Partnerships — Business Associations

Amir and Bao agree to run a food-truck business through Tasty LLC. They buy trucks, sign a supplier contract, and open for business. What they never do is file the certificate of organization. Months later the supplier goes unpaid and sues them personally for the whole debt. They point at the LLC. Does it protect them?

Not even slightly. No LLC ever legally existed, and two people carrying on a business as co-owners for profit are a general partnership whether they meant to be one or not. So each of them is personally on the hook for the entire bill. That is the thing to understand about this topic. A general partnership is the business form you can fall into by accident, and the law's default setting when something else fails.

Here is the route. Six stops. How a partnership forms, including by default when a corporation or an LLC is botched. Who can bind the firm. How the partners govern each other. What the partnership agreement can and cannot change. Partners by estoppel. And how a partner exits. The governing law throughout is the Revised Uniform Partnership Act, RUPA for short.

Start with formation, because the headline rule is almost startling. An intent to be partners is not required. Under RUPA § 202, what matters is what people actually do. Do two or more of them carry on a business, as co-owners, for profit? If yes, a partnership exists, even if they never signed anything, never used the word partner, or flatly insisted they were not partners. The label does not control. The conduct does.

Co-owners is the key idea. The parties share the right to control and manage the business, and share its profits as owners, not the way a lender, a landlord, or an employee would. And note that the firm is an entity distinct from its partners. The partnership, not the individual partners, owns the property, sues and is sued in its own name, and can survive a partner's departure.

Sharing profits is the single strongest signal, so RUPA makes it a rebuttable presumption. Take a share of the profits and you are presumed to be a partner. But plenty of people receive money that rises and falls with profits without owning anything. A bank paid interest. A landlord paid percentage rent. A retired founder paid a pension. An employee paid a profit-linked bonus.

So § 202(c) lists the categories where a profit share does not trigger the presumption. Repayment of a debt. Wages or other compensation to an employee or contractor. Rent. A retirement or health benefit. Interest or other loan charges, even if the amount varies with profits. And the price for the sale of goodwill or other property.

Work an example. Priya lends a diner $40,000 and is repaid $1,000 a month plus 5% of monthly profits until the loan is satisfied. Partner, or not? Not a partner. Her profit share is really repayment of a debt with interest, which fits an exception squarely. Now change the facts. Priya shares the profits indefinitely, helps hire staff, and co-signs the firm's checks. Now the presumption snaps back into place, and she looks like an owner.

Which brings us back to Amir and Bao. A general partnership needs no paperwork, but a corporation or an LLC does. You have to file with the state, and only a validly formed entity gives its owners limited liability. So the general partnership is the law's default setting.

Suppose people try to form a corporation or an LLC and never properly file. If they go ahead and run a business together for profit, the law treats them as what they actually are. General partners. They lose the limited liability they thought they had, and each becomes personally, jointly and severally liable for the venture's debts. Two rescue doctrines can sometimes save a defective corporation, but those belong to the corporate formation topic. Absent them, the fallback is a general partnership.

Part two. Who can act for the firm? Every partner is an agent of the partnership for the purpose of its business. That is § 301, and it means a single partner can commit the whole firm. RUPA draws the line at the ordinary course of business.

If a partner does something that looks like ordinary business for a firm of this kind, the partnership is bound. Bound even if the partners had privately agreed the partner should not do it, unless the outsider actually knew, or had been notified, of that internal limit. Acts that are not ordinary bind the firm only if the other partners actually authorized them.

Try one. A partner in a retail electronics partnership orders $10,000 of inventory on the firm's credit. The partners have a secret internal rule capping orders at $5,000, and the seller knows nothing about it. Is the firm bound?

Bound. Ordering inventory is squarely ordinary course for an electronics retailer, and a secret internal limit does not travel to an outsider who never heard of it. Now change the act. That same partner tries to sell the store's building, or borrow two million dollars secured by all the firm's assets. That is not ordinary course, so the firm is bound only if the other partners authorized it.

Part three, the partners among themselves. § 301 governs the firm's relationship with outsiders. § 401 governs the partners' relationships with each other, and those are default rules the agreement can rewrite. Absent a contrary agreement, RUPA's defaults are deliberately egalitarian. Management power does not track money. A partner who contributed 90% of the capital still gets one equal vote.

