Partnership

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Chapter 19

Partnership Operation and Termination

LEARNING OBJECTIVES

After reading this chapter, you should understand the following:

1. The operation of a partnership, including the relations among partners and relations between

partners and third parties

2. The dissolution and winding up of a partnership

19.1 Operation: Relations among Partners

LEARNING OBJECTIVES

1. Recognize the duties partners owe each other: duties of service, loyalty, care, obedience,

information, and accounting.

2. Identify the rights that partners have, including the rights to distributions of money, to management,

to choice of copartners, to property of the partnership, to assign partnership interest, and to enforce

duties and rights.

Most of the rules discussed in this section apply unless otherwise agreed, and they are really intended

for the small firm.“The basic mission of RUPA is to serve the small firm. Large partnerships can fend

for themselves by drafting partnership agreements that suit their special needs.” Donald J. Weidner,

“RUPA and Fiduciary Duty: The Texture of Relationship,” Law and Contemporary Problems 58, no. 2

(1995): 81, 83. The Uniform Partnership Act (UPA) and the Revised Uniform Partnership Act (RUPA)

do not dictate what the relations among partners must be; the acts supply rules in the event that the

partners have not done so for themselves. In this area, it is especially important for the partners to

elaborate their agreement in writing. If the partners should happen to continue their business beyond

the term fixed for it in their agreement, the terms of the agreement continue to apply.

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Duties Partners Owe Each Other

Among the duties partners owe each other, six may be called out here: (1) the duty to serve, (2) the duty

of loyalty, (3) the duty of care, (4) the duty of obedience, (5) the duty to inform copartners, and (6) the

duty to account to the partnership. These are all very similar to the duty owed by an agent to the

principal, as partnership law is based on agency concepts.Revised Uniform Partnership Act, Section

404, Comment 3: “Indeed, the law of partnership reflects the broader law of principal and agent, under

which every agent is a fiduciary.”

Duty to Serve

Unless otherwise agreed, expressly or impliedly, a partner is expected to work for the firm. The

partnership, after all, is a profit-making co-venture, and it would not do for one to loaf about and still

expect to get paid. For example, suppose Joan takes her two-week vacation from the horse-stable

partnership she operates with Sarah and Sandra. Then she does not return for four months because she

has gone horseback riding in the Southwest. She might end up having to pay if the partnership hired a

substitute to do her work.

Duty of Loyalty

In general, this requires partners to put the firm’s interests ahead of their own. Partners are fiduciaries

as to each other and as to the partnership, and as such, they owe a fiduciary duty to each other and

the partnership. Judge Benjamin Cardozo, in an often-quoted phrase, called the fiduciary duty

“something stricter than the morals of the market place. Not honesty alone, but the punctilio of an

honor the most sensitive, is then the standard of behavior.”Meinhard v. Salmon, 164 N.E. 545 (N.Y.

1928). Breach of the fiduciary duty gives rise to a claim for compensatory, consequential, and incidental

damages; recoupment of compensation; and—rarely—punitive damages. See Section 19.4.1 “Breach of

Partnership Fiduciary Duty”, Gilroy v. Conway, for an example of breach of fiduciary duty.

Application of the Fiduciary Standard to Partnership Law

Under UPA, all partners are fiduciaries of each other—they are all principals and agents of each other—

though the word fiduciary was not used except in the heading to Section 21. The section reads, “Every

partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by

him without the consent of the other partners from any transaction connected with the formation,

conduct, or liquidation of the partnership or from any use by him of its property.”

Section 404 of RUPA specifically provides that a partner has a fiduciary duty to the partnership and

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other partners. It imposes the fiduciary standard on the duty of loyalty in three circumstances:

(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the

partner in the conduct and winding up of the partnership business or derived from a use by the partner

of partnership property, including the appropriation of a partnership opportunity;

(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership

business as or on behalf of a party having an interest adverse to the partnership; and

(3) to refrain from competing with the partnership in the conduct of the partnership business before

the dissolution of the partnership.

Limits on the Reach of the Fiduciary Duty

This sets out a fairly limited scope for application of the fiduciary standard, which is reasonable because

partners do not delegate open-ended control to their copartners. Further, there are some specific limits

on how far the fiduciary duty reaches (which means parties are held to the lower standard of “good

faith”). Here are two examples. First, RUPA—unlike UPA—does not extend to the formation of the

partnership; Comment 2 to RUPA Section 404 says that would be inappropriate because then the

parties are “really dealing at arm’s length.” Second, fiduciary duty doesn’t apply to a dissociated partner

(one who leaves the firm—discussed in Section 19 “Dissociation”) who can immediately begin

competing without the others’ consent; and it doesn’t apply if a partner violates the standard “merely

because the partner’s conduct furthers the partner’s own interest.”RUPA, Section 503(b)(2); RUPA,

Section 404 (e). Moreover, the partnership agreement may eliminate the duty of loyalty so long as that

is not “manifestly unreasonable.”RUPA, Section 103(2)(c).

Activities Affected by the Duty of Loyalty

The duty of loyalty means, again, that partners must put the firm’s interest above their own. Thus it is

held that a partner

may not compete with the partnership,

may not make a secret profit while doing partnership business,

must maintain the confidentiality of partnership information.

This is certainly not a comprehensive list, and courts will determine on a case-by-case basis whether the

duty of loyalty has been breached.

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Duty of Care

Stemming from its roots in agency law, partnership law also imposes a duty of care on partners.

Partners are to faithfully serve to the best of their ability. Section 404 of RUPA imposes the fiduciary

standard on the duty of care, but rather confusingly: how does the “punctilio of an honor the most

sensitive”—as Judge Cardozo described that standard—apply when under RUPA Section 404(c) the

“the duty of care…is limited to refraining from engaging in grossly negligent or reckless conduct,

intentional misconduct, or a knowing violation of law”? Recognize that a person can attend to business

both loyally and negligently. For example, Alice Able, a partner in a law firm who is not very familiar

with the firm’s computerized bookkeeping system, attempts to trace a missing check and in so doing

erases a month’s worth of records. She has not breached her duty of care: maybe she was negligent, but

not grossly negligent under RUPA Section 404(c). The partnership agreement may reduce the duty of

care so long as it is not “unreasonably reduce[d]”; it may increase the standard too.RUPA, Section

103(2)(d); RUPA, Section 103.

Duty of Obedience

The partnership is a contractual relationship among the partners; they are all agents and principals of

each other. Expressly or impliedly that means no partner can disobey the partnership agreement or fail

to follow any properly made partnership decision. This includes the duty to act within the authority

expressly or impliedly given in the partnership agreement, and a partner is responsible to the other

partners for damages or losses arising from unauthorized activities.

Duty to Inform Copartners

As in the agency relationship, a partner is expected to inform copartners of notices and matters coming

to her attention that would be of interest to the partnership.

Duty to Account

The partnership—and necessarily the partners—have a duty to allow copartners and their agents access

to the partnership’s books and records and to provide “any information concerning the partnership’s

business and affairs reasonably required for the proper exercise of the partner’s rights and duties under

the partnership agreement [or this Act].”UPA, Sections 19 and 20; RUPA, Section 403. The fiduciary

standard is imposed upon the duty to account for “it any property, profit, or benefit derived by [a]

partner,” as noted in RUPA Section 404.RUPA, Section 404(1).

The Rights That Partners Have in a Partnership

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Necessarily, for every duty owed there is a correlative right. So, for example, if a partner has a duty to

account, the other partners and the partnership have a right to an accounting. Beyond that, partners

have recognized rights affecting the operation of the partnership.

Here we may call out the following salient rights: (1) to distributions of money, (2) to management, (3)

to choose copartners, (4) to property of the partnership, (5) to assign partnership interest, and (6) to

enforce duties and rights.

Rights to Distributions

The purpose of a partnership is ultimately to distribute “money or other property from a partnership to

a partner in the partner’s capacity.”RUPA, Section 101(3). There are, however, various types of money

distributions, including profits (and losses), indemnification, capital, and compensation.

Right to Profits (and Losses)

Profits and losses may be shared according to any formula on which the partners agree. For example,

the partnership agreement may provide that two senior partners are entitled to 35 percent each of the

profit from the year and the two junior partners are entitled to 15 percent each. The next year the

percentages will be adjusted based on such things as number of new clients garnered, number of

billable hours, or amount of income generated. Eventually, the senior partners might retire and each be

entitled to 2 percent of the firm’s income, and the previous junior partners become senior, with new

junior partners admitted.

If no provision is stated, then under RUPA Section 401(b), “each partner is entitled to an equal share of

the partnership profits and is chargeable with a share of the partnership losses in proportion to the

partner’s share of the profits.” Section 18(a) of the Uniform Partnership Act is to the same effect. The

right to share in the profits is the reason people want to “make partner”: a partner will reap the benefits

of other partners’ successes (and pay for their failures too). A person working for the firm who is not a

partner is an associate and usually only gets only a salary.

Right to Indemnification

A partner who incurs liabilities in the normal course of business or to preserve its business or property

is entitled to indemnification (UPA Section 18(b), RUPA Section 401(c)). The liability is a loan owing to

the partner by the firm.

Right to Return of Capital Contribution

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When a partner joins a partnership, she is expected to make a capital contribution to the firm; this may

be deducted from her share of the distributed profit and banked by the firm in its capital account. The

law provides that “the partnership must reimburse a partner for an advance of funds beyond the

amount of the partner’s agreed capital contribution, thereby treating the advance as a loan.”UPA,

Section 18(c); RUPA, Section 401(d). A partner may get a return of capital under UPA after creditors

are paid off if the business is wound down and terminated.UPA, Section 40(b); RUPA, Section 807(b).

Right to Compensation

Section 401(d) of RUPA provides that “a partner is not entitled to remuneration for services performed

for the partnership, except for reasonable compensation for services rendered in winding up the

business of the partnership”; UPA Section 18(f) is to the same effect. A partner gets his money from the

firm by sharing the profits, not by a salary or wages.

Right to Management

All partners are entitled to share equally in the management and conduct of the business, unless the

partnership agreement provides otherwise.UPA, Section 18(e); RUPA, Section 401(f). The partnership

agreement could be structured to delegate more decision-making power to one class of partners (senior

partners) than to others (junior partners), or it may give more voting weight to certain individuals. For

example, perhaps those with the most experience will, for the first four years after a new partner is

admitted, have more voting weight than the new partner.

Right to Choose Partners

A business partnership is often analogized to a marriage partnership. In both there is a relationship of

trust and confidence between (or among) the parties; in both the poor judgment, negligence, or

dishonesty of one can create liabilities on the other(s). In a good marriage or good partnership, the

partners are friends, whatever else the legal relationship imposes. Thus no one is compelled to accept a

partner against his or her will. Section 401(i) of RUPA provides, “A person may become a partner only

with the consent of all of the partners.” UPA Section 18(g) is to the same effect; the doctrine is called

delectus personae. The freedom to select new partners, however, is not absolute. In 1984, the

Supreme Court held that Title VII of the Civil Rights Act of 1964—which prohibits discrimination in

employment based on race, religion, national origin, or sex—applies to partnerships.Hishon v. King &

Spalding, 467 U.S. 69 (1984).

Right to Property of the Partnership

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Partners are the owners of the partnership, which might not include any physical property; that is, one

partner could contribute the building, furnishings, and equipment and rent those to the partnership (or

those could count as her partnership capital contribution and become the partnership’s). But

partnership property consists of all property originally advanced or contributed to the partnership or

subsequently acquired by purchase or contribution. Unless a contrary intention can be shown, property

acquired with partnership funds is partnership property, not an individual partner’s: “Property

acquired by a partnership is property of the partnership and not of the partners individually.”RUPA,

Section 203; UPA, Sections 8(1) and 25.

Rights in Specific Partnership Property: UPA Approach

Suppose that Able, who contributed the building and grounds on which the partnership business is

conducted, suddenly dies. Who is entitled to her share of the specific property, such as inventory, the

building, and the money in the cash register—her husband and children, or the other partners, Baker

and Carr? Section 25(1) of UPA declares that the partners hold the partnership property as tenants in

partnership. As spelled out in Section 25(2), the specific property interest of a tenant in partnership

vests in the surviving partners, not in the heirs. But the heirs are entitled to the deceased partner’s

interest in the partnership itself, so that while Baker and Carr may use the partnership property for the

benefit of the partnership without consulting Able’s heirs, they must account to her heirs for her proper

share of the partnership’s profits.

Rights in Specific Property: RUPA Approach

Section 501 of RUPA provides, “A partner is not a co-owner of partnership property and has no interest

in partnership property which can be transferred, either voluntarily or involuntarily.” Partnership

property is owned by the entity; UPA’s concept of tenants in partnership is abolished in favor of

adoption of the entity theory. The result, however, is not different.

Right to Assign Partnership Interest

One of the hallmarks of the capitalistic system is that people should be able to dispose of their property

interests more or less as they see fit. Partnership interests may be assigned to some extent.

Voluntary Assignment

At common law, assignment of a partner’s interest in the business—for example, as a mortgage in

return for a loan—would result in a legal dissolution of the partnership. Thus in the absence of UPA,

which changed the law, Baker’s decision to mortgage his interest in the car dealership in return for a

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$20,000 loan from his bank would mean that the three—Able, Baker, and Carr—were no longer

partners. Section 27 of UPA declares that assignment of an interest in the partnership neither dissolves

the partnership nor entitles the assignee “to interfere in the management or administration of the

partnership business or affairs, or to require any information or account of partnership transactions, or

to inspect the partnership books.” The assignment merely entitles the assignee to receive whatever

profits the assignor would have received—this is the assignor’s transferable interest.UPA, Section 26.

Under UPA, this interest is assignable.UPA, Section 27.

Under RUPA, the same distinction is made between a partner’s interest in the partnership and a

partner’s transferable interest. The Official Comment to Section 101 reads as follows: “‘Partnership

interest’ or ‘partner’s interest in the partnership’ is defined to mean all of a partner’s interests in the

partnership, including the partner’s transferable interest and all management and other rights. A

partner’s ‘transferable interest’ is a more limited concept and means only his share of the profits and

losses and right to receive distributions, that is, the partner’s economic interests.”RUPA, Official

Comment to Section 101.

This transferable interest is assignable under RUPA 503 (unless the partners agree to restrict transfers,

Section 103(a)). It does not, by itself, cause the dissolution of the partnership; it does not entitle the

transferee to access to firm information, to participate in running the firm, or to inspect or copy the

books. The transferee is entitled to whatever distributions the transferor partner would have been

entitled to, including, upon dissolution of the firm, the net amounts the transferor would have received

had there been no assignment.

RUPA Section 101(b)(3) confers standing on a transferee to seek a judicial dissolution and winding up

of the partnership business as provided in Section 801(6), thus continuing the rule of UPA Section

32(2). But under RUPA 601(4)(ii), the other partners may by unanimous vote expel a partner who has

made “a transfer of all or substantially all of that partner’s transferable interest in the partnership,

other than a transfer for security purposes [as for a loan].” Upon a creditor foreclosure of the security

interest, though, the partner may be expelled.

Involuntary Assignment

It may be a misnomer to describe an involuntary assignment as a “right”; it might better be thought of

as a consequence of the right to own property. In any event, if a partner is sued in his personal capacity

and a judgment is rendered against him, the question arises: may the judgment creditor seize

partnership property? Section 28 of UPA and RUPA Section 504 permit a judgment creditor to obtain a

charging order, which charges the partner’s interest in the partnership with obligation to satisfy the

judgment. The court may appoint a receiver to ensure that partnership proceeds are paid to the

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judgment creditor. But the creditor is not entitled to specific partnership property. The partner may

always pay off the debt and redeem his interest in the partnership. If the partner does not pay off the

debt, the holder of the charging order may acquire legal ownership of the partner’s interest. That

confers upon the judgment creditor an important power: he may, if the partnership is one at will,

dissolve the partnership and claim the partner’s share of the assets. For that reason, the copartners

might wish to redeem the interest—pay off the creditor—in order to preserve the partnership. As with

the voluntary assignment, the assignee of an involuntary assignment does not become a partner. See

Figure 19.1 “Property Rights”.

Figure 19.1 Property Rights

Right to Enforce Partnership Rights

The rights and duties imposed by partnership law are, of course, valueless unless they can be enforced.

Partners and partnerships have mechanisms under the law to enforce them.

Right to Information and Inspection of Books

We noted in Section 19.1.1 “Duties Partners Owe Each Other” of this chapter that partners have a duty

to account; the corollary right is the right to access books and records, which is usually very important

in determining partnership rights. Section 403(b) of RUPA provides, “A partnership shall provide

partners and their agents and attorneys access to its books and records. It shall provide former partners

and their agents and attorneys access to books and records pertaining to the period during which they

were partners. The right of access provides the opportunity to inspect and copy books and records

during ordinary business hours. A partnership may impose a reasonable charge, covering the costs of

labor and material, for copies of documents furnished.”RUPA Section 403(b).

Section 19 of UPA is basically in accord. This means that without demand—and for any purpose—the

partnership must provide any information concerning its business and affairs reasonably required for

the proper exercise of the partner’s rights and duties under the partnership agreement or the act; and

on demand, it must provide any other information concerning the partnership’s business and affairs,

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unless the demand is unreasonable or improper.RUPA, Section 403(c)(1); RUPA, Section 403(c)(2).

Generally, the partnership agreement cannot deny the right to inspection.

The duty to account mentioned in Section 19.1.1 “Duties Partners Owe Each Other” of this chapter

normally means that the partners and the partnership should keep reasonable records so everyone can

tell what is going on. A formal accounting under UPA is different.

Under UPA Section 22, any partner is entitled to a formal account (or accounting) of the partnership

affairs under the following conditions:

1. If he is wrongfully excluded from the partnership business or possession of its property by his

copartners;

2. If the right exists under the terms of any agreement;

3. If a partner profits in violation of his fiduciary duty (as per UPA 22); and

4. Whenever it is otherwise just and reasonable.

At common law, partners could not obtain an accounting except in the event of dissolution. But from an

early date, equity courts would appoint a referee, auditor, or special master to investigate the books of a

business when one of the partners had grounds to complain, and UPA broadened considerably the right

to an accounting. The court has plenary power to investigate all facets of the business, evaluate claims,

declare legal rights among the parties, and order money judgments against any partner in the wrong.

