Partnerships

2. Partnerships Introduction to Forms of Business and Formation of Partnerships Operation of Partnerships Dissolution & Winding Up Limited Liability Companies & Limited Partnerships

3. PARTNERS’ DISSOCIATION AND PARTNERSHIPS’ DISSOLUTION AND WINDING UP

4. Learning Objectives Dissociation Dissolution and winding up the partnership business When the business is continued Partners joining an existing partnership

5. Sometimes even the best-laid plans go awry and a business fails Sometimes, it’s just time to make a change, modifying a partnership business to re-emerge as another partnership form, a Limited Liability Company, or a corporation Whether an ending or new beginning, this chapter is about controlling a change in direction

6. The Revised Uniform Partnership Act (RUPA) defines dissociation as a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business: A partner’s retirement, death, or expulsion A bankruptcy filing

7. Dissociation starts the process of dissolution, winding up (liquidation), and termination of a partnership A partner has the power – but not necessarily the right – to dissociate from the partnership at any time, such as by withdrawing from the partnership A partnership agreement may provide for a right of dissociation

8. Nonwrongful dissociation does not violate a partnership agreement and includes events such as the death of a partner and partner’s withdrawal in accordance with partnership agreement Wrongful dissociation includes: Withdrawal of a partner that breaches an express provision of partnership agreement

9. Withdrawal of a partner before the end of the partnership’s term or completion of its undertaking Unless partner withdraws within 90 days after another partner’s death, adjudicated incapacity, appointment of a custodian over his property, or wrongful dissociation

10. A partner’s filing a bankruptcy petition or being a debtor in bankruptcy Judicial expulsion of a partner by request of the partnership or another partner based on: Partner’s wrongful conduct that adversely affects partnership business Partner’s wilfull and persistent breach of fiduciary duties or the partnership agreement Partner’s conduct makes it unreasonable to conduct partnership business with the partner

11. Acts not causing dissociation include: Partner’s transfer of transferable partnership interest Creditor obtaining a charging order Adding a partner Disagreements between partners Partners may limit or expand the definition of dissociation and events considered wrongful or nonwrongful

12. When a partner dissociates, dissolution may be the next step, but RUPA allows the partnership business to continue after a partner’s dissociation Thus dissolution is not automatic

13. RUPA provides a list of events that force a partnership to be dissolved and wound up List may be altered by agreement In Horizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc., the court considered grounds for dissolution contained in RUPA and a partnership agreement In Horizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc., the court considered grounds for dissolution contained in RUPA and a partnership agreement , and whether a partner could be held liable for damages caused by a dissolution. The case points out the importance of careful drafting of partnership agreements. The court: “Southern Oaks argues Horizon wrongfully caused the dissolution because the basis for dissolution cited by the court is not one of the grounds for which the parties contracted…We find Southern Oaks’ argument without merit. First, the trial court’s finding that the parties are incapable of continuing to operate in business together is a finding of “irreconcilable differences,” a permissible reason for dissolving the partnerships under the express terms of the partnership agreements…. Second, even assuming the partnership was dissolved for a reason not provided for in the partnership agreements, damages were properly denied…. Certainly the law predating RUPA allowed for recovery of lost profits upon the wrongful dissolution of a partnership. However, RUPA brought significant changes to partnership law, among which was the adoption of the term “dissociation.” …In the instant case, because the dissolution either came within the terms of the partnership agreements or paragraph 620.8801(5)(c) (judicial dissolution where it is not reasonably practicable to carry on the partnership business), Southern Oaks’ claim for lost future profits is without merit. Judgment for Horizon affirmed.” In Horizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc., the court considered grounds for dissolution contained in RUPA and a partnership agreement , and whether a partner could be held liable for damages caused by a dissolution. The case points out the importance of careful drafting of partnership agreements. The court: “Southern Oaks argues Horizon wrongfully caused the dissolution because the basis for dissolution cited by the court is not one of the grounds for which the parties contracted…We find Southern Oaks’ argument without merit. First, the trial court’s finding that the parties are incapable of continuing to operate in business together is a finding of “irreconcilable differences,” a permissible reason for dissolving the partnerships under the express terms of the partnership agreements…. Second, even assuming the partnership was dissolved for a reason not provided for in the partnership agreements, damages were properly denied…. Certainly the law predating RUPA allowed for recovery of lost profits upon the wrongful dissolution of a partnership. However, RUPA brought significant changes to partnership law, among which was the adoption of the term “dissociation.” …In the instant case, because the dissolution either came within the terms of the partnership agreements or paragraph 620.8801(5)(c) (judicial dissolution where it is not reasonably practicable to carry on the partnership business), Southern Oaks’ claim for lost future profits is without merit. Judgment for Horizon affirmed.”

