BLTS 11e-IM-Ch27 - NACM



Chapter 31All Forms of PartnershipsIntroductionThe most common forms of business organization are the sole proprietorship and, when two or more persons are involved, the partnership and the corporation, with the limited liability company becoming increasingly popular. In this chapter, the basic features of partnerships are explained, and some of their advantages and disadvantages are spelled out.Additional Background—Partnership LawPartnerships can be traced to the earliest records of history. The Code of Hammurabi, from 2300 B.C., includes references to partnerships. Around 2000 B.C., the Jews developed a form of partnership, known as a shutolin, for agricultural purposes. Commercial Jewish partnerships developed later.In the Roman Code of Jusitinian, there were provisions for partnerships that resemble current American partnership law. The Romans also developed the rules of agency, which serve as the basis for much partnership law. Under Roman law, the essence of a partnership was the choosing of partners.As with other commercial law, English partnership law developed form the Law Merchant, according to the realities of how merchants did business. In 1353, the Statute of the Staple provided that law was to be administered in the Court Staple (the law merchant courts) from “day to day and hour to hour,” which meant quickly. Eventually, the English equity courts began to hear partnership cases, and by the time of the American Revolution, partnership law was being administered in the law courts.In civil law countries, partnership law is similar to partnership law in common law countries, because in civil law countries, partnership law also developed from the customs of the merchants.Chapter OutlineI.Basic Partnership ConceptsA.Agency Concepts and Partnership LawPartnership law is based on agency law: the fiduciary ties that bind agent and principal also bind partners. In a non-partnership agency relationship, the agent usually does not have an ownership interest in the business nor is the agent obligated to bear a portion of the ordinary business losses.B.The Uniform Partnership ActThe Uniform Partnership Act (UPA), as adopted by the states, governs the operation of partnerships in the absence of an express agreement among the partners to the contrary.C.Definition of a PartnershipUnder the UPA, a partnership is “an association of two or more persons to carry on as co-owners a business for profit” [UPA 101(6)]. Intent is a key element [UPA 401(g)]. The Revised Model Business Corporation Act and the UPA permit a corporation to be a partner.D.Essential Elements of a PartnershipSharing profits alone does not qualify, but sharing both profits and losses might. The three essential elements implicit in the definition of partnership are—?A sharing of profits or losses.?A joint ownership of the business.?An equal right in the management of the business.1.The Sharing of Profits and LossesSharing both profits and losses creates a presumption that a partnership exists unless the profits are received as payment of [UPA 202(c)(3)]—?A debt by installments or interest on a loan.?Wages of an employer or 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 of a business or property.2.Joint Property OwnershipJoint ownership of property does not alone create a partnership. The parties’ intentions are key.E.Entity v. AggregateA partnership is sometimes called a firm or a company, terms that connote an entity separate and apart from its aggregate members. Generally, the law treats a partnership as an independent entity.F.Tax Treatment of PartnershipsFor at least one purpose—federal income taxes—a partnership is regarded as an aggregate of individual partners.II.Formation and OperationPartners may agree to virtually any terms, as long as they are not illegal or contrary to public policy. A partnership statement may (or may not) be filed with the appropriate state office.A.Duration of the PartnershipA partnership for a term ends on a specific date or the completion of a particular project. Dissolution without consent of all partners before the end of the term is a breach of the agreement. If there is no fixed term, a partnership is at will, and any partner can dissolve the firm at any time.B.Partnership by Estoppel1.Liability ImposedA person who represents himself or herself to be a partner in an actual or alleged partnership is liable to any third person who acts in good faith reliance.2.Nonpartner AgentsWhen a partner represents that a nonpartner is a member of the firm, the nonpartner is regarded as an agent of the firm.C.Rights of Partners1.Management Rights?All partners have equal rights in management [UPA 401(f)]. Each partner has one vote, and the majority rules in ordinary matters. ?Extraordinary matters may require unanimous consent to [UPA 301(2), 401(j)]—Admit new partners or enter a new business.Amend partnership articles.Enter a new line of business.2.Interest in the PartnershipUnless provided otherwise, profits and losses are shared equally, regardless of the amount of a partner’s capital contribution [UPA 401(b)].pensationConducting partnership business is a partner’s duty and generally not compensable.4.Inspection of the BooksBooks must be kept at the firm’s principal office. Every partner, active or inactive, is entitled to inspect all books and records on demand (and can make copies) [UPA 403]. The personal representative of a deceased partner’s estate has the same right5.Accounting of Partnership Assets or ProfitsAn accounting can be called for voluntarily or compelled by a court. Formal accounting occurs by right in connection with dissolution, but a partner also has the right to an accounting in other circumstances, listed in the text, and in UPA 405(b).6.Property RightsProperty acquired in the name of the partnership or a partner, or with partnership funds, is normally partnership property [UPA 204]. A partner can use partnership property only on the firm’s behalf [UPA 401(g)]. A partner is