THE RULES OF PARTNERSHIPS: PERSONAL LIABILITY, PARTNERSHIP STRUCTURE & YOUR RIGHTS
THE RULES OF PARTNERSHIPS: PERSONAL LIABILITY, PARTNERSHIP STRUCTURE & YOUR RIGHTS
When business partnerships are good, you find partners working together with mutual respect, being open and honest, deferring to each other’s judgment, and striving to make decisions that benefit the business and parties involved. You even find them respectfully disagreeing on points that truly matter. As with any relationship, partnerships start with good intentions and well-laid plans. Then, life happens and the relationship changes course.
When partnerships are bad, you typically see a relationship lacking respect and consideration for other partners, withholding information, crumbling trust, and dwindling interest in once-shared goals. Worse than a failing partnership is the business breakup, which is typically fraught with heated emotions, misunderstandings and accusations. Just like marriage, starting a partnership is much easier than the breakup.
Often, business partners don’t fully understand their rights, liabilities and obligations during the honeymoon phase, rough patches, or the separation (when necessary). Having a well-crafted agreement outlining the terms or rules of engagement is not absolutely necessary, but extremely helpful and strongly recommended to establish rights and expectations during the business relationship and to help in reduce the risk of a rough or nasty breakup.
Partnership Basics
What is a Partnership?
I like the simplistic definition the Small Business Association uses for a “partnership” – a partnership is a business where two or more people share ownership. We’ll talk about the various types of partnerships below; but in the most common type of partnership structure, by definition each partner contributes to all aspects of the business (including money, property, and labor). In addition, each partner shares in the profits and losses of the business. In an ideal world, a formal agreement between partners would outline any particulars regarding levels of monetary contributions, devotion of skill and labor, sharing of profit gains and losses, and what happens should the partnership end (e.g., buyout, arbitration, debt payments, division of property, complete dissolution or termination of the business).
Different Partnership Structures
Partnership Structures can be formal or informal. Informal partnerships usually exist without any formal documentation or corporate registration of the partnership. The working relationship has limited governance and protection under state laws. In other words, either a written agreement exists or a gentlemen’s agreement (nothing in writing) is all that exists.
There are three types of informal partnerships and they operate quite differently — General Partnerships, Joint Ventures, and Limited Partnerships.
In the General Partnership model, all partners equally divide management responsibilities and profits. With Joint Ventures, as with General Partnerships, the partners share all responsibilities and profits, but only for a limited time or specific project. The last and most common partnership is a Limited Partnership. This model consists of one set of partners who are actively contributing in the management and operations of the business, and another set of partners who simply invest capital without the additional responsibilities. Essentially, capital partners are limited in the day-to-day management and are commonly referred to as “silent partners”. In this partnership model, it’s a good idea to have a separate agreement in place outlining the expectations of the silent partner. With all partnerships, to secure more legal protection and limited personal liability, you should formally register your partnership structure with the appropriate governing state.
The Partnership Rules
Choosing the right partners is critical. Connecting with partners who are subject matter experts, have good business sense, and who demonstrate a great level of interest and integrity are all great characteristics to seek out. The “rules of partnership engagement” may seem relatively simple, especially if you elected to forego a written agreement. However, as you’ll see below, there are inherent and legal rules, rights and liabilities to consider.
Personal Responsibilities and Rights
The rights and responsibilities of any partnership should be outlined in the partnership agreement. When there is conflict, matters can often be resolved by referring to the provisions described in the agreement. Where a formal written agreement does not exist, all partners have legally inherent responsibilities such as the following:
— Duty of loyalty – partners must share equally in profits and losses and not individually enrich themselves at the expense of the business and other partners.
— Duty of financial accounting – in other words, each partner has a duty to account for money going in and money going out.
Where a formal agreement exists, each partner is responsible for fulfilling his or her role and distributing profits as outlined by their written agreement. The benefit of a formal agreement is that you’ll have a guide to look back and point to should there be any questions, disagreements or “selective amnesia.” Plus, people generally feel more comfortable and at ease while fulfilling their duties when they know and understand their role, responsibilities and rights upfront.
Joint Authority and Joint Liability
Unless outlined differently in your partnership agreement, each partner shares the same authoritative privileges for the business. Therefore, each partner can negotiate and sign contracts on behalf of the business. Shared or Joint Authority also means that your partners have the authority to make contractual commitments for which you can personally be held responsible. So remember, in business partnerships the signature of one affects the liability of all.
Personal Liability
Considerable thought and evaluation should go into the decision to join or create a business partnership. The commitment carries great responsibility and great liability. As a business partner, your personal assets are exposed and are vulnerable to business obligations, debt or judgments. This means that if the partnership cannot afford to pay creditors or if the business fails, each partner is individually responsible. Essentially, creditors can go after each partner’s personal assets including bank accounts, cars and homes. General partners are personally (and in some cases severely) liable for the business obligations of the partnership. The exemption to this personal liability rule is if you form a corporate entity (like an LLC, LLP or S-Corp) to shield partners’ personal assets.
Thinking About Creating a Partnership?
Business partnerships work exceptionally well for some business owners. Some inherent perks include having help with business plans and decisions, added skillsets and knowledge, increased financial resources, and YES, even tax benefits. When deciding to enter into a partnership, be thoughtful about business partners you select, and consult with a business attorney who can help you navigate the details, including partnership structure, agreements and liability considerations.
Your Thoughts: Considering a business partnership? Are you already in a partnership? What advantages and disadvantages have you observed or considered?
This article is intended to provide you with general information; it does not constitute any type of legal advice. For recommendations related to your specific matter, we encourage you to review our Practice Areas page for additional information and then contact us to discuss your company’s legal needs.