Brett will share profits or losses, they will share both profits and losses equally.
In contrast, if the agreement provides for profits to be shared in the same ratio as capital contributions, 60 percent of the profits will go to Rick, and 40 percent will go to Brett. Unless the agreement provides otherwise, losses will be shared in the same ratio as profits.
Devoting time, skill, and energy to partnership business is a partner’s duty and generally is not a compensable service. Rather, as mentioned, a partner’s income from the partnership takes the form of a distribution of profits according to the partner’s share in the business.
Partners can, of course, agree otherwise. For instance, the managing partner of a law firm often receives a salary—in addition to her or his share of profits—for performing special administrative or managerial duties.
Inspection of the Books
Partnership books and records must be kept accessible to all partners. Each partner has the right to receive full and complete information concerning the conduct of all aspects of partnership business [UPA 403]. Partners have a duty to provide the information to the firm, which has a duty to preserve it and to keep accurate records.
The partnership books must be kept at the firm’s principal business office (unless the partners agree otherwise). Every partner is entitled to inspect all books and records on demand and can make copies of the materials. The personal representative of a deceased partner’s estate has the same right of access to partnership books and records that the decedent would have had [UPA 403].
Accounting of Partnership Assets or Profits
An accounting of partnership assets or profits is required to determine the value of each partner’s share in the partnership. An accounting can be performed voluntarily, or it can be compelled by court order. Under UPA 405(b), a partner has the right to bring an action for an accounting during the term of the partnership, as well as on the partnership’s dissolution.
Property acquired by a partnership is the property of the partnership and not of the partners individually [UPA 203]. Partnership property includes all property that was originally contributed to the partnership and anything later purchased by the partnership or in the partnership’s name (except in rare circumstances) [UPA 204].
A partner may use or possess partnership property only on behalf of the partnership [UPA 401(g)]. A partner is not a co-owner of partnership property and has no right to sell, mortgage, or transfer partnership property to another [UPA 501].
Because partnership property is owned by the partnership and not by the individual partners, the property cannot be used to satisfy the personal debts of individual partners. A partner’s creditor, however, can petition a court for a charging order to attach the partner’s interest in the partnership to satisfy the partner’s obligation [UPA 502]. A partner’s interest in the partnership includes her or his proportionate share of any profits that are distributed. A partner can also assign her or his right to receive a share of the partnership profits to another to satisfy a debt.Duties and Liabilities of Partners
The duties and liabilities of partners are derived from agency law. Each partner is an agent of every other partner and acts as both a principal and an agent in any business transaction within the scope of the partnership agreement.
Each partner is also a general agent of the partnership in carrying out the usual business of the firm “or business of the kind carried on by the partnership” [UPA 301(1)]. Thus, every act of a partner concerning partnership business and “business of the kind” and every contract signed in the partnership’s name bind the firm.
The fiduciary duties that a partner owes to the partnership and to the other partners are the duty of care and the duty of loyalty [UPA 404(a)]. Under the UPA, a partner’s duty of care is limited to refraining from “grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law” [UPA 404(c)]. A partner is not liable to the partnership for simple negligence or honest errors in judgment in conducting partnership business.
The duty of loyalty requires a partner to account to the partnership for “any property, profit, or benefit” derived by the partner in the conduct of the partnership’s business or from the use of its property. A partner must also refrain from competing with the partnership in business or dealing with the firm as an adverse party [UPA 404(b)]. The duty of loyalty can be breached by self-dealing, misusing partnership property, disclosing trade secrets, or usurping a partnership business opportunity.
A partner’s fiduciary duties may not be waived or eliminated in the partnership agreement. In fulfilling them, each partner must act consistently with the obligation of good faith and fair dealing [UPA 103(b), 404(d)]. The agreement can specify acts that the partners agree will violate a fiduciary duty.
Note that a partner may pursue his or her own interests without automatically violating these duties [UPA 404(e)]. The key is whether the partner has disclosed the interest to the other partners.
Jayne Trell, a partner at Jacoby & Meyers, owns a shopping mall. Trell may vote against a partnership proposal to open a competing mall, provided that she fully discloses her interest in the existing shopping mall to the other partners at the firm.
