Sole Proprietorship, General Partnerships, Joint Ventures, Limited Liability Partnership, Limited Partnerships, Limited Liability Limited Partnerships, Corporations

A sole proprietorship is one human being doing business without a formal organization, that is, without a wholly owned corporation or a single member limited liability company. Thus, all business is done in the individual’s name or in an assumed business name held by the individual. The individual would be fully responsible for all debts and liabilities of his or her business, and would be sued personally and could have all non-exempt assets, including personal assets or investments having nothing to do with the proprietorship business, seized by reason of such business debts and liabilities.

Start-up expenses for doing business without any form of organization certainly would not include any organization expenses. The start-up process would be very simple: get any necessary licenses and zoning approvals, file an assumed name application if such a name is desired, and go at it. If any employees will be hired, a separate tax identification number would be needed, otherwise, the individual may use his or her Social Security number.

All income from the business would be reported on the individual’s form 1040 tax return, likely using Schedule C. Individuals do not need to qualify to do business in other states, but may need to register any assumed name. To the extent business is done in more than one state, income tax returns would need to be filed in each state with an income tax, and normal sales tax and other tax and regulatory requirements would need to be met in each such state.

If the proprietor has employees or other agents, all employment laws, tax withholding rules, and other laws relating to employees or agents will apply. Among these applicable rules, the rule of respondeat superior and other agency rules will make the employing sole proprietor personally liable for any actions done in the scope of the employment or agency by the employee or agent.

The simplicity of a sole proprietorship may be attractive to people doing modest, relatively risk free businesses. Business insurance should be obtained; an individual’s homeowner’s policy will very likely exclude any coverage for business operations. Insurance will be the only real protection the sole proprietor will have against liabilities.

Although some business people think that because banks and some vendors or customers will require personal guarantees of the individual, a single owner organization will have little value. This view can be mistaken, because there are a number of areas of risk for which an organization providing limited liability can add a level of protection, including limiting and isolating liabilities arising from uninsured tortious acts of employees or from non-guaranteed contacts with vendors, customers, and others. As will be pointed out in this work, no form of organization provides protection from all risk, but a form of organization providing limited liability should be at least seriously considered for almost every business larger than a child’s lemonade stand.

 

General Partnerships, Joint Ventures, Limited Liability Partnership, Limited Partnerships, Limited Liability Limited Partnerships, Corporations

Let’s spend some time going into moderate detail about general partnerships. This attention is justifiable because the general partnership is the oldest form of business organization involving more than one person, and, as such, sets the stage for later forms of organization which distinguish themselves from partnerships either by a little (such as limited partnerships or limited liability companies) or by a lot (such as corporations). Thus, a number of key features of partnerships are either removed or carried over (perhaps in a modified form) in other types of organizations. Understanding such matters as to partnerships will help greatly in the understanding of the other types of organization.

This attention is also justified because partnerships and the types of organizations closely related to them (i.e., the unincorporated partnership derived forms of business organization known as limited partnerships and limited liability companies) have undergone the greatest changes under recent Utah legislation. The corporate form has been much less changed. Partnerships have had the most profound changes; the 100 year old act governing general partnerships was totally replaced with a brand new act based on an entirely new separate entity paradigm. Thus much of what you think you know about general partnerships may no longer be so.

What Are They? General partnerships are a form of enterprise involving more than one person carrying on a business for profit. Joint ventures are a form of general partnership directed at a limited project. Sometimes the term “joint venture” is loosely used to describe a contractual relationship, usually rather close, between two or more parties but which is not actually a partnership (usually because losses and expenses or gain and income are not shared). If the definition of a partnership is met, a relationship will be a partnership even if the parties call it something else, thus distinguishing a mere contractual or ownership arrangement from a partnership can be critical.
It is very important to understand partnerships because it is the fallback form of organization that will apply where two or more persons (which may include organizations) do business in a common enterprise, and because where there is a partnership, each partner, without fault or other involvement, may become personally liable based on the acts of another partner in the scope of the business.

Source of Rules. At one time every state except Louisiana had adopted a version of the Uniform Partnership Act (1914). Utah’s law was still based on this act until the Utah Uniform Partnership Act became effective January 1, 2014. UCA § 48-1d-101 et seq. We will focus on the new Utah law, which became effective in 2014. However, we will sometimes mention the prior partnership act for comparison and because the prior act is still effective until January 1, 2016, for partnerships existing before 2014, unless the partnership elects to be governed by the new Act. Unless otherwise specified, a reference to the Act is to the new 2014 Act; we will call the old act the “old act.” The old act is found at UCA §§ 48-1-1through 48-1-48.
Partnership Definitions. General partnerships formed in 2014 and later are governed by the Act, UCA §§ 48-1d-101 et seq., which defines general partnerships. The Act also defines a variation on general partnerships, called limited liability partnerships (discussed below in this general partnership section), which should not be confused with limited partnerships or limited liability companies. The limited liability partnership provisions, in addition to dealing with domestic (i.e., Utah) and foreign (i.e., other states) entities also include provisions dealing with professional services limited liability partnerships. See UCA §§ 48-1d-1101 et seq. for limited liability partnerships generally, 48-1d- 1201 et seq. for foreign limited liability partnerships, and 48-1d-1301 for professional services limited liability partnerships.

Partnership. A partnership is an association of two or more persons (a term including organizations) to carry on as co-owners a business for profit, formed under the Act or becoming subject to the Act by a merger, interest exchange, conversion, domestication, or the coming of January 1, 2016. UCA § 48-1d-102(12). It includes limited liability partnerships. If a partnership is not a limited liability partnership (or a limited partnership (under a separate statute)) the partnership is usually called a general partnership due to the general liability of the partners. Partners are liable, jointly and severally for all partnership debts, obligations, and liabilities. UCA § 48-1d-306(1). (However, as discussed below, there is an exception for limited liability partnerships.)
Joint Venture. A joint venture is not defined in the New Act and does not need to be. Under the old act it was an association of two or more persons to carry on as co-owners a single business enterprise. UCA § 48-1-3.1. “The parties must combine their property, money, effects, skill, labor and knowledge. As a general rule, there must be (1) a community of interest in the performance of the common purpose, (2) a joint proprietary interest in the subject matter,
(3) a mutual right to control, (4) a right to share in the profits, and

unless there is an agreement to the contrary, a duty to share in any losses which may be sustained.” Bassett v. Baker, 530 P.2d 1, 2 (Utah 1974). Although the Bassett court originally established these elements for the purpose of determining the existence of a joint venture, they have since been used to determine the existence of partnerships as well. See Mardanlou v. Ghaffarian, 135 P.3d 904 (Ut. App. 2006) (applying the Bassett elements to a partnership). The Bassett description is still useful. The definition of “partnership” under the New Act is certainly broad enough to cover a joint venture as a partnership, but one with a more limited scope of operations.
Limited Liability Partnership. A limited liability partnership (abbreviated as “LLP”) is a partnership that has filed a statement of qualification under the provisions of UCA § 48-1d-1101, et seq. A limited liability partnership is not the same thing as a limited partnership; limited partnerships have their own governing statute as a separate form of organization (discussed later in this work). A limited liability partnership is a variation of a general partnership, but without general liability.