Under RUPA Section 405, this “accounting” business is somewhat modified. Reflecting the entity

theory, the partnership can sue a partner for wrongdoing, which is not allowed under UPA. Moreover,

to quote from the Official Comment, RUPA “provides that, during the term of the partnership, partners

may maintain a variety of legal or equitable actions, including an action for an accounting, as well as a

final action for an accounting upon dissolution and winding up. It reflects a new policy choice that

partners should have access to the courts during the term of the partnership to resolve claims against

the partnership and the other partners, leaving broad judicial discretion to fashion appropriate

remedies[, and] an accounting is not a prerequisite to the availability of the other remedies a partner

may have against the partnership or the other partners.”RUPA Official Comment 2, Section 405(b).

KEY TAKEAWAY

Partners have important duties in a partnership, including (1) the duty to serve—that is, to devote herself

to the work of the partnership; (2) the duty of loyalty, which is informed by the fiduciary standard: the

obligation to act always in the best interest of the partnership and not in one’s own best interest; (3) the

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duty of care—that is, to act as a reasonably prudent partner would; (4) the duty of obedience not to

breach any aspect of the agreement or act without authority; (5) the duty to inform copartners; and (6)

the duty to account to the partnership.

Partners also have rights. These include the rights (1) to distributions of money, including profits (and

losses), indemnification, and return of capital contribution (but not a right to compensation); (2) to

management; (3) to choose copartners; (4) to property of the partnership, and no partner has any rights

to specific property; (5) to assign (voluntarily or involuntarily) the partnership interest; and (6) to enforce

duties and rights by suits in law or equity. (Under RUPA, a formal accounting is not first required.)

EXERCISES

1. What is the “fiduciary duty,” and why is it imposed on some partners’ actions with the partnership?

2. Distinguish between ownership of partnership property under UPA as opposed to under RUPA.

3. Carlos obtained a judgment against Pauline, a partner in a partnership, for negligently crashing her

car into Carlos’s while she was not in the scope of partnership business. Carlos wants to satisfy the

judgment from her employer. How can Carlos do that?

4. What is the difference between the duty to account and a formal partnership accounting?

5. What does it mean to say a partnership interest has been involuntarily assigned?

19.2 Operation: The Partnership and Third Parties

LEARNING OBJECTIVES

1. Understand the partners’ and partnership’s contract liability.

2. Understand the partners’ and partnership’s tort and criminal liability.

3. Describe the partners’ and partnership’s tax liability.

By express terms, the law of agency applies to partnership law. Every partner is an agent of the

partnership for the purpose of its business. Consequently, the following discussion will be a review of

agency law, covered in Chapter 18 “Partnerships: General Characteristics and Formation” as it applies

to partnerships. The Revised Uniform Partnership Act (RUPA) adds a few new wrinkles to the liability

issue.

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Contract Liability

Liability of the Partnership

Recall that an agent can make contracts on behalf of a principal under three types of authority: express,

implied, and apparent. Express authority is that explicitly delegated to the agent, implied authority is

that necessary to the carrying out of the express authority, and apparent authority is that which a third

party is led to believe has been conferred by the principal on the agent, even though in fact it was not or

it was revoked. When a partner has authority, the partnership is bound by contracts the partner makes

on its behalf. Section 19.4.2 “Partnership Authority, Express or Apparent”, Hodge v. Garrett, discusses

all three types of authority.

The General Rule

Section 305 of RUPA restates agency law: “A partnership is liable for loss or injury, or for a penalty

incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in

the ordinary course”RUPA Section 305. of partnership business or with its authority. The ability of a

partner to bind the partnership to contract liability is problematic, especially where the authority is

apparent: the firm denies liability, lawsuits ensue, and unhappiness generally follows.

But the firm is not liable for an act not apparently in the ordinary course of business, unless the act was

authorized by the others.RUPA, Section 301(2); UPA, Section 9(2). Section 401(j) of RUPA requires the

unanimous consent of the partners for a grant of authority outside the ordinary course of business,

unless the partnership agreement provides otherwise.

Under the Uniform Partnership Act (UPA) Section 9(3), the firm is not liable for five actions that no

single partner has implied or apparent authority to do, because they are not “in the ordinary course of

partnership.” These actions are: (1) assignment of partnership property for the benefit of creditors, (2)

disposing of the firm’s goodwill (selling the right to do business with the firm’s clients to another

business), (3) actions that make it impossible to carry on the business, (4) confessing a judgment

against the partnership, and (5) submitting a partnership claim or liability. RUPA omits that section,

leaving it to the courts to decide the outer limits of the agency power of a partner. In any event,

unauthorized actions by a partner may be ratified by the partnership.

Partnership “Statements”

New under RUPA is the ability of partnerships, partners, or even nonpartners to issue and file

“statements” that announce to the world the establishment or denial of authority. The goal here is to

control the reach of apparent authority. There are several kinds of statements authorized.

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A statement of partnership authority is allowed by RUPA Section 303. It specifies the names of

the partners authorized, or not authorized, to enter into transactions on behalf of the partnership and

any other matters. The most important goal of the statement of authority is to facilitate the transfer of

real property held in the name of the partnership. A statement must specify the names of the partners

authorized to execute an instrument transferring that property.

A statement of denial, RUPA Section 304, operates to allow partners (and persons named as

partners) an opportunity to deny any fact asserted in a statement of partnership authority.

A statement of dissociation, RUPA Section 704, may be filed by a partnership or a dissociated

partner, informing the world that the person is no longer a partner. This tells the world that the named

person is no longer in the partnership.

There are three other statements authorized: a statement of qualification establishes that the

partnership has satisfied all conditions precedent to the qualification of the partnership as a limited

liability partnership; a statement of foreign qualification means a limited liability partnership is

qualified and registered to do business in a state other than that in which it is originally registered; and

a statement of amendment or cancellation of any of the foregoing.RUPA, Section 1001(d); RUPA,

Section 1102. Limited liability partnerships are taken up in Chapter 20 “Hybrid Business Forms”.

Generally, RUPA Section 105 allows partnerships to file these statements with the state secretary of

state’s office; those affecting real estate need to be filed with (or also with) the local county land

recorder’s office. The notices bind those who know about them right away, and they are constructive

notice to the world after ninety days as to authority to transfer real property in the partnership’s name,

as to dissociation, and as to dissolution. However, as to other grants or limitations of authority, “only a

third party who knows or has received a notification of a partner’s lack of authority in an ordinary

course transaction is bound.”RUPA, Section 303, Comment 3.

Since RUPA is mostly intended to provide the rules for the small, unsophisticated partnership, it is

questionable whether these arcane “statements” are very often employed.

Personal Liability of Partners, in General

It is clear that the partnership is liable for contracts by authorized partners, as discussed in the

preceding paragraphs. The bad thing about the partnership as a form of business organization is that it

imposes liability on the partners personally and without limit. Section 306 of RUPA provides that “all

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partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by

the claimant or provided by law.”RUPA, Section 306. Section 13 of UPA is in accord.

Liability of Existing Partners

Contract liability is joint and several: that is, all partners are liable (“joint”) and each is “several.” (We

usually do not use several in modern English to mean “each”; it’s an archaic usage.) But—and here’s the

intrusion of entity theory—generally RUPA requires the judgment creditor to exhaust the partnership’s

assets before going after the separate assets of a partner. Thus under RUPA the partners are

guarantors of the partnership’s liabilities.RUPA Section 306.

Under UPA, contract liability is joint only, not also several. This means the partners must be sued in a

joint action brought against them all. A partner who is not named cannot later be sued by a creditor in a

separate proceeding, though the ones who were named could see a proportionate contribution from the

ones who were not.

Liability of Incoming Partners

Under RUPA Section 306(b), a new partner has no personal liability to existing creditors of the

partnership, and only her capital investment in the firm is at risk for the satisfaction of existing

partnership debts. Sections 17 and 41(7) of UPA are in accord. But, again, under either statute a new

partner’s personal assets are at risk with respect to partnership liabilities incurred after her admission

as a partner. This is a daunting prospect, and it is the reason for the invention of hybrid forms of

business organization: limited partnerships, limited liability companies, and limited liability

partnerships. The corporate form, of course, also (usually) obviates the owners’ personal liability.

Tort and Criminal Liability

Partnership Liability for Torts

The rules affecting partners’ tort liability (discussed in Section 19.2.1 “Contract Liability”) and those

affecting contract liability are the same. Section 13 of UPA says the partnership is liable for “any

wrongful act or omission of any partner acting in the ordinary course of the business of the partnership

or with the authority of his co-partners.”UPA, Section 13.A civil “wrongful act” is necessarily either a

tort or a breach of contract, so no distinction is made between them. (Section 305 of RUPA changed the

phraseology slightly by adding after any wrongful act or omission the words or other actionable

conduct; this makes the partnership liable for its partner’s no-fault torts.) That the principal should be

liable for its agents’ wrongdoings is of course basic agency law. RUPA does expand liability by allowing

a partner to sue during the term of the partnership without first having to get out of it, as is required

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under UPA.

For tortious acts, the partners are said to be jointly and severally liable under both UPA and RUPA, and

the plaintiff may separately sue one or more partners. Even after winning a judgment, the plaintiff may

sue other partners unnamed in the original action. Each and every partner is separately liable for the

entire amount of the debt, although the plaintiff is not entitled to recover more than the total of his

damages. The practical effect of the rules making partners personally liable for partnership contracts

and torts can be huge. In his classic textbook Economics, Professor Paul Samuelson observed that

unlimited liability “reveals why partnerships tend to be confined to small, personal enterprises.…When

it becomes a question of placing their personal fortunes in jeopardy, people are reluctant to put their

capital into complex ventures over which they can exercise little control.…In the field of investment

banking, concerns like JPMorgan Chase used to advertise proudly ‘not incorporated’ so that their

creditors could have extra assurance. But even these concerns have converted themselves into

corporate entities.”Paul A. Samuelson, Economics (New York: McGraw-Hill, 1973), 106.

Partners’ Personal Liability for Torts

Of course, a person is always liable for his own torts. All partners are also liable for any partner’s tort

committed in the scope of partnership business under agency law, and this liability is—again—personal

and unlimited, subject to RUPA’s requirement that the judgment creditor exhaust the partnership’s

assets before going after the separate assets of the partners. The partner who commits a tort or breach

of trust must indemnify the partnership for losses paid to the third party.RUPA, Section 405(a).

Liability for Crimes

Criminal liability is generally personal to the miscreant. Nonparticipating copartners are ordinarily not

liable for crimes if guilty intent is an element. When guilty intent is not an element, as in certain

regulatory offenses, all partners may be guilty of an act committed by a partner in the course of the

business.

Liability for Taxes

Corporate income gets taxed twice under federal law: once to the corporation and again to the

shareholders who receive income as dividends. However, the partnership’s income “passes through” the

partnership and is distributed to the partners under the conduit theory. When partners get income

from the firm they have to pay tax on it, but the partnership pays no tax (it files an information return).

This is perceived to be a significant advantage of the partnership form.

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KEY TAKEAWAY

The partnership is generally liable for any contract made by a partner with authority express, implied, or

apparent. Under RUPA the firm, partners, or even nonpartners may to some extent limit their liability by

filing “statements” with the appropriate state registrar; such statements only affect those who know of

them, except that a notice affecting the right of a partner to sell real estate or regarding dissociation or

dissolution is effective against the world after ninety days.

All partners are liable for contracts entered into and torts committed by any partner acting in or

apparently in the normal course of business. This liability is personal and unlimited, joint and several

(although under UPA contract liability it is only joint). Incoming partners are not liable, in contract or in

tort, for activities predating their arrival, but their capital contribution is at risk. Criminal liability is

generally personal unless the crime requires no intention.

EXERCISES

1. What is the partnership’s liability for contracts entered into by its partners?

2. What is the personal liability of partners for breach of a contract made by one of the partnership’s

members?

3. Why would people feel more comfortable knowing that JPMorgan Bank—Morgan was at one time

the richest man in the United States—was a partnership and not a corporation?

4. What is the point of RUPA’s “statements”? How can they be of use to a partner who has, for

example, retired and is no longer involved in the firm?

5. Under what circumstances is the partnership liable for crimes committed by its partners?

6. How is a partnership taxed more favorably than a corporation?

19.3 Dissolution and Winding Up

LEARNING OBJECTIVES

1. Understand the dissolution of general partnerships under the Uniform Partnership Act (UPA).

2. Understand the dissociation and dissolution of general partnerships under the Revised Uniform

Partnership Act (RUPA).

3. Explain the winding up of partnerships under UPA and RUPA.

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It is said that a partnership is like a marriage, and that extends to its ending too. It’s easier to get into a

partnership than it is to get out of it because legal entanglements continue after a person is no longer a

partner. The rules governing “getting out” of a partnership are different under the Revised Uniform

Partnership Act (RUPA) than under the Uniform Partnership Act (UPA). We take up UPA first.

Dissolution of Partnerships under UPA

Dissolution, in the most general sense, means a separation into component parts.

Meaning of Dissolution under UPA

People in business are sometimes confused about the meaning of dissolution. It does not mean the

termination of a business. It has a precise legal definition, given in UPA Section 29: “The dissolution of

a partnership is the change in the relation of the partners caused by any partner ceasing to be

associated in the carrying on as distinguished from the winding up of the business.” The partnership is

not necessarily terminated on dissolution; rather, it continues until the winding up of partnership

affairs is completed, and the remaining partners may choose to continue on as a new partnership if they

want.UPA, Section 30. But, again, under UPA the partnership dissolves upon the withdrawal of any

partner.

Causes of Dissolution

Partnerships can dissolve for a number of reasons.UPA, Section 31.

In Accordance with the Agreement

The term of the partnership agreement may have expired or the partnership may be at will and one of

the partners desires to leave it. All the partners may decide that it is preferable to dissolve rather than

to continue. One of the partners may have been expelled in accordance with a provision in the

agreement. In none of these circumstances is the agreement violated, though its spirit surely might

have been. Professor Samuelson calls to mind the example of William Dean Howells’s Silas Lapham,

who forces his partner to sell out by offering him an ultimatum: “You may buy me out or I’ll buy you

out.” The ultimatum was given at a time when the partner could not afford to buy Lapham out, so the

partner had no choice.

In Violation of the Agreement

Dissolution may also result from violation of the agreement, as when the partners decide to discharge a

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partner though no provision permits them to do so, or as when a partner decides to quit in violation of a

term agreement. In the former case, the remaining partners are liable for damages for wrongful

dissolution, and in the latter case, the withdrawing partner is liable to the remaining partners the same

way.

By Operation of Law

A third reason for dissolution is the occurrence of some event, such as enactment of a statute, that

makes it unlawful to continue the business. Or a partner may die or one or more partners or the entire

partnership may become bankrupt. Dissolution under these circumstances is said to be by operation of

law.UPA, Section 31.

By Court Order

Finally, dissolution may be by court order. Courts are empowered to dissolve partnerships when “on

application by or for a partner” a partner is shown to be a lunatic, of unsound mind, incapable of

performing his part of the agreement, “guilty of such conduct as tends to affect prejudicially the

carrying on of the business,” or otherwise behaves in such a way that “it is not reasonably practicable to

carry on the business in partnership with him.” A court may also order dissolution if the business can

only be carried on at a loss or whenever equitable. In some circumstances, a court will order dissolution

upon the application of a purchaser of a partner’s interest.UPA, Section 32.

Effect of Dissolution on Authority

For the most part, dissolution terminates the authority of the partners to act for the partnership. The

only significant exceptions are for acts necessary to wind up partnership affairs or to complete

transactions begun but not finished at the time of dissolution.UPA, Section 33. Notwithstanding the

latter exception, no partner can bind the partnership if it has dissolved because it has become unlawful

to carry on the business or if the partner seeking to exercise authority has become bankrupt.

After Dissolution

After a partnership has dissolved, it can follow one of two paths. It can carry on business as a new

partnership, or it can wind up the business and cease operating (see Figure 19.2 “Alternatives Following

UPA Dissolution”).

Figure 19.2 Alternatives Following UPA Dissolution

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Forming a New Partnership

In order to carry on the business as a new partnership, there must be an agreement—preferably as part

of the original partnership agreement but maybe only after dissolution (and maybe oral)—that upon

dissolution (e.g., if a partner dies, retires, or quits) the others will regroup and carry on.

Under UPA the remaining partners have the right to carry on when (1) the dissolution was in

contravention of the agreement, (2) a partner was expelled according to the partnership agreement, or

(3) all partners agree to carry on.UPA, Sections 37 and 38.

Whether the former partner dies or otherwise quits the firm, the noncontinuing one or his, her, or its

legal representative is entitled to an accounting and to be paid the value of the partnership interest, less

damages for wrongful dissolution.UPA, Section 38. The firm may need to borrow money to pay the

former partner or her estate; or, in the case of a deceased partner, the money to pay the former partner

is obtained through a life insurance buyout policy.

Partnerships routinely insure the lives of the partners, who have no ownership interests in the

insurance policies. The policies should bear a face amount equal to each partner’s interest in the

partnership and should be adjusted as the fortunes of the partnership change. Proceeds of the

insurance policy are used on death to pay the purchase price of the interest inherited by the deceased’s

estate. If the insurance policy pays out more than the interest at stake, the partnership retains the

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difference. If the policy pays out less, the partnership agrees to pay the difference in installments.

Another set of issues arises when the partnership changes because an old partner departs and a new

one joins. Suppose that Baker leaves the car dealership business and his interest is purchased by Alice,

who is then admitted to the partnership. Assume that when Baker left, the business owed Mogul Parts

Company $5,000 and Laid Back Upholsterers $4,000. After Baker left and Alice joined, Mogul sells

another $5,000 worth of parts to the firm on credit, and Sizzling Radiator Repair, a new creditor,

advances $3,000 worth of radiator repair parts. These circumstances pose four questions.

