Chapter 33 Sole Proprietorships and Partnerships

WHAT THIS CHAPTER IS ABOUT

This chapter outlines part of the law of partnerships. In the absence of
express agreement, partnerships are governed by the Uniform Partnership Act
(UPA). The Revised Uniform Partnership Act (RLJPA) significantly changes
some of the rules. Besides these statutes, agency concepts (see Chapters 31
and 32) apply.

CHAPTER OUTLINE

I.SOLE PROPRIETORSHIPS The simplest form of business-the owner is the
business.

A ADVANTAGES
The proprietor takes all the profits. Easier to start than other kinds of
businesses (few legal forms involved); has more flexibility (proprietor is
free to make all decisions); owner pays only personal income tax on profits.

B. DISADVANTAGES
The proprietor has all the risk (unlimited liability for all debts); limited
opportunity to raise capital; the business dissolves when the owner dies.

II. THE LAW GOVERNING PARTNERSHIPS
A partnerships arises from an agreement between two or more persons to carry
on a business for profit. A partnership is governed by this agreement, the
principles of agency law, and the Uniform Partnership Act (UPA) or the
Revised Uniform Partnership Act (RUPA).

III. DEFINITION OF PARTNERSHIP

A. ELEMENTS OF A PARTNERSHIP
"[A]n association of two or more persons to carry on as co-owners a business
for profit" [UPA 6(l)]. There are three essential elements:

1. A sharing of profits or losses.
2. A joint ownership of the business.
3. An equal right in the management of the business.

B. SHARING PROFITS IS NOT ENOUGH
Sharing profits from a business does not imply a partnership, if the profits
were received as payment of a debt by installments or interest on a loan,
wages of an employee, rent to a landlord, an annuity to a widow or
representative of a deceased partner, or a sale of goodwill of a business or
property [UPA 7(4)]. Sharing profits from the joint ownership of property is
not enough to create a partnership [UPA 7(2), (3)].

IV. THE NATURE OF PARTNERSHIPS

A. PARTNERSHIP AS AN ENTITY
In many states, and under the UPA, the RUPA, and federal law, a partnership
can be treated as an entity for certain purposes.

1. Legal Capacity
Some states (and federal courts, when a federal question is at issue) permit
a partnership to sue and be sued in the firm name; others allow a partnership
to be sued as an entity but not to sue others in its firm name (it must use
the names of the individual partners).

2. Judgments

When a judgment is against a firm name, the liability is paid first out of
partnership assets and then out of general partners' personal assets.

3. Marshaling Assets
Partnership creditors have first priority to the partnership's assets, and
personal creditors of the individual partners have first priority to the
individual assets of each partner.

4. Bankruptcy
In federal court, a bankruptcy in the firm name applies only to the
partnership entity-it is not personal bankruptcy for the partners.

5. Conveyance of Property
A partnership can own property as an entity [LTPA 8(3)] and can convey it
without each individual partner's joining in the transaction.

B. AGGREGATE THEORY OF PARTNERSHIP
If a partnership is not regarded as a separate entity, it is treated as an
aggregate of the individual partners.

V. PARTNERSHIP FORMATION
A partnership agreement generally states the intention to create a
partnership, contribute capital, share profits and losses, and participate in
management.

A. FORMALITIES
A partnership agreement can be oral, written, or implied by conduct. Some
must be in writing under the Statute of Frauds (see Chapter 15). Partners
can agree to any terms that are not illegal or contrary to public policy.

B. DURATION

1. Partnership for a Term
The agreement can specify the duration of the partnership in terms of a date
or the completion of a particular project. Dissolution without a II
partners' consent before expiration is a breach of the agreement.
2. Partnership at Will No duration is set; any partner can dissolve a
partnership at any time.

C. CAPACITY
Any person having capacity to enter a contract can become a partner. @ors and
mentally incompetent persons can avoid their partnership contracts (see
Chapter 13). If a partner is adjudicated mentally incompetent during the
partnership, dissolution can be decreed by a court.

D. A CORPORATION AS PARTNER
Many states (not the UPA) restrict the ability of corporations to become
partners. In those states, courts sometimes validate such arrangements by
characterizing them as joint ventures.

E. PARTNERSHIP BY ESTOPPEL
When parties who are not partners hold themselves out as partners and make
representations that third persons rely on in dealing with them, liability is
imposed on the alleged partner. A partner who consents to the
misrepresentation is also liable to third persons who extend credit in good
faith reliance [UPA 161 (but the partnership is not).

