CUNY Borough of Manhattan Community College Business Law Memorandum

Two of your friends from college, Hernandez and Darling, formed a software securitycompany a little over a year ago. They have operated as a general partnership doing
business under the name “FORTRESS Software Solutions.” FORTRESS currently
operates out of an office in lower Manhattan and has five software developers who
work full time for the company in the Manhattan office. Darling has a great deal of
experience with software development and closely supervises the software
developers.
Hernandez and Darling have asked you to invest $50,000 in their business and would
like you to work with them on a regular basis as head of accounting and business
development. Hernandez and Darling have given you access to their books and
records so you can conduct your own due diligence before you decide whether to
invest. You discover the following:
1. A file containing letters from Overpriced Properties, LLC, FORTRESS’s
landlord, seeking a thirty percent increase in rent for next year. You ask
Hernandez about this. She tells you she thinks she can negotiate a new lease
for only a twenty percent increase since she is a ten percent owner of
Overpriced Properties, LLC. You ask Darling about this. He tells you he did
not know anything about Hernandez’s ownership in Overpriced Properties,
LLC.
2.
Darling has made transfers of FORTRESS’s funds to a company called
“Quixotic Commodities, LLC.” You ask Darling about this. He tells you
these were short term, interest-free loans to a commodities trading firm in
which he has invested and that all amounts will be repaid shortly. You learn
from Hernandez that she knows nothing about these loans.
3. A file entitled “Trademarks” which reflects that Hernandez has made a filing
with the U.S. Patent and Trademark Office for the trademark “FORTRESS
Software.” You notice that Hernandez has made the filing in her own name.
You ask Darling about this. He tells you he knows nothing about it.
4. Darling tells you he has recently been in a car accident in which his car was
heavily damaged. He says he drove to Yonkers to meet with a prospective
customer. After the meeting, Darling drove to Vermont to meet a friend.
The accident occurred in southern Vermont. Darling advises you that he
expects “FORTRESS” to reimburse him for the $30,000 damage to his car.
5. In the partnership’s tax filings, Darling has characterized all five software
developers working for FORTRESS as “independent contractors.” You ask
Darling about this. He tells you he did this to save money, mostly to avoiding
paying employee benefits, and to avoid liability “if they do something wrong.”
6. Hernandez tells you that she expects FORTRESS’s sales to double during
the second half of 2022 because she recently resigned from a company
called Cyber Security Strategies and now plans to use her former
employer’s customer list to expand FORTRESS’s customer base.
Write a brief memo stating whether you would be willing to invest in FORTRESS and
addressing any issues you see arising from the facts set forth in paragraphs 1-6.
ONLY use the following materials: the textbook, your class notes, any item posted on
Blackboard, e.g., Power Points, cases,
PART
BUSINESS LAW:
THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
8
Agency Law
• Chapter 35 The Agency Relationship
• Chapter 36 Third-Party Relations of the
Principal and the Agent
© 2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted
without the prior written consent of McGraw-Hill Education.
1
The Agency Relationship
CHAPTER
35
I’ve got an ego and all that, but I know I need help. So I
go and hire the very best people.
H. Ross Perot, EDS
founder. Inc. magazine
© 2019 McGraw-Hill Education.
2
Learning Objectives
35-1 Know when and how an agency relationship is
created.
35-2 Understand the distinction between employees
and nonemployee agents (independent contractors).
35-3 Recognize when an agent risks breaching a
fiduciary duty.
35-4 Learn the way agency relationships are
terminated.
© 2019 McGraw-Hill Education.
3
Introduction
Agency is a two-party relationship in which one party
(agent) is authorized to act on behalf of, and under the
control of another party (principal).
In fact, without agency, business as we know it would
not be able to exist!
Agency permits individuals or entities (principals) to
conduct business more efficiently by authorizing others
(agents) to transact business and make binding
commitments on behalf of principals.
© 2019 McGraw-Hill Education.
4
Creation of an Agency
Anyone may be an agent or principal. However,
the arrangement is voidable by minors and the
mentally incapacitated.
Principal must have authority to perform the
actions for which the agent is retained.
Note: certain duties are non-delegable, e.g.
voting, making a will, services contracts where
the principal’s performance is essential.
© 2019 McGraw-Hill Education.
5
Creation of an Agency: Krakauer v.
Dish Network, L.L.C.
Jury properly found existence of agency between
Dish Network and non-party Satellite Systems
Network (SSN).
Dish had contracted with SSN for telemarketing
services. SSN violated the Telephone Consumer
Protection Act.
Finding of agency was proper where Dish had broad
authority over SSN’s business and was aware of
SSN’s actions but did nothing to correct them.
© 2019 McGraw-Hill Education.
6
Agency Authority
An agent can bind his principal only when the agent has authority
to do so.
Authority: ability of agent to affect principal’s legal relations (bind)
Two forms: actual or apparent authority.
Actual authority is express or implied.
• Express authority is created by the principal’s actual words
(written or oral).
• Example: “I want to hire you as my real estate agent to sell
my house.”
© 2019 McGraw-Hill Education.
7
Implied Authority
Agent has implied authority to do whatever it is
reasonable to assume that the principal wanted
the agent to do given principal’s statements and
surrounding circumstances.
• Example: a person hired as general manager in a
restaurant will have broad authority to run the
business while a person hired as a cashier will have
limited authority.
© 2019 McGraw-Hill Education.
8
Apparent Authority
Apparent authority arises when principal’s
conduct leads a third party to believe that an
agent (who lacks actual authority) is authorized
to act a certain way and the third party
reasonably relies on the agent’s appearance
(cloak) of authority.
To protect third parties, agency law allows an
agent to bind a principal on the basis of the
agent’s apparent authority.
© 2019 McGraw-Hill Education.
9
Apparent Authority
Agent cannot create authority without
principal’s consent or acquiescence via: (i) P’s
direct statements to 3P; (ii) P’s permission to A
to make statements to 3P; (iii) P permitting A to
act in a way that creates an appearance of
authority with regard to 3P.
© 2019 McGraw-Hill Education.
10
Employees and
Nonemployee Agents
The principal’s liability depends on whether a person
who contracts with the principal is an employee
(servant) or non-employee (independent contractor).
• Factors: right to control physical details of the work,
skill required, source of tools, location, schedule
control, duration of relationship, payment method,
benefits, tax treatment of hired party, uniqueness
of work in relation to hiring party’s regular business.
© 2019 McGraw-Hill Education.
11
Employees or Nonemployees: CBS
Corp. v FCC
Jackson and Timberlake were compensated by onetime, lump-sum contractual payments and
“promotional considerations” rather than by salaries.
There is no evidence that Jackson, Timberlake, or CBS
considered their contractual relationships to be those
of employer-employee.
HELD: reversed for CBS. Jackson and Timberlake were
independent contractors rather than employees and
respondeat superior does not apply on these facts.
© 2019 McGraw-Hill Education.
12
Duties of Agent to Principal
1
Since agency is a fiduciary relationship of trust and
confidence, an agent has a duty of loyalty to the
principal. Agent must act solely for principal’s
interests, not agent’s personal interests.
Rationale: Agent is entrusted with Principal’s property
and/or ability to affect Principal’s legal relations.
Agent must (1) avoid conflicts of interest with the
principal, (2) maintain confidentiality of information
received from the principal. The duty of confidentiality
survives termination of the agency.
© 2019 McGraw-Hill Education.
13
Duties of Agent to Principal
2
Conflicts of interest include self-dealing,
competition with the principal, acting for another
party, commingling the principal’s property with
that of the agent, or failing to convey information
to the principal relevant to the subject of the
agency.
• These duties generally end after the period of agency
but may be extended by agreement, e.g. noncompete.
© 2019 McGraw-Hill Education.
14
Duties of Agent: North
Atlantic Instruments v Haber
Haber’s employment agreement required he keep
secret and retain in the strictest confidence all
confidential matters which related to North Atlantic.
Haber violated his duties by using North Atlantic’s
confidential information for the benefit of a
competitor business.
HELD: North Atlantic demonstrated likelihood of
success on the merits and irreparable harm in the
absence of an injunction.
© 2019 McGraw-Hill Education.
15
Confidential Information
Agent may not use or communicate Principal’s
confidential information for the Agent’s own
benefit or that of a third party.
Confidential Information: facts valuable to
Principal as not widely known and which could
harm Principal if disclosed, e.g. business plans,
manufacturing methods, customer lists, pricing,
formulas, other trade secrets.
© 2019 McGraw-Hill Education.
16
Other Agent Duties
Agents have a duty to:
• obey the principal’s reasonable instructions
regarding the purpose of the agency;
• exercise appropriate care and skill;
• promptly communicate to the principal matters
reasonably relevant or material to the purpose of
the agency;
• and a duty to account to the Principal.
• BUT… an agent has no duty to obey illegal or
unethical orders.
© 2019 McGraw-Hill Education.
17
Duties of Principal to Agent
A written agency contract normally states the
duties the principal owes the agent; but the law
does impose certain duties on the principal:
1. To compensate the agent.
2. To reimburse the agent for money spent or expenses
incurred in the principal’s service.
3. To indemnify the agent for losses suffered in
conducting the principal’s business; but there is no
duty to indemnify for A’s unauthorized acts.
© 2019 McGraw-Hill Education.
18
Termination of Agency:
By Acts of the Parties
Termination by act of the parties includes:
• At a time or event stated in the agreement.
• When agency was created to achieve a special
purpose and the purpose was achieved.
• By mutual agreement of the parties.
• At the option of either party.
© 2019 McGraw-Hill Education.
19
Termination of Agency:
By Operation of Law
1
Termination by operation of law includes:
• Serious breach of the agent’s duty of loyalty.
• Principal’s permanent loss of capacity or agent’s
loss of capacity to perform agency business.
© 2019 McGraw-Hill Education.
20
Termination of Agency:
By Operation of Law
2
Termination by operation of law includes:
• Change in value of agency property or subject matter
(including loss or destruction).
• Changes in law making the agency illegal.
• Changed business conditions or outbreak of war.
© 2019 McGraw-Hill Education.
21
Termination of Agency:
By Operation of Law
3
Termination by operation of law also includes:
• Impossibility of performance.
• Death or bankruptcy of either party.
