According to a model statute known as, “The Revised Uniform Partnership Act (RUPA),” 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.
For example, suppose Person A and Person B open a coffee shop. They split the profits and make joint decisions about the coffee shop. Although they do not refer to themselves as partners, their relationship meets the above definition required to form a partnership.
Although there are no other legal formalities that need to be met in order to create a partnership, almost all partnerships have a partnership agreement.
How Do You Make a Successful Partnership Agreement?
A partnership agreement is an agreement between the partners that describes the relationship that each partner has with the business, as well as outlines the rights and obligations that each individual partner has to the partnership. It may also include:
- The amount or portion of the partnership owned by each partner;
- Which partners have authority to make business decisions on behalf of the partnership;
- The method the partners will use to resolve business disputes among the partners;
- How the partnership can be dissolved or transferred;
- The process for adding new partners; and
- Any other policies or procedures that the partners have in place to make major decisions or handle important aspects of the partnership.
Basically, the clearer and more detailed that the partnership agreement is, the more likely it will be successful. The partnership agreement should provide a solution for every foreseeable and potential issue that could arise and harm the business. This will also help to strengthen the partnership itself.
Additionally, while partnership agreements may be formed orally or impliedly (by the partners actions), it is best to put the partnership agreement in writing. That way the agreement may act as a reference to resolve disputes quickly, or can be used as proof to solve any future legal issues, should they occur.
Who Has Control in a Partnership?
Control in a partnership can be determined by focusing on three primary factors: ownership, management, and the authority to do business. This is why it is so important to define these concepts and which partners they apply to in a partnership agreement.
In general, unless the partnership agreement states otherwise, all partners have equal rights to control a partnership. This means that issues, such as decisions regarding ordinary day-to-day business operations, require a majority vote of the partners.
Matters outside the scope of daily business decisions, however, will require the consent of all the partners (e.g., selling the partnership).
Control in a partnership may also depend on the type of partnership that was formed and the laws of the state, which may vary by state.
Can I Face Liability in a 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. There are three types of partnerships:
- 1. General Partnership: This is the most common type of partnership and is formed by the association of two or more individuals intending to be co-owners of a business for profit.
- Liability: General partners are individually and jointly responsible for any losses or debts incurred by the general partnership; to third parties in tort or contract law claims against the partnership; and to the other partners in the event of a breach of their fiduciary duties to the partnership.
- 2. Limited Liability Partnership (LLP): An LLP allows the individuals to be free from the debts and liabilities of all the other parties, as well as from certain debts and liabilities of the partnership. Partners to an LLP have the same financial rights and obligations as a general partnership. Note, however, that to form an LLP does require filing with the state.
- Liability: Partners in an LLP are not liable for partnership obligations of any kind, but every partner does remain liable for their own acts or any acts that they supervise or direct. In other words, unlike general partners, they are not exposed to unlimited legal liability.
- 3. Limited Partnership: In a limited partnership, there are general and limited partners. There may be one or more for each type of partner, but there must be at least one partner selected to be a general partner. A general partner makes management decisions, whereas a limited partner does not. Limited partners have limited authority over the partnership.
- Liability: General partners are individually and jointly responsible for any liabilities or debts incurred by the limited partnership. In contrast, limited partners are only liable to the extent of their investment contributed to the limited partnership.
What is the Difference Between a General Partnership and a Limited Partnership?
As previously mentioned, general partnerships are the most common type of partnership. They are formed by the association of two or more people intending to be co-owners for a profit. All of the general partners share in the profits, losses, and liabilities of the limited partnership.
The main difference between a general partnership and limited partnership is the fact that all of the partners in a general partnership can be held individually and jointly responsible for any debts and liabilities incurred by the partnership.
In a limited partnership, there are two kinds of partners: limited partners and general partners. While there may be one or more of either type of partner, there must be at least one general partner. The general partner is typically responsible for management decisions and day-to-day operations.
In contrast, the limited partners are only responsible for investment duties and have limited authority over the partnership. Additionally, limited partners are only liable up to the amount that they contributed to the partnership, whereas general partners are responsible for all debts and liabilities of the limited partnership.
Do Partnerships Pay Taxes?
In general, a partnership does not pay taxes on the income generated by the partnership. Instead, it is what the IRS calls a “pass-through entity.” This means that the individual partners pay taxes on their share of the business income, e.g., the business income “passes through” the business to the partners.
The partners report their share of profits and losses on their own individual income tax returns. Additionally, partners are also required to pay self-employment tax on their partnership income.
How Do You End a Partnership?
Partnerships may end for a variety of reasons. Some of these include:
- When one of the partners becomes deceased, incapacitated, or has filed for bankruptcy;
- If disputes arise between the partners and they cannot be resolved;
- One of the partners has already retired or is planning on retiring;
- There may be specific terms set out in a partnership agreement that provide for a termination date; or
- By operation of law (e.g., the partnership is engaging in illegal activity and must be dissolved).
The way in which a partnership is officially terminated may depend on the state laws governing the partnership, the type of partnership it is, and whether it is an actual dissolution or a disassociation.
The dissolution process refers to the termination of the entire partnership. A disassociation, on the other hand, is only used when one partner is attempting to end its association with the partnership.
In general, a disassociation terminates the partner’s legal relationship with the partnership, including any rights and profits. If the partnership decides to continue in the absence of this partner, then the partnership must buy out the dissociating partner’s interest.
As for the dissolution process, any partner may dissolve the partnership at any time by providing a notice of dissolution. The partnership must then “wind up” its business activities and distribute its assets. Winding up refers to the methods used to distribute or liquidate any property or assets remaining after a dissolution of a partnership.
The money resulting from the wind up stage is first used to pay off any debts the partnership may still have, and the remaining funds will go to the partners individually. This is usually based on their ownership interest in the partnership.
Additionally, the partnership should notify state and federal tax authorities, as well as creditors and clients, that the partnership is dissolving.
Do I Need a Lawyer to Form a Partnership?
There are many reasons why you should strongly consider hiring an experienced business lawyer to form a partnership. For one, a business lawyer can help you draft or review your partnership agreement to ensure that it is clear and includes any provisions that may be necessary to avoid future hardship.
While partnerships do not generally require any legal formalities to be created, they are subject to certain statutory requirements and state laws. A local business lawyer can provide counsel concerning applicable laws and making sure that your partnership is not in violation of any of them.
Another reason you should contact a lawyer is to help you decide which type of partnership is best for your business. Some formations of partnerships are better suited for specific businesses than others. The type you choose may determine the amount of taxes you and your partners will be responsible for, as well as the liability risks associated with the partnership selected.
Finally, a lawyer can also assist with any disputes that may arise regarding the partnership and can guide the partnership through the dissolution process. They can also represent you individually or the entire partnership (depending on the type of partnership and basis of the case) in court, if necessary.