The defaults worth memorizing. Equal management, regardless of capital contributed. Ordinary decisions are decided by a majority of the partners. Extraordinary decisions, and any amendment to the partnership agreement, require the consent of all partners. Profits are shared equally, and losses follow the profits. No salary, except reasonable compensation for services in winding up. And every partner has a right to the books and records.

Notice the symmetry, because the exam builds on it. Ordinary course means majority internally, and one partner binding the firm externally. Extraordinary means unanimous internally, and no binding externally without actual authority. Selling the firm's main assets, taking on large debt, amending the agreement, admitting a new partner. All extraordinary.

Control also shapes what a partner can hand to someone else. A partner's only freely transferable asset is the transferable interest, the right to receive that partner's share of distributions. A partner cannot unilaterally transfer management rights, or specific items of partnership property, which belong to the entity. So if a partner sells the interest, or a personal creditor gets a charging order against it, the transferee gets money if and when distributions are made. No vote, no management role, no right to inspect the books.

Part four, the partnership agreement. Think of RUPA as the factory settings and the agreement as the customization. The agreement governs relations among the partners and between the partners and the firm, and RUPA fills the gaps only where the agreement is silent. It can be written, oral, or even implied from how the partners actually behave.

But freedom of contract has limits. Under § 105 there is a mandatory core the agreement may not eliminate. It may not eliminate the duty of loyalty, or unreasonably reduce the duty of care. It may not eliminate the obligation of good faith and fair dealing. It may not unreasonably restrict access to books and records. It may not vary a partner's power to dissociate, though it may require the notice be in writing. And it may not restrict the rights of third parties.

Part five, partners by estoppel, and this one catches people. Sometimes there is no real partnership at all, yet a person is held liable as if there were. Under § 308, suppose you represent that you are a partner in a firm, or consent to someone else representing it. You are then liable to a third party who reasonably relies on that representation and does business with the firm.

Two things must be present. A holding out, by you or by another with your consent. And reasonable reliance by the third party who then extends credit or does business. Picture this. Nadia introduces Owen to a supplier as my business partner, and Owen stands there and says nothing. Relying on Owen's strong credit, the supplier ships $30,000 of goods on account.

Owen is liable as a partner by estoppel for that debt, because he consented to the holding out and the supplier reasonably relied. But contrast a supplier who never heard the representation and shipped anyway. No reliance, no estoppel. And note the limits. Liability reaches only the transaction the outsider actually relied on. It does not make Owen a partner for all purposes, and it creates no real partnership between him and Nadia.

Last part, and here is the single most important modern rule in this topic. RUPA carefully separates two events that older law jumbled together. Dissociation is one partner leaving the firm. Dissolution is the whole firm shutting down and winding up. And a partner's dissociation does not automatically dissolve the partnership. Very often the firm simply continues and buys out the departing partner.

Whether a departure triggers full dissolution turns on what kind of partnership it is, and that is exactly the fork the exam likes. A partnership at will has no agreed end date or task, and partners may leave whenever they wish. A term or particular-undertaking partnership runs for a fixed term, or until a specific job is finished.

Try one. Two equal partners run a design shop with no written agreement and no fixed term. After a falling-out, one sends the other clear written notice that he is withdrawing effective immediately. The other wants to keep operating and says he just gets a buyout. Buyout, or dissolution?

Dissolution. In a partnership at will, a partner's notice of an express will to withdraw is itself a dissolution trigger. The firm must be wound up unless the partners agree to continue. Flip the facts to a fixed ten-year term, and the answer flips too. There, one partner's withdrawal does not dissolve anything. The firm continues, and the departing partner is bought out.

Now separate power from right. A partner always has the power to walk away. Nobody can be forced to stay in a partnership. But having the power is not the same as having the right. Under § 602, a dissociation is wrongful if it breaches an express term of the agreement. Or if, in a term or particular-undertaking partnership, a partner quits before the term ends or the job is finished.

A partner who dissociates wrongfully is liable to the partnership and the other partners for the damages the early exit causes. Picture three architects who agree to partner until the Riverside project is complete, a particular undertaking. One quits halfway through to join a rival. She had the power to leave, but her withdrawal before completion is wrongful, so she owes damages, and those damages come out of her buyout.