not a co-owner of this property and has no interest in it that can be transferred [UPA 501].D.Duties and Liabilities of PartnersEvery act of a partner concerning partnership business and every contract signed in the partnership name bind the firm [UPA 301(1)].1.Fiduciary DutiesA partner owes the firm and its partners duties of care and loyalty [UPA 404].?Duty of care—a partner must refrain from “grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law” [UPA 404(c)].?Duty of loyalty—a partner must account to the firm for “any property, profit, or benefit” in the conduct of its business or from a use of its property, and refrain from dealing with the firm as an adverse party or competing with it [UPA 404(b)].Case Synopsis—Case 31.1: Meinhard v. Salmon“Walter Salmon negotiated a twenty-year lease for Hotel Bristol in New York City. To pay for the conversion of the building into shops and offices, Salmon entered into an agreement with Morton Meinhard to assume half of the cost. They agreed to share the profits and losses from the venture. Before the end of the lease, the building’s owner Elbridge Gerry approached Salmon about a project to raze the converted structure, clear five adjacent lots, and construct a single building across the whole property. Salmon agreed and signed a new lease in the name of his own business. When Meinhard learned of the deal, he filed a suit in a New York state court against Salmon. From a judgment in Meinhard’s favor, Salmon appealed.The Court of Appeals of New York held that Salmon breached his fiduciary duty by failing to inform Meinhard of the business opportunity and secretly taking advantage of it himself. “Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. .??.??. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Thus “a man obtaining [an] .??.??. opportunity .??.??. by the position he occupies as a partner is bound by his obligation to his copartners in such dealings not to separate his interest from theirs, but, if he acquires any benefit, to communicate it to them.” The court granted Meinhard an interest “measured by the value of half of the entire lease.”..................................................................................................................................................Notes and QuestionsWould the reasoning and result in this case have been the same under the principles of agency law? Possibly. An agent, like a partner, owes his or her principal a duty of loyalty. This duty requires the agent to refrain from self-dealing without the principal’s consent. In circumstances similar to the situation in this case, an agent who engaged in the same conduct as Salmon would have violated the agent’s duty of loyalty. The remedy might have been different, however. In the context of an agency relationship, the entire contract might have been awarded to the principal.2.Breach and Waiver of Fiduciary DutiesThese duties cannot be waived and partners must comply with the obligations of good faith and fair dealing, but a partner may pursue his or her own interests without automatically violating these duties [UPA 103(b). 404(d)].Additional Cases Addressing this Issue —Breach of Fiduciary DutiesCases in which partners were considered to have breached their fiduciary duties owed to other partners include the following.?McBeth v. Carpenter, 565 F.3d 171 (5th Cir. 2009): (general partner in partnership formed to buy property falsely assured limited partners that any issues stemming from negotiations with city to secure property’s water entitlements were not significant obstacles to closing the deal).?Magellan Morada Investments, L.P. v. Miller, __ P.3d __ (Ariz.App. Div. 1 2008) (the finance managers of the general partner of a limited liability partnership that sold condominiums breached their fiduciary duty to the other partners when they invested funds from the sale of partnership assets in violation of the limited partnership agreement).?Farber v. Breslin, 47 A.D.3d 873, 850 N.Y.S.2d 604 (2 Dept. 2008) (general partner’s failure to disclose that he was negotiating a lease with a retailer that would stop foreclosure proceedings on partnership property, before the limited partner she sold her interest in the property for substantially less than its actual worth, stated a cause of action against the general partner for breach of fiduciary duty).?Ederer v. Gursky, 9 N.Y.3d 514, 881 N.E.2d 204 (2007) (in withdrawing law-firm partner’s action against other members of the limited liability partnership for an accounting, the general partner was not shielded from personal liability for breaches of the partnership's or partners' obligations to each other).3.Authority of PartnersEach partner is a general agent of the partnership in carrying out the usual business of the firm, unless designated otherwise.a.Limitations on AuthorityA partnership may limit a partner’s capacity to act as the firm’s agent by filing a “statement of partnership authority” in a designated state office—though this is normally effective only with respect to third parties who know of it.b.The Scope of Implied PowersPartners can exercise all implied powers reasonably necessary and customary to carry on partnership business, including the power to contract on its behalf.4.Liability of Partnersa.Joint LiabilityAt one time, partners were jointly liable for partnership obligations. A creditor had to sue all of the partners as a group, but each could be liable for the entire judgment. Partnership assets had to be exhausted before individual partners’ assets could be reached.b.Joint and Several LiabilityPartners are jointly liable and severally liable for partnership obligations, including contracts, torts, and breaches of trust [UPA 306(a)]. But a creditor cannot collect a partnership debt from the partner of a non-bankrupt partnership without first attempting to collect from the partnership [UPA 307(d)].c.Liability of Incoming PartnersA new partner to an existing partnership is liable only to the extent