The statement of qualification for a limited liability partnership needs to be approved by the vote or consent necessary to amend the partnership agreement, or, if there are specific provisions in the agreement relating to contributions to the partnership, the vote or consent necessary to amend those specific provisions. UCA § 48-1d-1101(2). For example, if the generally required vote to amend the agreement were a simple majority but it would require a 75% majority to amend the provisions on obligations to contribute to the partnership, a 75% majority vote would be needed to authorize filing a statement of qualification.

The difference between a normal general partnership and a limited liability partnership is that no partner of a limited liability partnership is personally liable, directly or indirectly, by way of contribution or otherwise, for the debts, obligations, or other liabilities of the partnership. UCA § 48-1d-306(3). Naturally, everyone is liable for their own negligence or misconduct because the liability limitation is limited to being or acting as a partner. Also, professionals are expressly made liable for their acts or omissions. UCA § 48-1d-306(6). Further, any limitation of liability is subject to rules allowing the piercing of the veil between the organization and its owners so that in cases of abuse creditors of one can reach assets of the other; this issue has mostly arisen with corporations and limited liability companies in the past, but the rules have more general applicability. It is always wise to look to good insurance coverage as the first line of defense, and entity limits on liability as the second line of defense. Partnerships qualifying as LLPs will want to amend inconsistent partnership agreements with provisions which assumed full general liability because such provisions would otherwise confuse the liability issue. However, the liability protection applies despite contrary provisions in the partnership agreement as it existed immediately before the vote or consent to qualify. UCA § 48-1d- 306(3)(a).

All forms of organization providing for limited liability require a filing with the state; in Utah the filing is made with the Utah Department of Commerce, Division of Corporations and Commercial Code (“Division”). This is true of corporations, limited liability companies, and limited partnerships, and it is true of LLPs as well. UCA § 48-1d- 1101 (for LLP). The failure to maintain the filing by a simple annual report filed with the Division, or otherwise losing the effect of the filing (e.g., it can be revoked by the state in certain cases), will result in the organization’s either being wound up (if the partners so choose) or continuing but as a general partnership with general liability. UCA §§ 48-1d-1102 (administrative revocation).

Determining Partnership Status. The statute provides some additional rules to determine if an association is a partnership or if a person is a partner or liable as a partner. These rules apply both to general partnerships and to LLPs. They are important in determining whether a partnership exists and whether a person is liable as a general partner to third parties. From these provisions, we learn:
Receipt of a share of profits creates a presumption that the person is a partner, but no such inference is drawn where the profits are paid in these ways: as a debt by installments or otherwise, as wages for compensation to an employee or independent contractor for services, as rent to a landlord, as an annuity or retirement or health benefit as to a deceased or retired partner, as interest on a loan though the amounts vary with profits, or as consideration for the sale of the good will of a business by installments or otherwise. UCA § 48-1d-202(3)(c).
Mere co-ownership (joint tenancy, tenancy-in-common, etc.) does not alone establish a partnership, whether or not the co- owners share profits made by the use of the property. UCA § 48-1d-202(3)(a).
Mere sharing of gross returns alone (i.e., instead of bottom line profits after expenses) does not establish a partnership, whether or not the sharers have a common right or interest in the property from which the returns are derived. UCA § 48-1d-202(3)(b).
A person claiming (orally, in writing, or by action) to be a partner in an actual or nonexistent partnership who really is not one, becomes liable to third persons who give credit either acting in reliance on the representation as to an actual or apparent partnership, or acting even without knowing of the representation where the person has made the representation in a public manner. If partnership liability results, the person is liable as if a partner. Otherwise, the representing person and all persons (partners or not) who consent to the contract or representation are jointly and severally liable. This is partnership by estoppel, or liability as a purported partner, as to obligations to third persons. UCA § 48-d1-308. It does not create any actual partnership rights.

Formation and State Qualification. No written agreement is needed to form a general partnership, and no central filing is needed (other than for limited liability partnerships). Utah allows a “statement of partnership authority” to be filed. UCA § 48-1d-303. The statement of authority may be relied on by third persons in determining who has authority to bind the partnership to third persons, where the third person gives value in reliance on the grant of authority unless the third person has knowledge to the contrary or the statement of authority has been cancelled, modified, or superseded. UCA § 48-1d-303(5).

Law Governing. In Utah, general partnerships formed after 2013 are governed by UCA § 48-1d-101, et seq. Under general conflicts of laws principles, a partnership without an express choice of law provision would be governed by the law of the state where the contract is made or the state with the most significant contacts. This may not be clear where parties are from different states. States, like Utah, with a version of the Revised Uniform Partnership Act follow a different rule and provide that the internal affairs of a general partnership are governed by the law of the state in which the partnership has its principal office. This, too, may not always be clear with partners spread among a number of states. Also, if the partnership is a Utah limited liability partnership having filed and qualified in Utah for that status, Utah law governs. UCA § 48-1d-104.
Use of Assumed Name. An assumed name filing and the appointment of a registered agent are needed if the partnership does business under a name different from the names of its partners. UCA

§§ 42-2-5 and 42-2-11. The penalties for not doing so are that access to the courts to pursue a claim, counterclaim, etc., is denied until the filing requirements are met, and a late filing fee penalty may be charged. UCA

§ 42-2-10. Filings of assumed names are only effective for three years and need to be re-filed to remain effective. UCA § 42-2-8.

ii. Qualification in Other States. General partnerships with only individuals as partners generally don’t need to become qualified to do business in other states. However, they will need to comply with the other state’s assumed name requirements and if claiming limited liability partnership status, will need to comply with the other state’s registration requirements. Partnerships with corporate or other organizations as partners may need to qualify to do business in other jurisdictions. Business licensing laws will apply wherever a partnership operates. Partnerships which are limited liability partnerships will need to register in other states. See UCA § 48-1d-1202 requiring foreign limited liability partnerships to register in Utah.