Authority of Partners
The UPA affirms general principles of agency law that pertain to a partner’s authority to bind a partnership in contract. If a partner acts within the scope of her or his authority, the partnership is legally bound to honor the partner’s commitments to third parties.
A partner may also subject the partnership to tort liability under agency principles. When a partner is carrying on partnership business with third parties in the usual way, apparent authority exists, and both the partner and the firm share liability. The partnership will not be liable, however, if the third parties know that the partner has no such authority.
Limitations on Authority
A partnership may limit a partner’s capacity to act as the firm’s agent or transfer property on its behalf by filing a “statement of partnership authority” in a designated state office [UPA 105, 303]. Such limits on a partner’s authority normally are effective only with respect to third parties who are notified of the limitation. (An exception is made in real estate transactions when the statement of authority has been recorded with the appropriate state office.)
The Scope of Implied Powers
The extent of implied authority generally is broader for partners than for ordinary agents. In an ordinary partnership, the partners can exercise all implied powers reasonably necessary and customary to carry on that particular business. Some customarily implied powers include the authority to make warranties on goods in the sales business and the power to enter into contracts consistent with the firm’s regular course of business.
Liability of Partners
One significant disadvantage associated with a general partnership is that the partners are personally liable for the debts of the partnership. In most states, the liability is essentially unlimited, because the acts of one partner in the ordinary course of business subject the other partners to personal liability [UPA 305]. Note that normally the partnership’s assets must be exhausted before creditors can reach the partners’ individual assets.
Each partner in a partnership generally is jointly liable for the partnership’s obligations. Joint liability means that a third party must sue all of the partners as a group, but each partner can be held liable for the full amount. If, for instance, a third party sues one partner on a partnership contract, that partner has the right to demand that the other partners be sued with her or him. In fact, if all of the partners are not named as defendants in a lawsuit, then the assets of the partnership cannot be used to satisfy any judgment in that case.
Joint and Several Liability
In the majority of the states, under UPA 306(a), partners are both jointly and severally (separately, or individually) liable for all partnership obligations. Joint and several liability means that a third party has the option of suing all of the partners together (jointly) or one or more of the partners separately (severally). All partners in a partnership can be held liable even if a particular partner did not participate in, know about, or ratify the conduct that gave rise to the lawsuit.
A judgment against one partner severally does not extinguish the others’ liability. (Similarly, a release of one partner does not discharge the partners’ several liability.) Those not sued in the first action normally may be sued subsequently, unless the court in the first action held that the partnership was in no way liable. If a plaintiff is successful in a suit against a partner or partners, he or she may collect on the judgment only against the assets of those partners named as defendants.
With joint and several liability, a partner who commits a tort can be required to indemnify (reimburse) the partnership for any damages it pays. Indemnification will typically be granted unless the tort was committed in the ordinary course of the partnership’s business.
Nicole Martin, a partner at Patti’s Café, is working in the café’s kitchen one day when her young son suffers serious injuries to his hands from a dough press. Her son, through his father, files a negligence lawsuit against the partnership. Even if the suit is successful and the partnership pays damages to Martin’s son, the firm, Patti’s Café, is not entitled to indemnification. Martin would not be required to indemnify the partnership because her negligence occurred in the ordinary course of the partnership’s business (making food for customers).
Liability of Incoming Partners
A partner newly admitted to an existing partnership is not personally liable for any partnership obligations incurred before the person became a partner [UPA 306(b)]. The new partner’s liability to the partnership’s existing creditors is limited to her or his capital contribution to the firm.
Smartclub, an existing partnership with four members, admits a new partner, Alex Jaff. He contributes $100,000 to the partnership. Smartclub has debts amounting to $600,000 at the time Jaff joins the firm. Although Jaff’s capital contribution of $100,000 can be used to satisfy Smartclub’s obligations, Jaff is not personally liable for partnership debts incurred before he became a partner. If, however, the partnership incurs additional debts after Jaff becomes a partner, he will be personally liable for those amounts, along with all the other partners.
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