of his or her capital contribution for preexisting partnership debts and obligations [UPA 306(b)].Additional Cases Addressing this Issue —Liability of PartnersCases considering the liability of partners include the following.?Peter v. GC Services L.P., 310 F.3d 344 (5th Cir. 2002) (a collection agency’s general partners were jointly and severally liable for the agency’s violations of law in attempting to collect a student loan debt).?In re Tsurukawa, __ Bankr. __, 2002 WL 31941454 (9th Cir. BAP 2002) (a business partnership existed between a debtor and her husband, in connection with a company that the debtor formed and to which the husband channeled most of his corporate employer’s repair work at prices exceeding those of vendors to which the work was farmed out, and thus, it was appropriate to impute the husband’s fraud to the debtor).?Action Mechanical, Inc. v. Deadwood Historic Preservation Commission, 2002 SD 121, 652 N.W.2d 742 (2002) (in a plumbing subcontractor’s suit to foreclose a mechanic’s lien and for unjust enrichment, seeking recovery for work performed on a hotel and casino for a lessee that lost possession of the hotel and casino to the lessor, the lessor’s partners were jointly and severally liable for the debts of their partnership).III.Dissociation and TerminationWhen a partner ceases to be associated in the carrying on of the partnership business, he or she can have his or her interest bought by the firm, which otherwise continues to do business.A.Events That Cause DissociationUnder UPA 601—?A partner may give notice and withdraw.?The occurrence of an event specified in the partnership agreement can cause dissociation.?A partner might be expelled by the firm.?A partner might be expelled by a court.?A partner dissociates by declaring bankruptcy, assigning his or her interest, or through death or incapacity.B.Wrongful DissociationThis can occur if dissociation is in breach of a partnership agreement, before the expiration of its term or completion of its undertaking [UPA 602]. A partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociationC.Effects of Dissociation1.Rights and DutiesOn dissociation, a partner’s right to participate in the firm’s business ends [UPA 603]. The duty of loyalty also ends, and the duty of care continues only with respect to events that occurred before dissociation, unless the partner participates in winding up.2.BuyoutsThe partner’s interest in the firm must be purchased according to the rules in UPA 701.3.Liability to Third PartiesTo avoid liability for obligations under a theory of apparent authority, a partnership should notify its creditors of a partner’s dissociation and file a statement of dissociation in the appropriate state office [UPA 704].D.Partnership Termination1.Dissolution?A partnership may be dissolved by the partners’ agreement or dissociation of a partner [UPA 801, 802].?A partnership for a definite term or undertaking is dissolved when the term expires or the undertaking is accomplished.?A partnership is dissolved if an event occurs that makes it impossible to continue lawfully [UPA 801(4)].Case Synopsis—Case 31.2: Estate of Webster v. ThomasClyde Webster, James Theis, and Larry Thomas formed T&T Agri-Partners to own and farm 180 acres in Christian County, Illinois. Under the partnership agreement, the firm was to continue until 2010 unless it was dissolved, any withdrawing partner was to sell his interest to the firm according to specific terms, and the death of any partner would dissolve the partnership. Webster died in 2002, but when Theis and Thomas did not liquidate T&T and distribute its assets, Webster’s estate filed a complaint in an Illinois state court. The trial occurred in 2011. The court ordered the liquidation and distribution of the assets, to be valued at the time of liquidation, with payment of attorneys’ fees to the estate. The defendants appealed.A state intermediate appellate court affirmed. “The circuit court properly determined that the defendants had failed to liquidate and distribute the partnership assets pursuant to agreement and court order.”..................................................................................................................................................Notes and QuestionsWhat did the partnership agreement at the center of this case require on the death of a partner and the dissolution of the firm? The parties to the partnership agreement at the center of this case were Clyde Webster, James Theis, and Larry Thomas, who formed T&T Agri-Partners Company to own and farm 180 acres in Christian County, Illinois. Under the partnership agreement, the firm was to continue until January 31, 2010 unless it was dissolved, and the death of any partner would dissolve the partnership. Partners owning at least 120 “Partnership units” could, by “written consent,” or by vote in the case of a partner’s death, continue the partnership. In the event of a partner's death, the vote had to occur within 120 days of the date of the death.On the dissolution of the firm, the partnership assets were to be “liquidated and distributed.”What conduct by which parties triggered this litigation? There were a number of events that led to the litigation in this case. Initially, the death of Clyde Webster triggered the provision in the partnership agreement that required the firm’s dissolution or a vote by certain remaining partners to continue the partnership.The failure of the surviving partners James Theis and Larry Thomas to either vote to continue the business of the firm or to dissolve the partnership, as per the partnership agreement, led to the complaint by Webster’s estate, seeking the liquidation and distribution of the firm’s assets. The continuing failure of the surviving partners to take a vote or to dissolve the firm according to the partnership agreement, and those partners’ failure to act on a court’s order to dissolve the firm, triggered the trial, which led to a second court order to dissolve the firm and pay the plaintiff’s attorney fees.On what did the court base its order regarding attorneys’ fees? After a trial, the court in the Webster case based its order regarding attorney fees on the provision in the partnership agreement that stated “Any Partner who shall violate any of the terms of this Agreement *??