Partnerships

Chapters 31 and 32

Partnerships - Defined • A partnership is an association of two or more

persons carrying on a business as co-owners for a profit– Any person with capacity can be a partner; minors

have right to disaffirm and return of capital and unpaid share of profits, except to extent necessary to pay creditors.

– Must be a business, trade, or profession – Must have an intent to make a profit (no charitable

organizations, social clubs)– Must be continuous in activities/transactions– Must be for a LEGAL purpose

Partnership by Estoppel• When, through words or conduct, a person

who is NOT a partner is represented to a third party as BEING a partner, with the approval, knowledge and consent of the partners, a Partnership by Estoppel is created.

• The person who is NOT truly a partner will nonetheless be liable to a third party who extended credit on reliance of the partnership

Treatment of a Partnership • As a distinct entity

– The assets are treated as belonging to the business, not as individual assets of the members

– Title to real property may acquired in the Partnership name

– Each partner is a fiduciary of the partnership

– Each partner is considered an agent of the partnership

• May sue and be sued

• As an aggregate of the individual partners– A partnership lacks

continuity of existence

– No person can become a partner without consent of all partners

– A partnership is not subject to federal income tax

– Partnership debts are debts of the individuals

Formation of Partnership

• No formalities required; may be implied by conduct (however, Articles are suggested)

• No writing required, except for partnerships that must comply with the Statute of Frauds (partnerships to last longer than a year; real estate partnerships)

• Written partnership agreements should contain the firm’s name; nature of the business; capital contributions; share profits & losses equally (unless Articles state otherwise); managerial duties, withdrawal rights; provisions in case of death of a partner.

Partnership Profits• The sharing of profits is prima facie evidence

of a partnership, BUT the sharing of gross returns does not, in itself, establish a partnership.

• Sharing of profits does not infer a partnership when the profits are received in payment of: (1) a debt (2) wages (3) rent; (4) annuity, retirement or health benefit to decedent’s beneficiary (5) sale of goodwill of the business.

Evidence of a Partnership

• Sharing of Profits• Intent to form a partnership• Title to property held as Joint Tenants or

Tenants-in-Common• Partners designate their relationship as a

partnership• Extensive, continuous activity between the

two.

Partnership Capital

• A partnership may begin with no capital (services partner)

• The total assets contributed for permanent use is partnership capital

• A fixed amount, may be listed in the Articles of Partnership

• May be money, property, or services • Capital is returned upon dissolution

Partnership Property• All property, including contributed capital,

brought into, acquired, purchased, manufactured by partnership funds. May consist of: – Real and personal property purchased by partnership

funds. If title is in the partnership’s name it belongs to partnership; BUT property in the name of an individual partner, or a third party, may ALSO belong to the partnership.

– Real and personal property contributed by the partners.

– Property manufactured by the partnership– Profits earned by the partnership

Property as a Partnership Asset

• Legal title is only one element.

• Look at the intent of the parties.

• Was property improved with partnership funds? How was property used?

• How was property treated on the books?

• Who paid taxes, liens, insurance, repairs?

• Was income or the proceeds of the property treated as partnership funds?

Conveyance of Partnership Property

• Title to real property acquired in the partnership name can be conveyed only in the partnership name.

• Any partner can convey title to real property by a conveyance signed on behalf of a partnership if title is in the name of the partnership

• If partner improperly transfers, the partnership can recover it UNLESS sold to a subsequent good faith purchaser

No partner owns specific partnership property directly

• Property owned by the partnership belongs to the partnership.

• No right to personally use, control or sell partnership property

• Creditors have no right to specific partnership property

• Assignability - Partner may sell/assign his interest (right to receive profits), but not partnership status.

Creditors

• Must get a “charging order

• A “receiver” collects and turns over partnership profits

• Creditor may “foreclose”, causing debtor’s interest to be sold at judicial sale

Dissociation, Dissolution, & Winding Up

• Dissociation- A change in the partnership relationship (Buyout, Creditor’s Charging Order, Death)

• Dissolution - Results in Winding up of Partnership - Rightful (time up); Wrongful, (Breach of Fiduciary Duty); Operation of Law (Death, Bankruptcy); Court Order. Partnership continues through winding up.

• Winding up - Liquidation, complete unfinished business, take inventory, etc.

Partnership Authority After Dissolution

• Actual authority ends, except to wind up affairs.

• Person who causes a wrongful dissolution has no right to participate in winding up or to take “goodwill” into account.

• Apparent authority may continue to bind partnership for acts w/n scope of partnership business unless NOTICE of the dissolution is given to the third party:

– Actual Notice - verbal/writing to those who extended credit in the past

– Constructive Notice - to those who knew of partnership but didn’t extend credit

– No notice - to those who had no knowledge of partnership

Liability of Incoming/Outgoing Partners

• Incoming - Complete liability after joining the partnership

• However, liability for pre-existing debts before becoming a partner are limited to his capital contribution Liability may only be satisfied out of partnership property; no personal liability

• Outgoing Partner - Remains fully liable for debts and liabilities incurred when a partner UNLESS a novation is signed with the continuing partners AND the creditors

Rights Among Partners• Right in specific partnership property• Right to share distributions• Right to share profits• Right to return of capital• Right to return of advances• Right to compensation• Right to participate in management (equal unless agree

otherwise)• Right to choose associates (consent required)• Right to information & inspection of books

• Right to a Formal Accounting

Consent for Action• Majority consent is needed for ordinary matters

that are connected with the partnership business.