• Exception: if agent’s power is coupled with an
interest, agency does not terminate by the principal’s
revocation, loss of capacity by principal or agent, or
death of either principal or agent, e.g. bank
authorized to act as “agent” to sell mortgaged
property upon default by mortgagor.
© 2019 McGraw-Hill Education.
22
Termination of Agency:
rd
Notice to 3 Parties
After agency terminates, agent’s express and
implied authority ends.
• BUT: ex-agents may retain apparent authority that
could bind a former principal.
Principals should reduce risk of liability to third
parties relying on ex-agent’s apparent authority
by actual or constructive notice to third parties
about agency termination.
© 2019 McGraw-Hill Education.
23
Termination of Agency: Gniadek v.
Camp Sunshine
Plaintiff attended summer camp and was
assaulted by former camp counselor two months
after summer season ended.
Actual authority terminated at season’s end.
Apparent authority ceased when plaintiff
learned the counselor left camp’s employ.
HELD: defendant camp was not liable for former
counselor’s assault on plaintiff.
© 2019 McGraw-Hill Education.
24
Test Your Knowledge
1
True = A, False = B
• Agency is a contract in which an agent is authorized to
act on behalf of, and under the control of, a principal.
• All employees are agents, and all agents are
employees.
• Agents may bind a principal on the basis of apparent
authority.
• Agency may be created unintentionally.
© 2019 McGraw-Hill Education.
25
Test Your Knowledge
2
True = A, False = B
• All duties are delegable.
• An agent’s duty of confidentiality continues after the
agency ends.
• To be considered actual authority, the authority must
be expressed in words orally or in writing.
• Agency is a fiduciary relationship.
© 2019 McGraw-Hill Education.
26
Test Your Knowledge
3
Multiple Choice
• Principals have the following duties to agent:
a) Duty to compensate.
b) Duty to reimburse for reasonable expenses for doing
agency business.
c) Duty to indemnify the agent for losses suffered due to
agency’s business.
d) Both A and B.
e) All of the above.
© 2019 McGraw-Hill Education.
27
Test Your Knowledge
5
Multiple Choice
• Manuel asked his friend Sunil, a good salesman, to
sell his car and Sunil agreed. Does an agency
relationship exist?
a) Yes, Sunil is an agent for Manuel.
b) Yes, but only if there is a written contract describing the
agency’s purpose.
c) No, since friends cannot engage in an agency relationship.
d) No, unless Sunil sells Manuel’s car.
© 2019 McGraw-Hill Education.
28
Thought Question
Have you been an agent or a principal?
Do you think the agency rules of liability are fair?
What are the ethical issues involved in an agency
relationship?
© 2019 McGraw-Hill Education.
29
PART
BUSINESS LAW:
THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
8
Agency Law
• Chapter 35 The Agency Relationship
• Chapter 36 Third-Party Relations of the
Principal and the Agent→
© 2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted
without the prior written consent of McGraw-Hill Education.
1
Third Party Relations of the
Principal and Agent
CHAPTER
36
We intend to conduct our business in a way that not
only meets but exceeds the expectations of our
customers, business partners, shareholders, and
creditors, as well as the communities in which we
operate and society at large.
Akira Mori, President and CEO
Mori Trust Co., Ltd. (Japan)
© 2019 McGraw-Hill Education.
2
Learning Objectives
36-1 Know when an agent has authority to bind
a principal to a contract.
36-2 Understand when an agent may be liable
on contracts made for the principal.
36-3 Recognize when an agent is able to make a
principal liable for torts committed by the agent.
© 2019 McGraw-Hill Education.
3
Introduction
A principal bears tort and contract liability for
her own acts or omissions.
A principal also controls her agent. Thus, the
principal may be liable for her agent’s acts or
omissions (respondeat superior).
© 2019 McGraw-Hill Education.
4
Contract Liability
Generally, a principal is liable on a contract
made by the agent if the agent had express,
implied, or apparent authority to make the
contract.
Implied Authority: an agent has implied
authority to do whatever it is reasonable to
assume that his principal wanted him to do, in
light of the principal’s manifestations and
objectives of the agency.
© 2019 McGraw-Hill Education.
5
Apparent Authority
Apparent authority arises if communications by
principal to third party creates a reasonable
appearance of authority in the agent.
Key element: reasonable belief by third party
that the agent has the requisite authority.
Apparent authority protects third parties who
reasonably rely on the principal’s manifestations
that the agent has authority.
© 2019 McGraw-Hill Education.
6
Notice to Agent
If third party gives agent proper notification, the
principal is bound as if the notification had been
given directly to the principal.
Notification to a third party by an agent is
considered notification by the principal.
Sometimes, an agent’s knowledge of facts is
imputed to the principal.
Exception: when A acts contrary to P’s interests.
© 2019 McGraw-Hill Education.
7
Ratification
In ratification, a principal becomes obligated for
an unauthorized act done by an agent or person
posing as an agent.
• Act in question usually is contract creation.
Ratification relates back to contract creation
and binds principal as if agent had authority.
May be express or implied (by P’s conduct).
© 2019 McGraw-Hill Education.
8
Ratification
Basic contract law applies, e.g., P’s capacity, statute of
frauds.
Act ratified must be valid.
P must have been in existence at time agent undertook
obligation.
A must have told 3P that A was acting for a principal.
P must have legal capacity at time of ratification.
P must have knowledge of all pertinent facts (no
imputation).
P must ratify entire transaction.
© 2019 McGraw-Hill Education.
9
Estoppel
A principal may be liable for an agent’s transaction
with a third party who justifiably is induced to
make a detrimental legal change in position
because she believed the agent had the principal’s
authority. The principal must have:
• Intentionally or carelessly caused the 3P to believe
agent had authority.
• Based on this knowledge, P failed to take reasonable
steps to notify 3P of the facts.
© 2019 McGraw-Hill Education.
10
Estoppel: Frontier Leasing Corp. v.
Links Engineering, LLC
District court granted summary judgment ruling that
Fleming had authority to bind Bluff Creek (Clute) and that
Bluff Creek was liable for the lease based on Fleming’s
apparent authority.
Iowa Court of Appeals reversed summary judgment and
Frontier Leasing appealed to the Iowa Supreme Court.
HELD: Affirmed for Bluff Creek. Clute’s affidavit could
cause one to doubt Fleming’s apparent authority given the
customary authority of golf professionals and that Clute
did not ratify the transaction.
© 2019 McGraw-Hill Education.
11
Contract Liability of Agent
An agent’s liability for a contract depends on the nature of the
principal:
• Agent who represents a disclosed principal is not liable on
contracts made for the principal. Disclosed: 3P knows (i) A is
acting for a P; and (ii) identity of P.
• Agents are liable on contracts made for a (i) partially
disclosed (unidentified) principal (3P knows A is acting for P
but not P’s identity); or (ii) undisclosed principal (3P does not
know A is acting for a P).
• Rationale: 3P relies on integrity, creditworthiness of party
with whom 3P is actually dealing.
© 2019 McGraw-Hill Education.
12
Agent Liability: Treadwell v J.D.
Construction Co.
Construction company owner (Derr) organized his
company as JCDER, Inc., but entered into contracts as
J.D. Construction Co.
Customer sued Derr, individually, and J.D. Construction
Co. for failing to complete their home building project
in a workmanlike manner.
HELD: Derr held personally liable for performance of
contracts entered into as agent for the non-existent
J.D. Construction, Co., Inc., or the undisclosed principal
JCDER, Inc.
© 2019 McGraw-Hill Education.
13
Liability of Agent by Agreement
An agent may bind herself to contracts she
makes for a principal by expressly agreeing to be
liable.
An agent may expressly bind herself by:
• (1) making the contract in her own name rather
than in the principal’s name,
• (2) joining the principal as an additional obligor on
the contract, or
• (3) acting as surety or guarantor for the principal.
© 2019 McGraw-Hill Education.
14
Implied Warranty of Authority
1
If an agent contracts for a competent and
existing principal but lacks authority, the
principal is not bound.
The result is unfair to a third party, so the agent
will be bound on the theory of an implied
warranty of authority to contract.
However…
© 2019 McGraw-Hill Education.
15
Implied Warranty of Authority
2
An agent is not personally liable for making an
unauthorized contract if:
• (1) The third party actually knows the agent lacks
authority, or
• (2) The principal subsequently ratifies the contract, or
• (3) The agent adequately notifies the third party that
he does not warrant his authority to contract.
© 2019 McGraw-Hill Education.
16
Implied Warranty of Authority;
DePetris & Backrach v. Srour
Apparent authority is irrelevant since plaintiffs do not
seek to hold principals liable on the ground that
defendants had apparent authority.
Plaintiffs seek to hold defendant- agents liable for
contracts they made on behalf of the principal while
acting without authority from the principal.
HELD: Judgment modified in part and affirmed in
part. The trial court erred in relying on the principle
of apparent authority.
© 2019 McGraw-Hill Education.
17
Tort Liability of Principal
A principal may be liable for a tort committed by
another in four circumstances:
• Respondeat superior (vicarious liability).
• Direct liability.
• Independent Contractors (certain exceptions to the
general rule).
• Misrepresentation.
© 2019 McGraw-Hill Education.
18
Tort Liability:
Respondeat Superior
1
An employer is vicariously liable for torts by
employees who commit the tort while acting
within the scope of their employment.
• Note: an employer may be vicariously liable for both
negligent and intentional torts.
© 2019 McGraw-Hill Education.
19
Tort Liability:
Respondeat Superior
2
To be within the scope of employment, the conduct:
• Was the kind that the employee was employed to
perform.
• Occurred substantially within the location authorized
by employer.
• Occurred substantially during authorized time
period.
• Was motivated, at least in part, by the purpose of
serving the employer.
© 2019 McGraw-Hill Education.
20
Principal’s Tort Liability: Synergies3
Tec Services, LLC v. Corvo
Plaintiffs brought action v. DIRECT TV and S3.
DIRECT TV hired S3 to install satellite TV equipment.
Two of S3’s employees stole a jewel and cash while installing
equipment at plaintiffs’ home.
Plaintiffs brought action for theft and conversion and sought to
hold DIRECT TV and S3 liable based on respondeat superior.
Court reversed judgment for plaintiffs as theft was a “marked
and unusual deviation” from business of DIRECT TV and S3.
© 2019 McGraw-Hill Education.
21
Direct Tort Liability
Direct Liability: A principal may incur direct
liability for an agent’s torts because the
principal is at fault and liability need not be
imputed.
