Partnerships

Learning Objectives

In this chapter, students will learn to:

• Explain what constitutes a legal partnership and distinguish it from other business entities;

• Identify the key elements required to form a partnership, including express and implied agreements, and discuss the role of partnership agreements in defining rights and responsibilities;

• Explain the fiduciary duties that partners owe to each other and to the partnership;

• Assess the extent of partners’ personal liability for partnership debts and obligations, including joint and several liability, and explore ways to mitigate risk through agreements and entity selection;

• Identify how management authority is allocated among partners, the decision-making process in a partnership, and how disputes are resolved;

• Explain how partnerships may be dissolved, including voluntary and involuntary dissolution, and analyze legal and financial consequences for partners; and

• Outline how partnerships are taxed under U.S. law, including pass-through taxation, and discuss financial considerations such as profit-sharing and capital contributions.

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The general partnership is perhaps the oldest and most intuitive form of business organization. It arises easily—sometimes inadvertently—when two or more people co-own a business for profit. That spontaneity is part of its appeal, but also part of the problem: co-ownership without formal structure introduces a range of economic and legal frictions, many of which are best understood in terms of transaction costs and public choice dynamics.

At the most basic level, a partnership aggregates capital and labor to pursue a business goal. When the level of capital or expertise needed for a successful enterprise outstrips the capital that a single individual can amass—whether from individual wealth or loans to the individual qua individual—other individuals (and their wealth) will be needed. Partnerships are one institution that has emerged to facilitate that aggregation of wealth and expertise.

Each partner contributes resources—money, property, effort, or expertise—and expects to share in the gains. But with multiple principals and no centralized authority, partnerships face acute coordination and monitoring challenges. Who gets to decide what? How are profits split? What happens when someone wants out—or wants to exclude someone else? What if someone new wants to join, but not all partners agree? Each of these is a potential site of conflict. If every dispute required bespoke negotiation or litigation, partnerships would be too costly to form or maintain.

Partnership law reduces these transaction costs by providing a ready-made set of default rules. These rules do not eliminate the need for negotiation. Indeed, freedom of contract is central to the emergence of spontaneous, voluntary arrangements between business owners. Partnership default rules do lower the cost of contracting by supplying off-the-shelf answers to common problems: how to allocate profits and losses, how to make decisions, how to resolve disputes, and how to handle exit or dissolution. The Uniform Partnership Act (1914) (UPA) and the Revised Uniform Partnership Act (1997) (RUPA) serve this role, allowing parties to contract around the defaults but avoiding the need to negotiate every detail in advance.

Perhaps more importantly, partnership law mitigates problems of incentive misalignment that naturally arise in shared enterprises. Like agency law, it assumes that participants may shirk, cheat, or opportunistically exit if their incentives are not properly aligned. In other words, partners may engage in internal rent-seeking, attempting to gain additional benefits from the partnership at the expense of the other co-owners.

Without institutions that better align incentives and reduce internal rent-seeking, partners would need to engage in significant oversight of each other, raising the cost of everything that the partnership does. Fiduciary duties—especially the duty of loyalty—act as internal enforcement mechanisms, increasing the cost of internal rent-seeking and, consequently, reducing its frequency. Fiduciary duties also replace costly and uncertain bargaining with enforceable legal norms. These duties are largely owed to the partnership as a separate entity, not to the other partners directly, helping to keep the firm intact as a going concern.

At the same time, partnership law must grapple with external public choice dynamics that arise when partnerships dissolve or encounter third-party claims. The relative informality of partnership formation creates uncertainty about who counts as a partner, who is liable for debts, and what happens when things go wrong. Courts may face pressure to stretch partnership doctrine to reach deep pockets or achieve equitable outcomes. Cases like Meinhard v. Salmon illustrate how courts may impose expansive fiduciary duties based on fairness rather than text or precedent.

This judicial discretion introduces predictability problems, which in turn increase transaction costs. If partners cannot predict how courts will resolve disputes—particularly about exit, fiduciary breach, or third-party liability—they may avoid partnerships altogether, or demand inefficient protective measures. Lawmakers have responded to this concern by revising the Uniform Partnership Acts to better distinguish between disassociation and dissolution, clarify capital account contributions, and rationalize the treatment of limited partners. Each revision reflects a tradeoff between reducing opportunism and preserving flexibility.

