Partnership

An association of two or more persons engaged in a business enterprise in which the profits and losses are shared proportionally. The legal definition of a partnership is generally stated as "an association of two or more persons to carry on as co-owners a business for profit" (Revised Uniform Partnership Act § 101 [1994]).Early English mercantile courts recognized a business form known as the societas. The societas provided for an accounting between its business partners, an agency relationship between partners in which individual partners could legally bind the partnership, and individual partner liability for the partnership's debts and obligations. As the regular English courts gradually recognized the societas, the business form eventually developed into the common-law partnership. England enacted its Partner-ship Act in 1890, and legal experts in the United States drafted a Uniform Partnership Act (UPA) in 1914. Every state has adopted some form of the UPA as its partnership statute; some states, however, have made revisions to the UPA or have adopted the Revised Uniform Partnership Act (RUPA), which legal scholars issued in 1994.

The authors of the initial UPA debated whether in theory a partnership should be treated as an aggregate of individual partners or as a corporate-like entity separate from its partners. The UPA generally opted for the aggregate theory in which individual partners ("an association") comprised the partnership. Under an aggregate theory, partners are co-owners of the business; the partnership is not a distinct legal entity. This led to the creation of a new property interest known as a "tenancy in partnership," a legal construct by which each partner co-owned partnership property. An aggregate approach nevertheless led to confusion as to whether a partnership could be sued or whether it could sue on its own behalf. Some courts took a technical approach to the aggregate theory and did not allow a partnership to sue on its own behalf. In addition, some courts would not allow a suit to go forward against a partnership unless the claimant named each partner in the complaint or added each partner as an "indispensable party."

The RUPA generally adopted the entity approach, which treats the partnership as a separate legal entity that may own property and sue on its own behalf. The RUPA nevertheless treats the partnership in some instances as an aggregate of co-owners; for example, it retains the joint liability of partners for partnership obligations. As a practical matter, therefore, the present-day partnership has both aggregate and entity attributes. The partnership, for instance, is considered an association of co-owners for tax purposes, and each co-owner is taxed on his or her proportional share of the partnership profits.

Formation

The formation of a partnership requires a voluntary "association" of persons who "coown" the business and intend to conduct the business for profit. Persons can form a partnership by written or oral agreement, and a partnership agreement often governs the partners' relations to each other and to the partnership. The term person generally includes individuals, corporations, and other partnerships and business associations. Accordingly, some partner-ships may contain individuals as well as large corporations. Family members may also form and operate a partnership, but courts generally look closely at the structure of a family business before recognizing it as a partnership for the benefit of the firm's creditors.

Certain conduct may lead to the creation of an implied partnership. Generally, if a person receives a portion of the profits from a business enterprise, the receipt of the profits is evidence of a partnership. If, however, a person receives a share of profits as repayment of a debt, wages, rent, or an Annuity, such transactions are considered "protected relationships" and do not lead to a legal inference that a partnership exists.

Relationship of Partners to Each Other

Each partner has a right to share in the profits of the partnership. Unless the partnership agreement states otherwise, partners share profits equally. Moreover, partners must contribute equally to partnership losses unless a partnership agreement provides for another arrangement. In some jurisdictions a partner is entitled to the return of her or his capital contributions. In jurisdictions that have adopted the RUPA, however, the partner is not entitled to such a return.

In addition to sharing in the profits, each partner also has a right to participate equally in the management of the partnership. In many partnerships a majority vote resolves disputes relating to management of the partnership. Nevertheless, some decisions, such as admitting a new partner or expelling a partner, require the partners' unanimous consent.

Each partner owes a fiduciary duty to the partnership and to copartners. This duty requires that a partner deal with copartners in Good Faith, and it also requires a partner to account to copartners for any benefit that he or she receives while engaged in partnership business. If a partner generates profits for the part-nership, for example, that partner must hold the profits as a trustee for the partnership. Each partner also has a duty of loyalty to the partnership. Unless copartners consent, a partner's duty of loyalty restricts the partner from using partnership property for personal benefit and restricts the partner from competing with the partnership, engaging in self-dealing, or usurping partnership opportunities.

Relationship of Partners to Third Persons

A partner is an agent of the partnership. When a partner has the apparent or actual authority and acts on behalf of the business, the partner binds the partnership and each of the partners for the resulting obligations. Similarly, a partner's admission concerning the partnership's affairs is considered an admission of the partnership. A partner may only bind the partnership, however, if the partner has the authority to do so and undertakes transactions while conducting the usual partnership business. If a third person, however, knows that the partner is not authorized to act on behalf of the partnership, the partnership is generally not liable for the partner's unauthorized acts. Moreover, a partnership is not responsible for a partner's wrongful acts or omissions committed after the dissolution of the partnership or after the dissociation of the partner. A partner who is new to the partnership is not liable for the obligations of the partnership that occurred prior to the partner's admission.