• Examples:
• Car salesperson merely followed the dealership’s
deceptive sales policies.
• Corporation authorizes employees to sell refurbished
products as “new.”
© 2019 McGraw-Hill Education.
22
P’s Liability for
Nonemployee-Agents (Independent
Contractors)
Since a principal does not control the work of an
independent contractor, a principal is not liable
for an independent contractor’s torts except:
• A principal may be directly liable for negligent
retention of an independent contractor (e.g., hiring
a dangerously incompetent independent
contractor).
© 2019 McGraw-Hill Education.
23
P’s Liability for
Nonemployee-Agents
A principal is liable for harm resulting from an
independent contractor’s failure to perform a
non-delegable duty, e.g., landlord, carrier
municipality.
Professionals and those with special artistic or
technical skills tend to have non-delegable
duties, e.g., lawyer, doctor, accountant.
© 2019 McGraw-Hill Education.
24
P’s Liability for
Nonemployee-Agents
A principal is liable for an independent
contractor’s negligent failure to take special
precautions to conduct highly dangerous or
inherently dangerous activities, e.g., nuclear
reactor, construction of dam, demolition of
building.
The law will not permit delegation of such
duties due to their hazardous nature.
© 2019 McGraw-Hill Education.
25
P’s Liability for
Agent’s Misrepresentations
A principal may be liable for an agent’s false
statements directly (intentionally or negligently)
or vicariously (agent authorized to make true
statements on the subject).
• Examples:
• Misrepresentation about the safety of medical
devices by sales personnel.
• False statements by broker re real property.
© 2019 McGraw-Hill Education.
26
Tort Liability of Agent
Agents are liable for their torts except when:
• Agent exercises a privilege of the principal (e.g., uses an
easement granted to principal).
• Agent takes privileged action to defend his person or
principal’s property (e.g., security guard in store).
• Agent makes a false statement in conduct of principal’s
business but doesn’t know the falsity of the
statements.
• Third parties are injured by defective tools or
instrumentalities furnished by the principal.
© 2019 McGraw-Hill Education.
27
Test Your Knowledge
1
True = A, False = B
• An agent is always liable for his own torts.
• The doctrine of respondeat superior means that a
principal is liable for torts committed by employees
acting within the course and scope of employment.
• If an agent contracts for a legally existing and
competent principal but lacks authority to enter
contracts, the principal is not bound.
© 2019 McGraw-Hill Education.
28
Test Your Knowledge
2
True = A, False = B
• A principal is never liable for an independent
contractor’s torts.
• Apparent authority arises if communications by
principal to third party creates reasonable
appearance of authority in the agent.
• If a principal fails to inform the agent about a defect
in the product, the principal will be directly liable for
an agent’s torts.
© 2019 McGraw-Hill Education.
29
Test Your Knowledge
3
Multiple Choice
• Carl owned a pizza business and employed Zip to
deliver pizzas. Carl knew that Zip occasionally drank
beer while driving, but didn’t fire Zip. Zip injured Dan
while delivering pizzas and driving drunk. Is Carl liable
to Dan for Zip’s conduct?
a) No, only Zip is liable. Drunk driving was not within the
scope of employment.
b) Yes, since Carl knew about Zip’s drinking and negligently
retained Zip.
© 2019 McGraw-Hill Education.
30
Test Your Knowledge
4
Multiple Choice
• Carl’s Pizza hired Miller to be general manager.
Miller hired Sam for pizza prep work. In general,
would Carl’s Pizza be obligated to honor the contract
with Sam?
a) No; only the owner of Carl’s Pizza can hire Sam, thus
Sam’s contract is void.
b) Yes; Miller acted with implied authority since he is general
manager and Carl’s Pizza must honor Sam’s employment
contract.
© 2019 McGraw-Hill Education.
31
Thought Questions
Do you think the doctrine of respondeat superior
is good policy? Why or why not?
© 2019 McGraw-Hill Education.
32
PART
BUSINESS LAW:
THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
9
Foundations of American Law
• Chapter 37 Introduction to Forms of Business
and Formation of Partnerships→
• Chapter 38 Operation of Partnerships & Related Forms
• Chapter 39 Partners’ Dissociation and Partnerships’
Dissolution and Winding Up
• Chapter 40 Limited Liability Companies, Limited
Partnerships, and Limited Liability Limited Partnerships
© 2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted
without the prior written consent of McGraw-Hill Education.
1
Introduction to Form of Business and
Formation of Partnerships
CHAPTER
37
Forms of Business: Continuum
Sole Proprietorship
Partnership
Limited Partnership
Corporation
Subchapter S Corporation
Professional Corporation
Limited Liability Partnership/
Limited Liability Company
© 2019 McGraw-Hill Education.
2
Learning Objectives
1
37-1 Choose an appropriate form of business for a
particular enterprise.
37-2 List the traits of each form of business.
37-3 Compare and contrast the various forms of
business.
37-4 Apply the definition of partnership and avoid
inadvertently being a partner of another person.
37-5 Appreciate the consequences of being a partner.
© 2019 McGraw-Hill Education.
3
Learning Objectives
2
37-6 Understand the risks of being a purported partner
and avoid being a purported partner.
37-7 Distinguish partner’s property from partnership
property.
37-8 List and compare the rights of a creditor having a
charging order and the rights of a transferee of a
partner’s interest in a partnership.
© 2019 McGraw-Hill Education.
4
Overview
Choosing a form of business is important because the
business owner’s liability and control of the business
vary greatly among the many forms of business.
Which business form you choose depends on where
you want to take your business.
Key issues: 1. Limiting personal liability; 2. Degree of
control over business; 3. Tax efficiency.
© 2019 McGraw-Hill Education.
.
5
Choosing a Form
of Business
Sole proprietorship.
Partnership.
• General, limited, or limited liability limited
partnership.
Corporation.
• Regular “C”, Subchapter “S”, nonprofit,
professional.
Limited liability company/Limited Liability
Partnership.
© 2019 McGraw-Hill Education.
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Sole Proprietorship
A sole proprietorship has only one owner and is
an extension of its owner.
It is not a legal entity and cannot sue or be sued,
so creditors/claimants sue the owner.
Advantages: no formalities, taxes flow to owner,
owner takes all profit and control.
Can operate under trade name (“d/b/a”), e.g.
“Peekskill Hardware”.
© 2019 McGraw-Hill Education.
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Sole Proprietorship
Disadvantage: owner bears all risk of loss,
including liability for acts of agents or
employees.
Personal assets of business owner are subject
to claims of creditors of business.
Possible rationale: new business with expected
losses and very low risk early on; also, low cost
option.
© 2019 McGraw-Hill Education.
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Partnership
1
A partnership has two or more owners or partners
and takes several forms:
• general, limited (LP), limited liability (LLP), limited
liability limited (LLLP).
A partnership is a legal entity but does not pay
federal income tax. All income or loss must be
reported on an individual partner’s federal income
tax return whether or not distributed or allocated
to the partners.
© 2019 McGraw-Hill Education.
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Partnership
Definition:
An association of two or more persons to carry
on as co-owners of a business for profit.
Any lawful trade, occupation or profession may
qualify as a business.
There must be an intention to earn a profit, i.e.
not a charitable purpose.
© 2019 McGraw-Hill Education.
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Partnership
2
Advantages: relatively easy to create, is a legal
entity but allows individual tax treatment
partners control the business, partners take all
gain, flexible structure.
Disadvantages: partners bear all risk of loss
jointly and severally, different levels of liability
to partners depending on sub-form, may be
created as a general partnership by default
(unintentionally).
© 2019 McGraw-Hill Education.
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General Partnership
Partners:
• Share equally in profits and losses (according to
ownership share).
• Have equal rights in managing business.
• Are liable for acts of agents, employees, and other
partners who can bind the partnership.
• Personal assets are subject to claims of creditors of
business when assets of partnership are insufficient.
© 2019 McGraw-Hill Education.
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General Partnership
May be created with no formalities.
Partners are not employees of the partnership.
Partnership may own property and sue and be
sued in its own name.
Partners are fiduciaries of the partnership and
owe fiduciary duties to each other.
Partners may sue each other.
© 2019 McGraw-Hill Education.
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Presumption of Partnership
When persons share profits and losses in a
business, there may be a presumption of
partnership.
Exceptions: payment of debt out of partnership
operations (e.g. revolving credit loan), wages to
employee, rent (based in part on tenant’s sales),
annuity paid to retired partner, sale of goodwill
of business with earn-out.
© 2019 McGraw-Hill Education.
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Limited Partnership
One or more general partners; one or more
limited partners.
General partners: rights and liabilities similar to
partners in general partnership, management,
liability (GP can be a corporation).
Limited partners pay capital contribution and
then have no further liability for debts of L.P.
Generally, no right to manage business.
© 2019 McGraw-Hill Education.
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Limited Partnership
Can elect to be taxed as corporation or
partnership:
• If taxed as partnership, GPs report income
and losses on individual returns; LPs pay tax
on their share of profits and may deduct
losses up to extent of investment.
• Requires filing with Sec’y of State to form
limited partnership, e.g., “Sterling Mets, L.P.”
© 2019 McGraw-Hill Education.
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Limited Partnership
Benefits:
-Liability of limited partners capped at
investment obligation.
-Liability of GP may be limited by incorporating.
-Tax benefits if taxed as partnership.
-LPs may invest without unlimited liability or
duty to manage.
© 2019 McGraw-Hill Education.
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Professional Corporation
The P.C. is similar to a business corporation in
most respects.
P.C. is formed by a filing with the secretary of
state, and managed by a board of directors,
unless a statute permits it to be managed like a
partnership.
The rigid management structure can make the
professional corporation inappropriate for some
smaller professional practices.
© 2019 McGraw-Hill Education.
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Professional Corporation
Available for professionals, e.g. doctors,
accountants, lawyers.
Form is similar to corporation, e.g. Board of
Directors.
No personal liability for P.C. debts or
malpractice of other shareholders.
Unlimited liability for own malpractice or that of
supervised associate.
© 2019 McGraw-Hill Education.
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LLP
A limited liability partnership is a partnership
whose partners have elected limited liability
status.
An LLP is similar to a partnership except that an
LLP partner has no liability for most LLP
obligations (e.g., lease); however, an LLP partner
retains unlimited liability for her own wrongful
acts, such as her malpractice liability to a client.
