Relationship Between Partners
We have discussed fiduciary duties in the context of LLCs in our previous posts. Just like LLC managers, partners in a general partnership owe fiduciary duty to the partnership. Thus, partners must act as an ordinarily prudent person would, refrain from competing with the partnership, and generally act in good faith. Additionally, they must put the best interests of the partnership ahead of their own. So, in the farming partnership case above, the parties owe fiduciary duties to the partnership, which they would not otherwise owe, if it was just a farming agreement. Partners can enter into a partnership agreement to govern the relations of the partners, though such agreement generally may not eliminate fiduciary duties of partners.
Just like LLC members, partners have a great deal of flexibility in setting the terms of the partnership agreement. If there is no such agreement, the law fills the gap. For example, all partners have equal rights in the management of the partnership business, unless they agree differently. Each partner shares equally in the profits after all liabilities are satisfied, unless, again, they agree otherwise. In terms of remuneration, partners are generally not paid for their work, even where one partner is forced to assume more work than others, except in extraordinary circumstances, such as winding up of the partnership business. Each partner, however, is expected to devote his or her entire time and energies to the partnership business, or he or she may be charged in an accounting for damages caused to the partnership, including the amount expended to replace the services he or she should have performed. Most importantly, partners may want to think about situations where dissolution, winding-up, or withdrawal of partners may occur and document their understanding in a partnership agreement, just as LLC members would set forth their buyout terms in an LLC agreement.
So, going back to the two brothers’ story discussed in Post 1, did the brothers form a general partnership? You bet. This was actually a recent court case, not a hypothetical.[1] When the administrator brother failed to pay property taxes and various tax authorities initiated foreclosure proceedings, the other brother sued, claiming, among other things, that his brother breached his fiduciary duty based on their partnership agreement by jeopardizing ownership of the properties. The court agreed, finding that the brothers formed a general partnership and that the administrator brother breached his fiduciary duty to the other brother in relation to their partnership.
The takeaway here is that, despite the popularity of LLCs, general partnerships are here to stay, and it is far easier than most people think to form a general partnership without even realizing. We recommend that business owners consult a lawyer early on regarding their choice of business form(s) and proactively set the terms of such business in a written agreement. And they should strongly consider using a limited liability entity, such as a corporation or LLC, unless extreme circumstances exist.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] Flores v. Flores, No. 04-10-00118-CV, 2011 WL 3610428 (Tex. App.—San Antonio Aug. 17, 2011, pet. denied) (mem. op.).