14. Dissolution begins the winding up process: Orderly liquidation of the partnership assets and the distribution of the proceeds to those having claims against the partnership The implied authority of a winding up partner is the power to do those acts appropriate for winding up the partnership business

15. Winding up partners have apparent authority to conduct business as they did before dissolution To eliminate apparent authority of winding up partner to conduct business in ordinary way, the partnership must ensure that one of the following occurs: A third party knows or has reason to know the partnership has been dissolved

16. A third party received notification of dissolution by delivery of a communication to third party’s place of business Dissolution has come to the attention of the third party A partner filed a Statement of Dissolution with the secretary of state limiting the partners’ authority during winding up

17. Facts: Partnership owned racehorse; a disagreement arose related to veterinary care and training Two partners (plaintiffs) notified partner Crane they were dissolving the partnership and directed Crane to deliver horse to a trainer Crane refused to relinquish control and plaintiffs sued, requesting court to appoint a receiver to continue racing the horse and then sell the horse; Crane objected Black Ace, a harness racehorse of exceptional speed, was the fourth best pacer in the United States in 1979. He was owned by a partnership: Richard Paciaroni owned 50 percent; James Cassidy, 25 percent; and James Crane, 25 percent. Crane, a professional trainer, was in charge of the daily supervision of Black Ace, including training. It was understood that all of the partners would be consulted on the races in which Black Ace would be entered, the selection of drivers, and other major decisions; however, the recommendations of Crane were always followed by the other partners because of his superior knowledge of harness racing. In 1979, Black Ace won $96,969 through mid-August. Seven other races remained in 1979, including the prestigious Little Brown Jug and the Messenger at Roosevelt Raceway. The purse for these races was $600,000. A disagreement among the partners arose when Black Ace developed a ringbone condition and Crane followed the advice of a veterinarian not selected by Paciaroni and Cassidy. The ringbone condition disappeared, but later Black Ace became uncontrollable by his driver, and in a subsequent race he fell and failed to finish the race. Soon thereafter, Paciaroni and Cassidy sent a telegram to Crane dissolving the partnership and directing him to deliver Black Ace to another trainer they had selected. Crane refused to relinquish control of Black Ace, so Paciaroni and Cassidy sued him in August 1979, asking the court to appoint a receiver who would race Black Ace in the remaining 1979 stakes races and then sell the horse. Crane objected to allowing anyone other than himself to enter the horse in races. Before the trial court issued the following decision, Black Ace had entered three additional races and won $40,000. Black Ace, a harness racehorse of exceptional speed, was the fourth best pacer in the United States in 1979. He was owned by a partnership: Richard Paciaroni owned 50 percent; James Cassidy, 25 percent; and James Crane, 25 percent. Crane, a professional trainer, was in charge of the daily supervision of Black Ace, including training. It was understood that all of the partners would be consulted on the races in which Black Ace would be entered, the selection of drivers, and other major decisions; however, the recommendations of Crane were always followed by the other partners because of his superior knowledge of harness racing. In 1979, Black Ace won $96,969 through mid-August. Seven other races remained in 1979, including the prestigious Little Brown Jug and the Messenger at Roosevelt Raceway. The purse for these races was $600,000. A disagreement among the partners arose when Black Ace developed a ringbone condition and Crane followed the advice of a veterinarian not selected by Paciaroni and Cassidy. The ringbone condition disappeared, but later Black Ace became uncontrollable by his driver, and in a subsequent race he fell and failed to finish the race. Soon thereafter, Paciaroni and Cassidy sent a telegram to Crane dissolving the partnership and directing him to deliver Black Ace to another trainer they had selected. Crane refused to relinquish control of Black Ace, so Paciaroni and Cassidy sued him in August 1979, asking the court to appoint a receiver who would race Black Ace in the remaining 1979 stakes races and then sell the horse. Crane objected to allowing anyone other than himself to enter the horse in races. Before the trial court issued the following decision, Black Ace had entered three additional races and won $40,000.

18. Legal Reasoning and Conclusion: Once dissolution occurs, the partnership continues only to the extent necessary to complete transactions begun but not finished. The partnership’s business purpose was to race the horse, thus “the winding up of the partnership affairs should include the right to race” the horse The court also established some conditions. Court: “It is generally accepted that once dissolution occurs, the partnership continues only to the extent necessary to close out affairs and complete transactions begun but not then finished. It is not generally contemplated that new business will be generated or that new contractual commitments will be made. This, in principle, would work against permitting Black Ace to participate in the remaining few races for which he is eligible. However, in Delaware, there have been exceptions to this…The business purpose of the partnership was to own and race Black Ace for profit…. He is currently “racing fit” according to the evidence. He has at best only seven more races to go over a period of the next six weeks,…Under these circumstances, I conclude that the winding up of the partnership affairs should include the right to race Black Ace in some or all of the remaining 1979 stakes races for which he is now eligible. The final question, then, is who shall be in charge of racing him…. On this point, I rule in favor of Paciaroni and Cassidy. They may, on behalf of the partnership, continue to race the horse through their new trainer, subject, however, to the conditions hereafter set forth. Crane does have a monetary interest in the partnership assets that must be protected…” The Court set several conditions that effectively slapped the hands of all parties. Court: “It is generally accepted that once dissolution occurs, the partnership continues only to the extent necessary to close out affairs and complete transactions begun but not then finished. It is not generally contemplated that new business will be generated or that new contractual commitments will be made. This, in principle, would work against permitting Black Ace to participate in the remaining few races for which he is eligible. However, in Delaware, there have been exceptions to this…The business purpose of the partnership was to own and race Black Ace for profit…. He is currently “racing fit” according to the evidence. He has at best only seven more races to go over a period of the next six weeks,…Under these circumstances, I conclude that the winding up of the partnership affairs should include the right to race Black Ace in some or all of the remaining 1979 stakes races for which he is now eligible. The final question, then, is who shall be in charge of racing him…. On this point, I rule in favor of Paciaroni and Cassidy. They may, on behalf of the partnership, continue to race the horse through their new trainer, subject, however, to the conditions hereafter set forth. Crane does have a monetary interest in the partnership assets that must be protected…” The Court set several conditions that effectively slapped the hands of all parties.