• Extraordinary matters require unanimous consent:– Consent to the entry of a court judgment– Submitting a partnership claim to arbitration– Assigning partnership property for the benefit of

creditors– Disposing of partnership goodwill– Acting in any way that makes ordinary partnership

business impossible

Fiduciary Duties

• A partnership is a fiduciary relationship. It is breached if a partner tries to secure an advantage by internal/external dealings. If one partner breaches his duty, can be required to surrender illicit profits. Innocent partner may seek indemnification from wrongful partner.

• Duty of Good Faith and Loyalty– Must not profit except agreed upon compensation– Shouldn’t compete with the partnership.

• Duty of Due Care - Partners are only liable for culpable negligence, not ordinary, business mistakes.

• Duty of Obedience-• Duty of Accounting

Order of Distribution of Assets

• Creditors

• Loans/Advances made by Partners

• Amounts owed to Partners for Capital

• Amounts owed to Partners for Profits

Solvent Partnership -Book p. 629• A contributes $6000 capital & $3000 loan• B contributes $4000 capital• C contributes services only• No agreement on sharing profits/losses• Assets: $54,000; Liabilities to C’s: $26,000• Total Assets ($ 54,000) minus Total Liabilities

($39,000)=Profits ($15,000)• A gets $14,000 ($3000+$6000+$5000)• B gets $9000 ($4000 + $5000)• C gets $5000 (his share of profits)

Insolvent Partnership - p. 629• Same contributions by A, B and C

• Assets $12,000; Owe Creditors $26,000

• Total Liabilities ($39,000) minus Total Assets($12,000)= Aggregate Loss ($27,000)

• Share losses equally ($9000 each)

• After pay the Creditors the $26,000– A receives 0 ($3000 for loan + 6000 for capital

minus $9000 for his share of losses)– B must contribute $5000 ($4000 owed for capital

minus $9000 for his share of losses) – C must contribute $9000 for his share of losses

Insolvency of Partnership and of a Partner - p. 629

• If A were insolvent, results are the same• If A and B solvent, & C insolvent, then A and B

must contribute equally, an additional $4500 (C’s share)(contribution would be the relative portion in which they share profits) Acontributes $4500; B $9500

• If A and C individually insolvent, B would pay entire $14,000 (B’s unpaid share plus contribution of full amount of C’s unpaid share of the loss.

Problem # 11• No one is correct. The total contributions are

$15,000. After paying debts, the remaining assets are $6000 (Loss, $9000, to be shared equally- $3000 each) Lauren is entitled to return of her $10,000 capital contribution, less loss, or $7000. Matthew is entitled to the return of his $5000 contribution, less loss, or $2000. Susan must pay her share of the loss, $3000, which sum added to the $6000 on hand would be paid to Lauren & Matthew in the amounts stated.

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Problem #13• Ben must contribute $9000; Lilli $15,000.• IF Dan were subject to process, the partners

would be liable: Ben, $6000; Dan, $8000; and Lilli, $10,000. Since Dan is NOT subject to process, Ben & Lilli must contribute Dan’s share. Ben & Lilli share profits in the proportion of 3 to 5 (1/4 divided by 5/12 = 3/5). Ben must contribute 3/8ths of the $24,000 ($9000) required to pay creditors & Lilli must contribute 5/8ths of the $24,000, or $15,000.

Problem # 15• Total capital contributions =100,000 & interest of

$39,000 is due to S and J each on their respective capital contributions. Liabilities to creditors = $420,000, assets are $400,000. Total losses are $198,000 ($4000-($420,000 + $100,000 + $78,000). Losses same ration as profits. S & J get $29,600 ($50,000 in capital + $39,000 minus his share of loss, 30% or $59,400) J gets $29,600. W & B should each pay $39,600 for their share of loss, total $79,200 This sum added to the $400,000 = $479,200. Cr’s claims of $420,000 are paid 1st; leaving $59,200. S & J are then paid $29,600. Answer assumes W & B are solvent.

Tort Liability• A partnership is liable for loss or injury caused

by wrongdoing (trespass, fraud, negligence) of any partner while acting within the scope of partnership business; liable for any torts committed within the ordinary course of partnership business.

• Each partner has unlimited personal liability for the partnership obligation

• Wrongful partner must indemnify other

• Joint & Several liability

• Partnership liability is like vicarious liability

Criminal Liability

• Partners not usually criminally liable for the crimes of other partners committed within the scope of partnership business (i.e., embezzlement) unless the other partner authorized or participated in the crimes

Contractual Liability• Contractual liability is limited to their partnership

obligation; can’t be sued personally. • Because a partner acts concurrently as a principal and

an agent, a partner may contractually bind the partnership and each co-partner by contract if partner had (1) Actual Express Authority to act as per the partnership agreement; (2) Actual Implied Authority (hire/fire, ordering, doing things for customers, ordinary daily transactions); (3) Apparent Authority, authority that a third person may reasonably believe exists (doesn’t exist if third person knows partner has no authority)