First, do creditors of the old partnership remain creditors of the new partnership? Yes.UPA, Section

41(1).

Second, does Baker, the old partner, remain liable to the creditors of the old partnership? Yes.UPA,

Section 36(1). That could pose uncomfortable problems for Baker, who may have left the business

because he lost interest in it and wished to put his money elsewhere. The last thing he wants is the

threat of liability hanging over his head when he can no longer profit from the firm’s operations. That is

all the more true if he had a falling out with his partners and does not trust them. The solution is given

in UPA Section 36(2), which says that an old partner is discharged from liability if the creditors and the

new partnership agree to discharge him.

Third, is Alice, the new partner, liable to creditors of the old partnership? Yes, but only to the extent of

her capital contribution.UPA, Section 17.

Fourth, is Baker, the old partner, liable for debts incurred after his withdrawal from the partnership?

Surprisingly, yes, unless Baker takes certain action toward old and new creditors. He must provide

actual notice that he has withdrawn to anyone who has extended credit in the past. Once he has done

so, he has no liability to these creditors for credit extended to the partnership thereafter. Of course, it

would be difficult to provide notice to future creditors, since at the time of withdrawal they would not

have had a relationship with the partnership. To avoid liability to new creditors who knew of the

partnership, the solution required under UPA Section 35(l)(b)(II) is to advertise Baker’s departure in a

general circulation newspaper in the place where the partnership business was regularly carried on.

Winding Up and Termination

Because the differences between UPA’s and RUPA’s provisions for winding up and termination are not

as significant as those between their provisions for dissolution, the discussion for winding up and

termination will cover both acts at once, following the discussion of dissociation and dissolution under

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RUPA.

Dissociation and Dissolution of Partnerships under RUPA

Comment 1 to RUPA Section 601 is a good lead-in to this section. According to the comment, RUPA

dramatically changes the law governing partnership breakups and dissolution. An entirely new concept,

“dissociation,” is used in lieu of UPA term “dissolution” to denote the change in the relationship caused

by a partner’s ceasing to be associated in the carrying on of the business. “Dissolution” is retained but

with a different meaning. The entity theory of partnership provides a conceptual basis for continuing

the firm itself despite a partner’s withdrawal from the firm.

Under UPA, the partnership is an aggregate, a collection of individuals; upon the withdrawal of any

member from the collection, the aggregate dissolves. But because RUPA conforms the partnership as an

entity, there is no conceptual reason for it to dissolve upon a member’s withdrawal. “Dissociation”

occurs when any partner ceases to be involved in the business of the firm, and “dissolution” happens

when RUPA requires the partnership to wind up and terminate; dissociation does not necessarily cause

dissolution.

Dissociation

Dissociation, as noted in the previous paragraph, is the change in relations caused by a partner’s

withdrawal from the firm’s business.

Causes of Dissociation

Dissociation is caused in ten possible ways: (1) a partner says she wants out; (2) an event triggers

dissociation as per the partnership agreement; (3) a partner is expelled as per the agreement; (4) a

partner is expelled by unanimous vote of the others because it is unlawful to carry on with that partner,

because that partner has transferred to a transferee all interest in the partnership (except for security

purposes), or because a corporate partner’s or partnership partner’s existence is effectively terminated;

(5) by a court order upon request by the partnership or another partner because the one expelled has

been determined to have misbehaved (engaged in serious wrongful conduct, persists in abusing the

agreement, acts in ways making continuing the business impracticable); (6) the partner has declared

bankruptcy; (7) the partner has died or had a guardian appointed, or has been adjudicated as

incompetent; (8) the partner is a trust whose assets are exhausted; (9) the partner is an estate and the

estate’s interest in the partnership has been entirely transferred; (10) the partner dies or, if the partner

is another partnership or a corporation trust or estate, that entity’s existence is terminated.RUPA,

Section 601.

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Effect of Dissociation

After a partner dissociates, the partner’s right to participate in management terminates. (However, if

the dissociation goes on to dissolution and winding up, partners who have not wrongfully caused the

dissociation may participate in winding-up activities.)RUPA. Sections 603(b) and 804(a). The

dissociated partner’s duty of loyalty and care terminates; the former partner may compete with the

firm, except for matters arising before the dissociation.RUPA, Section 603(b)(3).

When partners come and go, as they do, problems may arise. What power does the dissociated partner

have to bind the partnership? What power does the partnership have to impose liability on the

dissociated one? RUPA provides that the dissociated partner loses any actual authority upon

dissociation, and his or her apparent authority lingers for not longer than two years if the dissociated

one acts in a way that would have bound the partnership before dissociation, provided the other party

(1) reasonably believed the dissociated one was a partner, (2) did not have notice of the dissociation,

and (3) is not deemed to have constructive notice from a filed “statement of dissociation.”RUPA,

Section 603(b)(1). The dissociated partner, of course, is liable for damages to the partnership if third

parties had cause to think she was still a partner and the partnership became liable because of that; she

is liable to the firm as an unauthorized agent.RUPA, Section 702.

A partner’s dissociation does nothing to change that partner’s liability for predissociation

obligations.RUPA, Section 703(a). For postdissociation liability, exposure is for two years if at the time

of entering into the transaction the other party (1) reasonably believed the dissociated one was a

partner, (2) didn’t have notice of the dissociation, and (3) is not deemed to have constructive notice

from a filed “statement of dissociation.” For example, Baker withdraws from the firm of Able, Baker,

and Carr. Able contracts with HydroLift for a new hydraulic car lift that costs $25,000 installed.

HydroLift is not aware at the time of contracting that Baker is disassociated and believes she is still a

partner. A year later, the firm not having been paid, HydroLift sues Able, Baker, and Carr and the

partnership. Baker has potential liability. Baker could have protected herself by filing a “statement of

dissociation,” or—better—the partnership agreement should provide that the firm would file such

statements upon the dissociation of any partner (and if it does not, it would be liable to her for the

consequences).

Dissolution

Dissociation does not necessarily cause dissolution (see the discussion later in this section of how the

firm continues after a dissociation); dissolution and winding up happen only for the causes stated in

RUPA Section 801, discussed in the following paragraphs.

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Causes of Dissolution

There are three causes of dissolution: (1) by act of the partners—some dissociations do trigger

dissolution; (2) by operation of law; or (3) by court order. The partnership agreement may change or

eliminate the dissolution trigger as to (1); dissolution by the latter two means cannot be tinkered

with.RUPA, Section 103.

(1) Dissolution by act of the partners may occur as follows:

Any member of an at-will partnership can dissociate at any time, triggering dissolution and

liquidation. The partners who wish to continue the business of a term partnership, though,

cannot be forced to liquidate the business by a partner who withdraws prematurely in violation of

the partnership agreement. In any event, common agreement formats for dissolution will provide

for built-in dispute resolution, and enlightened partners often agree to such mechanisms in

advance to avoid the kinds of problems listed here.

Any partnership will dissolve upon the happening of an event the partners specified would cause

dissolution in their agreement. They may change their minds, of course, agree to continue, and

amend the partnership agreement accordingly.

A term partnership may be dissolved before its term expires in three ways. First, if a partner

dissociated by death, declaring bankruptcy, becoming incapacitated, or wrongfully dissociates, the

partnership will dissolve if within ninety days of that triggering dissociation at least half the

remaining partners express their will to wind it up. Second, the partnership may be dissolved if the

term expires. Third, it may be dissolved if all the partners agree to amend the partnership

agreement by expressly agreeing to dissolve.

(2) Dissolution will happen in some cases by operation of law if it becomes illegal to continue the

business, or substantially all of it. For example, if the firm’s business was the manufacture and

distribution of trans fats and it became illegal to do that, the firm would dissolve.Trans fats are

hydrogenated vegetable oils; the process of hydrogenation essentially turns the oils into semisolids,

giving them a higher melting point and extending their shelf life but, unfortunately, also clogging

consumers’ arteries and causing heart disease. California banned their sale effective January 1, 2010;

other jurisdictions have followed suit. This cause of dissolution is not subject to partnership agreement.

(3) Dissolution by court order can occur on application by a partner. A court may declare that it is, for

various reasons specified in RUPA Section 801(5), no longer reasonably practicable to continue

operation. Also, a court may order dissolution upon application by a transferee of a partner’s

transferable interest or by a purchaser at a foreclosure of a charging order if the court determines it is

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equitable. For example, if Creditor gets a charging order against Paul Partner and the obligation cannot

reasonably be paid by the firm, a court could order dissolution so Creditor would get paid from the

liquidated assets of the firm.

Effect of Dissolution

A partnership continues after dissolution only for the purpose of winding up its business. The

partnership is terminated when the winding up of its business is completed.RUPA, Section 802.

However, before winding up is completed, the partners—except any wrongfully dissociating—may agree

to carry on the partnership, in which case it resumes business as if dissolution never happened.RUPA,

Section 802(b).

Continuing after Dissociation

Dissociation, again, does not necessarily cause dissolution. In an at-will partnership, the death

(including termination of an entity partner), bankruptcy, incapacity, or expulsion of a partner will not

cause dissolution.RUPA, Sections 601 and 801. In a term partnership, the firm continues if, within

ninety days of an event triggering dissociation, fewer than half the partners express their will to wind

up. The partnership agreement may provide that RUPA’s dissolution-triggering events, including

dissociation, will not trigger dissolution. However, the agreement cannot change the rules that

dissolution is caused by the business becoming illegal or by court order. Creditors of the partnership

remain as before, and the dissociated partner is liable for partnership obligations arising before

dissociation.

Section 701 of RUPA provides that if the firm continues in business after a partner dissociates, without

winding up, then the partnership must purchase the dissociated partner’s interest; RUPA Section

701(b) explains how to determine the buyout price. It is the amount that would have been distributed to

the dissociated partner if, on the date of dissociation, the firm’s assets were sold “at a price equal to the

greater of the liquidation value or the value based on a sale of the entire business as a going concern,”

minus damages for wrongful dissociation. A wrongful dissociater may have to wait a while to get paid in

full, unless a court determines that immediate payment “will not cause an undue hardship to the

partnership,” but the longest nonwrongful dissociaters need to wait is 120 days.RUPA, Section 701(e). A

dissociated partner can sue the firm to determine the buyout price and the court may assess attorney’s,

appraiser’s, and expert’s fees against a party the court finds “acted arbitrarily, vexatiously, or in bad

faith.”RUPA, Section 701(h)(4)(i).

Winding Up the Partnership under UPA and RUPA

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Figure 19.3 Priority

Partnership

Liabilities under

RUPA

If the partners decide not to continue the business upon dissolution, they are obliged to wind up the

business. The partnership continues after dissolution only for the purpose of winding up its business,

after which it is terminated.UPA, Section 30; RUPA, Section 802(a). Winding up entails concluding

all unfinished business pending at the date of dissolution and payment of all debts. The partners must

then settle accounts among themselves in order to distribute the remaining assets. At any time after

dissolution and before winding up is completed, the partners (except a wrongfully dissociated one) can

stop the process and carry on the business.

UPA and RUPA are not significantly different as to winding up, so they will be discussed together. Two

issues are discussed here: who can participate in winding up and how the assets of the firm are

distributed on liquidation.

Who Can Participate in Winding Up

The partners who have not wrongfully dissociated may participate in winding up the partnership

business. On application of any partner, a court may for good cause judicially supervise the winding

up.UPA, Section 37; RUPA, Section 803(a).

Settlement of Accounts among Partners

Determining the priority of liabilities can be problematic. For instance, debts might be incurred to both

outside creditors and partners, who might have lent money to pay off certain accounts or for working

capital.

An agreement can spell out the order in which liabilities are to be paid, but if it does not, UPA Section

40(a) and RUPA Section 807(1) rank them in this order: (1) to creditors other than partners, (2) to

partners for liabilities other than for capital and profits, (3) to partners for capital contributions, and

finally (4) to partners for their share of profits (see Figure 19.3 “Priority Partnership Liabilities under

RUPA”). However, RUPA eliminates the distinction between capital and profits when the firm pays

partners what is owed to them; RUPA Section 807(b) speaks simply of the right of a partner to a

liquidating distribution.

Partners are entitled to share equally in the profits and surplus remaining

after all liabilities, including those owed to partners, are paid off, although

the partnership agreement can state a different share—for example, in

proportion to capital contribution. If after winding up there is a net loss,

whether capital or otherwise, each partner must contribute toward it in

accordance with his share in the profits, had there been any, unless the

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agreement states otherwise. If any of the partners is insolvent or refuses to

contribute and cannot be sued, the others must contribute their own share

to pay off the liabilities and in addition must contribute, in proportion to

their share of the profits, the additional amount necessary to pay the liabilities of their defaulting

partners.

In the event of insolvency, a court may take possession of both partnership property and individual

assets of the partners; this again is a big disadvantage to the partnership form.

The estate of a deceased partner is credited or liable as that partner would have been if she were living

at the time of the distribution.

KEY TAKEAWAY

Under UPA, the withdrawal of any partner from the partnership causes dissolution; the withdrawal may

be caused in accordance with the agreement, in violation of the agreement, by operation of law, or by

court order. Dissolution terminates the partners’ authority to act for the partnership, except for winding

up, but remaining partners may decide to carry on as a new partnership or may decide to terminate the

firm. If they continue, the old creditors remain as creditors of the new firm, the former partner remains

liable for obligations incurred while she was a partner (she may be liable for debts arising after she left,

unless proper notice is given to creditors), and the former partner or her estate is entitled to an

accounting and payment for the partnership interest. If the partners move to terminate the firm, winding

up begins.

Under RUPA, a partner who ceases to be involved in the business is dissociated, but dissociation does not

necessarily cause dissolution. Dissociation happens when a partner quits, voluntarily or involuntarily;

when a partner dies or becomes incompetent; or on request by the firm or a partner upon court order for

a partner’s wrongful conduct, among other reasons. The dissociated partner loses actual authority to

bind the firm but remains liable for predissociation obligations and may have lingering authority or

lingering liability for two years provided the other party thought the dissociated one was still a partner; a

notice of dissociation will, after ninety days, be good against the world as to dissociation and dissolution.

If the firm proceeds to termination (though partners can stop the process before its end), the next step is

dissolution, which occurs by acts of partners, by operation of law, or by court order upon application by a

partner if continuing the business has become untenable. After dissolution, the only business undertaken

is to wind up affairs. However, the firm may continue after dissociation; it must buy out the dissociated

one’s interest, minus damages if the dissociation was wrongful.

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If the firm is to be terminated, winding up entails finishing the business at hand, paying off creditors, and

splitting the remaining surplus or liabilities according the parties’ agreement or, absent any, according to

the relevant act (UPA or RUPA).

EXERCISES

1. Under UPA, what is the effect on the partnership of a partner’s ceasing to be involved in the

business?

2. Can a person no longer a partner be held liable for partnership obligations after her withdrawal? Can

such a person incur liability to the partnership?

3. What obligation does a partnership or its partners owe to a partner who wrongfully terminates the

partnership agreement?

4. What bearing does RUPA’s use of the term dissociate have on the entity theory that informs the

revised act?

5. When a partnership is wound up, who gets paid first from its assets? If the firm winds up toward

termination and has inadequate assets to pay its creditors, what recourse, if any, do the creditors

have?

19.4 Cases

Breach of Partnership Fiduciary Duty

Gilroy v. Conway

391 N.W. 2d 419 (Mich. App. 1986)

PETERSON, J.

Defendant cheated his partner and appeals from the trial court’s judgment granting that partner a

remedy.

Plaintiff was an established commercial photographer in Kalamazoo who also had a partnership

interest in another photography business, Colonial Studios, in Coldwater. In 1974, defendant became

plaintiff’s partner in Colonial Studios, the name of which was changed to Skylight Studios. Under the

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partnership agreement, defendant was to be the operating manager of the partnership, in return for

which he would have a guaranteed draw. Except for the guaranteed draw, the partnership was equal in

ownership and the sharing of profits.

Prior to defendant’s becoming a partner, the business had acquired a small contractual clientele of

schools for which the business provided student portrait photographs. The partners agreed to

concentrate on this type of business, and both partners solicited schools with success. Gross sales,

which were $40,000 in 1974, increased every year and amounted to $209,085 in 1980 [about $537,000

in 2011 dollars].

In the spring of 1981, defendant offered to buy out plaintiff and some negotiations followed. On June

25, 1981, however, plaintiff was notified by the defendant that the partnership was dissolved as of July

1, 1981. Plaintiff discovered that defendant: had closed up the partnership’s place of business and

opened up his own business; had purchased equipment and supplies in preparation for commencing

his own business and charged them to the partnership; and had taken with him the partnership

employees and most of its equipment.

Defendant had also stolen the partnership’s business. He had personally taken over the business of

some customers by telling them that the partnership was being dissolved; in other cases he simply took

over partnership contracts without telling the customers that he was then operating on his own.

Plaintiff also learned that defendant’s deceit had included the withdrawal, without plaintiff’s

knowledge, of partnership funds for defendant’s personal use in 1978 in an amount exceeding $11,000

[about $36,000 in 2011 dollars].

The trial judge characterized the case as a “classic study of greed” and found that defendant had in

effect appropriated the business enterprise, holding that defendant had “knowingly and willfully

violated his fiduciary relationship as a partner by converting partnership assets to his use and, in doing

so, literally destroying the partnership.” He also found that the partnership could have been sold as a

going business on June 30, 1981, and that after a full accounting, it had a value on that date of $94,596

less accounts payable of $17,378.85, or a net value of $77,217.15. The division thereof after adjustments

for plaintiff’s positive equity or capital resulted in an award to plaintiff for his interest in the business of

$53,779.46 [about $126,000 in 2011 dollars].…

Plaintiff also sought exemplary [punitive] damages. Count II of the complaint alleged that defendant’s

conduct constituted a breach of defendant’s fiduciary duty to his partner under §§ 19-22 of the Uniform

Partnership Act, and Count III alleged conversion of partnership property. Each count contained

allegations that defendant’s conduct was willful, wanton and in reckless disregard of plaintiff’s rights

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and that such conduct had caused injury to plaintiff’s feelings, including humiliation, indignity and a

sense of moral outrage. The prayer for relief sought exemplary damages therefore.