© 2019 McGraw-Hill Education.
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LLP
Must file with Secretary of State to form, e.g.
“Deloitte LLP.”
LLP may be required to maintain certain levels
of insurance or assets.
Partners may elect to be taxed as partnership or
corporation.
Benefits for professionals: offers management
and tax flexibility with limited personal liability.
© 2019 McGraw-Hill Education.
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LLLP
An LLLP is created by a filing with the Secretary
of State.
Effectively a limited partnership in which all
partners, including GP, have limited liability.
Partners not liable for LLLP debts but liable for
own wrongful acts.
Management similar to limited partnership, i.e.
managed by general partner(s).
.
© 2019 McGraw-Hill Education.
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Corporation
1
A corporation is owned by shareholders who elect a
board of directors to manage the business, thus
ownership and management of a corporation may be
separate.
Shareholders have limited liability for the obligations
of the corporation.
The corporation is a legal and tax-paying entity for
federal income tax purposes.
• Exception: Subchapter S corporations.
© 2019 McGraw-Hill Education.
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Corporation
2
Advantages: shareholders enjoy limited liability
for corporate obligations, perpetual existence,
ability to raise large amounts of capital.
Disadvantages: greater formality required for
formation and operation, double-taxation,
complexity of structure.
Shareholders, BOD, officers not liable for
corporate debts but can be liable for own
wrongful acts, e.g. fraud.
© 2019 McGraw-Hill Education.
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Limited Liability Company
A limited liability company (LLC) combines the nontax
advantages of corporations with favorable tax
treatment of partnerships.
An LLC is owned by members, who may run the
business themselves or retain a manager to do so.
Members have limited liability for the obligations of the
LLC but retain liability for their own wrongful acts.
Must be formed by filing with Sec’y of State, e.g.
Amazon LLC.
© 2019 McGraw-Hill Education.
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General Partnerships
Every state has enacted partnership laws.
The Revised Uniform Partnership Act (RUPA) of
1994, with 1997 amendments, is a model
partnership statute.
37 States have adopted RUPA.
New York still governed by 1914 Uniform
Partnership Act.
© 2019 McGraw-Hill Education.
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Creation of Partnership
Examples:
Musicians agree to form a band and share profits.
Two students buy music memorabilia at yard
sales, resell via eBay, and split the profits.
Friends take turns operating a lemonade stand.
N.B.: Need not enter written partnership
agreement or make any filing with Sec’y of State.
© 2019 McGraw-Hill Education.
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RUPA Definition of Partnership
RUPA defines partnership as an “association of two
or more persons to carry on as co-owners a
business for profit.”
• Partners share profit and loss.
A partnership is a voluntary and consensual
relationship and may exist by law even if the parties
entered into it inadvertently, without considering
whether they had created a partnership.
© 2019 McGraw-Hill Education.
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RUPA: Rasmussen v. Jackson
There was no joint ownership of property. Magee’s
farmland was in her name and Rasmussen purchased
the property in his name.
Rasmussen entered into a written agreement with
Magee to purchase 28% of the herd, but no money
changed hands.
HELD: Affirmed for Rasmussen. No evidence
Rasmussen had ultimate control over a for-profit
business distinct from his own business.
© 2019 McGraw-Hill Education.
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RUPA and Joint Ventures
Generally, partnership law applies to joint ventures,
but a court may distinguish the two if the business
purpose is limited to a single project rather than
series of related transactions.
• Reason: joint venturers usually held to have less
implied and apparent authority than partners due to
limited scope of the enterprise.
© 2019 McGraw-Hill Education.
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Joint Ventures
Still, members of a JV:
• Are personally liable, jointly and severally, for
JV debts.
• Owe fiduciary duties.
• Share profits and losses.
• Have right to manage JV.
© 2019 McGraw-Hill Education.
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Mining Partnerships
Persons who cooperate in the working of either a mine
or an oil or gas well are treated as a mining partnership
if there is:
1. Joint ownership of a mineral interest.
2. Joint operation of the property.
3. Sharing of the profits and losses.
Does not require physical participation in operations but
must be more than merely financing the development of
the mineral interest.
© 2019 McGraw-Hill Education.
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Partnership Creation
Unlike a general partnership, those establishing an LP,
LLP, LLLP, or PC, must comply with a state’s applicable
statutes; cannot form by inadvertence.
Formation of any of these entities requires filing a form
with the secretary of state, paying an annual fee, and
using proper terminology, e.g. Sterling Mets LP; Deloitte,
LLP.
Operation of such an entity should be pursuant to an
agreement among the members of the entity.
© 2019 McGraw-Hill Education.
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Purported Partners
1
RUPA Section 308(e): “persons who are not partners as
to each other are not liable as partners to other
persons.”
However, liability under the doctrine of purported
partnership may arise: if a (i) person purports to be or
consents to being represented as a partner of another
person; and (ii) a third party reasonably relies on such
representation; and (iii) such third party concludes a
transaction with the purported partnership.
© 2019 McGraw-Hill Education.
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Purported Partners
2
Further, under the doctrine of purported
partners, if a third party proves that one
apparent partner misled him to believe that the
two (or more) people were partners, the third
party may sue the partner that caused the
deception for damages suffered when the
apparent partnership failed to perform as agreed.
© 2019 McGraw-Hill Education.
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Purported Partners: MP Nexlevel of
Cal. v. CVIN
MP argues a partnership by estoppel was created
between CVIN and CENIC based on their statements
they would jointly build and operate the project.
MP argues CVIN and CENIC represented they were
“partners” in the grant apps and websites but ‘partners’
can be an informal term that is not legal.
HELD: for CVIN. MP failed to allege sufficient facts to
establish that it reasonably believed that CVIN and
CENIC were partners.
© 2019 McGraw-Hill Education.
36
Partnership Capital
A partner’s contribution is called partnership
capital.
Cash or other property may be contributed, e.g.
intellectual or real property.
Partnership capital is the equity of the business
and may be increased by other means, such as
by partners agreeing to retention of some of the
profits.
© 2019 McGraw-Hill Education.
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Partnership Property
When a partnership or LLP is formed, partners
contribute cash or other property – partnership
capital – to the partnership.
• Belongs to partnership as an entity.
Tangible and intangible property acquired by a
partnership presumptively belongs to the
partnership as an entity rather than individual
partners.
© 2019 McGraw-Hill Education.
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Partnership Property
Presumptions giving rise to partnership
ownership of property:
• Transferred in name of partnership (e.g., “Crumley
Diary, LLP”).
• Transferred to a partner, acting as such and naming
partnership (e.g., “Crumley Diary, LLP by Clint
Crumley, partner”).
• Property purchased with partnership funds.
© 2019 McGraw-Hill Education.
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Partnership Property
However, the presumption of partnership
ownership of property does not apply when a
partner purchases property with her own funds
and in her own name (i.e., no reference to
partnership in transfer document).
© 2019 McGraw-Hill Education.
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Partnership Property:
Finch v Raymer
The two previous houses where the parties lived
were the subject of a partnership agreement
between Finch and Raymer.
The parties’ conduct with regard to the Pack Hill Rd
residence is consistent with co-owners and
partners, although titled only in Raymer’s name.
HELD: affirmed for Finch against Raymer. All the
assets were partnership property owned one-half
by each partner.
© 2019 McGraw-Hill Education.
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Partner’s Partnership Interest
As owner of a partnership or LLP, a partner has an
ownership interest in the partnership.
The partnership interest includes partner’s:
1. Transferable interest: partner’s share of profits and
losses and right to receive partnership distributions
2. Management and other rights, e.g. right to inspect
books and records.
© 2019 McGraw-Hill Education.
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Partner’s Partnership Interest
Transferee of partnership interest does not
become a partner.
Transferee receives only limited right to receive
distributions of profits.
Transferee has no right to manage partnership
or inspect books & records.
May petition court to dissolve partnership if
partnership is at will (right to share of
partnership assets when wound up).
© 2019 McGraw-Hill Education.
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Charging Order
A creditor who obtains a judgment v. a partner
may petition a court for charging order, i.e.
charging partner’s transferable interest with
payment of judgment.
If partnership distributions are insufficient,
creditor may ask court to foreclose on and sell
partner’s interest to satisfy judgment, i.e.
transfer partnership interest to purchaser.
Purchaser does not become a partner.
© 2019 McGraw-Hill Education.
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Effect of a Partnership Agreement
The partners may restrict the transfer of a
partner’s transferable interest (e.g., right of first
refusal) or impose negative consequences on a
partner who transfers their interest or suffers a
charging order (e.g., dissociation ).
Any restrictions must not unreasonably limit the
ability of a partner to transfer their property
interest.
© 2019 McGraw-Hill Education.
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Test Your Knowledge
1
True = A, False = B
• The Revised Uniform Partnership Act (RUPA) is a
model partnership statute.
• Partnership is an “association of two or more
persons to carry on as co-owners a business for
profit.”
• Partnership capital belongs to the individual partners
in equal shares.
© 2019 McGraw-Hill Education.
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Test Your Knowledge
2
Multiple Choice
• The partnership interest includes a partner’s:
a) Management and other rights participation.
b) Share of profits and losses and right to receive
partnership distributions.
c) Ownership interest in partnership capital.
d) both A and B.
e) none of the above.
© 2019 McGraw-Hill Education.
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Thought Question
Do you want to start a business? If you wanted
to start a business (snowboards, for example),
would you choose partnership as the form of
business?
© 2019 McGraw-Hill Education.
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PART
BUSINESS LAW:
THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
9
Partnerships
• Chapter 37 Introduction to Forms of Business
and Formation of Partnerships
• Chapter 38 Operation of Partnerships
& Related Forms→
• Chapter 39 Partners’ Dissociation and Partnerships’
Dissolution and Winding Up
• Chapter 40 Limited Liability Companies, Limited
Partnerships, and Limited Liability Limited Partnerships
© 2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted
without the prior written consent of McGraw-Hill Education.
1
Operation of Partnerships and
Related Forms
CHAPTER
38
It is not the individual but the team that is the
instrument of sustained and enduring success in
management.
Anthony Jay, quoted in Management Teams – Why
They Succeed
© 2019 McGraw-Hill Education.
2
Learning Objectives
38-1 List and explain the duties partners owe to the
partnership and each other.