*??* shall indemnify and hold harmless the Partnership, and all other Partners from any and all *??*??* losses, *??*??* including but not limited to attorneys' fees.”Does the judicial power to dissolve partnerships encourage partners to be more respectful toward each other? Why or why not? Most people do not want courts to dissolve their businesses. If partners honor their enterprise and each other, the partnership is more likely to succeed. And if the partnership succeeds, a court is very unlikely to dissolve it. Thus, the courts’ power to judicially dissolve partnerships should encourage partners to be more respectful toward each other.What might the defendants have done to avoid the dispute that arose from the circumstances of this case? To avoid the dispute that arose from the circumstances of this case, partners James Theis and Larry Thompson, with the personal representative of Webster’s estate, could have voted to continue the partnership after the death of Clyde Webster. A vote taken in accord with the partnership agreement could have averted the dispute and avoided the litigation. Alternatively, the surviving partners could have liquidated the partnership assets and distributed the proceeds. In the facts of the case, of course, the partners did neither, which prompted Webster’s estate to file a complaint against the other partners and the firm to liquidate and distribute its assets.1.Illegality or ImpracticalityA court can dissolve a partnership for commercial impracticality, improper conduct, or other circumstances [UPA 801(5)].2.Good FaithEach partner must act in good faith when dissolving a partnership.E.Winding Up and Distribution of AssetsAfter dissolution and notice, partners complete transactions begun and not finished (but they can create no new obligations). 1.Duties and CompensationPartnership assets are collected, debts are paid, the values of partners’ interests in the partnership are accounted for, and profits and losses distributed. A partner is entitled to compensation for these efforts.2.Creditors’ ClaimsUnder UPA 807, the priorities for the distribution of partnership assets are payment of debts, return of capital, and distribution of profits.IV.Limited Liability PartnershipsFamily businesses and professional services often use the limited liability partnership (LLP) form.A.Formation of an LLPAn LLP is formed in compliance with state statutes by filing in a central office an initial form and later annual reports. The business name must include “limited liability partnership” or “LLP” [UPA 1001, 1002]. The statutory rules (UPA) and common law of partnership apply.B.Liability in an LLPAn LLP allows professionals to avoid personal liability for the malpractice of other partners (but of course not their own). The UPA exempts partners from personal liability for any partnership obligation, “whether arising in contract, tort, or otherwise” [UPA 306(c)].1.Liability outside the State of FormationIn states outside the state of an LLP’s formation, most states will probably apply, to questions of liability, the law of the state in which the LLP was formed [UPA 1101].2.Sharing Liability among PartnersWhen the partners are members of an LLP, and more than one member is negligent (as when one partner is a negligent partner’s supervisor), there is a question as to how liability is to be shared. Some states provide for proportionate liability—that is, for separate determinations of the negligence of the partners.V.Limited PartnershipsMost states and the District of Columbia have adopted the Revised Uniform Limited Partnership Act (RULPA). The key difference between general and limited partnerships is, of course, the limited liability of limited partners.Case Synopsis—Case 31.3: DeWine v. Valley View Enterprises, Inc.Valley View Enterprises, Inc. built Pine Lakes Golf Club and Estates in Trumbull County, Ohio. Valley View Properties, Ltd., a limited partnership, cut out the roadways and constructed sewer lines, water lines, and storm water lines with water inlets. Joseph Ferrara is the owner and president of Valley View Enterprises and the sole general partner of Valley View Properties. Ferrara failed to obtain the proper state wetlands-fill permits for the development in a timely manner. The state filed a suit in an Ohio state court against the Valley View entities and Ferrara, alleging violations of the state water pollution control laws and seeking civil penalties. The court entered a judgment in the defendants’ favor, holding with respect to Ferrara that “a corporate officer cannot be held liable merely by virtue of his status as a corporate officer.” The state appealed.A state intermediate appellate court reversed. In relation to Valley View Properties, Ferrara is not a corporate officer—he is a general partner. “Therefore, he is not, in the course of his conduct as the general partner of that limited partnership, entitled to the insulation from liability of a corporate officer.”