Plaintiff’s testimony on the point was brief. He said:

The effect of really the whole situation, and I think it was most apparent when I walked into the empty

building, was extreme disappointment and really total outrage at the fact that something that I had

given the utmost of my talent and creativity, energy, and whatever time was necessary to build, was

totally destroyed and there was just nothing of any value that was left.…My business had been stolen

and there wasn’t a thing that I could do about it. And to me, that was very humiliating that one day I

had something that I had worked 10 years on, and the next day I had absolutely nothing of any value.

As noted above, the trial judge found that defendant had literally destroyed the partnership by

knowingly and willfully converting partnership assets in violation of his fiduciary duty as a partner. He

also found that plaintiff had suffered a sense of outrage, indignity and humiliation and awarded him

$10,000 [$23,000 in 2011 dollars] as exemplary damages.

Defendant appeals from that award, asserting that plaintiff’s cause of action arises from a breach of the

partnership contract and that exemplary damages may not be awarded for breach of that contract.…

If it were to be assumed that a partner’s breach of his fiduciary duty or appropriation of partnership

equipment and business contract to his own use and profit are torts, it is clear that the duty breached

arises from the partnership contract. One acquires the property interest of a co-tenant in partnership

only by the contractual creation of a partnership; one becomes a fiduciary in partnership only by the

contractual undertaking to become a partner. There is no tortious conduct here existing independent of

the breach of the partnership contract.

Neither do we see anything in the Uniform Partnership Act to suggest that an aggrieved partner is

entitled to any remedy other than to be made whole economically. The act defines identically the

partnership fiduciary duty and the remedy for its breach, i.e., to account:

Sec. 21. (1) Every partner must account to the partnership for any benefit, and hold as trustee for it any

profits derived by him without the consent of the other partners from any transaction connected with

the formation, conduct, or liquidation of the partnership or from any use by him of its property.

So, the cases involving a partner’s breach of the fiduciary duty to their partners have been concerned

solely with placing the wronged partners in the economic position that they would have enjoyed but for

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the breach.

[Judgment for plaintiff affirmed, as modified with regard to damages.]

CASE QUESTIONS

1. For what did the court award the plaintiff $53,000?

2. The court characterizes the defendant as having “cheated his partner”—that is, Conway

committed fraud. (Gilroy said his business had been “stolen.”) Fraud is a tort. Punitive

damages may be awarded against a tortfeasor, even in a jurisdiction that generally disallows

punitive damages in contract. In fact, punitive damages are sometimes awarded for breach

of the partnership fiduciary duty. In Cadwalader, Wickersham & Taft v. Beasley, 728 So.2d

253 (Florida Ct. App., 1998), a New York law firm was found to have wrongfully expelled a

partner lawyer, Beasley, from membership in its Palm Beach, Florida, offices. New York law

controlled. The trial court awarded Beasley $500,000 in punitive damages. The appeals court,

construing the same UPA as the court construed in Gilroy, said:

Under New York law, the nature of the conduct which justifies an award of punitive damages

is conduct having a high degree of moral culpability, or, in other words, conduct which shows

a “conscious disregard of the rights of others or conduct so reckless as to amount to such

disregard.”…[S]ince the purpose of punitive damages is to both punish the wrongdoer and

deter others from such wrongful behavior, as a matter of policy, courts have the discretion to

award punitive damages[.]…[The defendant] was participating in a clandestine plan to

wrongfully expel some partners for the financial gain of other partners. Such activity cannot

be said to be honorable, much less to comport with the “punctilio of an honor.” Because

these findings establish that [the defendant] consciously disregarded the rights of Beasley,

we affirm the award of punitive damages.

As a matter of social policy, which is the better ruling, the Michigan court’s in Gilroy or the

Florida court’s in Cadwalader?

Partnership Authority, Express or Apparent

Hodge v Garrett

614 P.2d 420 (Idaho 1980)

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Bistline, J.

[Plaintiff] Hodge and defendant-appellant Rex E. Voeller, the managing partner of the Pay-Ont Drive-

In Theatre, signed a contract for the sale of a small parcel of land belonging to the partnership. That

parcel, although adjacent to the theater, was not used in theater operations except insofar as the east 20

feet were necessary for the operation of the theater’s driveway. The agreement for the sale of land stated

that it was between Hodge and the Pay-Ont Drive-In Theatre, a partnership. Voeller signed the

agreement for the partnership, and written changes as to the footage and price were initialed by

Voeller. (The trial court found that Hodge and Voeller had orally agreed that this 20 foot strip would be

encumbered by an easement for ingress and egress to the partnership lands.)

Voeller testified that he had told Hodge prior to signing that Hodge would have to present him with a

plat plan which would have to be approved by the partners before the property could be sold. Hodge

denied that a plat plan had ever been mentioned to him, and he testified that Voeller did not tell him

that the approval of the other partners was needed until after the contract was signed. Hodge also

testified that he offered to pay Voeller the full purchase price when he signed the contract, but Voeller

told him that that was not necessary.

The trial court found that Voeller had actual and apparent authority to execute the contract on behalf of

the partnership, and that the contract should be specifically enforced. The partners of the Pay-Ont

Drive-In Theatre appeal, arguing that Voeller did not have authority to sell the property and that Hodge

knew that he did not have that authority.

At common law one partner could not, “without the concurrence of his copartners, convey away the real

estate of the partnership, bind his partners by a deed, or transfer the title and interest of his copartners

in the firm real estate.” [Citation] This rule was changed by the adoption of the Uniform Partnership

Act.…[citing the statute].

The meaning of these provisions was stated in one text as follows:

“If record title is in the partnership and a partner conveys in the partnership name, legal title passes.

But the partnership may recover the property (except from a bona fide purchaser from the grantee) if it

can show (A) that the conveying partner was not apparently carrying on business in the usual way or

(B) that he had in fact no authority and the grantee had knowledge of that fact. The burden of proof

with respect to authority is thus on the partnership.” [Citation]

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Thus this contract is enforceable if Voeller had the actual authority to sell the property, or, even if

Voeller did not have such authority, the contract is still enforceable if the sale was in the usual way of

carrying on the business and Hodge did not know that Voeller did not have this authority.

As to the question of actual authority, such authority must affirmatively appear, “for the authority of

one partner to make and acknowledge a deed for the firm will not be presumed.…” [Citation] Although

such authority may be implied from the nature of the business, or from similar past transactions

[Citation], nothing in the record in this case indicates that Voeller had express or implied authority to

sell real property belonging to the partnership. There is no evidence that Voeller had sold property

belonging to the partnership in the past, and obviously the partnership was not engaged in the business

of buying and selling real estate.

The next question, since actual authority has not been shown, is whether Voeller was conducting the

partnership business in the usual way in selling this parcel of land such that the contract is binding

under [the relevant section of the statute] i.e., whether Voeller had apparent authority. Here the

evidence showed, and the trial court found:

1. “That the defendant, Rex E. Voeller, was one of the original partners of the Pay-Ont Drive In

Theatre; that the other defendants obtained their partnership interest by inheritance upon the

death of other original partners; that upon the death of a partner the partnership affairs were not

wound up, but instead, the partnership merely continued as before, with the heirs of the deceased

partner owning their proportionate share of the partnership interest.

2. “That at the inception of the partnership, and at all times thereafter, Rex E. Voeller was the

exclusive, managing partner of the partnership and had the full authority to make all decisions

pertaining to the partnership affairs, including paying the bills, preparing profit and loss

statements, income tax returns and the ordering of any goods or services necessary to the operation

of the business.”

The court made no finding that it was customary for Voeller to sell real property, or even personal

property, belonging to the partnership. Nor was there any evidence to this effect. Nor did the court

discuss whether it was in the usual course of business for the managing partner of a theater to sell real

property. Yet the trial court found that Voeller had apparent authority to sell the property. From this it

must be inferred that the trial court believed it to be in the usual course of business for a partner who

has exclusive control of the partnership business to sell real property belonging to the partnership,

where that property is not being used in the partnership business. We cannot agree with this

conclusion. For a theater, “carrying on in the usual way the business of the partnership,” [Citation to

relevant section of the statute] means running the operations of the theater; it does not mean selling a

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parcel of property adjacent to the theater. Here the contract of sale stated that the land belonged to the

partnership, and, even if Hodge believed that Voeller as the exclusive manager had authority to transact

all business for the firm, Voeller still could not bind the partnership through a unilateral act which was

not in the usual business of the partnership. We therefore hold that the trial court erred in holding that

this contract was binding on the partnership.

Judgment reversed. Costs to appellant.

CASE QUESTIONS

1. What was the argument that Voeller had actual authority? What did the court on appeal say about

that argument?

2. What was the argument that Voeller had apparent authority? What did the court on appeal say

about that argument? To rephrase the question, what facts would have been necessary to confer on

Voeller apparent authority?

Partnership Bound by Contracts Made by a Partner on Its Behalf; Partners’

Duties to Each Other; Winding Up

Long v. Lopez

115 S.W.3d 221 (Texas App. 2003)

Holman, J.

Wayne A. Long [plaintiff at the trial court] sued Appellee Sergio Lopez to recover from him, jointly and

severally, his portion of a partnership debt that Long had paid. After a bench trial, the trial court ruled

that Long take nothing from Appellee. We reverse and render, and remand for calculation of attorney’s

fees in this suit and pre- and post-judgment interest.

Long testified that in September 1996, Long, Lopez, and Don Bannister entered into an oral partnership

agreement in which they agreed to be partners in Wood Relo (“the partnership”), a trucking business

located in Gainesville, Texas. Wood Relo located loads for and dispatched approximately twenty trucks

it leased from owner-operators.…

The trial court found that Long, Lopez, and Bannister formed a partnership, Wood Relo, without a

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written partnership agreement. Lopez does not contest these findings.

Long testified that to properly conduct the partnership’s business, he entered into an office equipment

lease with IKON Capital Corporation (“IKON”) on behalf of the partnership. The lease was a thirty-

month contract under which the partnership leased a telephone system, fax machine, and photocopier

at a rate of $577.91 per month. The lease agreement was between IKON and Wood Relo; the

“authorized signer” was listed as Wayne Long, who also signed as personal guarantor.

Long stated that all three partners were authorized to buy equipment for use by the partnership. He

testified that the partners had agreed that it was necessary for the partnership to lease the equipment

and that on the day the equipment was delivered to Wood Relo’s office, Long was the only partner at

the office; therefore, Long was the only one available to sign the lease and personal guaranty that IKON

required. [The partnership disintegrated when Bannister left and he later filed for bankruptcy.]…Long

testified that when Bannister left Wood Relo, the partnership still had “quite a few” debts to pay,

including the IKON lease.…

Eventually, IKON did repossess all the leased equipment. Long testified that he received a demand

letter from IKON, requesting payment by Wood Relo of overdue lease payments and accelerating

payment of the remaining balance of the lease. IKON sought recovery of past due payments in the

amount of $2,889.55 and accelerated future lease payments in the amount of $11,558.20, for a total of

$14,447.75, plus interest, costs, and attorney’s fees, with the total exceeding $16,000. Long testified

that he advised Lopez that he had received the demand letter from IKON.

Ultimately, IKON filed a lawsuit against Long individually and d/b/a Wood Relo, but did not name

Lopez or Bannister as parties to the suit. Through his counsel, Long negotiated a settlement with IKON

for a total of $9,000. An agreed judgment was entered in conjunction with the settlement agreement

providing that if Long did not pay the settlement, Wood Relo and Long would owe IKON $12,000.

After settling the IKON lawsuit, Long’s counsel sent a letter to Lopez and Bannister regarding the

settlement agreement, advising them that they were jointly and severally liable for the $9,000 that

extinguished the partnership’s debt to IKON, plus attorney’s fees.…

The trial court determined that Long was not entitled to reimbursement from Lopez because Long was

not acting for the partnership when he settled IKON’s claim against the partnership. The court based its

conclusion on the fact that Long had no “apparent authority with respect to lawsuits” and had not

notified Lopez of the IKON lawsuit.

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Analysis

To the extent that a partnership agreement does not otherwise specify, the provisions of the Texas

Revised Partnership Act govern the relations of the partners and between the partners and the

partnership. [Citations] Under the Act, each partner has equal rights in the management and conduct

of the business of a partnership. With certain inapplicable exceptions, all partners are liable jointly and

severally for all debts and obligations of the partnership unless otherwise agreed by the claimant or

provided by law. A partnership may be sued and may defend itself in its partnership name. Each

partner is an agent of the partnership for the purpose of its business; unless the partner does not have

authority to act for the partnership in a particular matter and the person with whom the partner is

dealing knows that the partner lacks authority, an act of a partner, including the execution of an

instrument in the partnership name, binds the partnership if “the act is for apparently carrying on in

the ordinary course: (1) the partnership business.” [Citation] If the act of a partner is not apparently for

carrying on the partnership business, an act of a partner binds the partnership only if authorized by the

other partners. [Citation]

The extent of authority of a partner is determined essentially by the same principles as those measuring

the scope of the authority of an agent. [Citation] As a general rule, each partner is an agent of the

partnership and is empowered to bind the partnership in the normal conduct of its business. [Citation]

Generally, an agent’s authority is presumed to be coextensive with the business entrusted to his care.

[Citations] An agent is limited in his authority to such contracts and acts as are incident to the

management of the particular business with which he is entrusted. [Citation]

Winding Up the Partnership

A partner’s duty of care to the partnership and the other partners is to act in the conduct and winding

up of the partnership business with the care an ordinarily prudent person would exercise in similar

circumstances. [Citation] During the winding up of a partnership’s business, a partner’s fiduciary duty

to the other partners and the partnership is limited to matters relating to the winding up of the

partnership’s affairs. [Citation]

Long testified that he entered into the settlement agreement with IKON to save the partnership a

substantial amount of money. IKON’s petition sought over $16,000 from the partnership, and the

settlement agreement was for $9,000; therefore, Long settled IKON’s claim for 43% less than the

amount for which IKON sued the partnership.

Both Long and Lopez testified that the partnership “fell apart,” “virtually was dead,” and had to move

elsewhere.…The inability of the partnership to continue its trucking business was an event requiring the

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partners to wind up the affairs of the partnership. See [Citation]…

The Act provides that a partner winding up a partnership’s business is authorized, to the extent

appropriate for winding up, to perform the following in the name of and for and on behalf of the

partnership:

(1) prosecute and defend civil, criminal, or administrative suits;

(2) settle and close the partnership’s business;

(3) dispose of and convey the partnership’s property;

(4) satisfy or provide for the satisfaction of the partnership’s liabilities;

(5) distribute to the partners any remaining property of the partnership; and

(6) perform any other necessary act. [Citation]

Long accrued the IKON debt on behalf of the partnership when he secured the office equipment for

partnership operations, and he testified that he entered into the settlement with IKON when the

partnership was in its final stages and the partners were going their separate ways. Accordingly, Long

was authorized by the Act to settle the IKON lawsuit on behalf of the partnership.…

Lopez’s Liability for the IKON Debt

If a partner reasonably incurs a liability in excess of the amount he agreed to contribute in properly

conducting the business of the partnership or for preserving the partnership’s business or property, he

is entitled to be repaid by the partnership for that excess amount. [Citation] A partner may sue another

partner for reimbursement if the partner has made such an excessive payment. [Citation]

With two exceptions not applicable to the facts of this case, all partners are liable jointly and severally

for all debts and obligations of the partnership unless otherwise agreed by the claimant or provided by

law. Because Wood Relo was sued for a partnership debt made in the proper conduct of the partnership

business, and Long settled this claim in the course of winding up the partnership, he could maintain an

action against Lopez for reimbursement of Long’s disproportionate payment. [Citations]

Attorneys’ Fees

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Long sought to recover the attorney’s fees expended in defending the IKON claim, and attorney’s fees

expended in the instant suit against Lopez. Testimony established that it was necessary for Long to

employ an attorney to defend the action brought against the partnership by IKON; therefore, the

attorney’s fees related to defending the IKON lawsuit on behalf of Wood Relo are a partnership debt for

which Lopez is jointly and severally liable. As such, Long is entitled to recover from Lopez one-half of

the attorney’s fees attributable to the IKON lawsuit. The evidence established that reasonable and

necessary attorney’s fees to defend the IKON lawsuit were $1725. Therefore, Long is entitled to recover

from Lopez $862.50.

Long also seeks to recover the attorney’s fees expended pursuing the instant lawsuit. See [Texas statute

citation] (authorizing recovery of attorney’s fees in successful suit under an oral contract); see also

[Citation] (holding attorney’s fees are recoverable by partner under because action against other

partner was founded on partnership agreement, which was a contract). We agree that Long is entitled

to recover reasonable and necessary attorney’s fees incurred in bringing the instant lawsuit. Because we

are remanding this case so the trial court can determine the amount of pre- and post-judgment interest

to be awarded to Long, we also remand to the trial court the issue of the amount of attorney’s fees due

to Long in pursuing this lawsuit against Lopez for collection of the amount paid to IKON on behalf of

the partnership.

Conclusion

We hold the trial court erred in determining that Long did not have authority to act for Wood Relo in

defending, settling, and paying the partnership debt owed by Wood Relo to IKON. Lopez is jointly and

severally liable to IKON for $9,000, which represents the amount Long paid IKON to defend and

extinguish the partnership debt. We hold that Lopez is jointly and severally liable to Long for $1725,

which represents the amount of attorney’s fees Long paid to defend against the IKON claim. We further

hold that Long is entitled to recover from Lopez reasonable and necessary attorney’s fees in pursuing

the instant lawsuit.

