Business Partnerships: Should You Gamble with the Default Rules?
Published on Mon, 05/01/2023 - 2:55pm
Business Partnerships: Should You Gamble with the Default Rules?
By Carl B. Rincker. ESQ.
Partnerships are ubiquitous in agriculture – you see them in one way or another in farm, ranch and agri-business enterprises, both big and small in a wide array of circumstances. Forming a partnership is exceedingly simple—that is the main draw of this kind of business organization. There are typically no legal formalities required to create a partnership. In fact, a partnership is presumed anytime two or more parties come together in business with an implied or express agreement to share the profits generated. Unlike other business formations, such as LLCs and corporations, in most states a partnership does not need to file any documentation with the relevant Secretary of State to operate as a legal business entity.
Because it is so easy to form a partnership and begin partnership operations, many partnerships choose to hit the ground running without first establishing a written partnership agreement. Though a formal written agreement is not required in most states, it is nevertheless advisable so that all parties in the partnership are on the same page with respect to the bounds of the business and their respective rights and duties.
The Default Rules
What happens when you form a partnership and chose not to establish a written partnership agreement? Most states have adopted some version of the Uniform Partnership Act of 1997, which is a model law that provides default statutory rules that apply where partnerships either a) do not have a written agreement, or b) have a written agreement that is silent on a particular issue. These default rules set out certain baseline understandings about how the partnership will operate, how profits and losses will be shared, what the rights and duties of the partners are, when and how a partnership will dissolve, and many other aspects of the partnership business.
While the default provisions are based on common sense, each partnership has its own unique considerations, which means that relying on the default rules may be a gamble. I discuss a few of the common default provisions you should be aware of below.
Profits. Without a written agreement stating otherwise, the default rule is that each partner in a partnership is entitled to an equal share of the partnership profits. While this may be what the partners intended, there are certain scenarios where an equal division of profits is not the goal. For example, one partner may have contributed much more initial capital than another did, or one partner may dedicate much more time and effort to the business operations than another does. Where the partners’ respective contributions are significantly asymmetrical, the default rule that each partner gets an equal share in the profits may be undesirable.
Losses. A partner’s share in the partnership’s losses is the same as that partner’s share in the partnership profits. In other words, where the default rule applies and partners share profits equally, they will also share losses equally.
Liabilities. In a general partnership, the default rule is that all partners are personally jointly and severally liable for the obligations of the partnership. This means that a single partner could be held liable and have to pay up from his or her personal finances for the entirety of a partnership loss if the other partners do not have the means to pitch in.
Acts of the Partners. If there is not a partnership agreement laying out which partners are authorized to undertake what acts, then each partner is considered an unrestricted agent of the partnership, and each partner has the authority to bind the partnership in the same way. The entire partnership is liable for any actionable conduct of any partner, if that partner is acting in the ordinary course of the business of the partnership.
Rights of the Partners. By default, every partner has an equal right in the management of the partnership, and differences of opinions are settled by a majority vote. This can be particularly tricky where a partnership is made up of two partners who are prone to disagreement. Regardless of a partner’s role, no partner is automatically entitled to compensation for the services he or she performs for the partnership. This can cause significant strain in a partnership where the partners disagree about whether, and to what extent, they should be compensated with a salary.
Dissolution. There are many events that, by default, will cause a dissolution of the partnership if there is no partnership agreement stating otherwise. For example, if a partner withdrawals from a partnership-at-will, the default rules provide that the partnership is dissolved and must wind down, even if there are multiple other partners remaining in the partnership.
These are just a few of the default provisions contained in the Uniform Partnership Act. Not all of these default rules will be a good fit for, or be desired by, any given partnership. Notably, a majority of these default rules can be overridden by a written partnership agreement that more definitively and accurately establishes the partners’ preferences.
Establishing a Written Partnership Agreement
While a written partnership agreement is not usually required by law, there are nevertheless compelling reasons to draft one. As already noted, there may be certain default rules that are not optimal for your specific partnership operation. Moreover, banks and lenders often require a written partnership agreement before they do business with a partnership. Finally, a written agreement can help avoid disputes between the partners. Handshake agreements are a landmine for future litigation, whereas setting out the terms in writing ahead of time ensures that all partners are on the same page with respect to the partnership’s ownership percentages, assets, profit sharing, etc.
A well-drafted partnership agreement should, at a minimum, specify the following:
• The full legal names and addresses of all partners;
• The name of the partnership;
• The principal place of business of the partnership;
• The initial contributions each partner has made to the partnership;
• The inventory of assets owned by the partnership;
• The percentage of profits and losses assigned to each partner; and
• Whether the partnership is a general or limited partnership.
The above terms relate to the bare-bones structure of the partnership; however, it may be helpful for your partnership agreement to address some of these additional issues:
• Subsequent capital contributions. Whether partners will owe future capital contributions; and if so, when.
• Duties of the Partners. Whether specific partners will have specific roles with respect to the partnership.
• Management and Voting Requirements. How decisions relating to the operation of the partnership will be made, and what kind of voting majority is required for decision-making.
• Salaries and Benefits of the Partners. Whether the partners may receive any salary or benefits.
• Restrictions on Partners. Whether there are certain activities the partners may not engage in, such as partaking in other businesses that compete with the business of the partnership.
• Transfer of Partnership Interest. Whether a partner may transfer his or her partnership interest to a third party and, if so, the effect of such a transfer.
• Retirement, Withdrawal, or Expulsion of Partners. The terms and conditions for the voluntary or involuntary exit of a partner from the partnership.
• Dissolution of the Partnership. The events that trigger a dissolution of the partnership, and the procedure for such dissolution.
While your partnership agreement can be tailored with respect to the above issues, a few of the default statutory rules governing partnerships are still non-waivable, meaning that they cannot be overridden by written agreement. For example, in Illinois, a partnership agreement cannot contract away the partners’ respective rights of access to the partnership’s books and records, the various fiduciary duties owed by the partners, and the partners’ right to dissociate with the partnership. Accordingly, while drafting a partnership agreement can be fairly straightforward, it may nevertheless be helpful to consult an attorney to ensure you are on the right track.
For more information contact:
Cari Rincker, Esq.
Rincker Law, PLLC
Licensed in IL, NY, NJ, CT, KY, TX and DC
229 E Main St
Shelbyville, IL 62565
New York Office:
535 Fifth Avenue, 4th Floor
New York, NY 10017