..................................................................................................................................................Notes and QuestionsDid any of the parties involved in this case commit an ethical violation? Ferrara might be viewed as violating ethical principles when he failed to obtain the proper state wetlands-fill permits for the development in a timely manner. The negative effect on a partnership of a partner’s conduct nearly always raises ethical “red flags”—possible conflicts of interest and self-dealing, for example. Although the facts do not indicate that those occurred in this case, Ferrara’s apparent refusal to compromise on the disputed issue without litigation could be seen as a stretch of ethical principles.Additional Background—A History of Limited PartnershipsLimited partnerships were first used in Pisa and Florence, Italy, in the twelfth century, as a method for parties—usually priests and nobles—to invest their money anonymously. The limited partnership spread to France and was brought to America by French explorers and settlers in Louisiana and Florida. Known as société en commandite, the French limited partnership served as the idea for the drafters of the original statutes in the United States.The first Limited Partnership Act was adopted by New York in 1822. By 1850, most of the other states had adopted similar statutes. Since the introduction of these early statutes, an important question has been the degree to which a limited partner can participate in the conduct of the business without becoming liable, beyond the extent of his or her investment, for its obligations.A.Formation of an LPFormation of a limited partnership is a public, formal proceeding: there must be two or more partners (at least one of whom must be a general partner), and a certificate of limited partnership must be signed and filed with a designated state official.Enhancing Your Lecture—????Jurisdiction Issues in Limited Partnerships?????Numerous business and investment opportunities are organized as limited partnerships. Often, especially when the business involves the Internet and technology, the limited partners live in different states and have little contact with each another. In this situation, significant jurisdiction issues can arise. Which court has jurisdiction in the event of a dispute? Do the courts of the state in which a limited partnership is organized have jurisdiction over all members of the partnership, regardless of they live?The Werner CaseThe question of jurisdiction over limited partners came before the court in Werner v. Miller Technology Management, L.P.a A New York resident, Marc Werner, invested $250,000 as a limited partner in Interprise Technology Partners (ITP), a Delaware limited partnership. ITP was formed in 1999 to invest in information technology companies (companies engaged in creating, storing, and exchanging information on computers). Under the partnership agreement, the general partner, Miller Technology Management (MTM), was to manage the business with the advice and assistance of an advisory board that consisted of five of ITP’s limited partners.In 2002, Werner sued MTM and ITP’s advisory board, claiming a pattern of self-dealing in breach of their fiduciary duties of care, disclosure, and loyalty. As it turned out, in three years of operation, ITP had invested over $45 million in companies that were affiliated with its general partner (MTM) and the limited partners on ITP’s advisory board. For example, ITP paid over $17.5 million for consulting services from a company called Answerthink, Inc., which was founded and controlled by the five members of ITP’s advisory board. In fact, four of the individuals on ITP’s advisory board held top positions in Answerthink for which they were paid salaries of over $500,000 per year. These conflicts of interest were never disclosed to Werner or to any of the other limited partners in ITP.“Minimum Contacts” RequiredWerner contended that the defendants used their positions of control and influence over ITP to engage in transactions that benefited them personally but were detrimental to ITP. Although the self-dealing nature of these transactions seems apparent, the court first had to determine whether Delaware had jurisdiction over the defendants. The advisory board defendants claimed that they did not have “minimum contacts” with Delaware because they were not residents and did not transact any business in that state. Werner argued that because the advisory board was created to participate in the management of a Delaware limited partnership, Delaware had jurisdiction.Ultimately, the court held that Delaware did not have jurisdiction over the limited partners on ITP’s advisory board. Limited partners are not legally entitled to participate in management. Even if ITP’s advisory board had done more than advise MTM, the court held that Werner had not shown that these defendants had any business contacts with Delaware, such as entering contracts or attending meetings. Thus, the court dismissed the case against the limited partners on ITP’s advisory board, but it allowed the plaintiff’s claim against the general partner (MTM).For Critical AnalysisGiven that the general partner and the limited partners on the advisory board engaged in the same pattern of self-dealing and nondisclosure, why did the court have jurisdiction only over the general partner? What policy considerations underlie the court’s decision?a. 831 A.2d 318 (Del. 2003).B.Liabilities of Partners in an LPThe liability of a limited partner for the firm’s obligations is limited to the capital that the partner contributes to the firm [RULPA 502]. A limited partner who participates in the management of the firm will be as liable as a general partner, however [RULPA 303]. If the sole general partner is a corporation, no one is personally liable for the firm’s obligations.C.Dissociation and Dissolution1.Events That Cause DissolutionThe dissociation, bankruptcy, death, retirement, or mental incompetence of a general partner will lead to the dissolution of the firm unless the other partners agree to continue the business [RULPA 702, 704, 705]. In the case of a limited partner, none of these occurrences will dissolve the firm. A limited partnership can be dissolved by court decree [RULPA 802]. 