Partnership Law

Why have joint ownership?

Pamela wants to buy grocery store for $200,000: $20,000 of own funds; $150,000 senior debt from Walter at 10% interest

$30,000 potential junior debt from Abe and Bill at 20%, but: debt load might be too high, Walter might object, or both.

Alternatives: “zero coupon” debt relieves the debt load a bit;

OR: give Abe & Bill a residual claim, I.e., some share of the profits or losses

Partnerships: Two or more people want to associate as co-owners rather than as principal and agent

DEAL POINTSDeal Points:

Risk of Loss - from investments in or operation of business

Return – Fixed claims (salaries, interests) and residual claims (profits, incentives)

Control – Who has the right to make which sort of decisions for business

Duration – How long? How terminated? Transferability?

Partners assume risks – make investments in and take returns contingent on operation of business

o In exchange for assuming risk, partners gain control rights

o CONTROL FOLLOWS RISK

Partnerships vs. Corporations

Big shortcoming: No limited liability

Major advantages over corporations:Simple to formFlexible in organization (informal)“Pass through” taxation

Looking Ahead: Corporate Priorities

CorporationAssets

IndividualAssets

CorporationCreditors

IndividualCreditors

Personal creditors have no claim oncorporate assets, and vice versa:

DefinitionA partnership is “an association of two or more

persons to carry on as co-owners a business for profit.” (UPA §6; RUPA §202(a))

“Co-owners”Residual control interestResidual financial interest

IntentPartnership may be formed “whether or not the

persons intend to form a partnership” RUPA §202(a)

Partners must intend only “to do the things which constitute a partnership”

Many partnerships are inadvertent

Profit SharingMost important factor: sharing profits

“Profits” … not “revenues”Partners v. employees or creditors

Partnership Relations with Third Parties

The Rights of Partnership Creditors UPA §15: PRs jointly and severally liable on partnership torts; jointly liable on

P’ship contracts. RUPA §306: PRs jointly and severally liable on partnership torts and

contracts. BUT: RUPA §307(d): Must exhaust business assets before pursuing personal

assets.

Three Aspects of Creditors’ Rights: Whom can creditors pursue? Who is a partner? When can a ex-partner escape partnership debts? How do partnership creditors fare in competition with personal creditors for

assets when the partnership and its partners are all bankrupt (a common scenario)?

Brudney UPA Problems

Gratia

Ars

Artis

Mayer

?

Contributes “sweat equity”;gets $5,000 or 1/3 of the profits each year

Contributes land worth $40K and handles sales

Contributes $30K cash and handles purchasing. Half thecash comes from Mayer (whichothers know); half the profits goto Mayer (others don’t know).

IF: a person represents itself as being a partner in an enterprise (or consents to others making the representation)

AND: a third party reasonably relies on the representation (actual reliance required) and does business with the enterprise,*

THEN: the person who was represented as a partner is personally liable on the transaction, even though that person is not in fact a partner.

=> somewhat analogous to apparent authority doctrine.

* While UPA § 16(1) refers only to those who “give credit”, RUPA § 308 expands this to all transactions and case law has made this clear even in the UPA context.

Partnership by Estoppel

Jingle Rule vs. 1978 Act

UPA § 40(h) & (i)(a.k.a. “Jingle Rule”)

‘78 Act (§ 723(c)), RUPA § 807(a)

PartnershipAssets

IndividualAssets

PartnershipCreditors

IndividualCreditors

First Priority

Second Priority

PartnershipAssets

IndividualAssets

PartnershipCreditors

IndividualCreditors

Looking Ahead: Corporate Priorities

CorporationAssets

IndividualAssets

CorporationCreditors

IndividualCreditors

Personal creditors have no claim oncorporate assets, and vice versa:

Vohland v. Sweet

Sweet does apprenticeship with Vohland the Elder; Elder dies, Vohland Junior (Charles) takes over and renames it “Vohland’s Nursery.”

Beginning in 1963, Sweet paid 20% of net profits of Vohland Nursery.

No explicit agreement. Sweet’s 20% share is (erroneously) called “commission.”

In 1979, Sweet sues to dissolve partnership – I.e., wind-up, sell assets, and distribute proceeds.

Dissolution & Disassociation

Under UPA:

Dissolution (§29): any change of partnership relations, e.g., the exit of a partner. Winding up (§37): Orderly liquidation and settlement of partnership affairs. Termination (§30): partnership ceases entirely at the end of winding up.

Under RUPA:

Disassociation (§ 601): a partner leaves but the partnership continues, e.g., pursuant to agreement.

Dissolution: (§ 801): the onset of liquidating of partnership assets and winding up its affairs.