We reverse the judgment of the trial court. We render judgment that Lopez owes Long $5362.50 (one-

half of the partnership debt to IKON plus one-half of the corresponding attorney’s fees). We remand

the case to the trial court for calculation of the amount of attorney’s fees owed by Lopez to Long in the

instant lawsuit, and calculation of pre- and post-judgment interest.

CASE QUESTIONS

1. Why did the trial court determine that Lopez owed Long nothing?

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2. Absent a written partnership agreement, what rules control the operation and winding up of the

partnership?

3. Why did the appeals court determine that Long did have authority to settle the lawsuit with IKON?

4. Lopez was not named by IKON when it sued Long and the partnership. Why did the court determine

that did not matter, that Lopez was still liable for one-half the costs of settling that case?

5. Why was Long awarded compensation for the attorneys’ fees expended in dealing with the IKON

matter and in bringing this case?

Dissolution under RUPA

Horizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc.

732 So.2d 1156 (Fla. App. 1999)

Goshorn, J.

Horizon is a large, publicly traded provider of both nursing home facilities and management for

nursing home facilities. It wanted to expand into Osceola County in 1993. Southern Oaks was already

operating in Osceola County[.]…Horizon and Southern Oaks decided to form a partnership to own the

proposed [new] facility, which was ultimately named Royal Oaks, and agreed that Horizon would

manage both the Southern Oaks facility and the new Royal Oaks facility. To that end, Southern Oaks

and Horizon entered into several partnership and management contracts in 1993.

In 1996, Southern Oaks filed suit alleging numerous defaults and breaches of the twenty-year

agreements.…[T]he trial court found largely in favor of Southern Oaks, concluding that Horizon

breached its obligations under two different partnership agreements [and that] Horizon had breached

several management contracts. Thereafter, the court ordered that the partnerships be dissolved, finding

that “the parties to the various agreements which are the subject of this lawsuit are now incapable of

continuing to operate in business together” and that because it was dissolving the partnerships, “there

is no entitlement to future damages.…” In its cross appeal, Southern Oaks asserts that because Horizon

unilaterally and wrongfully sought dissolution of the partnerships, Southern Oaks should receive a

damage award for the loss of the partnerships’ seventeen remaining years’ worth of future profits. We

reject its argument.

Southern Oaks argues Horizon wrongfully caused the dissolution because the basis for dissolution cited

by the court is not one of the grounds for which the parties contracted. The pertinent contracts

provided in section 7.3 “Causes of Dissolution”: “In addition to the causes for dissolution set forth in

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Section 7.2(c), the Partnership shall be dissolved in the event that:…(d) upon thirty (30) days prior

written notice to the other Partner, either Partner elects to dissolve the Partnership on account of an

Irreconcilable Difference which arises and cannot, after good faith efforts, be resolved.…”

Southern Oaks argues that what Horizon relied on at trial as showing irreconcilable differences—the

decisions of how profits were to be determined and divided—were not “good faith differences of

opinion,” nor did they have “a material and adverse impact on the conduct of the Partnerships’

Business.” Horizon’s refusal to pay Southern Oaks according to the terms of the contracts was not an

“irreconcilable difference” as defined by the contract, Southern Oaks asserts, pointing out that

Horizon’s acts were held to be breaches of the contracts. Because there was no contract basis for

dissolution, Horizon’s assertion of dissolution was wrongful, Southern Oaks concludes.

Southern Oaks contends further that not only were there no contractual grounds for dissolution,

dissolution was also wrongful under the Florida Statutes. Southern Oaks argues that pursuant to

section [of that statute] Horizon had the power to dissociate from the partnership, but, in the absence

of contract grounds for the dissociation, Horizon wrongfully dissociated. It asserts that it is entitled to

lost future profits under Florida’s partnership law.…

We find Southern Oaks’ argument without merit. First, the trial court’s finding that the parties are

incapable of continuing to operate in business together is a finding of “irreconcilable differences,” a

permissible reason for dissolving the partnerships under the express terms of the partnership

agreements. Thus, dissolution was not “wrongful,” assuming there can be “wrongful” dissolutions, and

Southern Oaks was not entitled to damages for lost future profits. Additionally, the partnership

contracts also permit dissolution by “judicial decree.” Although neither party cites this provision, it

appears that pursuant thereto, the parties agreed that dissolution would be proper if done by a trial

court for whatever reason the court found sufficient to warrant dissolution.

Second, even assuming the partnership was dissolved for a reason not provided for in the partnership

agreements, damages were properly denied. Under RUPA, it is clear that wrongful dissociation triggers

liability for lost future profits. See [RUPA:] “A partner who wrongfully dissociates is liable to the

partnership and to the other partners for damages caused by the dissociation. The liability is in addition

to any other obligation of the partner to the partnership or to the other partners.” However, RUPA does

not contain a similar provision for dissolution; RUPA does not refer to the dissolutions as rightful or

wrongful. [RUPA sets out] “Events causing dissolution and winding up of partnership business,” [and]

outlines the events causing dissolution without any provision for liability for damages.…[RUPA]

recognizes judicial dissolution:

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A partnership is dissolved, and its business must be wound up, only upon the occurrence of any of the

following events:…

(5) On application by a partner, a judicial determination that:

(a) The economic purpose of the partnership is likely to be unreasonably frustrated;

(b) Another partner has engaged in conduct relating to the partnership business which makes it not

reasonably practicable to carry on the business in partnership with such partner; or

(c) It is not otherwise reasonably practicable to carry on the partnership business in conformity with

the partnership agreement[.]…

Paragraph (5)(c) provides the basis for the trial court’s dissolution in this case. While “reasonably

practicable” is not defined in RUPA, the term is broad enough to encompass the inability of partners to

continue working together, which is what the court found.

Certainly the law predating RUPA allowed for recovery of lost profits upon the wrongful dissolution of a

partnership. See e.g., [Citation]: “A partner who assumes to dissolve the partnership before the end of

the term agreed on in the partnership articles is liable, in an action at law against him by his co-partner

for the breach of the agreement, to respond in damages for the value of the profits which the plaintiff

would otherwise have received.”

However, RUPA brought significant changes to partnership law, among which was the adoption of the

term “dissociation.” Although the term is undefined in RUPA, dissociation appears to have taken the

place of “dissolution” as that word was used pre-RUPA. “Dissolution” under RUPA has a different

meaning, although the term is undefined in RUPA. It follows that the pre-RUPA cases providing for

future damages upon wrongful dissolution are no longer applicable to a partnership dissolution. In

other words a “wrongful dissolution” referred to in the pre-RUPA case law is now, under RUPA, known

as “wrongful dissociation.” Simply stated, under [RUPA], only when a partner dissociates and the

dissociation is wrongful can the remaining partners sue for damages. When a partnership is dissolved,

RUPA…provides the parameters of liability of the partners upon dissolution.…

[Citation]: “Dissociation is not a condition precedent to dissolution.…Most dissolution events are

dissociations. On the other hand, it is not necessary to have a dissociation to cause a dissolution and

winding up.”

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Southern Oaks’ attempt to bring the instant dissolution under the statute applicable to dissociation is

rejected. The trial court ordered dissolution of the partnership, not the dissociation of Horizon for

wrongful conduct. There no longer appears to be “wrongful” dissolution—either dissolution is provided

for by contract or statute or the dissolution was improper and the dissolution order should be reversed.

In the instant case, because the dissolution either came within the terms of the partnership agreements

or [RUPA] (judicial dissolution where it is not reasonably practicable to carry on the partnership

business), Southern Oaks’ claim for lost future profits is without merit. Affirmed.

CASE QUESTIONS

1. Under RUPA, what is a dissociation? What is a dissolution?

2. Why did Southern Oaks claim there was no contractual basis for dissolution, notwithstanding the

determination that Horizon had breached the partnership agreement and the management

contract?

3. Given those findings, what did Southern Oaks not get at the lower-court trial that it wanted on this

appeal?

4. Why didn’t Southern Oaks get what it wanted on this appeal?

19.5 Summary and Exercises

Summary

Most of the Uniform Partnership Act (UPA) and Revised Uniform Partnership Act (RUPA) rules

apply only in the absence of agreement among the partners. Under both, unless the agreement

states otherwise, partners have certain duties: (1) the duty to serve—that is, to devote themselves to

the work of the partnership; (2) the duty of loyalty, which is informed by the fiduciary standard: the

obligation to act always in the best interest of the partnership and not in one’s own best interest;

(3) the duty of care—that is, to act as a reasonably prudent partner would; (4) the duty of obedience

not to breach any aspect of the agreement or act without authority; (5) the duty to inform

copartners; and (6) the duty to account to the partnership. Ordinarily, partners operate through

majority vote, but no act that contravenes the partnership agreement itself can be undertaken

without unanimous consent.

Partners’ rights include rights (1) to distributions of money, including profits (and losses) as per the

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agreement or equally, indemnification, and return of capital contribution (but not a right to

compensation); (2) to management as per the agreement or equally; (3) to choose copartners; (4)

to property of the partnership, but no partner has any rights to specific property (under UPA the

partners own property as tenants in partnership; under RUPA the partnership as entity owns

property, but it will be distributed upon liquidation); (5) to assign (voluntarily or involuntarily) the

partnership interest; the assignee does not become a partner or have any management rights, but a

judgment creditor may obtain a charging order against the partnership; and (6) to enforce duties

and rights by suits in law or equity (under RUPA a formal accounting is not required).

Under UPA, a change in the relation of the partners dissolves the partnership but does not

necessarily wind up the business. Dissolution may be voluntary, by violation of the agreement, by

operation of law, or by court order. Dissolution terminates the authority of the partners to act for

the partnership. After dissolution, a new partnership may be formed.

Under RUPA, a change in the relation of the partners is a dissociation, leaving the remaining

partners with two options: continue on; or wind up, dissolve, and terminate. In most cases, a

partnership may buy out the interest of a partner who leaves without dissolving the partnership. A

term partnership also will not dissolve so long as at least one-half of the partners choose to remain.

When a partner’s dissociation triggers dissolution, partners are allowed to vote subsequently to

continue the partnership.

When a dissolved partnership is carried on as a new one, creditors of the old partnership remain

creditors of the new one. A former partner remains liable to the creditors of the former partnership.

A new partner is liable to the creditors of the former partnership, bur only to the extent of the new

partner’s capital contribution. A former partner remains liable for debts incurred after his

withdrawal unless he gives proper notice of his withdrawal; his actual authority terminates upon

dissociation and apparent authority after two years.

If the firm is to be terminated, it is wound up. The assets of the partnership include all required

contributions of partners, and from the assets liabilities are paid off (1) to creditors and (2) to

partners on their accounts. Under RUPA, nonpartnership creditors share equally with unsatisfied

partnership creditors in the personal assets of their debtor-partners.

EXERCISES

1. Anne and Barbara form a partnership. Their agreement specifies that Anne will receive two-thirds of

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the profit and Barbara will get one-third. The firm suffers a loss of $3,000 the first year. How are the

losses divided?

2. Two lawyers, Glenwood and Higgins, formed a partnership. Glenwood failed to file Client’s

paperwork on time in a case, with adverse financial consequences to Client. Is Higgins liable for

Glenwood’s malpractice?

3. When Client in Exercise 2 visited the firm’s offices to demand compensation from Glenwood, the two

got into an argument. Glenwood became very agitated; in an apparent state of rage, he threw a law

book at Client, breaking her nose. Is Higgins liable?

4. Assume Glenwood from Exercise 2 entered into a contract on behalf of the firm to buy five computer

games. Is Higgins liable?

5. Grosberg and Goldman operated the Chatham Fox Hills Shopping Center as partners. They agreed

that Goldman would deposit the tenants’ rental checks in an account in Grosberg’s name at First

Bank. Without Grosberg’s knowledge or permission, Goldman opened an account in both their

names at Second Bank, into which Goldman deposited checks payable to the firm or the partners. He

indorsed each check by signing the name of the partnership or the partners. Subsequently, Goldman

embezzled over $100,000 of the funds. Second Bank did not know Grosberg and Goldman were

partners. Grosberg then sued Second Bank for converting the funds by accepting checks on which

Grosberg’s or the partnership’s indorsement was forged. Is Second Bank liable? Discuss.

6. Pearson Collings, a partner in a criminal defense consulting firm, used the firm’s phones and

computers to operate a side business cleaning carpets. The partnership received no compensation

for the use of its equipment. What claim would the other partners have against Collings?

7. Follis, Graham, and Hawthorne have a general partnership, each agreeing to split losses 20 percent,

20 percent, and 60 percent, respectively. While on partnership business, Follis negligently crashes

into a victim, causing $100,000 in damages. Follis declares bankruptcy, and the firm’s assets are

inadequate to pay the damages. Graham says she is liable for only $20,000 of the obligation, as per

the agreement. Is she correct?

8. Ingersoll and Jackson are partners; Kelly, after much negotiation, agreed to join the firm effective

February 1. But on January 15, Kelly changed his mind. Meanwhile, however, the other two had

already arranged for the local newspaper to run a notice that Kelly was joining the firm. The notice

ran on February 1. Kelly did nothing in response. On February 2, Creditor, having seen the newspaper

notice, extended credit to the firm. When the firm did not pay, Creditor sought to have Kelly held

liable as a partner. Is Kelly liable?

SELF-TEST QUESTIONS

1. Under UPA, a partner is generally entitled to a formal accounting of partnership affairs

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a. whenever it is just and reasonable

b. if a partner is wrongfully excluded from the business by copartners

c. if the right exists in the partnership agreement

d. all of the above

2. Donners, Inc., a partner in CDE Partnership, applies to Bank to secure a loan and assigns to

Bank its partnership interest. After the assignment, which is true?

a. Bank steps into Donners’s shoes as a partner.

b. Bank does not become a partner but has the right to participate in the management of

the firm to protect its security interest until the loan is paid.

c. Bank is entitled to Donners’s share of the firm’s profits.

d. Bank is liable for Donners’s share of the firm’s losses.

e. None of these is true.

3. Which of these requires unanimous consent of the partners in a general partnership?

a. the assignment of a partnership interest

b. the acquisition of a partnership debt

c. agreement to be responsible for the tort of one copartner

d. admission of a new partner

e. agreement that the partnership should stand as a surety for a third party’s obligation

4. Paul Partner (1) bought a computer and charged it to the partnership’s account; (2) cashed a

firm check and used the money to buy a computer in his own name; (3) brought from home

a computer and used it at the office. In which scenario does the computer become

partnership property?

a. 1 only

b. 1 and 2

c. 1, 2, and 3

5. That partnerships are entities under RUPA means they have to pay federal income tax in

their own name.

a. true

b. false

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6. That partnerships are entities under RUPA means the partners are not personally liable for

the firm’s debts beyond their capital contributions.

a. true

b. false

SELF-TEST ANSWERS

1. d

2. c

3. d

4. b

5. a

6. b

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Chapter 18

Partnerships: General Characteristics and Formation

LEARNING OBJECTIVES

After reading this chapter, you should understand the following:

1. The importance of partnership and the present status of partnership law

2. The extent to which a partnership is an entity

3. The tests that determine whether a partnership exists

4. Partnership by estoppel

5. Partnership formation

18.1 Introduction to Partnerships and Entity Theory

LEARNING OBJECTIVES

1. Describe the importance of partnership.

2. Understand partnership history.

3. Identify the entity characteristics of partnerships.

Importance of Partnership Law

It would be difficult to conceive of a complex society that did not operate its businesses through

organizations. In this chapter we study partnerships, limited partnerships, and limited liability

companies, and we touch on joint ventures and business trusts.

When two or more people form their own business or professional practice, they usually consider

becoming partners. Partnership law defines a partnership as “the association of two or more persons

to carry on as co-owners a business for profit…whether or not the persons intend to form a

partnership.”Revised Uniform Partnership Act, Section 202(a). In 2011, there were more than three

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million business firms in the United States as partnerships (see Table 18.1 “Selected Data: Number of

US Partnerships, Limited Partnerships, and Limited Liability Companies”, showing data to 2006), and

partnerships are a common form of organization among accountants, lawyers, doctors, and other

professionals. When we use the word partnership, we are referring to the general business

partnership. There are also limited partnerships and limited liability partnerships, which are discussed

in Chapter 20 “Hybrid Business Forms”.

Table 18.1 Selected Data: Number of US Partnerships, Limited Partnerships, and Limited Liability

Companies

2003 2004 2005 2006

Total number of active partnerships 2,375,375 2,546,877 2,763,625 2,947,116

Number of partners 14,108,458 15,556,553 16,211,908 16,727,803

Number of limited partnerships 378,921 402,238 413,712 432,550

Number of partners 6,262,103 7,023,921 6,946,986 6,738,737

Number of limited liability companies 1,091,502 1,270,236 1,465,223 1,630,161

Number of partners 4,226,099 4,949,808 5,640,146 6,361,958

Source: IRS, http://www.irs.gov/pub/irs-soi/09sprbul.pdf.

Partnerships are also popular as investment vehicles. Partnership law and tax law permit an investor to

put capital into a limited partnership and realize tax benefits without liability for the acts of the general

partners.

Even if you do not plan to work within a partnership, it can be important to understand the law that

governs it. Why? Because it is possible to become someone’s partner without intending to or even

realizing that a partnership has been created. Knowledge of the law can help you avoid partnership

liability.

History of Partnership Law

Through the Twentieth Century

Partnership is an ancient form of business enterprise, and special laws governing partnerships date as

far back as 2300 BC, when the Code of Hammurabi explicitly regulated the relations between partners.

Partnership was an important part of Roman law, and it played a significant role in the law merchant,

the international commercial law of the Middle Ages.

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In the nineteenth century, in both England and the United States, partnership was a popular vehicle for

business enterprise. But the law governing it was jumbled. Common-law principles were mixed with

equitable standards, and the result was considerable confusion. Parliament moved to reduce the

uncertainty by adopting the Partnership Act of 1890, but codification took longer in the United States.

