Partnership II

Why do people choose the partnership form of business? A partnership provides some tax advantages. The partnership is not a separate taxable entity. The income and deductions of a partnership flow through to the partners and land on their individual return. If the partnership has losses, the partners may use those losses on their individual return in most cases. If it has income, the partners are taxed once, at the individual rate. Most of these advantages, however, will be available in the S-Corporation. However, the S-Corporation option requires more administrative, legal and accounting expense to assure compliance. An ordinary general partnership does not provide the limited liability protection available to a corporation, and this has been a strong motivation for incorporation, especially for businesses with additional employees beyond the individual partners. However, many states now provide a "limited liability partnership" option. The limited liability partnership confers some of the liability protections found in a corporation, and thus provides an additional choice of business form.

A properly drafted partnership agreement provides greater continuity than an individual proprietorship. It may provide for continuation of the partnership upon death, disability or retirement, although a corporate form generally provides even greater assurances of continuity. A partnership agreement can provide mutual agreements among the partners to purchase the interests of other partners, thus providing an estate planning component not available in an individual proprietorship.

Many companies now operating as regular partnership should consider converting to a limited liability partnership. A limited liability partnership, is a newer business form which allows corporation like limited liability protections. Limited liability protects the personal assets of the owner of a business from liability for the debts of the business. When a partnership cannot pay its debts, each partner becomes personally liable for those debts. But if an entity has limited liability, then creditors of the entity must look exclusively to the assets of the entity to pay the debt. Limited liability also protects owners of an entity from suits for damages against the entity. Without limited liability, a successful plaintiff, say in a products liability case, could collect from the partnership assets (including insurance), and then if these assets are insufficient, proceed to collect from the non-partneship assets of the partners themselves. If the entity has limited liability, the successful plaintiff can collect only from the assets of the partner and the individual assets of any partner who has himself culpably contributed to the wrong. Other partners are insulated from that liability. (Is this what the partners really want?)

A partnership can be formed without any formal act of registration with the state. But in order to form a limited liability partnership, one must comply with the qualification, MSA section 323A.10-01, and registration requirements, 323A.10-01, of RUPA.

In panel I, we discussed the definition of a partnership. In this panel, we discuss the ways in which persons outside the partnership deal with the partnership. This aspect of partnership law deals with questions like:

• How do you collect a debt owed by a partnership
• Suppose a partner enters into a transaction, but the other partners claim that he lacked authority

Partners are agents: RUPA says: "Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority."

What does this mean? In agency law, we distinguish between power and authority. A simple example will illustrate this point. Suppose you give your diamond ring to a trusted friend and ask your friend to sell that ring for you for a price no less than $2,000. You appoint that person your agent for purposes of selling the ring, and the law of agency now applies. Your friend has only your actual authority to sell the ring for $2,000, or more. If he sells it for $1500, he will have breached your agency agreement, and he may owe you $500. But your friend has the legal power to sell the ring to third parties, at least those who do not know the limitation of your agency agreement. As a result, if your friend sells the ring for less than $2,000, you will not have the right to get the ring back from a third party: your agent has the power (sometimes called apparent authority) to bind you to the transaction.

Partners are agents of the partnership. This same authority-power distinction drives partnership law as well. Partners may have all sorts of internal operating agreements about limitations on each partners authority, but those limitations do not bind third parties who deal with a partner, unless that third party has knowledge of the limitation. The central question, then, in determining whether a partner binds the partnership, is not the terms of the partnership agreement, but rather whether the transaction is done in the ordinary course the partnership business or business of the kind carried on by the partnership.

Any partner in a landscaping business has apparent authority, the power to bind the business, in undertaking a contract to landscape. But if the partner attempted to sell the partnerships tools and trucks, a third party would be well advised to obtain evidence of authority from the other partners. "An act of a partner which is not apparently for carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership only if the act was authorized by the other partners." RUPA has a number of provisions which allow a partnership to file a statement of partnership authority, as a way of attempting to give notice to third parties of limitations on individual partners' authority. Minnesota Statutes Section 323A.3-03. There are limitations on the effectiveness of these notices, however, beyond the scope of this discussion.

Persons dealing with a partnership rightfully expect that each partner has authority to engage in ordinary course transactions, and they expect that the assets of that partner will answer for partnership debt. When a partner leaves the business, the public may continue to believe that the former partner has responsibility and authority. It is thus critical, both for the partnership and the outgoing partner, that the fact of withdrawal be made known. Certainly, persons formerly dealing with the partnership should be advised. RUPA contains formal mechanisms for providing official notice.