Dissolution – Three Issues

1. Ability of partners to opt out of statutory wind-up in a partnership at will (Adams v. Jarvis)

2. Mode of liquidation in a statutory wind-up (Dreifuerst v. Dreifuerst)

3. Limitations on the power to force statutory dissolution and wind-up (Page v. Page)

Adams v. Jarvis

Dr. Adams withdraws from the three-doctor “Tomahawk Clinic” partnership; contends that his withdrawal constitutes a “dissolution” that requires a winding-up.

UPA § 38(1): “When dissolution is caused in any way, except in contravention of the partnership agreement, each partner, as against his co-partners . . , unless otherwise agreed, may have the partnership property applied to discharge its liabilities, and the surplus applied to pay in cash the net amount owing to the respective partners.”

Partnership Agreement: “The incapacity, withdrawal, or death of a partner shall not terminate this partnership” (§ 15). Instead, Adams should get 5/12 * 1/3 = 5/36 of profits in the year of his withdrawal (§ 16).

Trial court finds that Adams’ withdrawal worked as a dissolution of the partnership => statutory winding-up is required => Adams is entitled to liquidation and 1/3 of the Accounts Receivable under UPA § 38(1).

Dreifuerst v. Dreifuerst

Winding-up of at-will partnership among three brothers to run two feed mills. No partnership agreement.

Trial court declines one brother’s request for a sale of the assets; instead, gives one mill (St. Cloud) to the one brother and other mill (Elkhart Lake) to the other two brothers.

UPA §38(1): “When dissolution is caused in any way, except in contravention of the partnership agreement, each partner, as against his co-partners . . , unless otherwise agreed, may have the partnership property applied to discharge its liabilities, and the surplus applied to pay in cash the net amount owing to the respective partners.”

Page v. Page

Meinhard v. Salmon revisited: Oral partnership agreement to run a laundry (linen supply company). Both partners contribute $43K in original equity capital, and “Big Page” (a.k.a., the brains, like Salmon) loans the partnership another $47K through his wholly-owned corporation.

Just when business seems to turn a corner in 1958-59, Big Page seeks to dissolve the partnership. Little Page claims that Big Page is trying to take an opportunity for himself stemming from the new Vandenberg Air Force Base.

Trial court finds that the partnership is for a term rather than at will => Big Page can’t dissolve.

Partners Forever? Within Andersen, Personal Liability May Bring RuinWall Street Journal (April 2, 2002)

Among the life-threatening issues facing Arthur Andersen LLP, one looming especially large for its partners is how effectively those three letters, LLP, shield them from potentially ruinous personal liability.

Concerns are growing among Andersen's roughly 1,750 U.S. partners that even those who had nothing to do with the firm's work for Enron Corp. could eventually face personal liability stemming from the botched audit. . .

The limited-liability partnership is a comparatively new corporate structure, untested by the kind of stress now besetting Andersen. But that testing appears to be just around the corner as Enron creditors, shareholders and employees seek to recover the billions of dollars they have lost from someone.

Because it is unclear how much protection the LLP structure will provide Andersen partners, partnership and bankruptcy lawyers are expected to be following the matter closely.

Example: Andersen (2002)

Private-Equity Firms Make Far More Charging InvestorsWall Street Journal (September 13, 2007)

The [Metrick & Yasuda] study shows that, on average, leveraged-buyout funds can expect to collect $10.35 in management fees for every $100 they manage. In comparison, slightly more than half as much -- $5.41 for every $100 -- comes from carried interest.

Carried interest represents the 20% cut of any profit that buyout firms retain for themselves after auctioning off a company, getting dividends from a portfolio company or selling all or some of a company in an initial public offering of stock.

The Wharton study draws from a unique trove of data, the actual performance records of a large institutional investor in private-equity funds. That investor shared data from 144 separate buyout funds from 1992 to 2006, with authors Andrew Metrick and Ayako Yasuda, both Wharton professors of finance. . . .

Private Equity LP’s (p.75)

Limited Liability Companies &IRS Four-Factor Test

1. Limited liability for the owners of the business

2. Centralized management

3. Freely transferable ownership interests

4. Continuity of life

Pre-1997: LLC’s failed continuity of life test (typically by requiring dissolution when a member leaves, unless remaining members consent) and transferability of interest (by requiring consent of members to transfer interest).

IRS Reg. § 7701-1 to –3 (1997-) check-the-box rules scrapped four-factor test, and allow all new unincorporated businesses to choose taxation as partnership or corporation.

BUT: IRC § 7704(a) (1987-): any enterprise with publicly traded equity faces same two-tier taxation as C corps.

A Brief History of Double Taxation of Corporate Profits

2003: Jobs and Growth Tax Relief Reconciliation Act reduces taxation of dividends to 15% through the end of 2008.

2005: Tax Increase Prevention and Reconciliation Act extends reduction through the end of 2010.

2009: Obama Administration plans to increase dividend tax rate to 20%, for households earnings more than $250,000.