The Commissioners on Uniform State Laws undertook the task at the turn of the twentieth century. The

Uniform Partnership Act (UPA), completed in 1914, and the Uniform Limited Partnership Act (ULPA),

completed in 1916, were the basis of partnership law for many decades. UPA and ULPA were adopted

by all states except Louisiana.

The Current State of Partnership Law

Despite its name, UPA was not enacted uniformly among the states; moreover, it had some

shortcomings. So the states tinkered with it, and by the 1980s, the National Conference of

Commissioners on Uniform Laws (NCCUL) determined that a revised version was in order. An

amended UPA appeared in 1992, and further amendments were promulgated in 1993, 1994, 1996, and

1997. The NCCUL reports that thirty-nine states have adopted some version of the revised act. This

chapter will discuss the Revised Uniform Partnership Act (RUPA) as promulgated in 1997, but because

not all jurisdictions have not adopted it, where RUPA makes significant changes, the original 1914 UPA

will also be considered.NCCUSL, Uniform Law Commission, “Acts: Partnership Act,”

http://www.nccusl.org/Act.aspx?title=Partnership%20Act. The following states have adopted the

RUPA: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, District of Columbia,

Florida, Hawaii, Idaho, Illinois, Iowa, Kansas, Kentucky, Maine, Maryland, Minnesota, Mississippi,

Montana, Nebraska, Nevada, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Puerto Rico,

South Dakota (substantially similar), Tennessee, Texas (substantially similar), US Virgin Islands,

Vermont, Virginia, and Washington. Connecticut, West Virginia, and Wyoming adopted the 1992 or

1994 version. Here are the states that have not adopted RUPA (Louisiana never adopted UPA at all):

Georgia, Indiana, Massachusetts, Michigan, Mississippi, New Hampshire, New York, North Carolina,

Ohio, Pennsylvania, Rhode Island, and Wisconsin. The NCCUL observes in its “prefatory note” to the

1997 act: “The Revised Act is largely a series of ‘default rules’ that govern the relations among partners

in situations they have not addressed in a partnership agreement. The primary focus of RUPA is the

small, often informal, partnership. Larger partnerships generally have a partnership agreement

addressing, and often modifying, many of the provisions of the partnership act.”University of

Pennsylvania Law School, Biddle Law Library, “Uniform Partnership Act (1997),” NCCUSL Archives,

http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/upa97fa.pdf.

Entity Theory

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Meaning of “Legal Entity”

A significant difference between a partnership and most other kinds of business organization relates to

whether, and the extent to which, the business is a legal entity. A legal entity is a person or group that

the law recognizes as having legal rights, such as the right to own and dispose of property, to sue and be

sued, and to enter into contracts; the entity theory is the concept of a business firm as a legal person,

with existence and accountability separate from its owners. When individuals carry out a common

enterprise as partners, a threshold legal question is whether the partnership is a legal entity. The

common law said no. In other words, under the common-law theory, a partnership was but a

convenient name for an aggregate of individuals, and the rights and duties recognized and imposed by

law are those of the individual partners. By contrast, the mercantile theory of the law merchant held

that a partnership is a legal entity that can have rights and duties independent of those of its members.

During the drafting of the 1914 UPA, a debate raged over which theory to adopt. The drafters resolved

the debate through a compromise. In Section 6(1), UPA provides a neutral definition of partnership

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

the common-law theory that a partnership is an aggregation of individuals—the aggregate theory.

RUPA moved more toward making partnerships entities. According to the NCCUL, “The Revised Act

enhances the entity treatment of partnerships to achieve simplicity for state law purposes, particularly

in matters concerning title to partnership property. RUPA does not, however, relentlessly apply the

entity approach. The aggregate approach is retained for some purposes, such as partners’ joint and

several liability.”University of Pennsylvania Law School, Biddle Law Library, “Uniform Partnership Act

(1997),” NCCUSL Archives, http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/upa97fa.pdf.

Section 201(a) provides, “A partnership is an entity distinct from its partners.”RUPA, Section 201(a).

Entity Characteristics of a Partnership

Under RUPA, then, a partnership has entity characteristics, but the partners remain guarantors of

partnership obligations, as always—that is the partners’ joint and several liability noted in the previous

paragraph (and discussed further in Chapter 19 “Partnership Operation and Termination”). This is a

very important point and a primary weakness of the partnership form: all partners are, and each one of

them is, ultimately personally liable for the obligations of the partnership, without limit, which includes

personal and unlimited liability. This personal liability is very distasteful, and it has been abolished,

subject to some exceptions, with limited partnerships and limited liability companies, as discussed in

Chapter 20 “Hybrid Business Forms”. And, of course, the owners of corporations are also not generally

liable for the corporation’s obligations, which is a major reason for the corporate form’s popularity.

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For Accounting Purposes

Under both versions of the law, the partnership may keep business records as if it were a separate

entity, and its accountants may treat it as such for purposes of preparing income statements and

balance sheets.

For Purposes of Taxation

Under both versions of the law, partnerships are not taxable entities, so they do not pay income taxes.

Instead, each partner’s distributive share, which includes income or other gain, loss, deductions, and

credits, must be included in the partner’s personal income tax return, whether or not the share is

actually distributed.

For Purposes of Litigation

In litigation, the aggregate theory causes some inconvenience in naming and serving partnership

defendants: under UPA, lawsuits to enforce a partnership contract or some other right must be filed in

the name of all the partners. Similarly, to sue a partnership, the plaintiff must name and sue each of the

partners. This cumbersome procedure was modified in many states, which enacted special statutes

expressly permitting suits by and against partnerships in the firm name. In suits on a claim in federal

court, a partnership may sue and be sued in its common name. The move by RUPA to make

partnerships entities changed very little. Certainly it provides that “a partnership may sue and be sued

in the name of the partnership”—that’s handy where the plaintiff hopes for a judgment against the

partnership, without recourse to the individual partners’ personal assets.RUPA, Section 307(a). But a

plaintiff must still name the partnership and the partners individually to have access to both estates,

the partnership and the individuals’: “A judgment against a partnership is not by itself a judgment

against a partner. A judgment against a partnership may not be satisfied from a partner’s assets unless

there is also a judgment against the partner.”RUPA, Section 307(c).

For Purposes of Owning Real Estate

Aggregate theory concepts bedeviled property co-ownership issues, so UPA finessed the issue by stating

that partnership property, real or personal, could be held in the name of the partners as “tenants in

partnership”—a type of co-ownership—or it could be held in the name of the partnership.Uniform

Partnership Act, Section 25(1); UPA, Section 8(3). Under RUPA, “property acquired by the partnership

is property of the partnership and not of the partners.”RUPA, Section 203. But RUPA is no different

from UPA in practical effect. The latter provides that “property originally brought into the partnership

stock or subsequently acquired by purchase…on account of the partnership, is partnership

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property.”UPA, Section 8(1). Under either law, a partner may bring onto the partnership premises her

own property, not acquired in the name of the partnership or with its credit, and it remains her

separate property. Under neither law can a partner unilaterally dispose of partnership property,

however labeled, for the obvious reason that one cannot dispose of another’s property or property

rights without permission.UPA, Sections 9(3)(a) and 25; RUPA, Section 302. And keep in mind that

partnership law is the default: partners are free to make up partnership agreements as they like, subject

to some limitations. They are free to set up property ownership rules as they like.

For Purposes of Bankruptcy

Under federal bankruptcy law—state partnership law is preempted—a partnership is an entity that may

voluntarily seek the haven of a bankruptcy court or that may involuntarily be thrust into a bankruptcy

proceeding by its creditors. The partnership cannot discharge its debts in a liquidation proceeding

under Chapter 7 of the bankruptcy law, but it can be rehabilitated under Chapter 11 (see Chapter 13

“Bankruptcy”).

KEY TAKEAWAY

Partnership law is very important because it is the way most small businesses are organized and because

it is possible for a person to become a partner without intending to. Partnership law goes back a long

way, but in the United States, most states—but not all—have adopted the Revised Uniform Partnership

Act (RUPA, 1997) over the previous Uniform Partnership Act, originally promulgated in 1914. One salient

change made by RUPA is to directly announce that a partnership is an entity: it is like a person for

purposes of accounting, litigation, bankruptcy, and owning real estate. Partnerships do not pay taxes; the

individual partners do. But in practical terms, what RUPA does is codify already-existing state law on

these matters, and partners are free to organize their relationship as they like in the partnership

agreement.

EXERCISES

1. When was UPA set out for states to adopt? When was RUPA promulgated for state adoption?

2. What does it mean to say that the partnership act is the “default position”? For what types of

partnership is UPA (or RUPA) likely to be of most importance?

3. What is the aggregate theory of partnership? The entity theory?

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18.2 Partnership Formation

LEARNING OBJECTIVES

1. Describe the creation of an express partnership.

2. Describe the creation of an implied partnership.

3. Identify tests of partnership existence.

4. Understand partnership by estoppel.

Creation of an Express Partnership

Creation in General

The most common way of forming a partnership is expressly—that is, in words, orally or in writing.

Such a partnership is called an express partnership. If parties have an express partnership with no

partnership agreement, the relevant law—the Uniform Partnership Act (UPA) or the Revised Uniform

Partnership Act (RUPA)—applies the governing rules.

Assume that three persons have decided to form a partnership to run a car dealership. Able contributes

$250,000. Baker contributes the building and space in which the business will operate. Carr

contributes his services; he will manage the dealership.

The first question is whether Able, Baker, and Carr must have a partnership agreement. As should be

clear from the foregoing discussion, no agreement is necessary as long as the tests of partnership are

met. However, they ought to have an agreement in order to spell out their rights and duties among

themselves.

The agreement itself is a contract and should follow the principles and rules spelled out in Chapter 8

“Contracts” of this book. Because it is intended to govern the relations of the partners toward

themselves and their business, every partnership contract should set forth clearly the following terms:

(1) the name under which the partners will do business; (2) the names of the partners; (3) the nature,

scope, and location of the business; (4) the capital contributions of each partner; (5) how profits and

losses are to be divided; (6) how salaries, if any, are to be determined; (7) the responsibilities of each

partner for managing the business; (8) limitations on the power of each partner to bind the firm; (9)

the method by which a given partner may withdraw from the partnership; (10) continuation of the firm

in the event of a partner s death and the formula for paying a partnership interest to his heirs; and (11)

method of dissolution.

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Specific Issues of Concern

In forming a partnership, three of these items merit special attention. And note again that if the parties

do not provide for these in their agreement, RUPA will do it for them as the default.

Who Can Be a Partner?

As discussed earlier in this chapter, a partnership is not limited to a direct association between human

beings but may also include an association between other entities, such as corporations or even

partnerships themselves.A joint venture—sometimes known as a joint adventure, coadventure, joint

enterprise, joint undertaking, syndicate, group, or pool—is an association of persons to carry on a

particular task until completed. In essence, a joint venture is a “temporary partnership.” In the United

States, the use of joint ventures began with the railroads in the late 1800s. Throughout the middle part

of the twentieth century joint ventures were common in the manufacturing sector. By the late 1980s,

they increasingly appeared in both manufacturing and service industries as businesses looked for new,

competitive strategies. They are aggressively promoted on the Internet: “Joint Ventures are in, and if

you’re not utilizing this strategic weapon, chances are your competition is, or will soon be, using this to

their advantage.…possibly against you!” (Scott Allen, “Joint Venturing 101,” About.com Entrepreneurs,

http://entrepreneurs.about.com/od/beyondstartup/a/jointventures.htm).As a risk-avoiding device, the

joint venture allows two or more firms to pool their differing expertise so that neither needs to “learn

the ropes” from the beginning; neither needs the entire capital to start the enterprise.Partnership rules

generally apply, although the relationship of the joint venturers is closer to that of special than general

agency as discussed in Chapter 14 “Relationships between Principal and Agent”. Joint venturers are

fiduciaries toward one another. Although no formality is necessary, the associates will usually sign an

agreement. The joint venture need have no group name, though it may have one. Property may be

owned jointly. Profits and losses will be shared, as in a partnership, and each associate has the right to

participate in management. Liability is unlimited.Sometimes two or more businesses will form a joint

venture to carry out a specific task—prospecting for oil, building a nuclear reactor, doing basic scientific

research—and will incorporate the joint venture. In that case, the resulting business—known as a “joint

venture corporation”—is governed by corporation law, not the law of partnership, and is not a joint

venture in the sense described here. Increasingly, companies are forming joint ventures to do business

abroad; foreign investors or governments own significant interests in these joint ventures. For example,

in 1984 General Motors entered into a joint venture with Toyota to revive GM’s shuttered Fremont,

California, assembly plant to create New United Motor Manufacturing, Inc. (NUMMI). For GM the

joint venture was an opportunity to learn about lean manufacturing from the Japanese company, while

Toyota gained its first manufacturing base in North America and a chance to test its production system

in an American labor environment. Until May 2010, when the copartnership ended and the plant

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closed, NUMMI built an average of six thousand vehicles a week, or nearly eight million cars and

trucks. These vehicles were the Chevrolet Nova (1984–88), the Geo Prizm (1989–97), the Chevrolet

Prizm (1998–2002), and the Hilux (1991–95, predecessor of the Tacoma), as well as the Toyota Voltz,

the Japanese right-hand-drive version of the Pontiac Vibe. The latter two were based on the Toyota

Matrix. Paul Stenquist, “GM and Toyota’s Joint Venture Ends in California,” New York Times, April 2,

2010, http://wheels.blogs.nytimes.com/2010/04/02/g-m-and-toyotas-joint-venture-ends-in-

california. Family members can be partners, and partnerships between parents and minor children are

lawful, although a partner who is a minor may disaffirm the agreement.

Written versus Oral Agreements

If the business cannot be performed within one year from the time that the agreement is entered into,

the partnership agreement should be in writing to avoid invalidation under the Statute of Frauds. Most

partnerships have no fixed term, however, and are partnerships “at will” and therefore not covered by

the Statute of Frauds.

Validity of the Partnership Name

Able, Baker, and Carr decide that it makes good business sense to choose an imposing, catchy, and well-

known name for their dealership—General Motors Corporation. There are two reasons why they cannot

do so. First, their business is a partnership, not a corporation, and should not be described as one.

Second, the name is deceptive because it is the name of an existing business. Furthermore, if not

registered, the name would violate the assumed or fictitious name statutes of most states. These require

that anyone doing business under a name other than his real name register the name, together with the

names and addresses of the proprietors, in some public office. (Often, the statutes require the

proprietors to publish this information in the newspapers when the business is started.) As Loomis v.

Whitehead in Section 18.3.2 “Creation of a Partnership: Registering the Name” shows, if a business fails

to comply with the statute, it could find that it will be unable to file suit to enforce its contracts.

Creation of Implied Partnership

An implied partnership exists when in fact there are two or more persons carrying on a business as

co-owners for profit. For example, Carlos decides to paint houses during his summer break. He gathers

some materials and gets several jobs. He hires Wally as a helper. Wally is very good, and pretty soon

both of them are deciding what jobs to do and how much to charge, and they are splitting the profits.

They have an implied partnership, without intending to create a partnership at all.

Tests of Partnership Existence

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But how do we know whether an implied partnership has been created? Obviously, we know if there is

an express agreement. But partnerships can come into existence quite informally, indeed, without any

formality—they can be created accidentally. In contrast to the corporation, which is the creature of

statute, partnership is a catchall term for a large variety of working relationships, and frequently,

uncertainties arise about whether or not a particular relationship is that of partnership. The law can

reduce the uncertainty in advance only at the price of severely restricting the flexibility of people to

associate. As the chief drafter of the Uniform Partnership Act (UPA, 1914) explained,

All other business associations are statutory in origin. They are formed by the happening of an event

designated in a statute as necessary to their formation. In corporations this act may be the issuing of a

charter by the proper officer of the state; in limited partnerships, the filing by the associates of a

specified document in a public office. On the other hand, an infinite number of combinations of

circumstances may result in co-ownership of a business. Partnership is the residuum, including all

forms of co-ownership, of a business except those business associations organized under a specific

statute.W. D. Lewis, “The Uniform Partnership Act,” Yale Law Journal 24 (1915): 617, 622.

Figure 18.1 Partnership Tests

Because it is frequently important to know whether a partnership exists (as when a creditor has dealt

with only one party but wishes to also hold others liable by claiming they were partners, see Section

18.3.1 “Tests of Partnership Existence”, Chaiken v. Employment Security Commission), a number of

tests have been established that are clues to the existence of a partnership (see Figure 18.1 “Partnership

Tests”). We return to the definition of a partnership: “the association of two or more persons to carry

on as co-owners a business for profit[.]” The three elements are (1) the association of persons, (2) as co-

owners, (3) for profit.

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Association of Persons

This element is pretty obvious. A partnership is a contractual agreement among persons, so the persons

involved need to have capacity to contract. But RUPA does not provide that only natural persons can

be partners; it defines person as follows: “‘Person’ means an individual, corporation, business trust,

estate, trust, partnership, association, joint venture, government, governmental subdivision, agency, or

instrumentality, or any other legal or commercial entity.”RUPA, Section 101(10). Thus unless state law

precludes it, a corporation can be a partner in a partnership. The same is true under UPA.

Co-owners of a Business

If what two or more people own is clearly a business—including capital assets, contracts with employees

or agents, an income stream, and debts incurred on behalf of the operation—a partnership exists. A

tougher question arises when two or more persons co-own property. Do they automatically become

partners? The answer can be important: if one of the owners while doing business pertinent to the

property injures a stranger, the latter could sue the other owners if there is a partnership.

Co-ownership comes in many guises. The four most common are joint tenancy, tenancy in common,

tenancy by the entireties, and community property. In joint tenancy, the owners hold the property

under a single instrument, such as a deed, and if one dies, the others automatically become owners of

the deceased’s share, which does not descend to his heirs. Tenancy in common has the reverse rule: the

survivor tenants do not take the deceased’s share. Each tenant in common has a distinct estate in the

property. The tenancy by the entirety and community property (in community-property states) forms of

ownership are limited to spouses, and their effects are similar to that of joint tenancy. These concepts

are discussed in more detail in relation to real property in Chapter 31 “The Transfer of Real Estate by

Sale”.