Certain Features. A number of noteworthy features relate to general partnerships. Except as to general liability, these features also apply to LLPs.

Owners. There is no such thing as a single-owner partnership. Any form of organization or individuals can be partners without any upward limitation in number, but there must be at least two. The partner’s rights are its rights to a transferrable interest (UCA
§ 48-1d-602) and an equal right to participate in management (UCA

§ 48-1d-402(1). As we will see later, these two aspects of a partnership interest are separable. Differences arising in the ordinary course of partnership activities are decided by a majority of the partners. UCA

§ 48-1d-402(4). The partner’s transferrable interest in the partnership is the right as initially owned by a person (although it could later be transferred to someone else) as a partner, to receive distributions. UCA § 48-1d-102(25). This transferrable interest is personal property. UCA § 48-1d-602. A person may become a partner without either acquiring a transferable interest or making or being obligated to make a contribution to the partnership. UCA § 48-1d-401. A partner is not a co-owner of partnership property and thus has no separate right to

transfer partnership property voluntarily or involuntarily. UCA § 48- 1d-601. A partner is not entitled to remuneration for services for the partnership except reasonable compensation for winding-up UCA § 48- 1d-402(3).

Entity Theory. Under earlier law, the owners of a general partnership were, for most purposes, treated in the aggregate, with the partnership being a relationship among them, not an entity. This is no longer the case for Utah general partnerships. Under the new paradigm of the Act, partnerships are now treated as entities separate from their partners. UCA § 48-1d-201. This is a very profound change. Partnerships could and still will hold title to property in the partnership name (UCA § 48-1d-203) but it is no longer a “tenancy in partnership” among the partners. Partnerships could and still can sue and be sued in the partnership name. Ut. Rul. of Civ. Proc. (“URCP”) 17(d). A partner can only use or possess partnership property on behalf of the partnership. UCA § 48-1d-402(2). This was true under the old act as well. Now, however, the organization itself is the focus not the partners. The partnership is no longer dissolved on a change in the relationship caused by a partner ceasing to be involved in the carrying on of the business. Under the old act dissolution was a change in who was in the relationship and did not generally lead to winding up. (See old act at former UCA § 48-1-26.) Rather, as we will see below, under the new Act certain events are required to trigger dissolution and wind- up, and a dissolution will lead to wind-up and will not be treated as only a separate change in relationship (even without wind-up) as under former law. Basically, under the old act an addition or subtraction of a partner created a new relationship, thus, in effect, a new partnership. No
longer.

Business. Partnerships are business organizations only; there are no not-for-profit partnerships. UCA § 48-1d-102(12). Just about any business can be in partnership form. (Some financial institutions and certain other businesses are required to be corporations.)
Flexible. There are minimal statutory requirements for general partnerships. They are mostly creatures of contract. Thus, they can be very flexible for determining how profits, losses, particular items of income or expense, or distributions are to be shared among the partners at various times and under various circumstances. The complexity often comes in determining the tax effects of such arrangements.

c. Tax. Let’s review in very broad strokes some key tax features of partnerships. These features can be critical in choosing a form of organization. Partnership tax rules are very different from corporate tax rules.

Partnership Tax Status. The federal income tax rules for partnerships have their own methods for determining which organizations are subject to the partnership tax rules. These methods overlap with, but are not identical with, state law methods for determining partnership existence. See Internal Revenue Code (“IRC”) § 7701(a)(2).
Pass Through and Allocations. In general, partnership tax rules provide for a pass through of income and deductions, etc. to the partners without the entity level tax typical of the corporate tax regime (at least without a special S-corporation election). Partnership tax rules allow for great flexibility including the special allocation of tax items among the partners impossible for any corporation with or without the special S-corporation election. With a special allocation, for example, one partner may receive all profits and another all losses for a period of time, if the arrangement has substantial economic effect. The complexity of partnership taxation derives from the need to have some limits to such great flexibility. IRC Subchapter K, § 701, et seq. These rules can lead to some timing surprises where a tax benefit today can lead to tax liability tomorrow, but without a cash distribution to help pay the tax (sometimes termed “phantom income”). Tax effects pass through to partners whether or not there are any distributions. This can mean that if the partnership has profits, but the partnership does not make a distribution, the partners must pay their taxes on their shares of profits from some other source of funds. This can be ameliorated by agreement. Distributions have their own tax effect designed to allow but one level of taxation, at the partner level.
Step Up Basis. Partnership taxed organizations are the only ones in which it is possible to obtain on death (and certain other events) not only a step up in income tax basis for a partnership interest (outside basis), but also, and importantly, obtain a similar step up in basis for the partner’s share of the assets held by the partnership itself (inside basis). IRC §§ 754 and 743. This is a highly desirable feature because it can truly eliminate built in gains at death for a partner’s family.

Self-Employment Tax. Partners who provide services are not employees. IRC § 707(a) and (c); Rev.Rul. 69-194, 1969-1
C.B. 256. They are not subject to wage withholding for federal income tax or Social Security (FICA, Federal Insurance Contributions Act) or Medicare taxes. Rather they pay income tax through the filing of quarterly estimated tax reports, and pay self-employment tax (OASDI, Old Age Survivor and Disability Insurance) at the same rates with the same limits as the FICA and Medicare tax, except that what would be the employee’s half of these taxes in the corporate tax regime are deductible by the partner. IRC § 164(f). A partner’s tax base for these purposes is not W-2 income, because they are not employees, but is their full distributive share less certain take-away items such as rents, royalties, and capital gain, designed to reduce the share to approximately the amount attributable to personal service income. See IRC §§ 1401 and 1402.

