BUSINESS LAW: Partnerships
A partnership is an association of two or more
persons coming together to carry on, as co-owners, a business for
profit, whether or not the persons intend to form a partnership.
Basically, there are three types of partnerships,
the "General Partnership" the "Limited Partnership"
and the "Limited Liability Partnership". This article
will discuss these entities.
WHAT IS A GENERAL PARTNERSHIP? . . .
A general partnership allows for the participation of a number
of principals, therefore permitting the distribution of work and
sharing of risks among the principals.
Although the Uniform Partnership Act of 1994 provides a statutory
framework for operating a partnership, the general partnership agreement,
if one exists, is the primary source for determining the rights
and obligations of the parties. Most of the statutory rights and
duties of partners to one another are expressly made subject to
any agreement between them.
NO PROTECTION FROM PERSONAL
LIABILITY . . .
General partnerships provide no protection to the principals
from losses generated by the business. General partners have the
right to bind the partnership to contracts with third parties, although
this right may be limited in certain situations. Each partner’s
assets are fully exposed to third-party claims that arise from the
operations of the partnership. All general partners may also be
held liable for the partnership’s payroll taxes, including any penalty
for nonpayment, regardless of which partners are responsible among
themselves for remitting the taxes. Therefore, one must be confident
in and comfortable with the other general partners.
Disparity of net worth, experience, or business acumen among
the principals may indicate that general partnership is not appropriate
in every case.
IMPORTANCE OF A WELL-DRAFTED
PARTNERSHIP AGREEMENT . . .
A good partnership agreement is necessary to address certain
issues common to every partnership, before a dispute arises. The
biggest mistake by partnerships is not having a well drafted partnership
agreement and costly litigation often occurs after the break-up
of a partnership, in order to resolve issues that could have been
provided for in the partnership agreement.
Also, among other things, a partnership agreement should address
issues regarding a buy-out of the partnership interest of a deceased
partner, and a life insurance policy to fund the buy-out, making
the transition of ownership of the partnership and estate issues
For partnerships formed before 1997, the Uniform Partnership
Act provides that a general partnership may be dissolved for myriad
reasons, including the death or bankruptcy of a partner, withdrawal
or admission by a partner, or the express will of any partner if
no definite term or particular undertaking is specified.
For partnerships formed after 1996, the Uniform Partnership
Act of 1994 controls. The newer version does not call for dissolution
when a single partner dies, but instead requires the express will
of at least half of the partners to dissolve and wind up the partnership
business, thereby allowing for longer continuity of existence.
The partnership agreement can provide for a continuity of existence
as agreed upon by all partners. Absent an agreement to the contrary,
a partner cannot sell a general partnership interest without the
consent of all other partners.
A partner is not a co-owner of partnership property, and has
no interest in partnership property that can be transferred. A partner
may, however, transfer his or her share of the profits and losses
of the partnership, as well as the partner’s right to receive distributions.
The remaining general partners of a general partnership traditionally
are the most likely potential purchasers of a general partner's
interest when an unanticipated occurrence forces a liquidation of
that partner's interest. If the remaining general partners are unable
or unwilling to purchase the interest of a withdrawing partner,
the partnership may be forced to liquidate, much in the same manner
as a proprietorship.
MANAGEMENT AND CONTROL . . .
A general partnership allows the responsibility for management,
as well as the control of the decision making, to be spread among
the partners. A general partnership allows the partners an infinite
number of choices in dividing up the management responsibilities
and allocating the ownership percentages. The choices are limited
only by the imagination of the practitioner drafting the partnership
agreement. Note, however, that the concept of centralized management
may be difficult for a general partnership to accomplish because
each general partner has the ability to bind the partnership in
dealing with third parties.
A general partnership does not protect the partners from personal
liability for company debts, but requires less formality and tax
consequences than a corporation, and is less expensive to maintain
than either a corporation or a limited liability company.
FAQ's - About General Partnerships . . .
QUESTION: How do I choose a business format?
ANSWER: Owners of small businesses often choose a business
format when they first open their doors, but this is a decision
that should be reevaluated at regular intervals throughout the business'
existence. What worked when you started may be costing you in taxes,
or liability exposure later.
QUESTION: What is a general partnership?
ANSWER: A general partnership is a business owned directly
by two or more people. Like a sole proprietorship, it is legally
and financially equated to its owners. Financially, all of the profit
or loss passes through to its owners, regardless of whether they
take that money out of the business or not. And legally, all of
the partners are liable for 100% of the business debts.
QUESTION: Why would anyone form a partnership?
ANSWER: A partnership does not have the formality requirements
of a corporation of limited liability company. If personal liability
is not an issue in the business, a partnership is an easy, natural,
flexible business entity, and sometimes has good tax consequences.
QUESTION: Can you agree with your partners that only
one of you will be liable for your share of the debts?