19. After partnership assets have been sold during winding up, proceeds are distributed to those who have claims against the partnership Includes partners, but creditor claims satisfied first

20. Remaining proceeds from sale of assets will be distributed to the partners according to the net amounts in their capital accounts Partner’s capital account is credited (increased) for capital contributions partner made to partnership plus partner’s share of profits Partner’s capital account is charged (decreased) for partner’s share of partnership losses

21. Asset distribution rules modified for a limited liability partnership since in an LLP most partners have no liability for partnership obligations If a partner committed malpractice or another wrong for which LLP statutes do not provide liability protection, the partner must contribute funds to the partnership

22. After partnership assets have been distributed, termination of the partnership occurs automatically

23. Partners may choose not to seek dissolution and winding up after dissociation When the business of a partnership is continued, creditors of the partnership continue as creditors of the person or partnership continuing the business. Original partners remain liable for obligations incurred prior to dissociation Including dissociated partners

24. When partnership continues, partnership is required to purchase dissociated partner’s partnership interest Partnership agreement may specify how to value the partnership or RUPA spells outs the amount and timing of the buyout of a dissociated partner’s interest See Creel v. Lilly Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership. Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership.

25. A partnership agreement generally states terms under which a new partner is admitted to a partnership In absence of a partnership agreement, RUPA sets rules for partner’s admission and rights and duties upon admission: New partner fully liable for all partnership obligations incurred after admission as partner, but no liability for obligations incurred before admission as partner Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership. Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership.

26. RUPA states that a new partner in an LLP incurs no liability for any LLP obligations, whether incurred before or after admission, beyond new partner’s capital contribution unless new partner committed malpractice or other wrong (and incurs personal liability) Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership. Creel v. Lilly, the court applied the partners’ buyout agreement and noted the RUPA’s bias in favor of continuing the business of the partnership.

27. Test Your Knowledge True=A, False = B Dissociation is the orderly liquidation of the partnership assets and the distribution of the proceeds to those having claims against the partnership. When a partner dissociates, dissolution is the required next step. Winding up is a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business. False. The description refers to winding up. False. When a partner dissociates, dissolution may be the next step. False. The description refers to dissociation. False. The description refers to winding up. False. When a partner dissociates, dissolution may be the next step. False. The description refers to dissociation.

28. Test Your Knowledge True=A, False = B In winding up, remaining proceeds from the sale of assets will be distributed to the partners according to the net amounts in their capital accounts Winding up partners have apparent authority to conduct business as they did before dissolution. When a partnership continues, the partnership must purchase the dissociated partner’s partnership interest False. A will is revocable until the moment of the testator’s death. False. Totten trust: a deposit of money in a bank or other financial institution in the name of the depositor as trustee for a named beneficiary. False. A trust is more private than a will since a will must be probated and a trust is outside the probate process. True.False. A will is revocable until the moment of the testator’s death. False. Totten trust: a deposit of money in a bank or other financial institution in the name of the depositor as trustee for a named beneficiary. False. A trust is more private than a will since a will must be probated and a trust is outside the probate process. True.

29. Test Your Knowledge Multiple Choice James was a partner in a three-person law partnership without a partnership agreement. Medical bills forced James to file for personal bankruptcy. James has: (a) Engaged in wrongful dissociation (b) Engaged in nonwrongful dissociation (c) Engaged in wrongful dissolution (d) Engaged in nonwrongful dissolution The correct answer is (a).The correct answer is (a).

30. Test Your Knowledge Multiple Choice Greg, Pat, and Oprah were partners in a music store. Greg transferred his transferable partnership interest to his nephew. Greg: (a) Engaged in wrongful dissociation (b) Has exercised a partnership right (c) Engaged in nonwrongful dissociation (d) None of the above The correct answer is (b). The correct answer is (b).

31. Thought Questions How would you deal with a partner who was mismanaging the firm or committed malpractice? How would you deal with a partner who had a substance abuse problem? Opportunity to discuss choices about coping with partners. Opportunity to discuss choices about coping with partners.