In short, the law of partnerships serves two economic functions: first, reducing transaction costs associated with forming, managing, and exiting a joint enterprise; and second, limiting the scope for opportunistic behavior, whether by partners, third parties, or courts themselves. It is a field where the internal tensions of business law—between equity and efficiency, flexibility and predictability—are on full display.

Partnerships are also formed through mutual assent rather than formal documentation. The actual transaction that forms the partnership, therefore, will not impose more than de minimis additional costs. The lack of formalities also means that the willing partners do not need to rely on the consent of a state actor to begin their business relationship, as they would if they wished to form a corporation or limited liability company (LLC).

Moreover, the default legal rules apply as soon as the parties agree—explicitly or implicitly—to be co-owners of a business. This makes it difficult for someone to act like a partner while evading legal responsibility through technicalities. As long as a person's conduct shows an objective intent to form a partnership, the law treats the partnership as formed. As a result, potential partners can move forward without needing to invest heavily in legal formalities or worry that a supposed partner is trying to game the system.

It is worth spending a moment thinking about partnership default rules and how they help reduce transaction costs. In order to be effective in this regard, the default rules need to be ones that most people would choose if they engaged in intentional bargaining. For example, UPA § 18(e) and RUPA § 401(f) establish the default rule for control as one of equal control rights for every partner. If one partner feels strongly that he or she should have a greater voice—perhaps because he or she has contributed more financial resources to the business—they will likely insist on that being part of the agreement. However, if no one feels strongly enough about control to insist on something other than equal control, the law sticks with equality as the reasonable outcome.

Similarly, if the partners choose not to bargain around the default rules, UPA § 18(a) or RUPA § 401(b) will grant each partner an equal share of profits. Importantly, however, the default rule for sharing of losses—who will have to pay out of his or her own pocket if the partnership has a bad month and bills need to be paid—is not necessarily equal shares. Instead, the default rule for loss-sharing is that it is the same as the division of profits. If the parties chose not to bargain over sharing of profits and losses, both will be apportioned equally between partners. However, the rules recognize that our natural optimism might lead partners to assume profits will be the rule and ignore the issue of apportioning losses. The rules assume that partners will generally want both profits and losses to be equally apportioned, as a matter of fairness, so the default rule for losses tracks profits exactly.

In all these cases, setting the default rule where it tracks with basic notions of fairness means that it will satisfy most aspiring partners. They need not bargain over these issues, and can save their time and effort for areas where their preferences might not be represented by a simple fairness standard. By requiring a partner to assert a preference that goes beyond fairness, it puts the other partners on notice of exactly where complications are likely to arise, once a partnership has emerged. And, if a partnership has already been formed, fewer disputes will arise if the default rules generally require only that the partners follow a fairness standard.

In modern times, the low transaction costs associated with partnership formation make them useful for early-stage entrepreneurs who are still testing an idea or operating informally with trusted colleagues. The partnership form allows them to begin working together without legal fees or bureaucratic delays.

All of these features make partnerships an attractive option, but as economist Thomas Sowell has pointed out, there are no solutions, only tradeoffs. The informal nature of partnerships makes them easy to form, but it also means that they can be formed accidentally, imposing legal duties and liabilities on individuals that they did not expect. Voluntary transactions are value-enhancing because both parties agree only when the trade-offs are net positive. Because individuals may not recognize they are forming a partnership, they will not appreciate all the benefits and costs of the bargain that creates the partnership. Partnerships, therefore, may not always be value-enhancing.

Among the things that might be non-obvious to the new partner are how contract liability attaches for contracts entered into by a single partner, what responsibilities constrain the actions of individual partners, and what remedies exist when things go wrong. These uncertainties can impose significant costs if the partners have not built a relationship of trust.

In essence, partnerships occupy a unique position in the transaction cost spectrum. They sit between pure market transactions, which are short-term and impersonal, and complex corporate structures, which are formalized and rule-heavy. Partnerships are relational and flexible—appropriate for ventures where trust is high and stakes are relatively low.

But as ventures grow in size, complexity, or risk, the transaction costs of a partnership—including ambiguity, mutual liability, and limited mechanisms for raising capital—may begin to outweigh the benefits. At that point, entrepreneurs often turn to more structured forms like corporations or LLCs. Each step along this continuum—from barter to market, from market to firm, and from informal firm to formal firm—represents a response to the challenge of reducing transaction costs in a world of scarcity and uncertainty.