ANSWER: Yes, you can, but that agreement isn't binding on
the creditors. They can look to you for 100% of the debt, and you
have to find, and collect from your deadbeat partners. After all,
you picked them.
QUESTION: What are the rest of the partnership choices?
ANSWER: There is a variation on the general partnership,
and that is a limited partnership. In a limited partnership there
is at least one general partner, who has full liability, and one
or more limited partners who are only liable up to the extent of
their investment. In other words, if the company becomes insolvent,
the limited partners will lose their investment, but no one can
come after them for any more money. The general partners, on the
other hand, are fully liable for all debts. Often, a corporation
will be the general partner, thereby insulating the shareholders
from personal liability.
QUESTION: A limited partnership sounds a lot better than
a general partnership. Why wouldn't you always use that?
ANSWER: First you would have to decide who was going to
be the general partner, with all the exposure. More significantly,
the limited partners can only have a limited role in the operation
and management of the business. If they overstep the legal limitations,
they become general partners and have full liability. Also, there
are special costs and filing requirements for limited partnerships.
For information on Limited Liability Companies, click here: LLC
A limited partnership is a partnership formed by two or more
persons that has one or more general partners and one or more limited
partners (or their equivalents under another name).
Often used for real estate transactions, the limited partnership
provides a vehicle through which certain principals (the limited
partners) may avoid subjecting their assets outside the limited
partnership to the claims of the limited partnership's creditors.
Only those assets contributed to the partnership by a limited partner,
or as to which the limited partner has an obligation to make subsequent
contributions, are subject to claims of third-party creditors of
the partnership. This makes the limited partnership a superior vehicle
for the attraction of equity capital.
A limited partnership must have at least one general partner
and one limited partner. There may be different classes of general
partners and limited partners. If there are, the Partnership Agreement
must define the rights, powers, and duties of those classes relative
to other classes of general and limited partners, respectively.
The different classes may be given the right to vote separately
or with all or any class or the general partners or any class of
general partners on any matter.
If a limited partnership is not formed in accordance with applicable
statutes, or if a limited partner is named as a general partner
in the certificate or participates in the control of the business,
the limited partner may lose the limitations on liability afforded
by the limited partnership.
General partners in a limited partnership generally have unlimited
liability for obligations incurred by the partnership. It is not
uncommon to require that limited partners execute guarantees in
certain business transactions. These guarantees subject the limited
partner to liabilities in excess of those imposed by the obligation
to make capital contributions.
In addition, if a limited partner participates in the control
of the business without being named as a general partner, that partner
is liable as a general partner only to persons who transact business
with the partnership with (1) actual knowledge of that partner's
participation in control and (2) a reasonable belief, based on that
partner's conduct, that the partner is a general partner at the
time of the transaction.
A limited partner is not deemed to be participating in control
merely because the limited partner acts on matters related to the
partnership business that are specified in a written partnership
agreement to be subject to the approval or disapproval of the limited
partners, or because the limited partner exercises any right or
power under the California Revised Limited Partnership Act.
Continuity of existence is not a characteristic generally associated
with limited partnerships. Although limited partnership interests
are generally transferable, a limited partnership will be dissolved
and its affairs wound up upon the earlier of the following:
1. The occurrence of an event specified in the partnership
2. The written consent of the general partners and a majority
of the limited partners (unless the agreement otherwise provides);
3. The general partner ceases to be a general partner (for
example, because of withdrawal, incompetence, or termination of
corporate status), unless:
(a) the partnership agreement allows the partnership to
be continued by other remaining general partners and there
are other remaining general partners who agree to continue
the partnership; or
(b) a majority in interest of the limited partners or
the greater interest provided in the partnership agreement
agree in writing to continue the business of the limited partnership
and, within six months after the last remaining general partner
has ceased to be a general partner, to admit one or more general
4. The entry of a decree of judicial dissolution.
The transferability of interests of partners in a limited partnership
has distinctively different characteristics depending on whether
a general or limited partnership interest is being transferred.
A partnership agreement may provide that a general partner may
not assign or encumber a partnership interest in a limited partnership.
In addition, the transferability of general partnership interests
is subject to significant restriction through (1) the requirement
that all general partners consent in writing to the admission of
a new general partner, and (2) the statutory right of limited partners
to vote on the admission of a general partner.
In addition, a general partner who assigns all of his or her
interest in a partnership to a third party may be removed by a majority
in interest of the limited partners.
The transfer of a limited partner's interest does not dissolve
a limited partnership, and the interests of limited partners tend
to be freely transferable.
A limited partnership interest is assignable in whole or in
A transfer by way of merger is also possible when two or more
limited partnerships merge into one limited partnership, subject
to dissenting limited partners' rights.