VI. PARTNERSHIP OPERATION

A. RIGHTS AMONG PARTNERS

1. Management

a. Ordinarily, the Majority Rules
"All partners have equal rights in the management and conduct of partnership
business" [UPA 18(e)]. Each partner has one vote.

b. When Unanimous Consent Is Required
Unanimous consent is required to (1) alter the essential nature of the firm's
business or capital structure; (2) admit new partners or enter a new business
[UPA 18(g), (h)]; (3) assign property into a trust for the benefit of
creditors; (4) dispose of the firm's goodwill; (5) confess judgment against
the firm or submit firm claims to arbitration; (6) undertake any act that
would make conduct of partnership business impossible [UPA 9(3)]; or (7)
amend partnership articles.

2. Interest in the Partnership
Unless the partners agree otherwise, profits and losses are shared equally
[UPA 18(a)].

3 . Compensation
Doing partnership business is a partner's duty and not compensable. On the
death of a partner, a surviving partner is entitled to compensation to wind
up partnership affairs [UPA 18(o];

4. Inspection of Books
A partner has a right to complete information concerning the conduct of
partnership business [UPA 201. Partnership books must be kept at the
principal business office [UPA 191.

5. Accounting
A partner has a right to a formal accounting (1) on dissolution [LTPA 221;
(2) when the partnership agreement provides for it; (3) when a partner
is wrongfully excluded from the business, the books, or both; (4) when a
partner withholds profits or benefits belonging to the partnership; or
(5) when circumstances 'render it just and reasonable."

6. Property Rights
A partner has an interest in the partnership, a right in partnership
property, and a right to participate in management [UPA 24].
a. Partner's Interest in the Firm
A personal asset consisting of a proportionate share of the profits [UPA 26]
and a return of capital. The interest can be assigned, and creditors can
attach it by obtaining a charging order [UPA 281.

b. Partnership Property
A partner is co-owner with his or her partners of partnership property,
holding it as a tenant in partnership [UPA 25(l)].

1) If a Partner Dies
Surviving partners, not the heirs of the deceased, have a right of
survivorship to the property (they must account to the decedent's estate for
the value [UPA 25(2)(d), (e)]).

2) Each Partner Has Equal Rights
Each partner can possess partnership property for business purposes or in
satisfaction of firm debts, but cannot sell, assign, or deal with the
property other than for partnership purposes [UPA 25(2)(a), (b)], without the
consent of all of the partners.

B. DUTIES AND POWERS OF PARTNERS

1. Fiduciary Duties
Partners (1) must act in good faith for the benefit of the partnership, (2)
cannot engage in independent competitive activities without the other
partners'consent, and (3) must account to the partnership for profits or
benefits derived in a partnership transaction [UPA 211.

2. General Agency Powers
Each partner is an agent of every other partner and of the partnership in
carrying out partnership business [UPA 9(l)].

a - Authority of Partners Agency concepts apply to partners' authority (see
Chapter 32).

b. Scope of Implied Powers
Implied authority is determined by the character and scope of the partnership
business and the customary nature of the business. Normally, partners
exercise all implied powers reasonably necessary to carry on the business
[UPA 111.

3. Joint Liability
In most states, partners are jointly liable for partnership debts and
contracts [UPA 15(b)] (each partner is liable for the entire debt; if one
pays, the partnership or the other partners must reimburse that partner [UPA
18(b)]). To bring a successful claim against the partnership, a plaintiff
must name all the partners as defendants.

4. Joint and Several Liability
In some states, partners are jointly and severally liable for partnership
debts and contracts [see RUPA 306]. hi all states, partners are jointly and
severally liable for torts and breaches of trust [UPA 15(a)] (a partner who
commits a tort must reimburse the partnership for any damages it pays). To
bring a successful claim, a plaintiff need not name all the partners as
defendants-a judgment against one partner does not extinguish the others'
liability.

5. Liability of Incoming Partner
A newly admitted partner is liable for partnership debts incurred before his
or her admission only to the extent of his or her interest in the partnership
[UPA 17].

VII. PARTNERSHIP TERMINATION
Termination is caused by any change in the relations of the partners that
demonstrates unwillingness or inability to carry on partnership business
[UPA29 To continue the business, a partner can organize a new partnership.

A. DISSOLUTION
Occurs when a partner ceases to be associated with the carrying m of
the business. Dissolution terminates the right of a partnership to exist as
a going concern, but the partnership exists long enough to wind up its
affairs.

1. Dissolution by Acts of the Partners

a . Dissolution by Agreement
The partnership agreement can stipulate events that will dissolve the firm.
Partners can agree to dissolve the partnership early.

b. Partner's Power to Withdraw
No person can be compelled to be a partner. Under the UPA, a part­ner's
withdrawal dissolves the partnership. Under the RUPA, dissolution results
only if the partnership must be liquidated, not i f a partner only quits the
business [RLJPA 601, 701, 801].

c. Admission of a New Partner
Admitting a new partner (without the consent of the others) causes
dissolution. If the remaining or new partners continue the business, a new
partnership arises (taking on the debts of the old [LTPA 411).

d. Transfer of a Partner's Interest
A transfer of a partner's interest or a sale of the interest for the ben­efit
of creditors [UPA 28] leads to judicial dissolution (see below).

