Business Law: Partnerships

5/1/2023 1 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS L AW B USINESS L AW T EXT AND C ASES T EXT AND C ASES CHAPTERS 37: PARTNERSHIPSCHAPTERS 37: PARTNERSHIPS © 2018 Cengage. May not be sca...

5/1/2023 1 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS L AW B USINESS L AW T EXT AND C ASES T EXT AND C ASES CHAPTERS 37: PARTNERSHIPSCHAPTERS 37: PARTNERSHIPS © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. IntroductionIntroduction  Historically, two or more persons entering into business together have most commonly organized their business as a partnership or a corporation .  A partnership arises from an agreement , express or implied, between two or more persons to carry on a business for a profit.  Partnerships are governed both by:  Common law concepts—in particular, those relating to agency, and  Statutory law 1 2 5/1/2023 2 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. IntroductionIntroduction  Partners:  Are co-owners of the business  Have joint control (management) over its operation  Have the right to share in its profits  Types of partnerships include:  Ordinary partnerships (also known as general partnerships )  Special forms of partnerships: Limited partnerships and limited liability partnerships © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Agency Concepts and Partnership Law Agency Concepts and Partnership Law  When two or more persons agree to do business as partners, their relationship is similar to an agency relationship.  Each partner is deemed to be the agent of the other partners and of the partnership.  In their relationships with one another, partners—like agents—are bound by fiduciary ties. 3 4 5/1/2023 3 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Essential Elements of a PartnershipEssential Elements of a Partnership  If there is no formal written partnership agreement (rare) , courts will determine whether a partnership exists by looking for the following three essential elements: 1. A joint ownership of the business 2. A sharing of profits or losses 3. An equal right to be involved in the management of the business © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Entity versus AggregateEntity versus Aggregate  At common law , a partnership was treated only as an aggregate of individuals and never as a separate legal entity.  A lawsuit could never be brought by or against the firm in its own name.  Each individual partner had to sue or be sued. 5 6 5/1/2023 4 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Entity versus AggregateEntity versus Aggregate  Today , in contrast, a majority of the states treat a partnership as a legal entity for most purposes.  A partnership usually can sue or be sued, collect judgments, and have all accounting performed in the name of the partnership entity.  As an entity, a partnership may hold the title to real or personal property in its name rather than in the names of the individual partners. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Tax Treatment of PartnershipsTax Treatment of Partnerships  An exception to this holding is that tax law does not treat a partnership as separate legal entity for federal income tax purposes.  The partnership is a pass-through entity and not a taxpaying entity.  As you should know, a pass-through entity is a business entity that has no tax liability.  The entity’s income is passed through to the owners, and they pay taxes on the income. 7 8 5/1/2023 5 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Tax Treatment of PartnershipsTax Treatment of Partnerships  A partnership itself is responsible only for filing an information return with the Internal Revenue Service.  This is a tax return submitted by a partnership that reports the business’s income and losses.  The partnership itself does not pay taxes on the income.  Each partner’s share of the profit ( whether distributed or not ) is taxed as individual income to that partner.  Similarly, partners can deduct a share of the partnership’s losses on their individual tax returns (in proportion to their partnership interests). © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Partnership AgreementThe Partnership Agreement  A partnership is a voluntary association of individuals, and as such, it is generally formed by the agreement of the partners.  Agreements to form a partnership can be either:  Oral  Written  Implied by conduct  Some partnership agreements must be in writing to be legally enforceable. 9 10 5/1/2023 6 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Partnership AgreementThe Partnership Agreement  The rights and duties of partners are governed largely by the specific terms of their partnership agreement.  In the absence of provisions to the contrary in the partnership agreement, state law imposes certain rights and duties. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Clarkson/Miller, Business Law: Text and Cases, Fifteenth Edition . © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Provisions Commonly Included in a Partnership Agreement • Name of the partnership and the names of the partners. • Location of the business and the state law under which the partnership is organized. • Purpose and duration of the partnership. Basic Structure • Amount of capital that each partner is contributing. • The agreed-on value of any real or personal property that is contributed instead of cash. • How losses and gains on contributed capital will be allocated, and whether contributions will earn interest. Capital Contributions • Percentage of the profits and losses of the business that each partner will receive. • When distributions of profit will be made and how net profit will be calculated. Sharing of Profits and Losses 11 12 5/1/2023 7 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Clarkson/Miller, Business Law: Text and Cases, Fifteenth Edition . © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Provisions Commonly Included in a Partnership Agreement • How management responsibilities will be divided among the partners. • Name(s) of the managing partner(s), and whether other partners have voting rights. Management and Control • Events that will cause the dissociation of a partner or dissolve the firm, such as the retirement, death, or incapacity of any partner. • How partnership property will be valued and apportioned on dissociation and dissolution. • Whether an arbitrator will determine the value of partnership property on dissociation and dissolution and whether that determination will be binding. Dissociation and Dissolution © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duration of the PartnershipDuration of the Partnership  If the partnership agreement specifies the duration of the partnership by stating that it will continue until a designated date or until the completion of a particular project, the partnership is called a partnership for a term .  Generally, withdrawing from a partnership for a term prematurely (before the expiration date) constitutes a breach of the agreement, and the responsible partner can be held liable for any resulting losses.  If no fixed duration is specified, the partnership is a partnership at will .  A partnership at will can be dissolved at any time without liability. 13 14 5/1/2023 8 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of PartnersRights of Partners  The rights of partners in a partnership relate to the following areas:  Management  Interest in the partnership  Compensation  Inspection of books  Accounting  Property © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: ManagementRights of Partners: Management  In a general partnership , all partners have equal rights in managing the partnership.  Unless the partners agree otherwise , each partner has one vote in management matters regardless of the proportional size of his or her interest in the firm.  Unless the partners agree otherwise, a majority vote controls decisions on ordinary matters connected with partnership business.  Decisions that significantly change the nature of the partnership or that are outside the ordinary course of the partnership business require the unanimous consent of the partners. 15 16 5/1/2023 9 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: Interest in Partnership Rights of Partners: Interest in Partnership  Each partner is entitled to the proportion of business profits and losses that is specified in the partnership agreement .  If the agreement does not apportion profits (indicate how the profits will be shared), then profits will be shared equally.  If the agreement does not apportion losses, losses will be shared in the same ratio as profits. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: CompensationRights of Partners: Compensation  Normally, a partner does not earn a salary from the partnership.  A partner’s income from the partnership takes the form of a distribution of profits according to the partner’s share in the business.  Remember: the partnership agreement can state otherwise. 17 18 5/1/2023 10 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: Inspection of Books Rights of Partners: Inspection of Books  Each partner has the right to receive full and complete information concerning the conduct of all aspects of partnership business.  Partners have a duty to provide the information to the firm, which has a duty to preserve it and to keep accurate records.  The partnership books must be kept at the firm’s principal business office (unless the partners agree otherwise).  Every partner is entitled to inspect all books and records on demand and can make copies of the materials. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: AccountingRights of Partners: Accounting  An accounting of partnership assets or profits is required to determine the value of each partner’s share in the partnership.  An accounting can be either:  Performed voluntarily  Compelled by court order  A partner has the right to bring an action for an accounting during the term of the partnership, as well as on the partnership’s dissolution. 19 20 5/1/2023 11 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rights of Partners: Property RightsRights of Partners: Property Rights  Property acquired by a partnership is the property of the partnership and not of the partners individually.  Except in rare circumstances, partnership property includes:  All property that was originally contributed to the partnership  Any property later purchased by the partnership or in the partnership’s name. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duties and Liabilities of PartnersDuties and Liabilities of Partners  Each partner is an agent of every other partner and acts as both a principal and an agent in any business transaction within the scope of the partnership agreement.  Every act of a partner concerning partnership business (and “business of the kind”) and every contract signed in the partnership’s name bind the firm. 21 22 5/1/2023 12 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duties and Liabilities of Partners: Fiduciary Duties Duties and Liabilities of Partners: Fiduciary Duties  A partner owes fiduciary duties to both the partnership itself and to the other partners.  The duty of care : a partner’s duty of care is limited to refraining from “grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.”  The duty of loyalty requires a partner to account to the partnership for “any property, profit, or benefit” derived by the partner in the conduct of the partnership’s business or from the use of its property © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duties and Liabilities of Partners: Authority of Partners Duties and Liabilities of Partners: Authority of Partners  The general principles of agency law pertain to a partner’s authority to bind a partnership in contract .  