Benefits. Many compensation-type programs are available to partners as well as employees. For example, although the contributions are determined by a different formula (based on distributive shares with adjustments (i.e., take-aways) instead of on W-2 income (with some possible adjustments as with corporations), partnerships may have, and partners may benefit under, tax qualified retirement plans such as profit sharing and 401K type plans – a very important benefit. Health insurance is available; the premiums are not deductible by the partnership, but are deductible above the line (i.e., in determining adjust gross income) on the partner’s personal tax returns. IRC § 162(1)(1)(B). However, other benefits are more restricted; for example, group term life insurance, cafeteria plans, meals and lodging at the employer’s premises, etc., are not available for partners as self- employed persons.
f. Tax Audit Authority. Federal income tax issues relating to partnership operations are audited and determined at the partnership level unless a special exception applies for small partnerships (10 or fewer partners, none of whom are nonresident aliens or any kind of tax flow- through or tax-disregarded entity; a typical revocable trust is a grantor trust and thus a disregarded entity which would prevent application of the exception). IRC §§ 6621, 6231(a)(1)(B). Where the exception does not apply, a tax matters partner will be named either by the partnership, or if this is not done, by a fallback rule appointing the partner with the largest profits interest. All partners may participate in proceedings, but the tax matters partner decides whether to litigate and in what forum and is required to keep partners informed. See IRC §§ 6223(g), 6226(a) and (b).

g. State Taxes. Partners are generally required to file nonresident tax returns in all states in which the partnership does business. This is true in Utah, too. Some states require or allow combined reporting by the partnership in lieu of individual filings, but Utah does not. Some states require the withholding of taxes on a nonresident partner’s distributive shares of income from that state, but Utah does not. See UCA § 59-10- 301, et seq.

Fallback Form. A general partnership is the form of organization a business with more than one co-owner will be, unless the owners organize the business as some other form of organization and also properly maintain that other organization so that it is not involuntarily dissolved by the state and is not disregarded by courts and creditors. If for any of these reasons a business of two or more persons fails to be another form of organization by inadvertence or otherwise, it will be a general partnership with general liability for its partners because it will not have qualified for, or will have lost its qualification for, treatment as an LLP.
Risk. General partnerships leave the partners more at risk for loss of their assets outside the business by reason of a partnership liability because (as we will discuss further below) each partner is an agent for, and can bind, the partnership (UCA § 48-1d-301) and because each partner has general liability, jointly and severally, for the obligations of the business (other than for the special exception for qualified limited liability partnerships). UCA § 48-1d-306. Such liability includes the obligation to make contributions in winding up to pay obligations where the partnership assets are insufficient to pay claims from periods when the partnership was not a LLP. UCA § 48-1d-906(3). This general liability is no longer based on the former cross agency theory under the old act which old act employed an aggregate concept where every partner was the agent of every other partner since no separate entity existed; rather the liability is now based on the New Act provisions specifying such liability for what is now a separate entity.

The liability of a general partner may be released on dissociation either by agreement of the creditor and of the partnership or else by a material change in the nature or time of payment of the obligation where the change is made by the creditor with knowledge or notice of the dissociation but without the consent of the dissociated person. UCA

§ 48-1d-803(3) and (4). The need for partnership consent is to help protect other partners because they may be called on to pay a greater share of the obligation if one former partner is released.

How Bound to Third Parties. Generally, as we have seen, each partner can bind the partnership, and each can bind the other partners as well, because each is an agent for the partnership, and general partners are liable for partnership obligations. Thus, for a general partner who is liable for partnership obligations, how the partnership becomes bound is very important. It is, of course, also important for others dealing with the partnership.

Binding the Business. A partner binds the partnership and other partners in apparently carrying on the business in the ordinary course, except where the other party knows the partner has no actual authority, or, outside the ordinary course, where actually authorized by the other partners. UCA § 48-1d-301. Authority is determined under the partnership agreement (see UCA § 48-1d-106) and under the rule that all partners have equal right to bind the partnership. UCA § 48- 1d-402(1). An act in contravention of any restrictions on a partner’s authority will still bind the partnership, unless the other person knew or had notice of the restriction. UCA § 48-1d-301(1).
A partnership may, if it wants, but need not, file a statement of authority with the Division describing who can bind the partnership or any limits the ability of a person to bind it. UCA § 48-1d-303. Third parties may rely on such a statement in most circumstances. A person does not become liable as a partner merely because someone else has named that person in a statement of partnership authority (UCA §48- 1d-308(3)) and does not continue to be liable after otherwise ceasing to be liable, merely because of a failure to file a statement of dissociation or an amendment to a statement of authority to reflect dissociation. UCA

§ 48-1d-308(4).

Dissociated Partner. A person who is a dissociated (we will deal with dissociation later) former partner may still bind the partnership for two years after dissociation if the act would have bound the partnership before dissociation, and the other party does not know or have notice of the dissociation and reasonably believes the person is a partner. Naturally, the dissociated person will be liable for any damage to the partnership and the partners. UCA § 48-1d-802(1) and (2). Further, the dissociation does not itself discharge the dissociated former partner for any obligation incurred earlier. After dissociation the dissociated former partner generally is not liable to third persons for later obligations, but nevertheless will be liable if the later obligation (even if not incurred through his or her own act) arises within 2 years after dissociation and is of the sort the dissociated person would have been liable for before dissociation, and if the third party does not have knowledge or notice of the dissociation. UCA § 45-1d-803. A notice of dissociation, however, must be filed with the Division.
Bad Conduct. Wrongful acts of a partner in the ordinary course of business or with authority of the other partners creates partnership liability, and the misapplication of third-party funds or property by a partner in the scope of apparent authority or while in the custody of the partnership will create partnership liability. UCA §§ 48-1d-305.
Estoppel. Also, if all the partners consent to a nonpartner representing himself or herself as a partner, the partnership becomes liable. UCA § 48-1d-308.
Dissolution. The power to bind the partnership changes in the event of dissolution (subject to the rights of third parties without actual or constructive notice of dissolution or of the lack of authority) and becomes limited to actions to wind up the business. UCA § 48-1d-904(1). A partner who acts outside of what is appropriate to winding up with knowledge of the dissolution and the termination of authority will be liable to the partnership and other partners for damage caused. UCA § 48-1d-905 (c)(1). Also, by an act after dissolution a person who is a dissociated former partner may cause the partnership to be bound to third persons who don’t have notice of the dissociation and who believe the person is a partner, where the act occurs within two years of the dissociation, and the act is appropriate for winding up. UCA § 48-1d-904(2). Naturally, the dissociated person will be liable to the partnership and its partners for any damage caused. UCA § 48-1d- 905(2).