Suppose a husband and wife who own their home as tenants by the entirety (or community property)

decide to spend the summer at the seashore and rent their home for three months. Is their co-

ownership sufficient to establish that they are partners? The answer is no. By UPA Section 7(2) and

RUPA Section 202(b)(1), the various forms of joint ownership by themselves do not establish

partnership, whether or not the co-owners share profits made by the use of the property. To establish a

partnership, the ownership must be of a business, not merely of property.

Sharing of Profits

There are two aspects to consider with regard to profits: first, whether the business is for-profit, and

second, whether there is a sharing of the profit.

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Business for Profit

Unincorporated nonprofit organizations (UNAs) cannot be partnerships. The paucity of coherent law

governing these organizations gave rise in 2005 to the National Conference of Commissioners of

Uniform Laws’ promulgation of the Revised Uniform Unincorporated Nonprofit Association Act

(RUUNAA). The prefatory note to this act says, “RUUNAA was drafted with small informal associations

in mind. These informal organizations are likely to have no legal advice and so fail to consider legal and

organizational questions, including whether to incorporate. The act provides better answers than the

common law for a limited number of legal problems…There are probably hundreds of thousands of

UNAs in the United States including unincorporated nonprofit philanthropic, educational, scientific

and literary clubs, sporting organizations, unions, trade associations, political organizations, churches,

hospitals, and condominium and neighborhood associations.”Revised Uniform Unincorporated

Nonprofit Associations Act, http://www.abanet.org/intlaw/leadership/policy/RUUNAA_Final_08.pdf.

At least twelve states have adopted RUUNAA or its predecessor.

Sharing the Profit

While co-ownership does not establish a partnership unless there is a business, a business by itself is

not a partnership unless co-ownership is present. Of the tests used by courts to determine co-

ownership, perhaps the most important is sharing of profits. Section 202(c) of RUPA provides that “a

person who receives a share of the profits of a business is presumed to be a partner in the business,” but

this presumption can be rebutted by showing that the share of the profits paid out was (1) to repay a

debt; (2) wages or compensation to an independent contractor; (3) rent; (4) an annuity, retirement, or

health benefit to a representative of a deceased or retired partner; (5) interest on a loan, or rights to

income, proceeds, or increase in value from collateral; or (5) for the sale of the goodwill of a business or

other property. Section 7(4) of UPA is to the same effect.

Other Factors

Courts are not limited to the profit-sharing test; they also look at these factors, among others: the right

to participate in decision making, the duty to share liabilities, and the manner in which the business is

operated. Section 18.3.1 “Tests of Partnership Existence”, Chaiken v. Employment Security

Commission, illustrates how these factors are weighed in court.

Creation of Partnership by Estoppel

Ordinarily, if two people are not legally partners, then third parties cannot so regard them. For

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example, Mr. Tot and Mr. Tut own equal shares of a house that they rent but do not regard it as a

business and are not in fact partners. They do have a loose “understanding” that since Mr. Tot is

mechanically adept, he will make necessary repairs whenever the tenants call. On his way to the house

one day to fix its boiler, Mr. Tot injures a pedestrian, who sues both Mr. Tot and Mr. Tut. Since they are

not partners, the pedestrian cannot sue them as if they were; hence Mr. Tut has no partnership liability.

Suppose that Mr. Tot and Mr. Tut happened to go to a lumberyard together to purchase materials that

Mr. Tot intended to use to add a room to the house. Short of cash, Mr. Tot looks around and espies Mr.

Tat, who greets his two friends heartily by saying within earshot of the salesman who is debating

whether to extend credit, “Well, how are my two partners this morning?” Messrs. Tot and Tut say

nothing but smile faintly at the salesman, who mistakenly but reasonably believes that the two are

acknowledging the partnership. The salesman knows Mr. Tat well and assumes that since Mr. Tat is

rich, extending credit to the “partnership” is a “sure thing.” Messrs. Tot and Tut fail to pay. The

lumberyard is entitled to collect from Mr. Tat, even though he may have forgotten completely about the

incident by the time suit is filed. Under Uniform Partnership Act Section 16(1), Mr. Tat would be liable

for the debt as being part of a partnership by estoppel. The Revised Uniform Partnership Act is to

the same effect:

Section 308. Liability of Purported Partner.

(a) If a person, by words or conduct, purports to be a partner, or consents to being represented by

another as a partner, in a partnership or with one or more persons not partners, the purported partner

is liable to a person to whom the representation is made, if that person, relying on the representation,

enters into a transaction with the actual or purported partnership.

Partnership by estoppel has two elements: (1) a representation to a third party that there is in fact a

partnership and (2) reliance by the third party on the representation. See Section 18.3.3 “Partnership

by Estoppel”, Chavers v. Epsco, Inc., for an example of partnership by estoppel.

KEY TAKEAWAY

A partnership is any two or more persons—including corporate persons—carrying on a business as co-

owners for profit. A primary test of whether a partnership exists is whether there is a sharing of profits,

though other factors such as sharing decision making, sharing liabilities, and how the business is operated

are also examined.

Most partnerships are expressly created. Several factors become important in the partnership

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agreement, whether written or oral. These include the name of the business, the capital contributions of

each partner, profit sharing, and decision making. But a partnership can also arise by implication or by

estoppel, where one has held herself as a partner and another has relied on that representation.

EXERCISES

1. Why is it necessary—or at least useful—to have tests to determine whether a partnership exists?

2. What elements of the business organization are examined to make this determination?

3. Jacob rents farmland from Davis and pays Davis a part of the profits from the crop in rent. Is Davis a

partner? What if Davis offers suggestions on what to plant and when? Now is he a partner?

4. What elements should be included in a written partnership agreement?

5. What is an implied partnership?

6. What is a partnership by estoppel, and why are its “partners” estopped to deny its existence?

18.3 Cases

Tests of Partnership Existence

Chaiken v. Employment Security Commission

274 A.2d 707 (Del. 1971)

STOREY, J.

The Employment Security Commission, hereinafter referred to as the Commission, levied an

involuntary assessment against Richard K. Chaiken, complainant, hereinafter referred to as Chaiken,

for not filing his unemployment security assessment report. Pursuant to the same statutory section, a

hearing was held and a determination made by the Commission that Chaiken was the employer of two

barbers in his barber shop and that he should be assessed as an employer for his share of

unemployment compensation contributions. Chaiken appealed the Commission’s decision.…

Both in the administrative hearing and in his appeal brief Chaiken argues that he had entered into

partnership agreements with each of his barbers and, therefore, was and is not subject to

unemployment compensation assessment. The burden is upon the individual assessed to show that he

is outside the ambit of the statutory sections requiring assessment. If Chaiken’s partnership argument

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fails he has no secondary position and he fails to meet his burden.

Chaiken contends that he and his “partners”:

1. properly registered the partnership name and names of partners in the prothonotary’s office, in

accordance with [the relevant statute],The word prothonotary means first notary of the court. The

prothonotary is the keeper of the civil records for the court system. The office is responsible for the

creation, maintenance, and certification of matters pending or determined by the court. The office

is also responsible for certain reporting and collection duties to state agencies.

2. properly filed federal partnership information returns and paid federal taxes quarterly on an

estimated basis, and

3. duly executed partnership agreements.

Of the three factors, the last is most important. Agreements of “partnership” were executed between

Chaiken and Mr. Strazella, a barber in the shop, and between Chaiken and Mr. Spitzer, similarly

situated. The agreements were nearly identical. The first paragraph declared the creation of a

partnership and the location of business. The second provided that Chaiken would provide barber

chair, supplies, and licenses, while the other partner would provide tools of the trade. The paragraph

also declared that upon dissolution of the partnership, ownership of items would revert to the party

providing them. The third paragraph declared that the income of the partnership would be divided 30%

for Chaiken, 70% for Strazella; 20% for Chaiken and 80% for Spitzer. The fourth paragraph declared

that all partnership policy would be decided by Chaiken, whose decision was final. The fifth paragraph

forbade assignment of the agreement without permission of Chaiken. The sixth paragraph required

Chaiken to hold and distribute all receipts. The final paragraph stated hours of work for Strazella and

Spitzer and holidays.

The mere existence of an agreement labeled “partnership” agreement and the characterization of

signatories as “partners” docs not conclusively prove the existence of a partnership. Rather, the

intention of the parties, as explained by the wording of the agreement, is paramount.

A partnership is defined as an association of two or more persons to carry on as co-owners a business

for profit. As co-owners of a business, partners have an equal right in the decision making process. But

this right may be abrogated by agreement of the parties without destroying the partnership concept,

provided other partnership elements are present.

Thus, while paragraph four reserves for Chaiken all right to determine partnership policy, it is not

standing alone, fatal to the partnership concept. Co-owners should also contribute valuable

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consideration for the creation of the business. Under paragraph two, however, Chaiken provides the

barber chair (and implicitly the barber shop itself), mirror, licenses and linen, while the other partners

merely provide their tools and labor—nothing more than any barber-employee would furnish. Standing

alone, however, mere contribution of work and skill can be valuable consideration for a partnership

agreement.

Partnership interests may be assignable, although it is not a violation of partnership law to prohibit

assignment in a partnership agreement. Therefore, paragraph five on assignment of partnership

interests does not violate the partnership concept. On the other hand, distribution of partnership assets

to the partners upon dissolution is only allowed after all partnership liabilities are satisfied. But

paragraph two of the agreement, in stating the ground rules for dissolution, makes no declaration that

the partnership assets will be utilized to pay partnership expenses before reversion to their original

owners. This deficiency militates against a finding in favor of partnership intent since it is assumed

Chaiken would have inserted such provision had he thought his lesser partners would accept such

liability. Partners do accept such liability, employees do not.

Most importantly, co-owners carry on “a business for profit.” The phrase has been interpreted to mean

that partners share in the profits and the losses of the business. The intent to divide the profits is an

indispensable requisite of partnership. Paragraph three of the agreement declares that each partner

shall share in the income of the business. There is no sharing of the profits, and as the agreement is

drafted, there are no profits. Merely sharing the gross returns does not establish a partnership. Nor is

the sharing of profits prima facie evidence of a partnership where the profits received are in payment of

wages.

The failure to share profits, therefore, is fatal to the partnership concept here.

Evaluating Chaiken’s agreement in light of the elements implicit in a partnership, no partnership intent

can be found. The absence of the important right of decision making or the important duty to share

liabilities upon dissolution individually may not be fatal to a partnership. But when both are absent,

coupled with the absence of profit sharing, they become strong factors in discrediting the partnership

argument. Such weighing of the elements against a partnership finding compares favorably with

Fenwick v. Unemployment Compensation Commission, which decided against the partnership theory

on similar facts, including the filing of partnership income tax forms.

In addition, the total circumstances of the case taken together indicate the employer-employee

relationship between Chaiken and his barbers. The agreement set forth the hours of work and days off—

unusual subjects for partnership agreements. The barbers brought into the relationship only the

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equipment required of all barber shop operators. And each barber had his own individual “partnership”

with Chaiken. Furthermore, Chaiken conducted all transactions with suppliers, and purchased licenses,

insurance, and the lease for the business property in his own name. Finally, the name “Richard’s Barber

Shop” continued to be used after the execution of the so-called partnership agreements. [The

Commission’s decision is affirmed.]

CASE QUESTIONS

1. Why did the unemployment board sue Chaiken?

2. Why did Chaiken set up this “partnership”?

3. What factors did the court examine to determine whether there was a partnership here? Which one

was the most important?

4. Why would it be unusual in a partnership agreement to set forth the hours of work and days off?

Creation of a Partnership: Registering the Name

Loomis v. Whitehead

183 P.3d 890 (Nev. 2008)

Per Curiam.

In this appeal, we address whether [Nevada Revised Statute] NRS 602.070 bars the partners of an

unregistered fictitious name partnership from bringing an action arising out of a business agreement

that was not made under the fictitious name. [The statute] prohibits persons who fail to file an assumed

or fictitious name certificate from suing on any contract or agreement made under the assumed or

fictitious name. We conclude that it does not bar the partners from bringing the action so long as the

partners did not conduct the business or enter into an agreement under the fictitious name or

otherwise mislead the other party into thinking that he was doing business with some entity other than

the partners themselves.

Background Facts

Appellants Leroy Loomis and David R. Shanahan raised and sold cattle in Elko County, Nevada. Each

of the appellants had certain responsibilities relating to the cattle business. Loomis supplied the

livestock and paid expenses, while Shanahan managed the day-to-day care of the cattle. Once the cattle

were readied for market and sold, Loomis and Shanahan would share the profits equally. While Loomis

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and Shanahan often called themselves the 52 Cattle Company, they had no formal partnership

agreement and did not file an assumed or fictitious name certificate in that name. Loomis and

Shanahan bring this appeal after an agreement entered into with respondent Jerry Carr Whitehead

failed.

In the fall of 2003, Shanahan entered into a verbal agreement with Whitehead, a rancher, through

Whitehead’s ranch foreman to have their cattle wintered at Whitehead’s ranch. Neither Loomis nor

Whitehead was present when the ranch foreman made the deal with Shanahan, but the parties agree

that there was no mention of the 52 Cattle Company at the time they entered into the agreement or

anytime during the course of business thereafter. Shanahan and Loomis subsequently alleged that their

cattle were malnourished and that a number of their cattle died from starvation that winter at

Whitehead’s ranch. Whitehead denied these allegations.

Suit against Whitehead

The following summer, Shanahan and Loomis sued Whitehead, claiming negligence and breach of

contract. Later, well into discovery, Whitehead was made aware of the existence of the 52 Cattle

Company when Shanahan stated in his deposition that he did not actually own any of the cattle on

Whitehead’s ranch. In his deposition, he described the partnership arrangement. At about the same

time, Whitehead learned that the name “52 Cattle Company” was not registered with the Elko County

Clerk.

Whitehead then filed a motion for partial summary judgment, asserting that, pursuant to NRS 602.070,

Loomis and Shanahan’s failure to register their fictitiously named partnership with the county clerk

barred them from bringing a legal action. The district court agreed with Whitehead, granted the

motion, and dismissed Loomis and Shanahan’s claims. Loomis and Shanahan timely appealed.

Discussion

The district court found that Loomis and Shanahan conducted business under a fictitious name without

filing a fictitious name certificate with the Elko County Clerk as required by NRS 602.010.NRS

602.010(1): “Every person doing business in this state under an assumed or fictitious name that is in

any way different from the legal name of each person who owns an interest in the business must file

with the county clerk of each county in which the business is being conducted a certificate containing

the information required by NRS 602.020.” The district court therefore concluded that, pursuant to

NRS 602.070, they were barred from bringing an action against Whitehead because they did not file a

fictitious name certificate for the 52 Cattle Company.NRS 602.070: “No action may be commenced or

maintained by any person…upon or on account of any contract made or transaction had under the

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assumed or fictitious name, or upon or on account of any cause of action arising or growing out of the

business conducted under that name, unless before the commencement of the action the certificate

required by NRS 602.010 has been filed.”

Loomis and Shanahan contend that the district court erred in granting partial summary judgment

because they did not enter into a contract with Whitehead under the name of the 52 Cattle Company,

and they did not conduct business with Whitehead under that name. Loomis and Shanahan argue that

NRS 602.070 is not applicable to their action against Whitehead because they did not mislead

Whitehead into thinking that he was doing business with anyone other than them. We agree.…

When looking at a statute’s language, this court is bound to follow the statute’s plain meaning, unless

the plain meaning was clearly not intended. Here, in using the phrase “under the assumed or fictitious

name,” the statute clearly bars bringing an action when the claims arise from a contract, transaction, or

business conducted beneath the banner of an unregistered fictitious name. However, NRS 602.070

does not apply to individual partners whose transactions or business with another party were not

performed under the fictitious name.

Here, Whitehead knew that Shanahan entered into the oral contract under his own name. He initially

thought that Shanahan owned the cattle and Loomis had “some type of interest.” Shanahan did not

enter into the contract under the fictitious “52 Cattle Company” name. Moreover, Whitehead does not

allege that he was misled by either Loomis or Shanahan in any way that would cause him to think he

was doing business with the 52 Cattle Company. In fact, Whitehead did not know of the 52 Cattle

Company until Shanahan mentioned it in his deposition. Under these circumstances, when there

simply was no indication that Loomis and Shanahan represented that they were conducting business as

the 52 Cattle Company and no reliance by Whitehead that he was doing business with the 52 Cattle

Company, NRS 602.070 does not bar the suit against Whitehead.

We therefore reverse the district court’s partial summary judgment in this instance and remand for trial

because, while the lawsuit between Loomis and Whitehead involved partnership business, the

transaction at issue was not conducted and the subsequent suit was not maintained under the aegis of

the fictitiously named partnership.

CASE QUESTIONS

1. The purpose of the fictitious name statute might well be, as the court here describes it, “to prevent

fraud and to give the public information about those entities with which they conduct business.” But

that’s not what the statute says; it says nobody can sue on a cause of action arising out of business

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conducted under a fictitious name if the name is not registered. The legislature determined the

consequence of failure to register. Should the court disregard the statute’s plain, unambiguous

meaning?

2. That was one of two arguments by the dissent in this case. The second one was based on this

problem: Shanahan and Loomis agreed that the cattle at issue were partnership cattle bearing the

“52” brand. That is, the cows were not Shanahan’s; they were the partnership’s. When Whitehead

moved to dismiss Shanahan’s claim—again, because the cows weren’t Shanahan’s—Shanahan

conceded that but for the existence of the partnership he would have no claim against Whitehead. If

there is no claim against the defendant except insofar as he harmed the partnership business (the

cattle), how could the majority assert that claims against Whitehead did not arise out of “the

business” conducted under 52 Cattle Company? Who has the better argument, the majority or the

dissent?