Liability

Generally, each partner is jointly liable with the partnership for the obligations of the partnership. In many states each partner is jointly and severally liable for the wrongful acts or omissions of a copartner. Although a partner may be sued individually for all the damages associated with a wrongful act, partnership agreements generally provide for indemnification of the partner for the portion of damages in excess of her or his own proportional share.

Some states that have adopted the RUPA provide that a partner is jointly and severally liable for the debts and obligations of the partnership. Nevertheless, before a partnership's creditor can levy a judgment against an individual partner, certain conditions must be met, including the return of an unsatisfied writ of execution against the partnership. A partner may also agree that the creditor need not exhaust partnership assets before proceeding to collect against that partner. Finally, a court may allow a partnership creditor to proceed against an individual partner in an attempt to satisfy the partnership's obligations.

Partnership Property

A partner may contribute Personal Property to the partnership, but the contributed property becomes partnership property unless some other arrangement has been negotiated. Similarly, if the partnership purchases property with partnership assets, such property is presumed to be partnership property and is held in the partnership's name. The partnership may convey or transfer the property but only in the name of the partnership. Without the consent of all the partners, individual partners may not sell or assign partnership property.

In some jurisdictions the partnership property is considered personal property that each partner owns as a "tenant in partnership," but other jurisdictions expressly state that the partnership may own property. The tenant in partnership concept, which is the approach contained in the UPA, is the result of adopting an aggregate approach to partnerships. Because the aggregate theory is that the partnership is not a separate entity, it was thought that the partnership could not own property but that the individual partners must actually own it. This approach has led to considerable confusion, and the RUPA has expressly stated that the partnership may own partnership property.

Partnership Interests

A partner's interest in a partnership is considered personal property that may be assigned to other persons. If assigned, however, the person receiving the assigned interest does not become a partner. Rather, the assignee only receives the economic rights of the partner, such as the right to receive partnership profits. In addition, an assignment of the partner's interest does not give the assignee any right to participate in the management of the partnership. Such a right is a separate interest and remains with the partner.

Partnership Books

Generally, a partnership maintains separate books of account, which typically include records of the partnership's financial transactions and each partner's capital contributions. The books must be kept at the partnership's principal place of business, and each partner must have access to the books and be allowed to inspect and copy them upon demand. If a partnership denies a partner access to the books, he or she usually has a right to obtain an Injunction from a court to compel the partnership to allow him or her to inspect and copy the books.

Partnership Accounting

Under certain circumstances a partner has a right to demand an accounting of the partnership's affairs. The partnership agreement, if any, usually sets forth a partner's right to a predissolution accounting. State law also generally allows for an accounting if copartners exclude a partner from the partnership business or if copartners wrongfully possess partnership property. In a court action for an accounting, the partners must provide a report of the partnership business and detail any transactions dealing with partnership property. In addition, the partners who bring a court action for an accounting may examine whether any partners have breached their duties to copartners or the partnership.

Taxation

One of the primary reasons to form a partnership is to obtain its favorable tax treatment. Because partnerships are generally considered an association of co-owners, each of the partners is taxed on her or his proportional share of partnership profits. Such taxation is considered "pass-through" taxation in which only the indimvidual partners are taxed. Although a partnership is required to file annual tax returns, it is not taxed as a separate entity. Rather, the profits of the partnership "pass through" to the individual partners, who must then pay individual taxes on such income.

Dissolution

A dissolution of a partnership generally occurs when one of the partners ceases to be a partner in the firm. Dissolution is distinct from the termination of a partnership and the "winding up" of partnership business. Although the term dissolution implies termination, dissolution is actually the beginning of the process that ultimately terminates a partnership. It is, in essence, a change in the relationship between the partners. Accordingly, if a partner resigns or if a partnership expels a partner, the partnership is considered legally dissolved. Other causes of dissolution are the Bankruptcy or death of a partner, an agreement of all partners to dissolve, or an event that makes the partnership business illegal. For instance, if a partnership operates a gambling casino and gambling subsequently becomes illegal, the partnership will be considered legally dissolved. In addition, a partner may withdraw from the partnership and thereby cause a dissolution. If, however, the partner withdraws in violation of a partnership agreement, the partner may be liable for damages as a result of the untimely or unauthorized withdrawal.

After dissolution, the remaining partners may carry on the partnership business, but the partnership is legally a new and different partnership. A partnership agreement may provide for a partner to leave the partnership without dissolving the partnership but only if the departing partner's interests are bought by the continuing partnership. Nevertheless, unless the partnership agreement states otherwise, dissolution begins the process whereby the partnership's business will ultimately be wound up and terminated.

Dissociation

Under the RUPA, events that would otherwise cause dissolution are instead classified as the dissociation of a partner. The causes of dissociation are generally the same as those of dis-solution. Thus, dissociation occurs upon receipt of a notice from a partner to withdraw, by expulsion of a partner, or by bankruptcy-related events such as the bankruptcy of a partner. Dissociation does not immediately lead to the winding down of the partnership business. Instead, if the partnership carries on the business and does not dissolve, it must buy back the former partner's interest. If, however, the partnership is dissolved under the RUPA, then its affairs must be wound up and terminated.