Partnership Formation

Forming and Defining a Partnership

One reason partnerships remain a popular form of business organization is the ease and flexibility with which they can be formed. Legally, forming a partnership requires mutual assent by two or more individuals to carry on as co-owners of a business for profit, § 6(1) of the UPA and § 202(a) of the RUPA. However, this simplicity in definition can lead to significant complexity in practice.

Determining mutual assent and identifying co-ownership often requires courts to look beyond mere profit-sharing arrangements, because profit-sharing alone can occur in non-ownership contexts, such as employee incentive programs designed to mitigate transaction costs. Recall, from Chapter II, the fundamental principal-agent problem: employers (principals) seek to maximize effort while minimizing pay, whereas employees (agents) naturally seek higher pay for minimal effort. Sharing profits can align incentives and reduce monitoring costs, but it does not necessarily indicate co-ownership.

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Courts, therefore, use a multifaceted approach, examining both formal agreements and the practical realities of how relationships evolve over time. The following case tells a typical story of employers and employees developing their business relationship and how it looks, ex post, to a court tasked with determining if a partnership has been created. As you read the case, consider how Sweet’s role in the nursery business changed over time. In what ways did Sweet appear to be acting as a co-owner? As an employee? Is the court concerned more with the formalities of the relationship or how the relationship functioned in the real world?

Vohland v. Sweet
433 N.E.2d 860 (Ct. App. Ind. 1982)

NEAL, Judge.

1. Plaintiff-appellee Norman E. Sweet (Sweet) brought an action for dissolution of an alleged partnership and for an accounting in the Ripley Circuit Court against defendant-appellant Paul Eugene Vohland (Vohland). From a judgment in favor of Sweet in the amount of $58,733, Vohland appeals.

2. We affirm.

STATEMENT OF THE FACTS

1. . . . Sweet, as a youngster, commenced working in 1956 for Charles Vohland, father of Paul Eugene Vohland, as an hourly employee in a nursery operated by Charles Vohland. Upon the completion of his military service, which was performed from 1958 to 1960, [Sweet] resumed his former employment. In approximately 1963 Charles Vohland retired, and [Eugene] Vohland commenced what became known as Vohland’s Nursery . . . Sweet’s status changed. He was to receive a 20 percent share of the net profit of the enterprise after all of the expenses were paid. . .

2. Sweet managed the physical aspects of the nursery and supervised the care of the nursery stock and the performance of the contracts for customers. . . Sweet testified that at the outset of the arrangement Vohland told him, “he was going to take . . . me in and that . . . I wouldn’t have to punch a time clock anymore, that I would be on a commission basis and that I would be, have more of an interest in the business if I had ‘an interest in the business.’ . . . He referred to it as a piece of the action.” Sweet's testimony, denied by Vohland, disclosed that, in a conversation in the early 1970’s regarding the purchase of inventory out of earnings, Vohland promised to take care of Sweet. . .

3. No partnership income tax returns were filed. Vohland and his wife, Gwenalda, filed a joint return in which the business of Vohland’s Nursery was reported in Vohland’s name on Schedule C. Money paid Sweet was listed as a business expense under “Commissions.” Also listed on Schedule C were all of the expenses of the nursery, including investment credit and depreciation on trucks, tractors, and machinery. Sweet’s tax returns declared that he was a self-employed salesman at Vohland’s Nursery. He filed a self-employment Schedule C and listed as income the income received from the nursery. . .

4. Vohland handled all of the finances and books and did most of the sales. He borrowed money from the bank solely in his own name for business purposes, including the purchase of the interests of his brothers and sisters in his father’s business, operating expenses, bid bonds, motor vehicles, taxes, and purchases of real estate. Sweet was not involved in those loans. . .