Separable Interests. A partner’s interest under the Act is in two parts: first, a transferable interest (defined at UCA § 48-1d-102(25)) to receive distributions in accordance with the partnership agreement, which interest in distributions is originally associated with a person’s partnership interest but continues whether or not the person continues as a partner or owns the interest; and, second, all other rights and duties. A transfer of the transferable interest is generally permissible but is not effective where a transferee has notice that the transfer is in violation of a restriction on transfer contained in the partnership agreement. UCA § 48-1d-603(5). The other rights of a partner, such as management rights and access to partnership information, are not transferable and do not transfer to a transferee. UCA § 48-1d-603(1)(c).
Transferees, including transferees through sale or gift or disassociated partners (we will return to this concept) who are always treated as transferees upon disassociation, receive (or if a disassociated partner, retain) distributions to which the transferor would otherwise be entitled and also receive a right to seek a judicial equitable winding up. UCA § 48-1d-603(2). A distribution means a transfer “on account of a transferable interest or in the person’s capacity as a partner.” UCA § 48-1d-102(4). A distribution, by definition, does not include reasonable compensation or benefits for services. UCA § 48-1d-102(4)(b). However, other issues with respect to compensatory payments remain. The Act provides that “a partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up…” UCA § 48-1d-402(3). Presumably, this apparent inconsistency between the definition of distribution and the statutory rights of a partner may be affected by the economic terms of the partnership agreement which may allow what would otherwise not exist. UCA § 48-1d-106.

Charging Order. One way a transferable interest may be transferred is by a creditor of a member, including a creditor on matters wholly unrelated to the business (e.g., through a divorce, judgment in a personal injury case, etc.), obtaining a judgment against the partner and then obtaining a charging order against the partner’s transferable interest. To obtain a charging order, a judgment creditor applies to a court which may enter such an order against the transferable interest of a judgment debtor who is a partner or transferee. The order, when granted, is a lien on the transferable interest. The partnership is then served with the order and from then on pays to the holder of the order any distributions that would otherwise be paid to the judgment debtor. UCA § 48-1d-604(1).

Exclusive Remedy. The charging order remedy is the exclusive remedy of a judgment creditor against a partner or against a transferee. UCA § 48-1d-604(7). Thus, if a transferee of a transferable interest (which eventually may include a creditor foreclosing a charging order lien) suffers a judgment, the stream of distributions is not seized or garnished in the usual way but would need to be made subject to a further charging order. The exclusive remedy provision does not, however, apply to security interests under Article 9 of the Uniform Commercial Code which are subject to their own remedies. Compensatory payments may need to be garnished in the usual way since they are excluded from the definition of a distribution.
Foreclosure. The creditor holding the charging order may then request the court to foreclose the lien of the charging order. The creditor must show, however, that distributions will not pay the judgment within a reasonable time. On the sale, the purchaser at the sale receives only the transferable interest in distributions and becomes a mere transferee. UCA § 48-1d-604(3). To stop the foreclosure, the charged partner, the partnership, or any other partner, may pay the judgment in full before the court’s order of foreclosure. UCA § 48-1d- 604(4) and (5).
Purpose. The general purpose of the charging order is not so much to help protect the partner who is the debtor, but to protect the other partners who could suffer if they were to be reduced to receiving a share of the proceeds of a nail by nail, board by board liquidation instead of retaining a share in a going concern as they intended.

Dissociation. Dissociation is the separation of the partner’s partnership interest into the transferable interest and the other rights (e.g., management rights, etc.) where the management rights terminate. Transfers of transferable interests do not alone cause disassociation as a partner (UCA § 48-1d-603(1)(b)), so it is possible for a partner to have no right to distributions yet maintain management rights, at least until the other partners dissociate that partner. Several things can cause dissociation. The dissociation may be rightful or wrongful (potentially giving rise to damages), but any partner can dissociate at any time. UCA
§ 48-1d-701(1). In addition, some other events will cause dissociation, such as, among others: (i) events stated in the partnership agreement;

(ii) expulsion under the partnership agreement; (iii) expulsion by unanimous consent of other partners when it is unlawful to carry on activities with the person, when the person’s entire transferable interest is transferred (including, e.g., on foreclosure, but not before, of a charging order) or when a corporation, a partnership, or a limited liability company member is dissolved (corporations losing their charter get a 90-day period to cure (UCA § 48-1d-701(4)(c)(ii)), but, partnerships or limited liability companies administratively dissolved do not receive such grace); (iv) expulsion by court order; (v) death of the partner; or

distribution of the entire transferable interest by a trust or estate which is a partner. Also, dissociation of a partner occurs on a partner’s bankruptcy or other insolvency process (e.g., receiver, assignment for creditors, etc.) or on appointment of a guardian or other incapacity finding by a court. UCA § 48-1d-701. The idea is that management rights do not fall into the hands of others where the remaining partners have not agreed to this.
Buy-Out on Dissociation. Where dissociation occurs without a resulting winding up, the dissociated person must be bought out under UCA § 48-1d-801 absent some other agreement. The buyout price under that section is determined by a pro-forma liquidation: the amount that would have been distributable under UCA § 48-1d-906(2) (return of contributions, and distributive share of any excess) as if the assets of the partnership were sold for the greater of liquidation value or the value as a going concern of the entire business without that dissociated person, with interest accruing on the price from dissociation, but subject to offsets for amounts owing by the person to the partnership whether or not currently due. UCA § 48-1d-801(1) and (2).

The partnership either may tender payment, or else may tender a proposal for deferred payments when the partner has wrongfully dissociated; in either case the tender must be accompanied by financial information, an explanation of how the price was calculated, and a notice that the payment is in full satisfaction of the purchase obligation unless the dissociated person brings an action within 120 days to determine price, offsets, or other terms of the purchase obligation. UCA § 48-1d- 801(5) through (9). Any such action needs to be brought within 120 days of the notice or, if there is no notice, one year from demand for payment. UCA § 48-1d-801(9).

The wrongful dissociation by a partner before the end of the definite term or completion of the particular undertaking, where these apply, prevents the person from being entitled to payment before the term ends or the undertaking is completed, unless a court determines earlier payment will not create an undue hardship to the business. For example, if the partnership has a 50 year term, would it be reasonable to make the dissociated former partner wait this long? Any deferred obligation must bear interest and be adequately secured. UCA § 48-1d-801(8).

