Is My Business a Partnership?
It isn't always clear whether or not your business is a partnership. If you haven't formally reduced your business arrangements to writing and formed a legal entity, things can get tricky.
Maybe you’ve heard the age old adage “strength in numbers?” The same is true in business. People engaging in business often work together to accomplish their business goals. In a lot of instances, the relationship between the two parties is not formalized with a written partnership agreement or anything in writing at all. In such cases, determining whether a legal partnership exists in the first place can actually be a difficult task even though the implications of whether or not a partnership exist can be significant. A partnership is an association of two or more people for the purposes of conducting business. The default if there is no agreement otherwise when you have partners is that they are assumed to have an equal share in the partnership. They share equally in the profits and they share equally in the losses. They also have equal voting power and, thus, are equal in management authority. There are a variety of elements to consider: the intent of the parties; the rights share profit; the obligations share losses; ownership; control; explicit language of the agreement; conduct towards third parties; rights to dissolve; and rights upon dissolution. Whether a partnership exists is a conclusion typically determined by a court after evidence of these elements is presented through litigation.
Fenwick v. Unemployment Compensation Com.
A good case to consider illustrating these principles is Fenwick v. Unemployment Compensation Com. In the case, Fenwick owned a beauty shop and had a receptionist who was looking for a pay increase. An agreement was made between the parties that if they made enough money, the receptionist would get 20% net profits. The primary issue before the court is whether she was an employee or a partner. Sometimes the existence of a partnership is instrumental to determine liability or to avoid the implications of having employees such as tax obligations or workers compensation. the court here looks to precedent for the test in determining a partnership. Usually this involves some consideration of the intention of the parties where the agreement itself is evidentiary but not conclusory. The idea is that we typically don’t want people to try to gain the benefits by using words that do not reflect the reality of the circumstances. Similarly, the appropriate legal policy to encourage is that people enter into contractual agreements that they fully understand and intend to enter. People might not know the ramifications of calling something a partnership. The court is focusing here on the term “partners” in their agreement and at its core involves the right to share profits as well as the obligation to share losses. Secondly, it is important to consider how control is divided over business operations and management. Additionally, the ownership of property and rights to dissolve are important. The court will weigh all the factors to see which ones indicate a partnership. Ultimately, the court did not find the existence of a partnership. In the court’s eyes, most of the factors weighed towards a sole proprietorship. In fact, there was only thing that suggested a partnership – the right to share profits.
Ultimately, we see how difficult it is to figure out if someone is just an investor or a partner. We only know the answer for certain when the court makes a ruling. The existence of a partner is a matter of degree and is factually sensitive. From a policy standpoint, we like people to invest in businesses but there may be dramatic repercussions in the event the business fails. If investors become too involved in the business, they can incur liability. You always want to think about the possible existence of a partnership and what that would mean.
Martin v. Peyton
In Martin, a group of old friends pooled resources to use towards a struggling business and they had an agreement to share in future profits (in addition to many other things). They are not found to be partners in this case either! Everything they own is on the hold because they would be personally liable as partners. They can’t just say they are not partners and walk away. When they advanced certain loans, they took a lot of control and did so to try to protect their investment. From a policy standpoint it’s a good thing to put money into businesses and we want to encourage that. There are advantages to allowing people to invest in businesses because it costs more to start a new one and they can possibly turn the business around. After analyzing the partnership factors, it seems like they’re sharing profits, obligated to share losses, and share control and management. This case, however, illustrates how difficult the determination can be.
The existence of a partnership is fact intensive. Ultimately, it is difficult to know whether a partnership has been formed until a court ruling and its impossible to know how the court will analyze all of the evidence. When thinking about the existence of a partnership, courts are probably going to place more weight on the intent of the parties when only the parties are involved. There are default rules and the parties can contract around default rules. If you just have the partners involved, more weight is given to them. If a third party is involved, less weight will be given to the intent of the partners because you cannot contract away third parties rights. There are a wide variety of exceptions, however, and it is just viewed as strong evidence because it is a quintessential element of all partnerships.
Southex Exhibitions, Inc. v. Rhode Island Builders Ass
There is some mutual agreement between the parties. They partnered up and produced a production over a couple decades. The plaintiff wanted the court to recognize a partnership to continue the relationship. The court ultimately concludes that there is no partnership. The claim relied on the fact that they referred to themselves as partners in the agreement but in the totality of the circumstances there was not enough control and the defendant could contract with other third parties. The strongest evidence was that the defendant’s president said they do not want to be a partnership. They expressly disclaim the partnership. The court seems to be more interested in how each behaved with respect to each other when a third party is not involved. You cannot contract away the rights of third parties. Since in this case, no further parties were involved, the court focused on the fact that the parties did not want the partnership. At the end of the case, the court says the sharing of profits will be prima facie evidence of a partnership. It is the quintessential aspect of a partnership. There always going to be exceptions, however, where the other factors weigh more strongly.
Chris Sawan holds a JD, MBA and is a CPA with a background that yields itself to some of the most complex legal challenges facing businesses, families, and individuals.
Dennis E. Sawan is licensed to practice law in the States of Florida and Ohio. His experience as a transactional attorney makes him a tremendous ally to have for all types of transactions.
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