If a partner acts within the scope of her or his authority , the partnership is legally bound to honor the partner’s commitments to third parties.  A partner may subject the partnership to tort liability under agency principles.  When a partner is carrying on partnership business with third parties in the usual way, apparent authority exists, and both the partner and the partnership itself share liability. 23 24 5/1/2023 13 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Duties and Liabilities of PartnersDuties and Liabilities of Partners  One significant disadvantage associated with a general partnership is that all partners are personally liable for the debts of the partnership (not the personal debts of the partner).  In most states, the liability is essentially unlimited, because the acts of one partner in the ordinary course of business subject the other partners to personal liability. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. DissociationDissociation  Dissociation is the severance of the relationship between a partner and a partnership.  Dissociation normally entitles the partner to have his or her interest purchased by the partnership.  Dissociation terminates the partner’s actual authority to act for the partnership and to participate in running its business. 25 26 5/1/2023 14 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. DissociationDissociation  A partner can be dissociated from a partnership in several ways.  The most common way is when a partner voluntarily gives notice of an “express will to withdraw”  When a partner gives notice of intent to withdraw, the remaining partners must decide whether to continue the partnership business.  If they decide not to continue, the voluntary dissociation of a partner will dissolve the firm. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Effects of DissociationEffects of Dissociation  After a partner’s dissociation and assuming the partnership continues, his or her interest in the partnership must be purchased by the partnership.  Buyout price – The amount payable to a partner on his or her dissociation from a partnership is normally based on the amount that would have been distributed to that partner if the firm had been terminated on that date. 27 28 5/1/2023 15 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Partnership TerminationPartnership Termination  A partnership may be terminated (dissolved) if the partners no longer wish to (or are unable to) continue the partnership business.  The termination of a partnership occurs in two stages:  Dissolution  Winding Up. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Partnership Termination: DissolutionPartnership Termination: Dissolution  Any partnership (including one for a fixed term) can be dissolved by the partners’ agreement .  If the partnership agreement states that it will dissolve on a certain event, such as a partner’s death or bankruptcy, then the occurrence of that event will dissolve the partnership.  A partnership for a fixed term or a particular undertaking is dissolved by operation of law at the expiration of the term or on the completion of the undertaking.  A court may order dissolution when it becomes impractical for the firm to continue. 29 30 5/1/2023 16 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Partnership Termination: Winding UpPartnership Termination: Winding Up  After dissolution, the partnership continues for the limited purpose of winding up the business.  During this process, the partners cannot create new obligations on behalf of the partnership, and they have authority only to:  Complete transactions begun but not finished at the time of dissolution  Wind up the business of the partnership. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Partnership TerminationPartnership Termination  Partnership buy-sell agreement is an express agreement made at the time of partnership formation for one or more of the partners to buy out the other or others should the situation warrant.  Alternatively, the agreement may specify that one or more partners will determine the value of the interest being sold and that the other or others will decide whether to buy or sell. 31 32 5/1/2023 17 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Limited Liability PartnershipsLimited Liability Partnerships  Limited liability partnership (LLP) – A hybrid form of business organization that is used mainly by professionals who normally do business in a partnership.  An LLP is a pass-through entity for tax purposes.  However, a partner’s personal liability for the malpractice of other partners is generally limited. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Limited PartnershipsLimited Partnerships  Limited partnership (LP) – A partnership consisting of one or more general partners and one or more limited partners .  General partner – A partner who assumes responsibility for the management of the partnership and has full liability for all partnership debts.  Limited partner – A partner who contributes capital to the partnership but has no right to participate in its management and has no liability for partnership debts beyond the amount of his or her investment .  Limited partnerships differ from general partnerships in several ways. 33 34 5/1/2023 18 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Limited PartnershipsLimited Partnerships  General partners in an LP are personally liable to the partnership’s creditors.  At least one general partner is necessary in a limited partnership so that someone has personal liability.  The liability of a limited partner is limited to the capital that she or he contributes or agrees to contribute to the partnership. 35