Before discussing some forms of illegal transactions in a partnership, it is helpful to have a basic understanding of what a partnership is first. A partnership is an association of two or more persons to carry on as co-owners a business for profit.
It does not matter whether the individuals were trying to create a partnership on purpose. It only matters that the parties intended to carry on as co-owners a business for profit. This can be determined by two main factors: whether they share in the profits and whether they have a right to control the business.
In general, there are three types of partnerships. These include a general partnership, a limited partnership, and a limited liability partnership.
The amount of liability that an individual may face as part of a partnership is directly based on the type of partnership that was formed. Thus, it is important to know the differences between the three forms of partnerships listed above.
Illegal transactions in a partnership can occur in two primary ways. The first refers to when a partnership participates in transactions that are specifically prohibited by law, such as the sale of illegal goods, drugs, or other types of contraband. The second happens when a partner of the partnership enters into a transaction without the authorization of the other partners.
In any type of partnership, each partner has a certain amount of control and influence when it comes to decision making. All the partners must be informed and normally have some say when an important decision is being made.
Therefore, if one of the partners enters into a transaction on behalf of the partnership without the authorization of all of the partners, it will be considered a violation of the partnership and as such, will be deemed to be illegal.
Transactions involving the following matters may be considered illegal under partnership laws, when conducted without the approval of the partnership:
- Surety Agreements: Partners are not allowed to use the name or assets of the partnership as surety for personal agreements. For example, a partner may not use the funds from a partnership trust to ensure that they will be issued a personal loan.
- They also may not use the partnership as “surety” (an express promise to be responsible for a debtor’s debts) on behalf of another person.
- Termination or Cessation of Business: A partner may not bind the partnership by signing a contract that would result in the partnership being terminated, or alternatively, that would make it impossible for the partnership to continue its business activities; at least, not without the authorization of all the necessary partners to the partnership.
- Debt or Personal Obligations: In addition to not being allowed to use partnership funds as the basis for being granted a loan, a partner is also not permitted to satisfy their own personal debt or financial obligations by commingling them with partnership activities.
- For example, if a partner owes a business debt to another company (e.g., a bank), they cannot satisfy that debt by using an account that the partnership has with that company.
Thus, any transaction that leads to a partner exceeding their scope of authority in regard to the partnership, could be considered an illegal activity. A partner is also prohibited from entering into transactions for personal gain if it means that it will harm the partnership.
If a partner has participated in what might amount to an illegal transaction in a partnership, it may result in certain legal consequences, such as:
- A transaction may be voided (canceled) upon the discovery that it was illegal;
- The partner may be liable to the partnership for any monetary losses that occurred, damage to its reputation, or other violations that they committed against the partnership;
- Any profits that the partner made may be “disgorged” or taken away from the partner and distributed to the partnership; and
- The partner may be disciplined by the partnership, or in accordance with both business and criminal laws (e.g., having to pay criminal fines, removal from decision making boards, etc.).
Therefore, it is important for all of the partners to have a good understanding of what their legal rights and duties are to the partnership, as well as each partner. This will help to prevent any disputes or illegal transactions from arising during the course of the business.
Finally, in many instances, the remedies for illegal partnership transactions can be included in the initial partnership agreement. This is a contract that is created between the partners at the formation stage of the business.
Illegal transactions that are attributed to a partnership can carry very serious consequences for both the individual partner and for the entire organization. Therefore, if you are experiencing issues regarding potential illegal transactions, you should contact a local business attorney.
A qualified business attorney will be able to help you to determine if any violations have occurred. If so, they can provide legal advice concerning how this might affect the partnership and the best options that are available to resolve the issue.
Additionally, if a lawsuit arises, an attorney will also be able to assist you in defending your interests in court.