Contributions. A partner need not make or agree to make a contribution to be a partner. UCA § 48-1d-401(3). Any contribution made can be of property or services provided or to be provided or of some other benefit to the partnership. UCA § 48-1d-501. The liability to make an agreed contribution continues and is not excused by death, disability, dissolution (e.g., of an organization that is a partner), or other inability to perform personally (e.g., services), rather the partnership may require an equal value in money if the agreed contribution of something other than money is not made. UCA § 48-1d-502(1) and (2). The obligation to make a contribution may be compromised only with unanimous consent of the partners, and a third party extending credit or otherwise acting in reliance on the obligation to make the contribution can enforce the obligation. UCA § 48-1d-502(3). Contributions do not determine allocations of profits and losses or interim (i.e., pre-liquidation) distributions unless the partnership agreement says they do. See UCA

 

§ 48-1d-503(1) (distributions are in equal shares). Contributions are a factor, however, in liquidating distributions on winding up because, as we will see, un-returned contributions are returned first out of any surplus left after creditors have been paid, before final distributions are made based on distribution shares. UCA § 48-1d-906(2).

Distribution Rights. Generally partners receive equal distributions, subject to the rights of proper transferees or under charging orders. UCA § 48-1d-503(1). This means that if this is not the deal among the partners a specific provision in the partnership agreement will be necessary. For example, it is often part of a deal that sharing will be in proportion to capital accounts; any such deal will require an agreement requiring capital accounts and stating the sharing provisions.

Timing and Type of Distributions. No distributions before winding up are required under the Act, but the partners may agree to interim distributions. UCA § 48-1d-503(2). This agreement may be ad hoc or may be in the partnership agreement. Only money is required to be distributed, but distributions in kind are possible if the property is fungible and distributions are proportionate to rights to distributions. UCA § 48-1d-503(3). Again, this can be restructured by express agreement. When a partner or transferee becomes entitled to a distribution, the partner or transferee becomes a creditor of the partnership, subject, however, to any offsets the partnership may have against the distributee. UCA § 48-1d-503(4).
Improper Distributions. Distributions by a limited liability partnership are not proper, however, where the distribution would leave the LLP unable to pay its debts as they come due, or would leave the total assets at less than the amount needed to pay liabilities plus, unless the agreement provides otherwise, the amount need to pay those with a higher priority right to distributions, including on liquidation. UCA § 48-1d-504(1). This restriction does not apply where the partnership is not an LLP, presumably because the creditors have access to the assets of all the general partners. Any partner who consents to an improper distribution by an LLP is personally liable to the LLP for the excess amount distributed. UCA § 48-1d-505(1). Also, any person receiving the improper distribution knowing it to be improper is personally liable to the LLP to the extent of the excess distribution received. UCA § 48-1d-505(2). There is a two year statute of limitations for such claims of the LLP to recover excess distributions from consenting partners or knowing recipients. UCA § 48-1d-505(4).

Term and Dissolution. A partnership is a sometime thing. It can be dissolved on a number of triggering events. Dissolution leads to winding up the partnership affairs. Understanding dissolution is important to understanding the investor’s exit options, and the ability of creditors of the owners to reach the business assets sooner rather than later.

Trigger Events. Under the new Act, a partnership dissolves and its affairs are wound up only in certain events, but the partnership is not expected to last indefinitely. In a partnership at will, any notice of the express will to withdraw by a partner (this is not the same as dissociation by other events) will cause dissolution. UCA § 48- 1d-901(1).
On the other hand, if the partnership is not a partnership at will but is a partnership for a particular term (say a term of years such as 10 years) or a particular undertaking (such as constructing and selling a building), dissolution occurs in one of three ways: (1) on dissociation of a partner by death, incapacity, bankruptcy or insolvency event, complete distribution of the transferrable interest of a trust or estate, or the termination of an entity (e.g., another business organization) that is a partner, if within 90 days of the event at least half the partners vote or consent (a rightful dissociation is treated as such a consent by the dissociated partner) to wind-up the partnership (without such a vote – the partnership continues); (2) on the express consent of all partners to wind-up, or (3) the expiration of the partnership term or the completion of its undertaking. UCA § 48-1d-901(2).

Other triggers for dissolution which apply regardless of whether the partnership is at will or for a term or undertaking, are events or circumstances specified in the partnership agreement, a court order, or the passage of 90 days during which there are not at least two partners (i.e., not just transferees). UCA § 48-1d-901(3) through (6).

Court Ordered Dissolution. The kinds of court orders that cause dissolution arise in two circumstances, on request by a partner, and on request by a transferee, and these two circumstances

require different grounds before the court will order the dissolution. If a partner asks for the court order, the grounds the partner needs to demonstrate are that, substantially all the affairs of the partnership are unlawful to conduct, the economic purpose of the partnership is likely to be unreasonably frustrated, a partner has engaged in conduct relating to the partnership’s affairs making it not reasonably practical to carry on the business in partnership with that partner, or it is not reasonably practical to carry on the partnership’s affairs in conformity with the partnership agreement. UCA § 48-1d-901(4).

Where the request for the court ordered dissolution is from a transferee, the grounds are different from those needed where a partner makes the request. The transferee needs to show the court that it is equitable to wind up the partnership either at the end of the partnership term or conclusion of the particular partnership’s undertaking where there was a term or particular undertaking at the time of the transfer or entry of the charging order giving rise to the transfer, or else at any time where the partnership was a partnership at will at the time of transfer or entry of the charging order giving rise to the transfer.

Existence During Dissolution Process. A dissolved partnership continues for purposes of winding up; thus dissolution does not completely terminate the partnership until winding-up is completed. UCA § 48-1d-902. Business as usual ceases, however, the partnership may preserve its activities, affairs, and property as a going concern for a reasonable time. UCA § 48-1d-902(2)(b)(ii). A termination statement may be filed with the Division, typically on completion of the winding up. UCA § 48-1d-902(2)(b)(vi).
Control of Winding Up. The winding up is controlled by the partners including a partner whose dissociation caused the dissolution (unless the dissociation by that partner was wrongful), or, if there are no partners, by the personal or legal representative of the last person who was a partner. UCA § 48-1d-902(3) and (4). If that personal or legal representative fails to exercise the right to control winding up, transferees by majority of rights to distributions can appoint a person to act. That person has the powers but not the general liability of a general partner for acting to wind up the partnership affairs. UCA § 48-1d- 902(4). If there is no such person appointed within a reasonable time, or for other good cause, a court can be asked to supervise the winding up. This request may come from a partner or any one entitled to participate in winding up which apparently could include, as applicable, the personal or legal representative of the last partner, or transferees. UCA § 48-1d-902(5).