5. Evidence was contradictory in certain respects. The nursery was located on approximately 13 acres of land owned by Charles Vohland. Sweet testified that at the commencement of the arrangement with Vohland in 1963, Charles Vohland grew the stock and maintained the inventory, for which he received 25 percent of the gross sales. In the late 1960’s, because of age, Charles Vohland could no longer perform. The nursery stock became depleted to nearly nothing, and new arrangements were made. An extensive program was initiated by Sweet and Vohland to replenish and enlarge the inventory of nursery stock; this program continued until February, 1979. The cost of planting and maintaining the nursery stock was assigned to expenses before Sweet received his 20 percent. . . Sweet testified that at the termination of the arrangement there existed $293,665 in inventory which had been purchased with the earnings of the business. Of that amount $284,860 was growing nursery stock. Vohland, on the other hand, testified that the inventory of 1963 was as large as that of 1979, but the inventory became depleted in 1969. . . However, Vohland conceded on cross-examination that the acquisition and enlargement of the existing inventory of nursery stock was paid for with earnings and, therefore, was financed partly with Sweet’s money. . .

DISCUSSION AND DECISION. . .

1. It has been said that an accurate and comprehensive definition of a partnership has not been stated; that the lines of demarcation which distinguish a partnership from other joint interests on one hand and from agency on the other, are so fine as to render approximate rather than exhaustive any attempt to define the relationship.

2. A partnership is defined by Ind.Code 23-4-1-6(1) (Uniform Partnership Act of 1949):

“A partnership is an association of two or more persons to carry on as co-owners a business for profit.”

1. . . . It is an established common law principle that a partnership can commence only by the voluntary contract of the parties. Bond v. May, (1906) 38 Ind.App. 396, 78 N.E. 260. In Bond it was said, “(t)o be a partner, one must have an interest with another in the profits of a business, as profits. There must be a voluntary contract to carry on a business with intention of the parties to share the profits as common owners thereof.” . . .

2. ”. . . [T]to establish the partnership relation, as between the parties, there must be (1) a voluntary contract of association for the purpose of sharing the profits and losses, as such, which may arise from the use of capital, labor or skill in a common enterprise; and (2) an intention on the part of the principals to form a partnership for that purpose. But it must be borne in mind, however, that the intent, the existence of which is deemed essential, is an intent to do those things which constitute a partnership. Hence, if such an intent exists, the parties will be partners notwithstanding that they proposed to avoid the liability attaching to partners or (have) even expressly stipulated in their agreement that they were not to become partners. (Citation omitted)

3. It is the substance, and not the name of the arrangement between them, which determines their legal relation toward each other, and if, from a consideration of all the facts and circumstances, it appears that the parties intended, between themselves, that there should be a community of interest of both the property and profits of a common business or venture, the law treats it as their intention to become partners, in the absence of other controlling facts.”

4. . . . [W]e are first constrained to observe that should an accrual method of accounting have been employed here, the enhancement of the inventory of nursery stock would have been reflected as profit, a point which Vohland, in effect, concedes. We further note that both parties referred to the 20 percent as “commissions.” To us the term “commission,” unless defined, does not mean the same thing as a share of the net profits. However, this term, when used by landscape gardeners and not lawyers, should not be restricted to its technical definition. “Commission” was used to refer to Sweet’s share of the profits, and the receipt of a share of the profits is prima facie evidence of a partnership. . . [I]t can readily be inferred from the evidence most favorable to support the judgment that the parties intended a community of interest in any increment in the value of the capital and in the profit. . . [A]bsence of contribution to capital is not controlling, and contribution of labor and skill will suffice. There is evidence from which it can be inferred that the parties intended to do the things which amount to the formation of a partnership, regardless of how they may later characterize the relationship. . . From the evidence the court could find that part of the operating profits of the business, of which Sweet was entitled to 20 percent, were put back into it in the form of inventory of nursery stock. In the authorities cited above it seems the central factor in determining the existence of a partnership is a division of profits.

5. From all the circumstances we cannot say that the court erred in finding the existence of a partnership.

[Notes & Questions]{.smallcaps}

Partnership requires mutual assent, which is also required for a binding contract; does that mean that partnership requires an explicit contract? Would implied assent be sufficient for a partnership? Does the arrangement between the partners need to be written down to be effective? If the arrangement was not written or specific, how can we tell whether there was a “meeting of the minds?”

When a partnership emerges out of the evolving relationship between employer and employee, what evidence would you look for, in order to determine whether the parties had shifted to a partnership? What would their relationship look like before? After?

What is it about profit sharing that leads the UPA and RUPA to conclude that profit sharing is strong, almost definitive proof of the existence of a partnership? Are there any other scenarios that you think would be equally convincing evidence of a partnership?