2.Distribution of AssetsPriorities on dissolution are creditors’ claims, unpaid distributions of partnership assets, and returns of partners’ contributions [RULPA 804].3.Valuation of AssetsDisputes commonly arise about how the partnerships assets should be valued and distributed and whether the business should be sold.D.Buy-Sell AgreementsOne or more partners may agree to buy out the other or others, if the situation warrants. To agree beforehand on who buys what, under what circumstances, and, if possible, at what price, eliminates costly negotiations or litigation later. If a partner’s dissociation does not result in dissolution, a buy out is mandatory, according to specific rules [UPA 701(b)].Teaching Suggestions1.Obtain copies of several partnership agreements and distribute them to students. Ask the students to indicate which passages reflect the fiduciary duties owed by each of the partners to the other partners.2.In the absence of a written partnership agreement, ask students what factors they would look for in deciding whether a group of individuals engaged in a common enterprise should be classified as partners. Is there any single factor that would be enough to justify classifying an enterprise as a partnership or must there be several factors that together have the “look and feel” of a partnership?3.A court has the power to order the dissolution of a partnership when it believes that such an action is warranted. Ask students to discuss some of the situations in which a court might order that a partnership be terminated. Do adequate guidelines exist to help courts make informed decisions in such matters? What are some of the problems that might arise when deciding whether a partnership should be dissolved?4.Explain that creditors are often reluctant to permit a debtor such as a partnership to contract out of personal liability due to the fact that a partnership’s assets following dissolution may be insufficient to satisfy all of its creditors’ claims (or difficult to reach). Many lenders, for example, insist that partners personally guarantee loans to the partnership so that the lender will have recourse to the personal assets of the partners.5.There are two important points that might be emphasized regarding the formation of a partnership. First, one of the essential elements is that a partnership must be carried on for a profit. Nonprofit entities do not qualify. Second, the sharing of profits is prima facie evidence of a partnership, whether or not the parties intended to form a partnership. Students should be reminded, however, that simply sharing profits is not enough. There needs to some shared control over the business.6.Ask students whether the roles played by general partners and limited partners in a limited partnership are truly distinct or instead merely arbitrary designations. Is it reasonable to assume that limited partners at least indirectly “manage” the business of a limited partnership by funding the partnership and paying the salary of the general partner? Would it be more useful to make all limited partners personally liable on partnership debts and thus avoid arbitrary court decisions about what forms of conduct do or do not constitute managerial activities? If so, what effect would this have on the investment world?7.Tell students that to remember the distinction between general partners and limited partners, they might find it helpful to think of a general partner’s management and control rights as general and a limited partner’s participation rights as limited. Similarly, a general partner’s liability can be described as general and the limited partner’s liability as limited.Cyberlaw LinkWhat are the legal and policy issues for the design, development, and operation of a partnership’s Web site? Should online businesses adopt a limited liability form of business organization? Why or why not?Discussion Questions1.What are the three essential elements necessary (but not necessarily sufficient) to form a partnership? The Uniform Partnership Act defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit.” In resolving disputes over whether partnership status exists, courts will look for the following three elements implicit in this definition: (1) a sharing of profits or losses; (2) a joint ownership of the business; and (3) an equal right in the management of the business.2.What is a partnership by estoppel? Parties who are not partners can hold themselves out as partners and make representations that third persons rely on in dealing with the alleged partners. In such a situation, a court may conclude that a partnership by estoppel exists and impose liability on the alleged partner or partners. The person representing himself or herself to be a partner is liable to any third person who extends credit in good faith reliance on such representations. Similarly, a person who expressly or impliedly consents to such misrepresentations of an alleged partnership relationship is also liable to third persons who extend credit in good faith reliance.3.When will majority rule not govern decisions connected with partnership business? Although majority rule controls decisions in ordinary matters connected with partnership business unless otherwise specified in the partnership agreement, unanimous consent of the partners is required to bind the firm in any actions that significantly affect the nature of the partnership. These may include (1) altering the essential nature of the firm’s business as expressed in the partnership agreement or altering the capital structure; (2) admitting new partners or entering a new business; (3) assigning partnership property into a trust for the benefit of creditors; (4) disposing of the partnership’s goodwill; (5) confessing judgment against the partnership or submitting partnership claims to arbitration; (6) undertaking any act that would make further conduct of partnership business impossible; or (7) amending the articles of the partnership agreement.4.When may a partner withdraw from a partnership? A partner has the power to dissociate from a partnership at any time. Note that although a partner always has the power to withdraw from the partnership, he or she may not have the right to do so. In a partnership for a specified term or for a specific purpose, a partner does not have the right to withdraw until the term has lapsed or the purpose has been fulfilled. If