3. Here is another problem along the same lines but with a different set of facts and a Uniform

Partnership Act (UPA) jurisdiction (i.e., pre–Revised Uniform Partnership Act [RUPA]). Suppose the

plaintiffs had a partnership (as they did here), but the claim by one was that the other partner had

stolen several head of cattle, and UPA was in effect so that the partnership property was owned as

“tenant in partnership”—the cattle would be owned by the partners as a whole. A person who steals

his own property cannot be criminally liable; therefore, a partner cannot be guilty of stealing (or

misappropriating) firm property. Thus under UPA there arise anomalous cases, for example, in People

v. Zinke, 555 N.E.2d 263 (N.Y. 1990), which is a criminal case, Zinke embezzled over a million dollars

from his own investment firm but the prosecutor’s case against him was dismissed because, the New

York court said, “partners cannot be prosecuted for stealing firm property.” If the partnership is a

legal entity, as under RUPA, how is this result changed?

Partnership by Estoppel

Chavers v. Epsco, Inc.

98 S.W.3d 421 (Ark. 2003)

Hannah, J.

Appellants Reggie Chavers and Mark Chavers appeal a judgment entered against them by the

Craighead County Circuit Court. Reggie and Mark argue that the trial court erred in holding them liable

for a company debt based upon partnership by estoppel because the proof was vague and insufficient

and there was no detrimental reliance on the part of a creditor. We hold that the trial court was not

clearly erroneous in finding liability based upon partnership by estoppel. Accordingly, we affirm.

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Facts

Gary Chavers operated Chavers Welding and Construction (“CWC”), a construction and welding

business, in Jonesboro. Gary’s sons Reggie Chavers and Mark Chavers joined their father in the

business after graduating from high school. Gary, Mark, and Reggie maintain that CWC was a sole

proprietorship owned by Gary, and that Reggie and Mark served only as CWC employees, not as CWC

partners.

In February 1999, CWC entered into an agreement with Epsco, Inc. (“Epsco”), a staffing service, to

provide payroll and employee services for CWC. Initially, Epsco collected payments for its services on a

weekly basis, but later, Epsco extended credit to CWC. Melton Clegg, President of Epsco, stated that his

decision to extend credit to CWC was based, in part, on his belief that CWC was a partnership.

CWC’s account with Epsco became delinquent, and Epsco filed a complaint against Gary, Reggie, and

Mark, individually, and doing business as CWC, to recover payment for the past due account. Gary

discharged a portion of his obligation to Epsco due to his filing for bankruptcy. Epsco sought to recover

CWC’s remaining debt from Reggie and Mark. After a hearing on March 7, 2002, the trial court issued a

letter opinion, finding that Reggie and Mark “represented themselves to [Epsco] as partners in an

existing partnership and operated in such a fashion to give creditors in general, and Epsco in particular,

the impression that such creditors/potential creditors were doing business with a partnership.…” On

May 21, 2002, the trial court entered an order stating that Reggie and Mark were partners by estoppel

as relates to Epsco. The trial court found that Reggie and Mark were jointly and severally liable for the

debt of CWC in the amount of $80,360.92. In addition, the trial court awarded Epsco pre-judgment

interest at the rate of six percent, post-judgment interest at the rate of ten percent, and attorney’s fees

in the amount of $8,036.92.

[The relevant Arkansas statute provides]:

(1) When a person, by words spoken or written or by conduct, represents himself, or consents to

another representing him to any one, as a partner in an existing partnership or with one (1) or more

persons not actual partners, he is liable to any person to whom such representation has been made,

who has, on the faith of such representation, given credit to the actual or apparent partnership, and if

he has made such representation or consented to its being made in a public manner, he is liable to that

person, whether the representation has or has not been made or communicated to that person so giving

credit by or with the knowledge of the apparent partner making the representation or consenting to it

being made.

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(a) When a partnership liability results, he is liable as though he were an actual member of the

partnership.

We have long recognized the doctrine of partnership by estoppel. [Citation, 1840], the court stated that

they who hold themselves out to the world as partners in business or trade, are to be so regarded as to

creditors and third persons; and the partnership may be established by any evidence showing that they

so hold themselves out to the public, and were so regarded by the trading community.

Further, we have stated that “[p]artnerships may be proved by circumstantial evidence; and evidence

will sometimes fix a joint liability, where persons are charged as partners, in a suit by a third person,

when they are not, in fact, partners as between themselves.” [Citation, 1843.]

In [Citation, 1906], the court noted that

[a] person who holds himself out as a partner of a firm is estopped to deny such representation, not

only as to those as to whom the representation was directly made, but as to all others who had

knowledge of such holding out and in reliance thereon sold goods to the firm.…

In addition, “if the party himself puts out the report that he is a partner, he will be liable to all those

selling goods to the firm on the faith and credit of such report.” [Citation] When a person holds himself

out as a member of partnership, any one dealing with the firm on the faith of such representation is

entitled to assume the relation continues until notice of some kind is given of its discontinuance.

[Citations]

In [Citation, 1944], the court wrote:

It is a thoroughly well-settled rule that persons who are not as between themselves partners, or as

between whom there is in fact no legal partnership, may nevertheless become subject to the liabilities of

partners, either by holding themselves out as partners to the public and the world generally or to

particular individuals, or by knowingly or negligently permitting another person to do so. All persons

who hold themselves out, or knowingly permit others to hold them out, to the public as partners,

although they are not in partnership, become bound as partners to all who deal with them in their

apparent relation.

The liability as a partner of a person who holds himself out as a partner, or permits others to do so, is

predicated on the doctrine of estoppel and on the policy of the law seeking to prevent frauds on those

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who lend their money on the apparent credit of those who are held out as partners. One holding himself

out as a partner or knowingly permitting himself to be so held out is estopped from denying liability as

a partner to one who has extended credit in reliance thereon, although no partnership has in fact

existed.

In the present case, the trial court cited specific examples of representations made by Reggie and Mark

indicating that they were partners of CWC, including correspondence to Epsco, checks written to Epsco,

business cards distributed to the public, and credit applications. We will discuss each in turn.

The Faxed Credit References

Epsco argues that Plaintiff’s Exhibit # 1, a faxed list of credit references, clearly indicates that Gary was

the owner and that Reggie and Mark were partners in the business. The fax lists four credit references,

and it includes CWC’s contact information. The contact information lists CWC’s telephone number, fax

number, and federal tax number. The last two lines of the contact information state: “Gary Chavers

Owner” and “Reggie Chavers and Mark Chavers Partners.”

Gary testified that he did not know that the list of credit references was faxed to Epsco. In addition, he

testified that his signature was not at the bottom of the fax. He testified that his former secretary might

have signed his name to the fax; however, he stated that he did not authorize his secretary to sign or fax

a list of credit references to Epsco. Moreover, Gary testified that the first time he saw the list of credit

references was at the bench trial.

This court gives deference to the superior position of the trial judge to determine the credibility of the

witnesses and the weight to be accorded their testimony. [Citations] Though there was a dispute

concerning whether Gary faxed the list to Epsco, the trial court found that Epsco received the faxed

credit references from CWC and relied on CWC’s statement that Reggie and Mark were partners. The

trial court’s finding is not clearly erroneous.

The Fax Cover Sheet

At trial, Epsco introduced Plaintiff’s Exhibit # 2, a fax cover sheet from “Chavers Construction” to

Epsco. The fax cover sheet was dated July 19, 2000. The fax cover sheet contained the address,

telephone number, and fax number of the business. Listed under this information was “Gary, Reggie, or

Mark Chavers.” Epsco argues that Gary, Reggie, and Mark are all listed on the fax cover sheet, and that

this indicates that they were holding themselves out to the public as partners of the business. The trial

court’s finding that the fax cover sheet indicated that Reggie and Mark were holding themselves out as

partners of CWC is not clearly erroneous.

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The Epsco Personnel Credit Application

Epsco introduced Plaintiff’s Exhibit # 9, a personnel credit application, which was received from CWC.

Adams testified that the exhibit represented a completed credit application that she received from

CWC. The type of business checked on the credit application is “partnership.” Adams testified that the

application showed the company to be a partnership, and that this information was relied upon in

extending credit. Clegg testified that he viewed the credit application which indicated that CWC was a

partnership, and that his decision to extend credit to CWC was based, in part, on his belief that CWC

was a partnership. Gary denied filling out the credit application form.

It was within the trial court’s discretion to find Adams’s and Clegg’s testimony more credible than

Gary’s testimony and to determine that Epsco relied on the statement of partnership on the credit

application before extending credit to CWC. The trial court’s finding concerning the credit application

is not clearly erroneous.

The Checks to Epsco

Epsco argues that Plaintiff’s Exhibit # 3 and Plaintiff’s Exhibit # 11, checks written to Epsco showing

the CWC account to be in the name of “Gary A. or Reggie J. Chavers,” indicates that Reggie was holding

himself out to be a partner of CWC. Plaintiff’s Exhibit # 3 was signed by Gary, and Plaintiff’s Exhibit #

11 was signed by Reggie. The checks are evidence that Reggie was holding himself out to the public as a

partner of CWC, and Epsco could have detrimentally relied on the checks before extending credit to

CWC. The trial court was not clearly erroneous in finding that the checks supported a finding of

partnership by estoppel.

The Business Card

Epsco introduced Plaintiff’s Exhibit # 4, a business card that states “Chavers Welding, Construction &

Crane Service.” Listed on the card as “owners” are Gary Chavers and Reggie Chavers. Gary testified that

the business cards were printed incorrectly, and that Reggie’s name should not have been included as

an owner. He also testified that some of the cards might have been handed out, and that it was possible

that he might have given one of the cards to a business listed as one of CWC’s credit references on

Plaintiff’s Exhibit # 1.

The business card listing Reggie as an owner indicates that Reggie was holding himself out as a partner.

As we stated in [Citation] when a person holds himself out as a member of partnership, any one dealing

with the firm on the faith of such representation is entitled to assume the relation continues until notice

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of some kind is given of its discontinuance. There is no indication that Reggie ever informed any person

who received a business card that the business relationship listed on the card was incorrect or had been

discontinued. The trial court’s finding concerning the business card is not clearly erroneous.

The Dealership Application

Epsco introduced Plaintiff’s Exhibit # 5, an application form from “Chavers Welding,” signed by Reggie,

seeking a dealership from Sukup Manufacturing. The application, dated January 23, 1997, lists “Gary &

Reggie Chavers” as owners of “Chavers Welding.” The application is signed by Reggie. Reggie admits

that he signed the dealership application and represented that he was an owner of “Chavers Welding,”

but he dismisses his statement of ownership as mere “puffery” on his part. Epsco argues that instead,

the application shows that Reggie was holding himself out to the public as being a partner. The trial

court’s determination that Reggie’s dealership application supports a finding of partnership by estoppel

is not clearly erroneous.

In sum, the trial court was not clearly erroneous in finding that Reggie and Mark held themselves out as

partners of CWC and that Epsco detrimentally relied on the existence of the partnership before

extending credit to CWC. The appellants argue that even if we find Reggie liable based upon

partnership by estoppel, there was scant proof of Mark being liable based upon partnership by estoppel.

We disagree. We are aware that some examples of holding out cited in the trial court’s order pertain

only to Reggie. However, the representations attributed to both Reggie and Mark are sufficient proof to

support the trial court’s finding that both Reggie and Mark are estopped from denying liability to

Epsco.

Affirmed.

CASE QUESTIONS

1. What is the rationale for the doctrine of partnership by estoppel?

2. Gary and Reggie claimed the evidence brought forth to show the existence of a partnership was

unconvincing. How credible were their claims?

18.4 Summary and Exercises

Summary

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The basic law of partnership is found in the Uniform Partnership Act and Revised Uniform

Partnership Act. The latter has been adopted by thirty-five states. At common law, a partnership

was not a legal entity and could not sue or be sued in the partnership name. Partnership law

defines a partnership as “an association of two or more persons to carry on as co-owners a business

for profit.” The Uniform Partnership Act (UPA) assumes that a partnership is an aggregation of

individuals, but it also applies a number of rules characteristic of the legal entity theory. The

Revised Uniform Partnership Act (RUPA) assumes a partnership is an entity, but it applies one

crucial rule characteristic of the aggregate theory: the partners are ultimately liable for the

partnership’s obligations. Thus a partnership may keep business records as if it were a legal entity,

may hold real estate in the partnership name, and may sue and be sued in federal court and in

many state courts in the partnership name.

Partnerships may be created informally. Among the clues to the existence of a partnership are (1)

co-ownership of a business, (2) sharing of profits, (3) right to participate in decision making, (4)

duty to share liabilities, and (5) manner in which the business is operated. A partnership may also

be formed by implication; it may be formed by estoppel when a third party reasonably relies on a

representation that a partnership in fact exists.

No special rules govern the partnership agreement. As a practical matter, it should sufficiently spell

out who the partners are, under what name they will conduct their business, the nature and scope

of the business, capital contributions of each partner, how profits are to be divided, and similar

pertinent provisions. An oral agreement to form a partnership is valid unless the business cannot

be performed wholly within one year from the time that the agreement is made. However, most

partnerships have no fixed terms and hence are “at-will” partnerships not subject to the Statute of

Frauds.

EXERCISES

1. Able, Baker, and Carr own, as partners, a warehouse. The income from the warehouse during the

current year is $300,000, two-thirds of which goes to Able. Who must file a tax return listing this as

income, the partnership or Able? Who pays the tax, the partnership or Able?

2. The Havana Club operated in Salt Lake City under a lease running to defendant Dale Bowen, who

owned the equipment, furnishings, and inventory. He did not himself work in operating the club. He

made an oral agreement with Frances Cutler, who had been working for him as a bartender, that she

take over the management of the club. She was to have the authority and the responsibility for the

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entire active management and operation: to purchase the supplies, pay the bills, keep the books, hire

and fire employees, and do whatever else was necessary to run the business. As compensation, the

arrangement was for a down-the-middle split; each was to receive $300 per week plus one half of

the net profits. This went on for four years until the city took over the building for a redevelopment

project. The city offered Bowen $30,000 as compensation for loss of business while a new location

was found for the club. Failing to find a suitable location, the parties decided to terminate the

business. Bowen then contended he was entitled to the entire $30,000 as the owner, Cutler being an

employee only. She sued to recover half as a partner. What was the result? Decide and discuss.

3. Raul, a business student, decided to lease and operate an ice cream stand during his summer

vacation. Because he could not afford rent payments, his lessor agreed to take 30 percent of the

profits as rent and provide the stand and the parcel of real estate on which it stood. Are the two

partners?

4. Able, Baker, and Carr formed the ABC Partnership in 2001. In 2002 Able gave her three sons, Duncan,

Eldon, and Frederick, a gift of her 41 percent interest in the partnership to provide money to pay for

their college expenses. The sons reported income from the partnership on their individual tax

returns, and the partnership reported the payment to them on its information return. The sons were

listed as partners on unaudited balance sheets in 2003, and the 2004 income statement listed them

as partners. The sons never requested information about the management of the firm, never

attended any meetings or voted, and never attempted to withdraw the firm’s money or even speak

with the other partners about the firm. Two of the sons didn’t know where the firm was located, but

they all once received “management fees” totaling $3,000, without any showing of what the “fees”

were for. In 2005, the partnership incurred liability for pension-fund contributions to an employee,

and a trustee for the fund asserted that Able’s sons were personally liable under federal law for the

money owing because they were partners. The sons moved for summary judgment denying liability.

How should the court rule?

5. The Volkmans wanted to build a house and contacted David McNamee for construction advice. He

told them that he was doing business with Phillip Carroll. Later the Volkmans got a letter from

McNamee on stationery that read “DP Associates,” which they assumed was derived from the first

names of David and Phillip. At the DP Associates office McNamee introduced Mr. Volkman to Carroll,

who said to Volkman, “I hope we’ll be working together.” At one point during the signing process a

question arose and McNamee said, “I will ask Phil.” He returned with the answer to the question.

After the contract was signed but before construction began, Mr. Volkman visited the DP Associates

office where the two men chatted; Carroll said to him, “I am happy that we will be working with

you.” The Volkmans never saw Carroll on the construction site and knew of no other construction

supervised by Carroll. They understood they were purchasing Carroll’s services and construction

expertise through DP Associates. During construction, Mr. Volkman visited the DP offices several

times and saw Carroll there. During one visit, Mr. Volkman expressed concerns about delays and

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expressed the same to Carroll, who replied, “Don’t worry. David will take care of it.” But David did

not, and the Volkmans sued DP Associates, McNamee, and Carroll. Carroll asserted he could not be

liable because he and McNamee were not partners. The trial court dismissed Carroll on summary

judgment; the Volkmans appealed. How should the court rule on appeal?

6. Wilson and VanBeek want to form a partnership. Wilson is seventeen and VanBeek is twenty-two.

May they form a partnership? Explain.

7. Diane and Rachel operate a restaurant at the county fair every year to raise money for the local 4-H

Club. They decide together what to serve, what hours to operate, and generally how to run the

business. Do they have a partnership?

SELF-TEST QUESTIONS

1. The basic law of partnership is currently found in

a. common law

b. constitutional law

c. statutory law

d. none of the above

2. Existence of a partnership may be established by

a. co-ownership of a business for profit

b. estoppel

c. a formal agreement

d. all of the above

3. Which is false?

a. An oral agreement to form a partnership is valid.

b. Most partnerships have no fixed terms and are thus not subject to the Statute of Frauds.

c. Strict statutory rules govern partnership agreements.

d. A partnership may be formed by estoppel.

4. Partnerships

a. are not taxable entities

b. may buy, sell, or hold real property in the partnership name

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c. may file for bankruptcy

d. have all of the above characteristics

5. Partnerships

a. are free to select any name not used by another partnership

b. must include the partners’ names in the partnership name

c. can be formed by two corporations

d. cannot be formed by two partnerships

SELF-TEST ANSWERS

1. c

2. d

3. c

4. d

5. c

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