In the following scenarios, would you find that there was a partnership? Which facts operate in favor of a partnership, and which against?

a. To help stabilize a struggling investment firm, three wealthy individuals loan the firm $2 million in bonds. In return, they receive 40% of the firm’s profits until the loan is repaid. The agreement also gives them the right to inspect the firm’s books and veto risky business decisions. They are referred to in the agreement as “trustees” and are given an option to become partners in the future, but they currently do not participate in day-to-day operations, cannot bind the firm to any business deals, and did not contribute capital beyond the loaned bonds. The bonds remain separate from the firm’s general assets and must be returned by a specific date. Martin v. Peyton, 158 N.E. 77 (1927).

b. Two lawyers share office space, a phone line, and a receptionist. They split overhead costs but maintain separate bank accounts, clients, and letterhead. Occasionally, they refer clients to one another, but they do not share profits or losses from their legal work. Brodsky v. Stadlen, 138 A.D. 2d 662 (1988).

c. A beauty shop owner agrees to give his receptionist a share of profits in lieu of a salary increase. They sign a document titled “Partnership Agreement,” stating she will receive 20% of the annual profits but make no capital contribution and bear no responsibility for losses. The owner retains full control over the business and finances, though both can inspect the books. The receptionist continues working under the arrangement but has no decision-making authority or ownership interest in the shop’s assets. Fenwick v. Unemployment Compensation Comm’n, 133 N.J. 295 (1945).

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As you contemplate partnership formation, you should consider the subject on two separate levels. The first is a high-level analysis, in which you should understand the general principle that partnership is co-ownership. A partnership emerges when two or more people decide that they can do more if they share the burdens and benefits of ownership. There will not always be an obvious moment where the partners sat down and declared their intent to join forces. In many cases, the decision will emerge gradually, and lawyers and courts will need to trace a series of choices that, eventually, lead to co-ownership.

The second level is more specific, focusing on the details of the alleged partnership in question. Exactly how do the individuals share profits/losses? How do they share control? How do they share the responsibilities of day-to-day operation of the business? There are many ways that partners might choose to split the burdens and benefits of co-ownership, and partnership law provides them the flexibility they need. That means there are no clear, bright-line rules on partnership formation. Instead, you will need to question whether a particular division of effort looks like the individuals intended—impliedly or expressly—to be co-owners.

“Accidental” Partnerships

Because general partnerships can be formed through conduct alone—unlike more formal business entities such as limited partnerships, LLCs, and corporations—parties can inadvertently create partnerships without realizing it. This phenomenon, often called an “accidental partnership,” arises not because parties unintentionally become partners, but because they choose co-ownership without explicitly intending the legal consequences of partnership status.

Allowing partnerships to form informally reduces transaction costs, making it easier for individuals to begin and conduct business together. Partnership law thus minimizes necessary due diligence, fostering greater trust among parties and protecting them from opportunistic behavior. However, this simplicity carries risks. Parties who think they are merely collaborating or sharing resources may later find themselves legally bound as partners, facing unanticipated rights and responsibilities. Courts examine multiple factors—such as intent, profit sharing, control, property management, and how parties present themselves to third parties—to discern whether a partnership was formed.

The accidental partnership doctrine thus emphasizes substance over form, protecting parties who rely on implied promises of co-ownership and deterring individuals from reaping partnership benefits while avoiding corresponding liabilities. The cases that follow demonstrate how courts navigate these complexities, focusing on conduct and practical realities over stated intentions or formal agreements. In every case, one of the partners disclaimed any intent to form a partnership, but you should ask yourself whether you think their words and actions indicate an intent to share ownership.

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In Byker v. Mannes, 641 N.W.2d 210 (Mich. 2002), Byker and Mannes engaged in a long-term business relationship involving multiple investments, primarily in real estate and telecommunications. They operated informally, without a written partnership agreement, and communicated largely through conversations and occasional correspondence. Mannes provided business expertise and managed the ventures, while Byker supplied most of the funding. They discussed sharing profits and losses, but never clearly defined the extent of each party’s obligations. Over time, Mannes incurred substantial debts in connection with the ventures, some of which were never repaid. When the relationship deteriorated, Byker sued to recover the money he had advanced, arguing the two had been partners and Mannes had breached fiduciary duties. Mannes responded that no partnership existed because they had never formally agreed to one. The court found that their conduct demonstrated the intent to carry on as co-owners for profit, satisfying the statutory test for a partnership under Michigan law.