Winding Up

Winding up refers to the procedure followed for distributing or liquidating any remaining partnership assets after dissolution. Winding up also provides a priority-based method for discharging the obligations of the partnership, such as making payments to non-partner creditors or to remaining partners. Only partners who have not wrongfully caused dissolution or have not wrongfully dissociated may participate in winding up the partnership's affairs.

State partnership statutes set the procedure to be used to wind up partnership business. In addition, the partnership agreement may alter the order of payment and the method of liquidating the assets of the partnership. Generally, however, the liquidators of a partnership pay non-partner creditors first, followed by partners who are also creditors of the partnership. If any assets remain after satisfying these obligations, then partners who have contributed capital to the partnership are entitled to their capital contributions. Any remaining assets are then divided among the remaining partners in accordance with their respective share of partnership profits.

Under the RUPA, creditors are paid first, including any partners who are also creditors. Any excess funds are then distributed according to the partnership's distribution of profits and losses. If profits or losses result from a liquidation, such profits and losses are charged to the partners' capital accounts. Accordingly, if a partner has a negative balance upon winding up the partnership, that partner must pay the amount necessary to bring his or her account to zero.

Limited Partnerships

A limited partnership is similar in many respects to a general partnership, with one essential difference. Unlike a general partnership, a limited partnership has one or more partners who cannot participate in the management and control of the partnership's business. A partner who has such limited participation is considered a "limited partner" and does not generally incur personal liability for the partnership's obligations. Generally, the extent of liability for a limited partner is the limited partner's capital contributions to the partnership. For this reason, limited partnerships are often used to provide capital to a partnership through the capital contributions of its limited partners. Limited partnerships are frequently used in real estate and entertainment-related transactions.

The limited partnership did not exist at Common Law. Like a general partnership, however, a limited partnership may govern its affairs according to a limited partnership agreement. Such an agreement, however, will be subject to applicable state law. States have for the most part relied on the Uniform Limited Partnership Act in adopting their limited partnership legislation. The Uniform Limited Partnership Act was revised in 1976 and 1985. Accordingly, a few states have retained the old uniform act, and other states have relied on either revision to the uniform act or on both revisions to the uniform act.

A limited partnership must have one or more general partners who manage the business and who are personally liable for partnership debts. Although one partner may be both a limited and a general partner, at all times there must be at least two different partners in a limited partnership. A limited partner may lose protection against personal liability if she or he participates in the management and control of the partnership, contributes services to the partnership, acts as a general partner, or knowingly allows her or his name to be used in partnership business. However, "safe harbors" exist in which a limited partner will not be found to have participated in the "control" of the partnership business. Safe harbors include consulting with the general partner with respect to partnership business, being a contractor or employee of a general partner, or winding up the limited partnership. If a limited partner is engaged solely in one of the activities defined as a safe harbor, then he or she is not considered a general partner with the accompanying potential liability.

Except where a conflict exists, the law of general partnerships applies equally to limited partnerships. Unlike general partnerships, however, limited partnerships must file a certificate with the appropriate state authority to form and carry on as a limited partnership. Generally, a certificate of limited partnership includes the limited partnership's name, the character of the limited partnership's business, and the names and addresses of general partners and limited partners. In addition, and because the limited partnership has a set term of duration, the certificate must state the date on which the limited partnership will dissolve. The contents of the certificate, however, will vary from state to state, depending on which uniform limited partnership act the state has adopted.

Further readings

Gow, Niel. 2000. A Practical Treatise on the Law of Partnership. Buffalo, N.Y.: W.S. Hein.

Gregory, William A. 2001. The Law of Agency and Partnership. 3d ed. St. Paul, Minn.: West Group.

Hamilton, Robert W., and Jonathan R. Macey. 2003. Cases and Materials on Corporations, Including Partnerships and Limited Liability Companies. 8th ed. St. Paul, Minn.: West Group.

Hynes, J. Dennis. 2001. Agency, Partnership, and the LLC in a Nutshell. 2d ed. St. Paul, Minn.: West Group.

Moye, John E., ed. 1999. The Law of Business Organizations. 5th ed. Albany, N.Y.: West Legal Studies.

Partnerships, LLCs, and LLPs: Uniform Acts, Taxation, Drafting, Securities, and Bankruptcy. 12th ed. Vol. 1. 1996. Philadelphia: American Law Institute–American Bar Association Committee on Continuing Professional Education.

Cross-references

Joint and Several Liability; Limited Liability Partnership.

winding up

n. liquidating the assets of a corporation or partnership, settling accounts, paying bills, distributing remaining assets to shareholders or partners, and then dissolving the business. Winding up a non-profit corporation requires a plan for distribution of assets to some charitable or other non-profit entity under the "cy pres" doctrine. (See: corporation, partnership)

winding up