38-2 Describe the default rules regarding partners’
management and compensation rights.
38-3 Draft a partnership agreement addressing
management, and compensation, withdrawal and other
issues.
38-4 Explain the liability of partners for contracts and
torts.
© 2019 McGraw-Hill Education.
3
Duties of Partners to the
Partnership and to Each Other
1
Revised Uniform Partnership Act (RUPA) states that
partners owe to the partnership and each other the
highest degree of loyalty and must act consistently
with the obligation of good faith and fair dealing (a
fiduciary relationship).
Meinhard v. Salmon: “A [partner] is held to something
stricter than the morals of the market place. Not
honesty alone, but the punctilio of an honor the most
sensitive, is then the standard of behavior.”
© 2019 McGraw-Hill Education.
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Duties of Partners to the
Partnership and to Each Other
2
Partners have duties to serve, account for use or
disposal of partnership funds, act within actual
authority, avoid interests adverse to the
partnership, disclose material information, and
maintain the confidentiality of partnership
information.
• Partners may compete with the partnership only
upon the consent of other partners.
• Also applies to Joint Ventures (within scope of JV).
© 2019 McGraw-Hill Education.
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Partnership Duties
Fiduciary Duty
Highest degree of loyalty; good faith and fair
dealing.
Partner’s sole compensation is share of
partnership profits (unless otherwise agreed).
May not: compete v. partnership; divert
partnership opportunity; place own self-interest
above the interests of the partnership.
© 2019 McGraw-Hill Education.
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Partnership Duties
Serve
Undertake fair share of running day-to-day partnership
operations. Failure to do so may result in (i) charging
such partner for cost of hiring third party to perform
partner’s duties; (ii) compensating other partners for
picking up slack.
Exception – “Silent partner”: one who merely
contributes capital; set forth no duty to serve in
partnership agreement.
© 2019 McGraw-Hill Education.
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Partnership Duties
Due Care
Undertake due investigation before making
decisions affecting partnership; consider hiring
experts.
Act reasonably and in best interests or
partnership.
No liability for honest errors but liable for gross
negligence, reckless, intentional misconduct,
knowing violation of law, breach of F/D.
© 2019 McGraw-Hill Education.
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Partnership Duties
Due Care (cont’d)
Partners may reduce level of duty in agreement,
e.g. no liability for acting in good faith, in best
interests of partnership.
May not reduce duty to none, e.g. no liability for
reckless conduct.
Essence: balancing duty to partnership with
flexibility to take reasonable business risks.
© 2019 McGraw-Hill Education.
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Partnership Duties
Act Within Actual Authority
Act consistent with authority set forth in
partnership agreement or within usual scope of
position.
E.g.: Abide by commitment restrictions in
partnership agreement (contracts in excess of
$50K require unanimous approval; partner
responsible for marketing signs long-term
lease).
© 2019 McGraw-Hill Education.
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Partnership Duties
Account
Maintain full and accurate records for:
• Use of partnership property (and reimbursement to
partnership).
• Disposal of partnership property.
• Receipt of partnership property.
• Receipt of partnership opportunities.
Right to inspect partnership records.
Right to reimbursement or indemnification for use of
personal assets.
© 2019 McGraw-Hill Education.
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Partnership Duties
Confidentiality
Maintain confidentiality of partnership
information (e.g. customer lists, trade secrets,
finances, business plans).
Use such information only for benefit of
partnership (not self or third parties).
Disclosure
Disclose all information material to business,
e.g. news re business opportunities, customers.
© 2019 McGraw-Hill Education.
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Examples of Partners’ Duties
1
Ann and Elkie own the Ann Elk Tavern as general
partners. Ann wants to invest in her boyfriend
Brock’s auto shop and her neighbor Carol’s Bar N’
Grill in the same town. Ann could invest in Brock’s
shop without competing with the Ann Elk Tavern
partnership, but should not invest in Carol’s Bar N’
Grill without first getting Elkie’s consent.
• A tavern and a bar are too similar and may give rise
to a breach of duty claim.
© 2019 McGraw-Hill Education.
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Examples of Partners’ Duties
2
Monty is a partner in Python Pet Shop and Brian
handles the partnership’s finances and accounting.
Monty wants to help Arthur run his auto shop while
still working for Python. While reviewing the books,
Monty discovered Brian used partnership funds for
a down payment on his car. Monty also found out
that Brian hired two employees yesterday without
consulting Monty.
• What issues are raised by these facts?
© 2019 McGraw-Hill Education.
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Partners’ Duties:
McMillian v McMillian
Robbie shut down Corporate Mail Source and took all its
assets and business opportunities with him to the new
company.
Bruce sued for damages, after Robbie left him with nothing
but the debts of Corporate Mail Source.
When a partner wrongfully appropriates a prospective
business opportunity of his partnership to his own use, the
remaining partners, may recover their share of the profits
that the partnership would have earned from the business
opportunity.
HELD: Judgment reversed in favor of Bruce McMillian.
© 2019 McGraw-Hill Education.
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Compensation of Partners
RUPA states that a partner is not entitled to
salary or wages, even if disproportionate time
spent conducting partnership business.
• A monthly draw is allowable.
Instead, partner compensation is a share of
business profits, offset by shared losses.
Shared equally among all partners unless agreement
to the contrary (not based on capital or time devoted).
© 2019 McGraw-Hill Education.
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Compensation of Partners
Losses are generally shared in same proportion as
profits.
By contract, partners may agree to share profits and
losses in set percentages, e.g. 70/30 profits; 60/40
losses.
Allocation of losses in Partnership Agreement is not
binding on third parties as all partners have joint and
several liability; however, a partner paying more than
her share has indemnification/contribution right
against other partners.
© 2019 McGraw-Hill Education.
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Compensation of Partners: Fish v.
Tex. Legislative Serv., P’ship
Russell argues the agreement does not authorize a
partner to receive any compensation absent “mutual
agreement” which means unanimous consent.
Andrew and John argue the agreement
unambiguously authorizes them to set compensation
as majority interest holders and working partners.
HELD: Judgment for Russell Fish. The agreement
unambiguously requires consent of all the partners in
order for a partner to be compensated.
© 2019 McGraw-Hill Education.
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Management Powers
of Partners
1
Each partner in a partnership or LLP is a general
manager of the business.
Each partner has implied authority to bind the
partnership and partners for acts within the
ordinary course of business.
Agreement among partners may expand, restrict,
or eliminate a partner’s implied authority (e.g.,
unanimous consent for borrowing, capex).
© 2019 McGraw-Hill Education.
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Management Powers
of Partners
2
A partner’s implied authority may not
contradict a partner’s express authority
created by agreement of the partners.
A partner’s express and implied authority together
constitute actual authority.
Same analysis as authority granted agent by
principal.
Ratification principles also apply.
© 2019 McGraw-Hill Education.
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Management Powers
of Partners
3
Apparent authority exists when it reasonably
appears to a third party that a partner has
authority to do an act. Often, the implied
authority and apparent authority of a partner are
coincident but need not be.
A partnership may ratify the unauthorized acts of
partners. Occurs when partners accept an act of a
partner who had no actual or apparent authority
to do the act when it was done.
© 2019 McGraw-Hill Education.
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Restricting Authority
When a partner’s implied authority is restricted or
eliminated, the partnership still risks the possibility
that apparent authority to undertake a prohibited
action may arise.
Partners may give notice of a partner’s authority or
limitation of authority by providing specific notice to
third parties or filing a Statement of Partnership
Authority or Statement of Denial with the secretary
of state.
© 2019 McGraw-Hill Education.
22
Management Powers
of Partners
4
Special Transactions.
• An individual partner’s transfer of real property
owned by a partnership will bind the partnership if
expressly, impliedly, or apparently authorized, or
ratified by the partnership.
• A partner has implied and apparent authority to sell
real property if the partnership sells real property in
the usual course of the partnership business (e.g.,
REIT or timeshare business but not an accounting
firm).
© 2019 McGraw-Hill Education.
23
Management Powers
of Partners
6
Special Transactions.
• Borrowing Money. A partner may not borrow money
in the partnership’s name without express, implied,
or apparent authority.
• A partner in a trading partnership (with inventory)
has implied and apparent authority to borrow
money for partnership, e.g. grocery, clothing,
appliance retailers.
© 2019 McGraw-Hill Education.
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Management Powers of Partners
A partner of a non-trading partnership (services)
has no implied or apparent authority to borrow
money, e.g., law firm, real estate broker.
More appropriate inquiry: Is regular borrowing
part of the ordinary course of the partnership’s
business?
© 2019 McGraw-Hill Education.
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Management Powers
of Partners
7
Special Transactions.
• Negotiating Instruments. A partner with authority to
borrow money has authority to issue negotiable
instruments (e.g., promissory notes) for that
purpose.
• If a partner’s name is on a checking account
signature card filed with a bank, that partner has
express authority to draw checks.
• Partners have authority to negotiate or transfer
instruments (e.g., checks) for the partnership.
© 2019 McGraw-Hill Education.
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Admissions and Notice
Admissions (e.g., liability for debt, litigation
admission) or statements of a partner within
scope of that partner’s authority are binding on
partnership.
Notice to one partner regarding partnership
business is deemed notice to partnership and
other partners (e.g., summons and complaint,
notice from gov’t agency, letter from client).
© 2019 McGraw-Hill Education.
27
Management Powers
of Partners
8
Disagreement Among Partners.
• In general, management decisions in the ordinary
course of partnership business are by majority rule,
one vote per partner, unless otherwise expressed by
agreement.
• Some decisions not in the ordinary course of
business require unanimous consent.
• Example: a decision to open new office or bring in
another partner.
© 2019 McGraw-Hill Education.
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Effect of Partnership Agreement
By unanimous agreement, partners may modify
management rules such as limiting or expanding
authority, creating classes of partners with special or
weighted voting rights, or delegating powers.
Many large firms vest overall management in a
managing partner or management committee but still
reserve some decisions to votes of partners, e.g., large
borrowing, acquiring other firm, opening new office.
© 2019 McGraw-Hill Education.
29
NBN Broadcasting v. Sheridan
Broadcasting Networks
The res judicata effect is limited to those claims that had
arisen at the time that NBN brought the State Court
action.
At that time, NBN did not submit a claim regarding
NBN’s equal right to decide whether the New York Office
should be moved.