2. Dissolution by Operation of Law
a. Death
The death of a partner dissolves the firm, even if the partnership agreement
provides for carrying an the business. (Tbe surviving partners can form a new
partnership.) Under the RUPA, death is not an automatic ground for
dissolution [RUPA 6011.

b. Bankruptcy
Bankruptcy of a partner (or the firm) will dissolve a partnership.

c. Illegality

Dissolution is caused by (1) an event that makes it unlawful for the
partnership to continue, unless the partners decide to change the nature of
the business and continue, or (2) an event that makes it i I ­legal for any
partner to carry on.

3. Dissolution by Judicial Decree

A court can dissolve a partnership for a partner's mental incompetency,
incapacity, or improper conduct; impracticality of the firm's business (if it
can be run only at a loss); or other circumstances [UPA 32].

4. Notice of Dissolution

T'he intent to dissolve (or to withdraw) must be communicated to each
partner. Unless the other partners have notice, a withdrawing partner will
continue to be bound as a partner to all contracts created for the fir-zn.
Notice must also be given to all affected third persons. A third person who
has extended credit to the partnership must receive actual notice. For
others, constructive notice is sufficient.

B. WINDING UP

Involves collecting and preserving partnership assets, paying debts, and
accounting to each partner for the value of Ms or her interest.

1. No New Obligations

Once dissolution has occurred and partners have been notified, they cannot
create new obligations on behalf of the partnership. Their only authority is
to complete transactions begun but not finis]10 at the time of dissolution
and to wind up the business of the partners@.

2. Interest of a Partner Who Violates the Partnership Agreement.,

The other partners can buy out the interest and continue the bush*s.

3. If Dissolution Is Caused by the Death of a Partner

All partnership assets vest in the surviving partners, who nwst settle
partnership affairs and account to the estate of the deceased for the value
of his or her interest. The surviving partners are entitled to payment for
their services in winding up and for any costs [UPA 18(f)].

C. DISTRIBUTION OF ASSETS

1. UPA Distribution

Priority for the distribution of a partnership's assets is [UPA 40(b)]: (1)
payment to third party creditors; (2) refund of loans made to or for the firm
by a partner; (3) return of capital contribution to a partner; and (4)
distribution of the balance, if any, to partners proportionate to their
shares in the profits.

2. RUPA Distribution

Partner creditors are included among creditors who take first priority [RUPA
8081. Capital contributions and profits or losses are then calcu­lated
together to determine the amounts that the partners receive or the amounts
that they must pay.

3. If the Partnership's Liabilities Are Greater Than Its Assets

Partners bear losses (in the absence of a contrary agreement) in the same
proportion in which they shared profits. If the firm is insolvent, partners
must still contribute their respective shares. If a partner does not
contribute, the others must make the extra payments but have a right of
contribution against whoever does not pay.

D. PARTNERSHIP BUY-SELL AGREEMENTS

1 UPA Buy-out
Partners may agree that one or more partners may buy out the others. The
agreement may state who buys what, under what circumstances, and at what
price, or that one or more partners will determine the value of the interest,
and the others can decide whether to buy or sell.

2. RUPA Buy-out
If a partner's dissociation does not result in a dissolution of the
partnership, a buy-out of the partner's interest is mandatory [RUPA 701] at
basically the same price as he or she would get on dissolution.

TRUE-FALSE QUESTIONS

(Answers at the Back of the Book)
1. In a sole proprietorship, the owner and the business are entirely
separate.

2. A partnership is an association of two or more persons to carry on, as
co­owners, a business for profit.

3. A partnership cannot exist unless a certificate of partnership is filed
with a state.

4. The sharing of profits from joint ownership of property is usually enough
to create a partnership. -

5. A writing is always necessary to form a partnership.

6. Unless a partnership agreement specifies otherwise, each partner has one
vote in management matters.

7. A partner is co-owner with his or her partners of partnership property.

8. A partner can dissolve a partnership at any time without liability to the
other partners for losses due to the termination.

9. A partnership pays income tax on its profits.

10. Partners pay income tax an the partnership's profits that are passed to
them.

FILL-IN QUESTIONS
(Answers at the Back of the Book)

In most states, partners (are/are not) subject to
joint liabilitym
partnership debts, contracts, and torts. Joint liability means that if a
third party
sues a partner on a partnership
(obligation/tort), the partner
has the right to insist that the other partners be sued with him or her. If
the third
party does not sue all of the partners, those partners who are