On the buyout itself, when a partner dissociates and the firm does not dissolve, RUPA requires the partnership to buy out the departing interest under § 701. The price is the greater of liquidation value or going-concern value, measured at the date of dissociation, plus interest, and minus any damages a wrongfully dissociating partner owes. Leave a healthy firm and you are bought out at fair value. Leave wrongfully and your damages come off the check.

And if a dissolution trigger is met, the firm enters winding up. It stops taking new business and exists only to finish existing business, collect assets, pay debts, and distribute what is left. A dissolved partnership is not dead yet. The partners can even call off the dissolution and resume business before winding up is complete.

When the accounts are settled, creditors come first. Partnership assets pay the firm's creditors, including partners owed money as creditors, for example on a loan. Only the surplus is then distributed to the partners according to their accounts. And if a partner's account is in deficit, charged with more losses than they contributed, that partner must pay in the shortfall so the firm can meet its obligations.

A word on authorities. This episode named no cases, and that was deliberate. This is a recognition-level topic, so the exam may hand you the relevant RUPA section and test whether you can spot the issue and apply it. So focus less on memorizing numbers and more on recognizing which rule is in play.

If you keep only three things, keep these. One, a partnership forms from conduct, and intent is irrelevant. Two, ordinary-course acts bind the firm even against a secret internal limit, while extraordinary acts need actual authority. Three, dissociation is not dissolution, except in a partnership at will.

Now the traps, straight from the examiners' favorites. One. Treating dissociation as dissolution. A partner leaving usually means a buyout, except in a partnership at will, where a withdrawal notice does dissolve the firm. Two. Confusing power with right. A partner can always leave. The question is whether the exit is wrongful, and so costs them damages.

Three. Treating intent as the test for formation. People can be partners while insisting they are not. Four. Seeing a profit share and stopping there. Run the exceptions first. Debt, wages, rent, interest, retirement, goodwill.

Five. Assuming a botched LLC or corporation still gives limited liability. If formation fails, the owners are usually general partners, personally liable. Six. Blurring ordinary and extraordinary. One partner binds the firm on ordinary acts even against a secret internal cap, unless the outsider knew. Extraordinary acts need actual authorization.

Seven. Treating estoppel as a real partnership. A purported partner is liable to the reliant third party, but that does not make them an actual partner, and it creates no partnership among the participants.

Time for the quick check, and this one comes straight from the BARGO question bank. A partnership of five equal partners runs hardware stores under a fixed twenty-year term. In year six, one partner dies, which dissociates her. The four remaining partners split. Two want to wind up and sell. Two want to carry on. Within a month of the death, the two who favor winding up formally vote to do so.

Does that vote require the firm to wind up? Option one. No, because dissolving before the fixed term expires requires the consent of all the remaining partners. Option two. Yes, because the death of any partner automatically dissolves a term partnership at once. Option three. Yes, because half of the remaining partners voted to wind up within 90 days. Pause here if you want a moment.

The answer is option three. Here is the rule. If within 90 days after a partner's death, bankruptcy, or wrongful dissociation at least half of the remaining partners consent to wind up, a term partnership dissolves. Two of the four survivors is exactly half, which satisfies at least half, and they voted inside the window.

Option one demands a unanimity the statute does not require. That mechanism deliberately lets a subset force dissolution after a death. Option two overstates the effect of death. A partner's death does not automatically dissolve a term partnership. It opens the 90-day window for the survivors to elect, which is exactly what happened.

There are thirty plus more questions on this topic alone, each explained like that.

Five things to take away. One. A partnership forms from conduct. Two or more people carrying on a business as co-owners for profit, whatever they call themselves. Two. A profit share raises a presumption, but run the exceptions first.

Three. On ordinary-course acts one partner binds the firm, and a secret internal limit does not bind an outsider who never heard it. Extraordinary acts need actual authority, and unanimous consent inside. Four. The agreement controls over RUPA's defaults, but cannot erase the mandatory core.

Five. Dissociation is not dissolution. In a term partnership the firm continues and buys the partner out. In a partnership at will, a withdrawal notice dissolves the firm.

Which is why Amir and Bao never had an LLC at all, only each other, and a supplier with a claim against both of them. Next time, Corporations and LLCs, Formation.

Practice this topic with more than 2,900 exam-style questions, free to start, at nextgenbargo.com. This episode is for education and exam preparation only, not legal advice, and we are not affiliated with or endorsed by the NCBE or any bar examining authority.