HELD: Judgment for Sheridan. Res judicata embraces all
claims of NBN, excluding those claims relating to the
relocation of the New York Office.
© 2019 McGraw-Hill Education.
30
Liability for Torts and Crimes
1
Respondeat superior doctrine of agency law may
be applied to determine liability of partners and
the partnership for torts of a partner and
partnership employees.
Partnership and partners are liable jointly and
severally for torts of a partner committed within
ordinary course of partnership business.
© 2019 McGraw-Hill Education.
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Liability for Torts and Crimes
Bases of Liability
I. Direct – A partner is responsible for her own
wrongful acts.
II. Vicarious (respondeat superior) – A partner
will usually bear responsibility for the
wrongful acts of other partners or
partnership employees committed within
the scope of partnership business.
© 2019 McGraw-Hill Education.
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Liability for Torts and Crimes
2
Under RUPA, a partnership may sue or be sued in
its own name.
Partners also may be sued since they are jointly
and severally liable for partnership obligations
(contract or tort).
If partnership and individual partners are sued,
any judgment must first be satisfied from
partnership assets, then from personal assets of
the partners.
© 2019 McGraw-Hill Education.
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Liability for Torts and Crimes
3
Partners and the partnership are liable:
• When a partner commits a breach of trust owed a 3P.
• For a partner’s negligence (generally).
• Usually not liable for intentional torts unless
committed within scope of authority (e.g., defaming
client in pursuing unpaid bill).
When a partnership and partners are held liable for a
partner’s tort, they may recover the amount of their
vicarious liability from the wrongdoing partner.
© 2019 McGraw-Hill Education.
34
Liability for Torts and Crimes
A partner is personally liable for his own crimes.
A partnership may be prosecuted for crimes
when committed by a partner acting within the
scope of his authority (e.g., partner in brokerage
firm defrauding customers).
A partner who did not participate in criminal
wrongdoing is not personally liable for crimes
committed by another partner.
© 2019 McGraw-Hill Education.
35
Liability for Torts and Crimes
4
Limited Liability Partnership (LLP)
The (LLP) was created to restrict the personal liability of
professional partners. An innocent partner of an LLP has
no liability for malpractice of other partners.
However, a partner remains liable for her own
malpractice and that of a supervised employee.
LLP partners also have no personal liability for debts of
the LLP, e.g., contracts, leases, loans.
© 2019 McGraw-Hill Education.
36
Liability for Torts and Crimes:
Mortgage Grader v. Ward & Olivo
Ward contends he is shielded from liability as a
partner in an LLP and is not vicariously liable for
the acts of his former partner, Olivo.
At the time of the incident, W&O was an LLP,
and Ward was not vicariously liable for the
alleged malpractice of his former partner Olivo.
HELD: Reversed for Ward. Ward is not
vicariously liable for the alleged malpractice of
his former partner Olivo.
© 2019 McGraw-Hill Education.
37
Test Your Knowledge
1
True = A, False = B
• Partners owe to the partnership and each other an
ordinary degree of loyalty.
• Partners may compete with the partnership as long
as it does not harm the partnership.
• A partner is liable to the partnership for losses
resulting from gross negligence or reckless conduct.
• A partnership may sue in its own name.
© 2019 McGraw-Hill Education.
38
Test Your Knowledge
2
True = A, False = B
• In general, management decisions in a partnership
are decided by majority rule.
• A general partnership is liable for a partner’s
negligence.
• For contract obligations of an LLP, only the partners
are liable.
• A partner with authority to borrow money has
authority to issue negotiable instruments.
© 2019 McGraw-Hill Education.
39
Test Your Knowledge
3
Multiple Choice
• Two accountants formed Caine & Able, LLP. The
partnership and each partner was sued for Able’s
alleged negligence. Who might be liable?
a) Only Able due to his negligence.
b) Only the partnership, Caine & Able.
c) The partnership and Able.
d) The partnership and either partner, jointly or severally.
© 2019 McGraw-Hill Education.
40
Test Your Knowledge
4
Multiple Choice
• A partner in a trading partnership has what type(s)
of authority for borrowing money?
a) Express authority.
b) Implied and apparent authority.
c) Actual authority.
d) Implied authority.
e) All of the above.
© 2019 McGraw-Hill Education.
41
Thought Question
When drafting the partnership agreement,
should duties and compensation be allocated
evenly or according to each partner’s
contribution and skill? Should partners be
shielded from personal liability?
© 2019 McGraw-Hill Education.
42
PART
BUSINESS LAW:
THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
9
Partnerships
• Chapter 37 Introduction to Forms of Business
and Formation of Partnerships
• Chapter 38 Operation of Partnerships
& Related Forms→
• Chapter 39 Partners’ Dissociation and Partnerships’
Dissolution and Winding Up
• Chapter 40 Limited Liability Companies, Limited
Partnerships, and Limited Liability Limited Partnerships
© 2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted
without the prior written consent of McGraw-Hill Education.
1
Operation of Partnerships and
Related Forms
CHAPTER
38
It is not the individual but the team that is the
instrument of sustained and enduring success in
management.
Anthony Jay, quoted in Management Teams – Why
They Succeed
© 2019 McGraw-Hill Education.
2
Learning Objectives
38-1 List and explain the duties partners owe to the
partnership and each other.
38-2 Describe the default rules regarding partners’
management and compensation rights.
38-3 Draft a partnership agreement addressing
management, and compensation, withdrawal and other
issues.
38-4 Explain the liability of partners for contracts and
torts.
© 2019 McGraw-Hill Education.
3
Duties of Partners to the
Partnership and to Each Other
1
Revised Uniform Partnership Act (RUPA) states that
partners owe to the partnership and each other the
highest degree of loyalty and must act consistently
with the obligation of good faith and fair dealing (a
fiduciary relationship).
Meinhard v. Salmon: “A [partner] is held to something
stricter than the morals of the market place. Not
honesty alone, but the punctilio of an honor the most
sensitive, is then the standard of behavior.”
© 2019 McGraw-Hill Education.
4
Duties of Partners to the
Partnership and to Each Other
2
Partners have duties to serve, account for use or
disposal of partnership funds, act within actual
authority, avoid interests adverse to the
partnership, disclose material information, and
maintain the confidentiality of partnership
information.
• Partners may compete with the partnership only
upon the consent of other partners.
• Also applies to Joint Ventures (within scope of JV).
© 2019 McGraw-Hill Education.
5
Partnership Duties
Fiduciary Duty
Highest degree of loyalty; good faith and fair
dealing.
Partner’s sole compensation is share of
partnership profits (unless otherwise agreed).
May not: compete v. partnership; divert
partnership opportunity; place own self-interest
above the interests of the partnership.
© 2019 McGraw-Hill Education.
6
Partnership Duties
Serve
Undertake fair share of running day-to-day partnership
operations. Failure to do so may result in (i) charging
such partner for cost of hiring third party to perform
partner’s duties; (ii) compensating other partners for
picking up slack.
Exception – “Silent partner”: one who merely
contributes capital; set forth no duty to serve in
partnership agreement.
© 2019 McGraw-Hill Education.
7
Partnership Duties
Due Care
Undertake due investigation before making
decisions affecting partnership; consider hiring
experts.
Act reasonably and in best interests or
partnership.
No liability for honest errors but liable for gross
negligence, reckless, intentional misconduct,
knowing violation of law, breach of F/D.
© 2019 McGraw-Hill Education.
8
Partnership Duties
Due Care (cont’d)
Partners may reduce level of duty in agreement,
e.g. no liability for acting in good faith, in best
interests of partnership.
May not reduce duty to none, e.g. no liability for
reckless conduct.
Essence: balancing duty to partnership with
flexibility to take reasonable business risks.
© 2019 McGraw-Hill Education.
9
Partnership Duties
Act Within Actual Authority
Act consistent with authority set forth in
partnership agreement or within usual scope of
position.
E.g.: Abide by commitment restrictions in
partnership agreement (contracts in excess of
$50K require unanimous approval; partner
responsible for marketing signs long-term
lease).
© 2019 McGraw-Hill Education.
10
Partnership Duties
Account
Maintain full and accurate records for:
• Use of partnership property (and reimbursement to
partnership).
• Disposal of partnership property.
• Receipt of partnership property.
• Receipt of partnership opportunities.
Right to inspect partnership records.
Right to reimbursement or indemnification for use of
personal assets.
© 2019 McGraw-Hill Education.
11
Partnership Duties
Confidentiality
Maintain confidentiality of partnership
information (e.g. customer lists, trade secrets,
finances, business plans).
Use such information only for benefit of
partnership (not self or third parties).
Disclosure
Disclose all information material to business,
e.g. news re business opportunities, customers.
© 2019 McGraw-Hill Education.
12
Examples of Partners’ Duties
1
Ann and Elkie own the Ann Elk Tavern as general
partners. Ann wants to invest in her boyfriend
Brock’s auto shop and her neighbor Carol’s Bar N’
Grill in the same town. Ann could invest in Brock’s
shop without competing with the Ann Elk Tavern
partnership, but should not invest in Carol’s Bar N’
Grill without first getting Elkie’s consent.
• A tavern and a bar are too similar and may give rise
to a breach of duty claim.
© 2019 McGraw-Hill Education.
13
Examples of Partners’ Duties
2
Monty is a partner in Python Pet Shop and Brian
handles the partnership’s finances and accounting.
Monty wants to help Arthur run his auto shop while
still working for Python. While reviewing the books,
Monty discovered Brian used partnership funds for
a down payment on his car. Monty also found out
that Brian hired two employees yesterday without
consulting Monty.
• What issues are raised by these facts?
© 2019 McGraw-Hill Education.
14
Partners’ Duties:
McMillian v McMillian
Robbie shut down Corporate Mail Source and took all its
assets and business opportunities with him to the new
company.
Bruce sued for damages, after Robbie left him with nothing
but the debts of Corporate Mail Source.
When a partner wrongfully appropriates a prospective
business opportunity of his partnership to his own use, the
remaining partners, may recover their share of the profits
that the partnership would have earned from the business
opportunity.
HELD: Judgment reversed in favor of Bruce McMillian.
© 2019 McGraw-Hill Education.
15
Compensation of Partners
RUPA states that a partner is not entitled to
salary or wages, even if disproportionate time
spent conducting partnership business.
• A monthly draw is allowable.
