Holmes v. Lerner
74 Cal. App. 4th 442 (1999).
Holmes and Lerner were once good friends. Together they rode horses and made plans together. One of these plans was for a business called Urban Decay. Urban Decay started out as a nail polish color and has since grown into a popular makeup business. Holmes came up with the idea and the mix while Lerner used her business expertise to grow the business. Eventually, the two had a falling out and Holmes was ousted from being a part of the business.
The parties expressly agreed to associate as co-owners with the intent to Cary on a business for profit. As such, they have formed a partnership. Likewise, there was a definite partnership agreement (“we will do everything . . . together.”)
The default rule of management is that every partner has an equal vote when making decisions for the partnership. As long as the decision is about the ordinary course of business, the decision requires a bare majority. If the decision is about something outside of the ordinary course of business, the decision must be unanimous.
The key is to determine what is the ordinary course of business. Because this determines how many votes the decision requires (if using the default rules).
Most partnerships are formed with a written partnership agreement. This agreement typically addresses management (voting power), allocation of profits and losses, admission and withdrawal of partners, etc. The partnership agreement can also alter the default rules (although there is no alteration of mandatory rules See RUPA § 103(b)).
If there are parts in a written agreement that are contrary to the mandatory rules, then the contract is void (if there is no severability clause). Thus, we see that every written partnership agreement should include a severability clause and a merger clause.
Fiduciary Duties and Obligation of Good Faith and Fair Dealing
There are at least two fiduciary duties partners owe each other: 1) duty of loyalty, 2) duty of care. Although these duties can be defined, they cannot be removed from the partnership. By default, RUPA defines these duties as
Duty of Loyalty:
“Duty to account to the partnership and hold as trustee for it any property, profit, or benefit . . . derived from a use by the partner of partnership property.” RUPA 404(b)
Duty of Care:
“Refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.” RUPA 404(c)
Additionally, the duty of loyalty also prevent partners from engaging in self-dealing (acting in personal interest rather than partnership interest) or competing against the partnership.
Other obligations that cannot be removed in the partnership agreement is the obligation of good faith and fair dealing.
Meinhard v. Salmon
164 N.E. 545 (N.Y. 1928).
Meinhard and Salmon came together to lease Bristol Hotel for 20 years. Near the end of the lease, Salmon was approached with the prospect of tearing down the hotel and building a new project in it’s place. Salmon agreed without consulting Meinhard. After the transaction occurred, Meinhard learned about it, demanded a portion of the transaction but was denied. Thus, this lawsuit ensued.
Salmon has a duty of loyalty to the partnership that brings along a desire to disclose. Due to the failure to disclose Meinhard may have missed out on opportunities that would have otherwise been fully available to him. Consequently, there was a breach of loyalty and Salmon can be found liable.
RUPA § 103(b) – You can’t eliminate the duty of loyalty or care, but you can limit it to a certain point. See comments 103(b)(3) and (b)(4).
Additionally, partners have the obligation of good faith and fair dealing. The terms of good faith and fair dealing are not defined in RUPA, but instead left to the courts to determine how they should be interpreted and applied. The obligation is integral in the other duties (not separate) and likewise cannot be eliminated.
Every partner in a partnership is subject to personal liability for the actions taken by the partnership (partnership assets go first then partner assets). A partner not in the wrong could then still indemnify against the partner who caused the loss.
Transferring Partnership Interests
The default rule under RUPA § 503 is that a partner is not allowed to transfer its management interest, but can transfer its economic interests. The reason for this is because of the “choose your own partner” principle. That is, partners have the right to choose their partners and thus one partner cannot freely give up the partnership to another without unanimous consent of other partners. This principle can be modified by the partnership agreement.
Allocation of Profits and Losses
According to RUPA § 401(b), the default rule is that partnerships equally divide profits and losses. The unique thing about a partnership though is that the partners can agree who bears most of those profits and losses (especially if one partner contributes more than others).
There is a difference between distribution and allocation of profits. Allocation of profits discusses how much each partner is required to report on their taxes. Distribution discusses how much each partner is actually paid. Most partnership agreements ensure that the distribution amount is sufficient to cover the taxes based on the allocation calculation.
A partner may no longer become part of the partnership either 1) express notification of the will to withdraw, 2) expelled by the partnership agreement, 3) becoming bankrupt, or 4) through death. The dissociated partner must then be bought out and immediately cash the check. See RUPA §§ 601 and 701.
A partnership may dissolve in one of several ways. For instance, if one partner expressly shares a will to withdraw, the partnership will dissolve. The partnership may also dissolve if the partnership has an expiration date, completes its scope of work, or is ordered by a court to dissolve. Although most of these methods for dissolution may be addressed in the partnership agreement, a court order to dissolve cannot be altered.
Once an event has triggered the dissolution, the partners begin the winding-up phase (wrapping up the work). In this phase, the partnership continues until all the work necessary to complete the dissolution has been achieved. This includes the balancing of capital accounts (Contributions + Profits – Distributions = Capital Accounts).
See RUPA §§ 801 and 807
Limited Liability Partnerships
A LLP is essentially the same as a partnership but with liability protection. Rather than having no filing, a LLP submits a “statement of qualification,” which requires the name of the partnership, street address, and a statement of the desired LLP status. See RUPA § 1001.
The benefit of the LLP is found in RUPA § 306(c). That is, a partner within a partnership is not personally liable for the contract, torts, or other issues made by the partnership.
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.