A limited partnership may merge with a general partnership into
a limited partnership or general partnership, provided that the
merger is specifically permitted in the general partnership agreement.
Mergers with other business entities are authorized. Limited
partnership interests do not represent an attractive commodity to
third-party purchasers, and limited partners may be faced with a
sale of their interests at a substantial discount if forced to liquidate
an investment in a limited partnership.
In a limited partnership, management and control rests primarily
in the general partners; as with general partnerships, management
responsibilities among general partners in a limited partnership
may be divided in a variety of ways in the limited partnership agreement.
Limited partners are allowed to vote on a limited number of
issues and engage in various activities with the limited partnership
without jeopardizing their status as limited partners.
A limited partnership is required to file appropriate certificates
of limited partnership in a timely manner in order to provide the
protection of limited liability to the limited partnership, and
the protections from liability available to a limited partner are
not fully available until the certificate of limited partnership
has been properly filed.
LIMITED LIABILITY PARTNERSHIPS (LLP)
(Only available to accountants and lawyers)
A limited liability partnership is a partnership formed by two
or more persons that has one or more general partners and one or
more limited partners (or their equivalents under another name).
However, only partnerships engaged in the practice of public accountancy
or the practice of law may be structured as a Limited Liability
Partnership (“LLP”). No other businesses may consider the LLP option.
Legal and accounting businesses must weigh the advantages and
disadvantages of an LLP compared to other entities. Among the advantages
of an LLP are the following:
Limited liability of partners for tort, contract, or other damages
that are incurred by the partnership while it is an LLP, and that
arise by reason of being a partner or acting in the conduct of the
business or activities of the partnership. An LLP partner cannot,
however, escape liability to third parties for his or her own tortuous
Flexibility in form and structure that is available to all
partnerships disporportionately allocate items of income, gain,
loss, deduction, and distributions pursuant to the partnership agreement,
within the restrictions of Internal Revenue Code Section 704(b).
This flexibility is not available to corporations. Treatment as
a partnership pass-through entity for federal tax purposes under
the elective entity classification rules.
Characterization as a partnership avoids the double taxation
imposed on subchapter "C" corporations, first on their
earnings at the entity level and again at the shareholder level
on dividends and distributions of property to shareholders, and
LLPs, as partnerships, are not subject to the accumulated earnings
tax or the tax on personal holding companies.
DIFFERENCES BETWEEN LLPs AND GENERAL PARTNERSHIPS . . .
The major difference between LLPs and general partnerships is
that LLP partners can limit their liability by registering as an
LLP and satisfying the security requirements. With certain exceptions,
such as for personal tortious conduct, LLP partners are not personally
liable for the LLP's obligations unless they agree to be liable,
guarantee its obligations, or are held liable for obligations due
to the LLP's failure to satisfy the statutory security or net worth
In contrast, all the assets of general partners are exposed
to claims arising from obligations of the general partnership. A
partnership is liable for loss or injury caused to a person, or
for a penalty incurred, as a result of a wrongful act or omission,
or other actionable conduct, of a partner acting in the ordinary
course of the partnership or with the authority of the partnership.
A partnership is also liable for the misapplication of funds or
property by a partner.
A partner may become jointly and severally liable from the resulting
partnership liability following from the above acts. Further, partners
are jointly liable for any other obligations of the partnership.
This extensive liability of general partners and the recourse to
each partner's personal assets constitutes a fundamental disadvantage
of a general partnership compared to an LLP, and is the primary
motivating factor behind a partnership's determination to convert
to a registered LLP.
DISADVANTAGES OF AN LLP . . .
Probably the most critical disadvantage of an LLP is that at
the present timeCalifornia has no case law on which to rely for
guidance in interpreting the limited liability that is intended
to be afforded by the LLP legislation. In contrast, well-developed
and instructive bodies of law exist concerning both corporations
and limited partnerships.
TAXES AND LLP'S . . .
An LLP is considered a general partnership for
state law purposes. An LLP may elect to be treated as a partnership
under federal tax law. Except for special registrations and security
requirements that must be complied with by LLPs, there is little
to distinguish the day-to-day functioning of the two entities. Any
existing partnership agreement of a general partnership converting
to LLP status, however, would need to be modified to take into account
various matters relating to the conversion.
CONCLUSION . . .
Chosing a business entity must be made through
a careful weighing and balancing of all the interrelated tax and
non-tax factors involved in the formation and conduct of a business
venture. It cannot be overemphasized that this choice must be made
on a case-by-case basis and must be tailored to the specific tax,
legal, and financial objectives and expectations of the principals
involved in the venture. Both short-term and long-term objectives
must be determined. The choice of the proper business entity need
not be made at the inception of a venture. It is an ongoing decision
that requires review and reconsideration at least yearly in the
light of changing tax laws and the changing circumstances of the
business and its principals. Changes can always be made when the
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