Instead, partner compensation is a share of
business profits, offset by shared losses.
Shared equally among all partners unless agreement
to the contrary (not based on capital or time devoted).
© 2019 McGraw-Hill Education.
16
Compensation of Partners
Losses are generally shared in same proportion as
profits.
By contract, partners may agree to share profits and
losses in set percentages, e.g. 70/30 profits; 60/40
losses.
Allocation of losses in Partnership Agreement is not
binding on third parties as all partners have joint and
several liability; however, a partner paying more than
her share has indemnification/contribution right
against other partners.
© 2019 McGraw-Hill Education.
17
Compensation of Partners: Fish v.
Tex. Legislative Serv., P’ship
Russell argues the agreement does not authorize a
partner to receive any compensation absent “mutual
agreement” which means unanimous consent.
Andrew and John argue the agreement
unambiguously authorizes them to set compensation
as majority interest holders and working partners.
HELD: Judgment for Russell Fish. The agreement
unambiguously requires consent of all the partners in
order for a partner to be compensated.
© 2019 McGraw-Hill Education.
18
Management Powers
of Partners
1
Each partner in a partnership or LLP is a general
manager of the business.
Each partner has implied authority to bind the
partnership and partners for acts within the
ordinary course of business.
Agreement among partners may expand, restrict,
or eliminate a partner’s implied authority (e.g.,
unanimous consent for borrowing, capex).
© 2019 McGraw-Hill Education.
19
Management Powers
of Partners
2
A partner’s implied authority may not
contradict a partner’s express authority
created by agreement of the partners.
A partner’s express and implied authority together
constitute actual authority.
Same analysis as authority granted agent by
principal.
Ratification principles also apply.
© 2019 McGraw-Hill Education.
20
Management Powers
of Partners
3
Apparent authority exists when it reasonably
appears to a third party that a partner has
authority to do an act. Often, the implied
authority and apparent authority of a partner are
coincident but need not be.
A partnership may ratify the unauthorized acts of
partners. Occurs when partners accept an act of a
partner who had no actual or apparent authority
to do the act when it was done.
© 2019 McGraw-Hill Education.
21
Restricting Authority
When a partner’s implied authority is restricted or
eliminated, the partnership still risks the possibility
that apparent authority to undertake a prohibited
action may arise.
Partners may give notice of a partner’s authority or
limitation of authority by providing specific notice to
third parties or filing a Statement of Partnership
Authority or Statement of Denial with the secretary
of state.
© 2019 McGraw-Hill Education.
22
Management Powers
of Partners
4
Special Transactions.
• An individual partner’s transfer of real property
owned by a partnership will bind the partnership if
expressly, impliedly, or apparently authorized, or
ratified by the partnership.
• A partner has implied and apparent authority to sell
real property if the partnership sells real property in
the usual course of the partnership business (e.g.,
REIT or timeshare business but not an accounting
firm).
© 2019 McGraw-Hill Education.
23
Management Powers
of Partners
6
Special Transactions.
• Borrowing Money. A partner may not borrow money
in the partnership’s name without express, implied,
or apparent authority.
• A partner in a trading partnership (with inventory)
has implied and apparent authority to borrow
money for partnership, e.g. grocery, clothing,
appliance retailers.
© 2019 McGraw-Hill Education.
24
Management Powers of Partners
A partner of a non-trading partnership (services)
has no implied or apparent authority to borrow
money, e.g., law firm, real estate broker.
More appropriate inquiry: Is regular borrowing
part of the ordinary course of the partnership’s
business?
© 2019 McGraw-Hill Education.
25
Management Powers
of Partners
7
Special Transactions.
• Negotiating Instruments. A partner with authority to
borrow money has authority to issue negotiable
instruments (e.g., promissory notes) for that
purpose.
• If a partner’s name is on a checking account
signature card filed with a bank, that partner has
express authority to draw checks.
• Partners have authority to negotiate or transfer
instruments (e.g., checks) for the partnership.
© 2019 McGraw-Hill Education.
26
Admissions and Notice
Admissions (e.g., liability for debt, litigation
admission) or statements of a partner within
scope of that partner’s authority are binding on
partnership.
Notice to one partner regarding partnership
business is deemed notice to partnership and
other partners (e.g., summons and complaint,
notice from gov’t agency, letter from client).
© 2019 McGraw-Hill Education.
27
Management Powers
of Partners
8
Disagreement Among Partners.
• In general, management decisions in the ordinary
course of partnership business are by majority rule,
one vote per partner, unless otherwise expressed by
agreement.
• Some decisions not in the ordinary course of
business require unanimous consent.
• Example: a decision to open new office or bring in
another partner.
© 2019 McGraw-Hill Education.
28
Effect of Partnership Agreement
By unanimous agreement, partners may modify
management rules such as limiting or expanding
authority, creating classes of partners with special or
weighted voting rights, or delegating powers.
Many large firms vest overall management in a
managing partner or management committee but still
reserve some decisions to votes of partners, e.g., large
borrowing, acquiring other firm, opening new office.
© 2019 McGraw-Hill Education.
29
NBN Broadcasting v. Sheridan
Broadcasting Networks
The res judicata effect is limited to those claims that had
arisen at the time that NBN brought the State Court
action.
At that time, NBN did not submit a claim regarding
NBN’s equal right to decide whether the New York Office
should be moved.
HELD: Judgment for Sheridan. Res judicata embraces all
claims of NBN, excluding those claims relating to the
relocation of the New York Office.
© 2019 McGraw-Hill Education.
30
Liability for Torts and Crimes
1
Respondeat superior doctrine of agency law may
be applied to determine liability of partners and
the partnership for torts of a partner and
partnership employees.
Partnership and partners are liable jointly and
severally for torts of a partner committed within
ordinary course of partnership business.
© 2019 McGraw-Hill Education.
31
Liability for Torts and Crimes
Bases of Liability
I. Direct – A partner is responsible for her own
wrongful acts.
II. Vicarious (respondeat superior) – A partner
will usually bear responsibility for the
wrongful acts of other partners or
partnership employees committed within
the scope of partnership business.
© 2019 McGraw-Hill Education.
32
Liability for Torts and Crimes
2
Under RUPA, a partnership may sue or be sued in
its own name.
Partners also may be sued since they are jointly
and severally liable for partnership obligations
(contract or tort).
If partnership and individual partners are sued,
any judgment must first be satisfied from
partnership assets, then from personal assets of
the partners.
© 2019 McGraw-Hill Education.
33
Liability for Torts and Crimes
3
Partners and the partnership are liable:
• When a partner commits a breach of trust owed a 3P.
• For a partner’s negligence (generally).
• Usually not liable for intentional torts unless
committed within scope of authority (e.g., defaming
client in pursuing unpaid bill).
When a partnership and partners are held liable for a
partner’s tort, they may recover the amount of their
vicarious liability from the wrongdoing partner.
© 2019 McGraw-Hill Education.
34
Liability for Torts and Crimes
A partner is personally liable for his own crimes.
A partnership may be prosecuted for crimes
when committed by a partner acting within the
scope of his authority (e.g., partner in brokerage
firm defrauding customers).
A partner who did not participate in criminal
wrongdoing is not personally liable for crimes
committed by another partner.
© 2019 McGraw-Hill Education.
35
Liability for Torts and Crimes
4
Limited Liability Partnership (LLP)
The (LLP) was created to restrict the personal liability of
professional partners. An innocent partner of an LLP has
no liability for malpractice of other partners.
However, a partner remains liable for her own
malpractice and that of a supervised employee.
LLP partners also have no personal liability for debts of
the LLP, e.g., contracts, leases, loans.
© 2019 McGraw-Hill Education.
36
Liability for Torts and Crimes:
Mortgage Grader v. Ward & Olivo
Ward contends he is shielded from liability as a
partner in an LLP and is not vicariously liable for
the acts of his former partner, Olivo.
At the time of the incident, W&O was an LLP,
and Ward was not vicariously liable for the
alleged malpractice of his former partner Olivo.
HELD: Reversed for Ward. Ward is not
vicariously liable for the alleged malpractice of
his former partner Olivo.
© 2019 McGraw-Hill Education.
37
Test Your Knowledge
1
True = A, False = B
• Partners owe to the partnership and each other an
ordinary degree of loyalty.
• Partners may compete with the partnership as long
as it does not harm the partnership.
• A partner is liable to the partnership for losses
resulting from gross negligence or reckless conduct.
• A partnership may sue in its own name.
© 2019 McGraw-Hill Education.
38
Test Your Knowledge
2
True = A, False = B
• In general, management decisions in a partnership
are decided by majority rule.
• A general partnership is liable for a partner’s
negligence.
• For contract obligations of an LLP, only the partners
are liable.
• A partner with authority to borrow money has
authority to issue negotiable instruments.
© 2019 McGraw-Hill Education.
39
Test Your Knowledge
3
Multiple Choice
• Two accountants formed Caine & Able, LLP. The
partnership and each partner was sued for Able’s
alleged negligence. Who might be liable?
a) Only Able due to his negligence.
b) Only the partnership, Caine & Able.
c) The partnership and Able.
d) The partnership and either partner, jointly or severally.
© 2019 McGraw-Hill Education.
40
Test Your Knowledge
4
Multiple Choice
• A partner in a trading partnership has what type(s)
of authority for borrowing money?
a) Express authority.
b) Implied and apparent authority.
c) Actual authority.
d) Implied authority.
e) All of the above.
© 2019 McGraw-Hill Education.
41
Thought Question
When drafting the partnership agreement,
should duties and compensation be allocated
evenly or according to each partner’s
contribution and skill? Should partners be
shielded from personal liability?
© 2019 McGraw-Hill Education.
42
BUSINESS LAW: THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
P
A
R
T
9
Partnerships
Chapter 37 Introduction to Forms of Business
and Formation of Partnerships
Chapter 38 Operation of Partnerships
& Related Forms
Chapter 39 Partners’ Dissociation and Partnerships’
Dissolution and Winding Up→
Chapter 40 Limited Liability Companies, Limited
Partnerships, and Limited Liability Limited Partnerships
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1
BUSINESS LAW: THE ETHICAL, GLOBAL, AND E-COMMERCE ENVIRONMENT,
LANGVARDT, BARNES, PRENKERT, MCCRORY, AND PERRY
C H A P T E R
39
Partners’ Dissociation and Partnerships’
Dissolution and Winding Up
Change is inevitable, but it is
in us to control its content and
directions.