a partner withdraws in contravention of the partnership agreement, he or she will be liable to the other partners for any damages resulting from the wrongful dissociation.5.Can a partnership be bound to new obligations after it has been dissolved? Yes, this is possible. To avoid liability for obligations incurred after dissolution, all affected third persons must have notice (actual, in the case of a creditor). A partner can file a notice of dissolution in the appropriate state office [UPA 805].6.What is the difference between a general partnership and a limited partnership? A partnership is a joint undertaking that arises from an agreement between two or more persons to carry on a business for profit. Because partners are co-owners of the enterprise and have joint control of the operation, their personal net worths are subject to partnership obligations. This personal liability holds true for all the partners in a general partnership as well as the general partners who operate a limited partnership. Yet a limited partnership also has limited partners. These limited partners are personally liable only to the extent of their capital contributions to the partnership. The flip-side of this limited liability is that limited partners usually have little say in how the limited partnership is operated; such decisions are typically made by the general partner (who is personally liable for the amount of the partnership obligations).7.What consequences result from a limited partner’s attempt to manage the affairs of the limited partnership? A limited partner is not personally liable for the debts of the partnership so long as he or she refrains from participating in the management of the partnership. If the limited partner becomes too heavily involved in running the daily affairs of the partnership, then the limited partner will be personally liable for any debts arising from his managerial activities.8.Why does the law impose fiduciary obligations on general partners? General partners operate partnerships with little input from the limited partners, whose liability would be affected if they offered much advice but whose investments are entrusted to those general partners. Any time one’s property is entrusted to the care of another, fiduciary obligations can arise.9.What is the motivation for a general partner to breach his or her fiduciary obligation to the limited partners in a limited partnership? The most likely motivation is money.10.What are the characteristics of a limited liability partnership (LLP)? An LLP is similar to an LLC. The difference between them is that an LLP is designed more for professionals who normally do business as partners in a partnership. The major advantage of the LLP is that it allows a partnership to continue as a pass-through entity for tax purposes but limits the personal liability of the partners.Activity and Research Assignments1.Ask students to compare the differences in the typical agency and partnership relationships. Although the law of partnerships includes many concepts of agency, the two areas do have significant differences such as the fact that all partners have rights to partnership profits while an agent generally has no proprietary rights in matters in which he or she acts on behalf of the principal.2.Ask students to discuss any of their own experiences working as employees (or partners) for a partnership. In particular, they should discuss the extent to which their own experiences confirmed or contradicted the ideas presented in the text as to how a partnership should be operated.3.Obtain copies of partnership agreement forms and ask students to discuss the significant provisions. What sorts of concerns are addressed in each agreement? How might these agreements be improved? How do these agreements differ from what a sole proprietor might be able to do? 4.After having discussed the structure and contents of partnership agreements, ask each student to draft a brief partnership agreement.5.Ask students to research their state’s statutes and case law on limited liability partnerships and limited liability limited partnerships.Explanations of Selected Footnotes in the TextFootnote 5: In 1978, Wilbur and Dee Warnick and their son Randall Warnick bought a ranch in Wyoming, for $335,000 and formed a partnership—Warnick Ranches. Their capital contributions totaled $60,000, of which Randall paid 34 percent. Wilbur and Dee moved onto the ranch in 1981, but Randall lived and worked on the ranch only occasionally. In 1999, Randall dissociated from the partnership and filed a suit in a Wyoming state court against the others and the partnership to recover what he believed to be a fair buyout price. The court awarded Randall $115,783.13 (his cash contributions plus 34 percent of the partnership assets' increase in value above all partners' cash contributions), with interest. The defendants appealed, arguing that $50,000 should be deducted from the appraised value of the assets for the estimated expenses of selling them. In Warnick v. Warnick, the Wyoming Supreme Court affirmed, holding that “hypothetical costs of sale are not a required deduction in valuing partnership assets.” Under UPA 701, the buyout price is “the amount that would have been paid to the dissociating partner following a settlement of partnership accounts upon the winding up of the partnership, if, on the date of dissociation, the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the business as a going concern without the dissociating partner.” The first step is to value the partnership’s assets according to the two methods. Liquidation value refers to the prices of assets if they are sold separately, as opposed to the value of the business as a whole. For this purpose, an asset’s price is the amount that “a willing and informed buyer would pay a willing and informed seller, with neither being under any compulsion to deal.” Such a seller would factor the cost of a sale into the price.Why does UPA 701 provide two