Rescission of Dissolution. If the partnership is dissolved, the partnership cannot nevertheless continue, rather it must wind up its affairs (i.e., liquidate). However, the dissolution may be rescinded unless a termination statement (which is a statement filed with the Division to the effect that the partnership is terminated) is effective or a court order of dissolution has been entered. The rescission requires the vote or consent of every partner and the rescinding of any filed statement of dissolution. If the partnership rescinds dissolution, it continues as if no dissolution occurred. UCA § 48-1d-903. The concept of administrative dissolution (usually with some right to obtain reinstatement) which applies to other types of business organizations does not apply to general partnerships which may not need to make any filing with the Division. If a limited liability partnership election is filed and not maintained, the result is general liability, not entity dissolution unless the partners choose to dissolve.
Liquidating Distributions. On wind up, creditors are paid first, including partners who are creditors. UCA § 48-1d-906(1). Then any surplus goes to return contributions not earlier returned in proportion to the value of unreturned contributions, and anything left is distributed amount partners and transferees in proportion to their rights to distributions. These distributions must be paid in money. UCA § 48-1d-906(2), (4), and (5). If assets are insufficient to satisfy the partnership obligations incurred while the partnership was not a limited liability partnership, then each person who is unreleased (by the creditor and the partnership or by a material change in the obligation by a creditor knowing of the dissociation but without the dissociated former general partner’s consent) and who was a general partner at the time the obligation was incurred (such a person need not be a partner at time of dissolution and winding up, but may be a dissociated former partner) must contribute to pay such obligations in proportion to each such person’s right to receive distributions in effect when the obligation was incurred. UCA § 48-1d-906(3). The persons liable and the proportions of liability can change over time. If one such person fails to contribute a full share, the others must contribute more. There is a right to obtain contributions from those failing to contribute a full share if a person is required to pay more than that person’s own share. UCA § 48-1d- 906(3)(b) to (d).

A dissolved limited liability partnership may give notice to known creditors with non-contingent pre-dissolution claims to file their claims within not fewer than 120 days or be barred. If a claim is made and rejected, the creditor must bring an action no later than 90 days after receiving notice of rejection. UCA § 48-1d-907. Other pre-dissolution claims not earlier barred may be barred in three years if a notice to creditors is published by the dissolved limited liability partnership. Creditors with unbarred claims can enforce them against the undistributed assets or against those receiving a distribution to the extent of the distributee’s proportionate share of the claim or of the assets distributed, whichever is less, but the total for all claims can’t exceed the assets distributed to the distributee. UCA § 48-1d-908. This process does not apply to general partners where the partnership has never been a limited liability partnership, but if it is a limited liability partnership at dissolution the notice to known creditors can also bar claims against a general partner or dissociated former general partner otherwise without a liability limitation. UCA § 48-1d-907(2)(e).

Formality. General partnerships are generally operated without a great deal of formality, but are flexible enough to allow greater formality under a partnership agreement if the partners desire it.
Fair Treatment. Partners have the right to a certain level of fair treatment from the partnership and partners, including rights to business information, some protection by fiduciary duties, and indemnity.

Rights to Information. Partners can have access to business information. Such rights cannot be unreasonably restricted, but reasonable restrictions on use and remedies for abuse may be agreed. UCA § 48-1d-106(3)(d). Under the Act, the information rights include, at a minimum:
– Partners are entitled to have partnership books kept at the principal place of business with reasonable access to inspect and copy them to the extent material to his or her rights and duties as a general partner. (UCA § 48-1d-403(1) and (2).

Partners are entitled to receive without demand information concerning the partnership’s affairs which is material to the exercise of a partner’s rights and duties (UCA § 48-1d-403(3) (a)), and to receive on demand and subject to paying the cost to produce it, other information concerning the partnership unless the demand is unreasonable or improper. (UCA § 48-1d-403(3)
(b) and (7).

Dissociated partners, however, can only obtain the material information in good faith and for the period they were a partner. (UCA § 48-1d-403(5).
Fiduciary and Related Duties. The general fiduciary and related duties which protect partners are described in the Act. They are modifiable within rather broad limits, and it is possible that additional duties may be found by courts based on the actual confidential relationship of the partners. The duties described in the Act are:
The general covenant of commercial good faith and fair dealing, which is implied in all contracts, will apply to the discharge of duties and obligations under the partnership agreement (UCA
§ 48-1d-405(4)). It may not be waived, but standards may be agreed upon if not unconscionable or against public policy. UCA § 48-1d-106(3)(f).

The duty of care of a partner in the conduct or winding up of the partnership is only to refrain from engaging in grossly negligent or reckless conduct or a knowing violation of law. UCA § 48- 1d-405(3). This is a considerably lower standard than applied before the New Act. Also, this lower duty may be further altered under the partnership agreement except to authorize intentional misconduct or a knowing violation of law. UCA § 48-1d-106(4) (b)(iii). If a higher standard than gross negligence is desired it must be stated in the partnership agreement. The definition in the Act or the agreement of the duty of care is very important because there can be no remedy (in damages or in equity) where there is no duty to be breached. Although the Act could have provided a higher standard of due care combined with a damage limitation where gross negligence (or worse) is not involved (as was the case with the old limited liability company act), thus leaving open the possibility of an equitable remedy for breach of the duty of due care, this Act has not done so; absent a contrary agreement, remedies appear to be all or nothing based on the defined duty.

– A partner’s duty of loyalty includes (there could be more): first the duty to account to the partnership and hold as trustee for it, property, profits, or benefits from the conduct or winding up of the partnership affairs, from the personal use by the partner of partnership property, or from the appropriation of partnership opportunities; second, the duty to refrain from dealing with the partnership on behalf of a person with an interest adverse to the partnership, but it is a defense that any such transaction is fair to the partnership; and, third, the duty to refrain from competing with the partnership before its dissolution. UCA § 48-1d-405. On the other hand, these aspects of the duty of loyalty may be altered or eliminated under the partnership agreement if the alteration or elimination is not unconscionable or against public policy. UCA § 48-1d-106(4)(6). The agreement may also specify how things otherwise violative of the duty of loyalty may be authorized or ratified by independent persons (UCA § 48- 1d-106(4)(a), and even without such a procedural provision, all partners may authorize or ratify a specific act or transaction which otherwise violates the duty of loyalty (UCA § 48-1d- 405(6)).