Indira Ghandhi, Indian Prime
Minister, speech (1967)
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
2
Learning Objectives
• 39-1 Define dissociation and identify actions that
cause wrongful and nonwrongful dissociations.
• 39-2 Understand the default consequences of
dissociation.
• 39-3 Draft a partnership agreement that changes the
rules applying when a partner dissociates.
• 39-4 Understand the causes of dissolution and the
process of winding up. →
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3
Learning Objectives
• 39-5 Draft a partnership agreement that changes the
rules applying when dissolution occurs.
• 39-6 Appreciate the default effects of continuing a
partnership after dissociation.
• 39-7 Identify issues involved in adding new partners
to existing partnerships.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
4
Life Intervenes
• Sometimes even the best-laid plans go awry
and a business fails to meet objectives.
• Sometimes, it is simply time to make a change
by modifying a partnership business to reemerge as another partnership form, such as a
Limited Liability Company, or a Corporation.
• Whether an ending or new beginning, this
chapter is about managing change.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
5
Key Terms
• Dissociation – A partner ceases to be associated in
carrying on the business of the partnership, e.g.
retirement, death, expulsion, bankruptcy.
• Dissolution – Commencement of winding up process.
• Winding Up – Collection and liquidation of assets;
payment of debts; distribution of remaining assets to
partners.
• Termination – End of partnership’s legal existence.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
6
Dissociation
• The RUPA defines dissociation as a change in
the relation of partners caused by any partner
ceasing to be associated in the carrying on of
the business:
– A partner’s retirement, death, or expulsion, or
– A bankruptcy filing.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7
Dissociation
• Dissociation may start the process of
dissolution, winding up (liquidation), and
termination…but need not do so.
– A partner has the power – but not necessarily the
right – to dissociate from the partnership at any
time, such as by withdrawing from the partnership.
– Note: unless the partnership agreement provides
otherwise, a partner has the right to withdraw or
dissociate at any time. Issue: was the withdrawal
wrongful or nonwrongful? →
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8
Nonwrongful Dissociation
•
Non-wrongful dissociation does not violate a
partnership agreement and includes events such as:
(i) the death or retirement of a partner, (ii)
withdrawal in accordance with the partnership
agreement, (iii) expulsion due to transfer of
transferable interest or charging order, (iv)
withdrawal within 90 days of another partner’s
death, incapacity, wrongful dissociation, expulsion
due to illegality of association, assets assigned for
benefit of creditors; (v) appointment of a guardian
due to a partner’s incapacity.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9
Rights on Non-Wrongful
Dissociation
• Withdrawing partner entitled to payment of
value of interest.
• No right to dissolve partnership unless
partnership at will, i.e., with no term.
• Partnership continues, except in case of death
of a partner, 50% of remaining partners have
right to dissolve partnership.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
10
Wrongful Dissociation
1. Withdrawal of a
partner that breaches
an express provision
of partnership
agreement.
2. Withdrawal of a
partner before the end
of the partnership’s
term or completion of
its undertaking.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
11
Wrongful Dissociation
3. A partner’s filing a bankruptcy petition or being
a debtor in bankruptcy.
4. Judicial expulsion of a partner by request of
partnership or another partner for:
–
–
–
Partner’s wrongful conduct that adversely affects
partnership business.
Partner’s willful and persistent breach of fiduciary duties
or the partnership agreement.
Partner’s conduct makes it unreasonable to conduct
partnership business with that partner.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
12
Rights on Wrongful Dissociation
• Partnership may continue.
• Withdrawing partner has no right to demand payment
of partnership share until partnership terminates.
• Withdrawing partner has no right to demand
dissolution, even if partnership is at-will.
• Fifty percent of remaining partners may elect to wind
up partnership.
• If remaining partners elect to wind up partnership,
withdrawing partner is entitled to partnership share,
less damages caused by withdrawing partner.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
13
Effect of a Partnership
Agreement
• The dissociations in RUPA are ‘default’ and
can be superseded by a partnership agreement.
• Partnership agreement may:
• limit or expand the definition of ‘wrongful’
dissociation
• reduce the number of partners that must approve
the expulsion of a partner, such as a two-thirds
vote, and expand the grounds for expulsion. →
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
14
Effect of a Partnership
Agreement
•
•
Under RUPA, Acts not causing dissociation include:
– Partner’s transfer of transferable partnership
interest.
– Creditor obtaining a charging order
– Adding a partner.
– Disagreements between partners.
However, partners may limit or expand the
definition of dissociation and events considered
wrongful or nonwrongful. →
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
15
Effect of a Partnership
Agreement
• A partnership agreement may allow the
partnership to require dissociation in certain
circumstances, such as:
– transfer of transferable interest, failure to discharge
a charging order with, e.g. 30 days, failure to make
a required capital contribution.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
16
Wrongful Dissociation:
Meyer v Christie
Defendants argue the dissociation provisions are not
applicable as the partnership was too speculative and
included nothing regarding dissociation.
A jury could have reasonably found Junction City
Partners to be a joint venture for a particular
undertaking, and defendants wrongfully dissociated.
HELD: for Meyer and Pratt affirmed. The amount of
$9.19 million was reasonably the parties expectations
when defendants wrongfully dissociated.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
17
Dissolution and Winding Up
the Partnership Business
• When a partner dissociates, dissolution may
be the next step, but RUPA allows the
partnership business to continue after a
partner’s dissociation.
– Thus, dissolution is not automatic.
– Rationale: protect remaining partners;
business may be more valuable as a going
concern.
Copyright 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
18
Dissolution
• RUPA provides a list of events that force a
partnership to be dissolved and wound up.
• Expiration of partnership term or completion of
undertaking.
• All partners agree to dissolve.
• Business of partnership becomes unlawful.
• Judicial: petition of partner showing purpose of
partnership unreasonably frustrated; or one partner’s
conduct makes it impracticable to carry on business.
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19
Partnership At-Will: Gelman v.
Buehler
• Oral partnership agreement alleged by plaintiff
lacked a fixed time during which the business
was to operate and only an “amorphous”
business plan.
• Accordingly, the alleged agreement lacked a
“definite term” or “particular undertaking.”
• Therefore, the partnership could be dissolved
upon the will of any partner.
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20
Dissolution and Winding Up:
Urbain v. Beierling
• Urbain argued that defendants’ decision to
discontinue the partnership and oust her was
wrongful absent the consent of all partners.
• Clinesmith, the partner responsible for accounting
duties, testified she personally looked into the
financials but there were only expenses.
• HELD: affirmed for Beierling. Urbain asserted
she was a “co-owner” of partnership property, but
there were no assets or profits to distribute.
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21
Winding Up
• Dissolution begins the winding up process:
– Orderly liquidation of partnership assets and the
distribution of proceeds to those having claims
against the partnership.
– Collect and preserve assets; pay creditors; settle
claims; make distributions to partners of
remaining assets.
– Partners retain fiduciary duty with regard to
winding up matters, e.g. use of partnership assets.
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22
Winding Up
• The winding up partner has implied authority
to do those acts appropriate for winding up the
partnership business and apparent authority to
conduct business as she did before dissolution.
• Perform existing contracts but not commit to
new obligations unless necessary to preserve
assets.
• Entitled to additional compensation for
winding up duties.
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23
Winding Up:
Apparent Authority
• To eliminate apparent authority of
winding up partner (and other partners)
to conduct business in ordinary way, the
partnership must ensure one or more of
these occur:
1. Third parties know or have reason to know
partnership has been dissolved, e.g. provide
notice to customers and suppliers. →
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24
Winding Up:
Apparent Authority
2. Third party received dissolution notification by
delivery of communication to third party’s place
of business.
3. Dissolution has come to the attention of the
third party, e.g., via media, notice in trade press.
4. A partner filed a Statement of Dissolution with
the secretary of state limiting the partners’
authority during winding up.
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25
Winding Up:
Paciaroni v Crane
• Once dissolution occurs, the partnership
continues only to extent necessary to complete
transactions begun but not finished.
• The partnership’s business purpose was to race
the horse, thus “the winding up of the
partnership affairs should include the right to
race” the horse.
• HELD: for Paciaroni, with conditions.
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26
Winding Up:
Distribution of Assets
• After partnership assets have been sold during
winding up, proceeds are distributed to those
who have claims against the partnership.
– Includes partners, but creditor claims satisfied
first.
– A partner who has loaned the partnership money
is entitled to be paid along with other creditors.
→
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27
Partnership Winding Up:
Distribution of Assets
• Remaining proceeds from sale of assets will
be distributed to the partners according to the
net amounts in their capital accounts.
– Partner’s capital account is credited (increased)
for capital contributions partner made to
partnership plus partner’s share of undistributed
profits.
– Partner’s capital account is charged (decreased)
for partner’s share of partnership losses.
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28
Partnership Winding Up:
Distribution of Assets
• If capital account is negative, partner may be
required to contribute amount of shortfall.
• If partnership assets are insufficient to pay
partnership debts, creditors may pursue
partners’ individual assets. Partners have joint
and several liability for partnership
obligations.
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29
LLP Winding Up:
Distribution of Assets
• Asset distribution rules modified for limited
liability partnership since in an LLP most
partners have no liability for partnership
obligations.
• If a partner committed malpractice or another
wrong for which LLP statutes do not provide
liability protection, the partner must contribute
funds to the LLP or have personal assets at
risk.
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30
After Distribution: Termination
• After partnership assets have been
distributed, termination of the
partnership occurs automatically.
• Statutes require filing with Secretary
of State.
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31
When the Business is Continued
• Partners may choose not to seek dissolution and
winding up after dissociation.
• When the business is continued, creditors continue as
creditors of the business. Obligations not eliminated
merely by starting new form of business.
• Original partners remain liable for obligations
incurred prior to dissociation.
– Including dissociated partners.
– Liability may be eliminated by the process of
novation.
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32
Novation
• Release of dissociated partner by:
• 1. Partnership; 2 Creditors.
• If partner is only able to obtain novation from
partnership, she may seek indemnification from
partnership for creditors’ claims.
• Implied Novation – With knowledge of partner’s
dissociation, creditor continues to extend credit to
partnership; may also arise from material
modification of credit terms post-dissociation, e.g.,
additional security granted by partnership.
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