approaches for calculating the buyout price on a partner’s dissociation? The court pointed out that the statute “contemplates variations that could result from differing appraisal techniques and varying business circumstances.” Assets that are a part of a going concern may have “greater value than the sum of the values of individual assets.” But “going concern value is lower than liquidation value if the assets cannot be liquidated because they are committed to a going concern.” In that situation, “dedication to a going concern is considered an encumbrance.” Under UPA 701, “however value is perceived, the higher of the two values is to be used.”Was it unethical for Randall to file a suit against his parents to obtain money in this case? Why or why not? Randall’s efforts towards the success of the ranch, in terms of time devoted to its operation, appears from the statement of facts to have been small. His capital contribution to the partnership, after deductions for distributions and other items, represented less than 10 percent of the total. When he tried to withdraw from the partnership and asked his parents for his share of the money, they could not agree on the amount. He retained counsel in an attempt to obtain what he felt was a fair price and ultimately this suit ensued. Whether Randall was acting unethically in the circumstances is not clear. He may have been greedy or resentful, or have had other base motivations, in which case filing the suit could have been unethical. The same might be surmised of his parents. To all parties, it may have simply been business.How and why might the value of a partnership interest in a going concern differ from the value of the same interest as a result of a liquidation? The court explained in this case, “Application of the two methods to the same partnership may yield two distinct values. .??.??. The method of valuation of a partnership interest in a going concern necessarily differs from the valuation of the same interest at the point of liquidation. The liquidation value looks to the value of the partnership's assets less its liabilities and determines each partner's appropriate share. When valuing a going concern, however, the market value of the partnership interest itself is what is at stake, rather than the percentage of net assets it represents. Depending on circumstances, the market value of the partnership interest may be more or less than the value of the same percentage of net assets.”Footnote 10: Midnight Star Enterprises, L.P., consists of a casino, bar, and restaurant in South Dakota. The owners are: Midnight Star Enterprises, Ltd. (MSEL), the general partner, which owns 22 partnership units; actor Kevin Costner, a limited partner, who owns 71.50 partnership units; and Carla and Francis Caneva, limited partners, who own 3.25 partnership units each. Costner also owns MSEL and thus controls 93.5 partnership units. MSEL filed a petition in a South Dakota state court to dissolve the partnership. Paul Thorstenson, an accountant, set the firm’s fair market value at $3.1 million. A competitor offered to buy the business for $6.2 million. The court ordered MSEL and Costner to buy the business for that price within ten days or sell it. MSEL appealed. In In re Dissolution of Midnight Star Enterprises, L.P., the South Dakota Supreme Court reversed and remanded for a revaluation. The partnership agreement did not require the business to be sold on dissolution. Only a decision to make an in-kind distribution of assets required that the business be offered for sale. Also, the correct value was the accountant’s figure, which was based on a fair market value analysis using a hypothetical buyer. This analysis provided a reasonable basis for determining value “by removing the irrationalities, strategies, and emotions” that exist in an actual offer. Besides, the partnership agreement required a “fair market value” of the assets.Why is the “hypothetical transaction” valuation standard, involving a hypothetical buyer and seller, rather than an actual offer with a real buyer, the proper standard to determine the fair market value of partnership property? The court in this case noted that “MSEL lists sound policy reasons why an offer cannot be the fair market value. For example, what if a partnership solicited a ‘strawman’ to offer a low price for the business? What if a businessman, for personal reasons, offers 10 times the real value of the business? What if the partnership, for personal reasons, such as sentimental value, refuses to sell for that absurdly high offer? These arbitrary, emotional offers and rejections cannot provide a rational and reasonable basis for determining the fair market value.”Why did the court hold that a forced sale of the property of the limited partnership was not appropriate in this case? The court in this case concluded that the partnership agreement did not require the business to be sold on the open market on the partnership’s dissolution. Under the agreement, during liquidation, the firm’s property could be distributed in kind among the partners if it was first offered for sale to a third party. In other words, only a decision to make an in-kind distribution of assets required that the business be offered for sale on the open market. That did not occur in this case. Thus, the majority partners were ordered only to pay the withdrawing partners the “fair market value” of their interests based on the business’s “hypothetical transaction” value.Under what circumstances might a forced sale of the property of a limited partnership on its dissolution be appropriate? The court in this case points out that “if the majority owners refuse to pay any amount owed to the Canevas after revaluation, then a forced sale is appropriate.” Also, under such egregious circumstances as a general partner’s breach of fiduciary obligation or other unfair dealings or deceptive conduct, a forced sale might be proper. ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download