Indemnity. Partners are entitled to expense reimbursement (UCA § 48-1d-404(1)) and to indemnity against claims, liabilities, and obligations incurred in the capacity as a partner which do not arise from breach of the management rights of partners (see UCA
§ 48-1d-402), the standards of conduct of partners (see UCA § 48-1d- 405 on care and loyalty), or of the restrictions on distributions (see UCA

§ 48-1d-504). UCA § 48-1d-404(2). Also, an operating agreement may not relieve or exonerate a person from liability for conduct involving bad faith, willful misconduct, or recklessness. UCA § 48-1d-206(3)(g). Partners may receive advances of defense expenses on a promise to repay the advances if the partner is not ultimately determined not to be entitled to indemnity. UCA § 48-1d-404(3). There is no special authorization procedure required for any of these payments, which is quite unlike the rules for corporations where there are much more detailed limits on indemnity and special procedures required to authorize payments.

Partnership Agreement. Partnerships are largely matters of agreement. The agreement should be, but need not be, in writing. UCA § 48-1d-102(13). The partnership agreement governs relations among the partnership and the partners as such. UCA §§ 48-1d-106(1)
and 107. The partnership agreement is originally made among all the partners. UCA § 48-1d-102(13). It can, however, specify how it is to be amended. UCA § 48-1d-106(1)(c). Thus amendment need not be unanimous if the agreement provides otherwise. Also, the agreement may require the consent of a third party (for example, a creditor or a transferee) to any amendment. UCA § 48-1d-108(1).

Effect on Former Partners of Amendments. An amendment can affect the rights relating to obligations of the partnership or partners to transferees or persons dissociated, except where restricted under a court order to effectuate a charging order, or where the change would impose a new obligation on the transferee or dissociated person, or where the change would prejudice the rights arising before the amendment under the Act (at UCA § 48-1d-801) of a dissociated person to be bought out. UCA § 48-1d-108(2).
Restrictions on Agreements. Not many matters are restricted from being changed by agreement. UCA § 48-1d-106. Among the most important items restricted are that: the contractual obligation of good faith cannot be eliminated (although standards for its application may be provided if not unconscionable or against public policy), a person may not be exonerated or relieved of liability for conduct involving bad faith, willful misconduct, or willfulness, information rights cannot be varied except for reasonable restrictions on information availability or use or for providing appropriate remedies for misuse, the power of a partner to dissociate cannot be varied except to require written notice (i.e., in a record), causes of judicial dissolution or dissolution after 90 days without at least two members can’t be varied, and certain requirements relating to winding up cannot be varied.

Why Are General Partnerships Used? For most businesses most of the time, some other form of organization will be more appropriate than a general partnership; an LLP would usually be better, and other forms of organization may be better still. If the business is a general partnership, it is mostly by accident or error. However, there are special circumstances when general partnerships can be a desirable form of organization.

Desirable Uses. The general liability feature is often a negative, but in the right circumstances such liability sometimes can be a positive or at least a neutral feature, and these circumstances are generally the conditions for general partnerships being desirable.

Other Liability Limits. General partnerships are sometimes used as joint venture vehicles between companies that otherwise have limited liability. Thus, the flexibility of the general partnership and its automatic imposition of shared liability for the venture may be attractive to corporations or limited liability companies (sometimes through special purpose subsidiaries) which want to share control of an enterprise, be able to withdraw cash from it without leaving much of a reserve behind, yet have assurance that each partner is required to fund obligations and liabilities as they arise. Special allocations and basis determinations, etc., for tax purposes are easier to accomplish where all partners have general liability. Although other forms of organization such as a limited liability partnership, a limited partnership, or a limited liability company, could be used to accomplish similar results by agreement, the relative simplicity of a general partnership may tip the scale toward its use for some ventures.
Carefully Selected Partners. Some individuals (or organizations without limited liability) may choose the general partnership form of organization for similar reasons of simplicity of sharing and funding as with the corporate joint venture. However, they should do so only when the partners are very carefully chosen for integrity and responsibility, are of similarly solid financial standing, and the business is not excessively risky and can be adequately insured.

Professionals. Some professional practices (lawyers, accountants, etc.) have been partnerships for generations before the advent of more recent forms of organization such as limited liability companies, and have long-established compensation and buy-out arrangements based on the partnership form of organization which the partners desire to continue. These groups were the lobbying force for the limited liability partnership which limits a partner’s risk, particularly the risk of the malpractice of the professional in the next office; such liabilities can cause enormous damages either in areas not covered by insurance or in amounts in excess of insurance coverage. Also, on a partner’s buy out, at retirement for example, the partnership and remaining partners might benefit from special tax rules relating to certain assets, notably unrealized receivables and goodwill, applicable to “general partners” in a service partnership. See IRC § 736(b)(2) and (c).
Areas Where Not Desirable. Business owners seeking liability protection generally have shunned general partnerships, and rightly so, at least prior to the advent of limited liability partnerships with relatively broad protection. However, there can be other reasons, often tax driven, to avoid them, as well. Some examples are:

Like-kind Exchanges. Persons desiring to use the IRC
§ 1031 like-kind exchange to defer income on the transfer of property (usually real estate) and to reinvest in some other similar property, will actively avoid partnership treatment for tax purposes. Where real estate is involved, real estate interests can be exchanged and then only for other real estate interests. Partnership interests, even interests in general partnerships holding nothing but the real property, do not qualify. The problem often comes up in tenancy-in-common arrangements where a person desires to exchange out of, say, a modest apartment building presently owned, for a tenancy-in-common interest in a professionally- run tenancy-in-common program involving, say, a very large office building. There it is important that the arrangement taken as a whole, including powers of attorney or management agreements, does not amount to a partnership.

Oil and Gas. Oil and gas development transactions are regularly established, at least on their face, as state law tenancies-in- common. However, these arrangements could also potentially be treated as partnerships for state law or federal tax purposes. The owners can sometimes elect out of partnership taxation where that type of taxation is not desired. The owners will also generally take steps to prevent state law general partnership treatment where general liability is not desirable.