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In Jynx, Inc. v. O’Neal, 634 S.W.2d 557 (Tex. App. 1982), O’Neal and another individual agreed to open a nightclub together. O’Neal was to manage the day-to-day operations, including hiring staff, overseeing promotions, and running the venue. The other party contributed capital to start the business but remained largely uninvolved in operations. They agreed orally to share profits but had no written agreement and did not discuss loss sharing in detail. O’Neal believed they were partners and operated accordingly. He made binding decisions for the business and represented himself as a co-owner. When financial troubles emerged and a third party sought payment, the capital-contributing party denied any partnership existed and disclaimed liability for debts incurred by O’Neal. The court found that their arrangement, particularly the agreement to split profits and O’Neal’s role in management, supported a finding of partnership.

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In Mattessich v. Fishman, 363 N.J. Super. 389 (App. Div. 2003), Mattessich and Fishman, both attorneys, established a law practice together after leaving their previous employment. They never signed a written partnership agreement but opened a joint office, used joint letterhead, split operating expenses, and divided net income equally. They presented themselves as partners to clients and shared some managerial responsibilities, including decisions about staff and budgeting. While their understanding of their relationship remained informal, both benefited from the appearance of operating as a unified firm. After a dispute, Fishman left the practice and claimed he had never been a true partner. Mattessich asserted that their conduct, shared income, and outward representation satisfied the requirements of a legal partnership. The court agreed, focusing on substance over form, and held that a partnership existed.

“Faux” Partnerships

Just as partnerships can accidentally form, they can also appear to exist when none truly do. Such cases are known as “faux partnerships,” or “partnership by estoppel,” and arise when individuals or entities represent—or allow others to represent—that a partnership exists, even though the legal requirements of a partnership have not been met. Unlike true partnerships, faux partnerships do not hinge on mutual assent or co-ownership but rather on how parties present their relationship to third parties.

Courts developed the faux partnership doctrine primarily to protect third parties who reasonably rely on these representations and suffer detriment as a result. The doctrine reduces transaction costs by discouraging misleading or deceptive behavior, as third parties entering into transactions can reasonably trust apparent partnership representations. This protection prevents opportunistic actors from falsely signaling partnership status to enhance their credibility or perceived financial stability.

To establish a faux partnership, courts generally look for three essential factors: (1) a representation (express or implied) of partnership existence, (2) reasonable reliance by a third party, and (3) detriment incurred by the third party as a result. Notably, the representation need not be directly communicated by the alleged partner; it suffices if the alleged partner knowingly allows the misrepresentation to persist uncorrected. Moreover, the third party’s reliance must be reasonable and directly linked to the detriment suffered.

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Exercise: Faux Partnership

The following exercise illustrates how courts might apply these principles in practical scenarios, emphasizing the necessity for clear, truthful communication about business relationships to avoid unintentional legal consequences. As you read, consider whether you think the court would invoke the doctrine and what you would change to avoid application of the document in the future.

Several high-net-worth U.S. investors are approached by an international investment advisory firm, Pinnacle-Bahamas Ltd., about placing their funds into a new offshore fund offering high returns through foreign currency arbitrage. Pinnacle-Bahamas uses professional-looking marketing materials prominently featuring the name and logo of Pinnacle Global LLP, a well-known U.S. accounting and financial services firm with offices in major cities like New York, Chicago, and Los Angeles.

The materials describe Pinnacle-Bahamas as “an affiliate of Pinnacle Global LLP” and state that the fund’s operations are “guided by the global standards and oversight of Pinnacle Global’s New York office.” The letterhead lists Pinnacle Global’s Manhattan address under a “World Headquarters” heading and includes testimonials from international conferences attended by executives of both entities.

One of Pinnacle Global’s U.S.-based partners even appeared on a panel with a Pinnacle-Bahamas executive at a wealth management symposium in Miami, where she praised the firm’s “forward-looking offshore strategy” and said she “looked forward to deeper collaboration.”

Based on these representations, the investors perform only minimal due diligence. They confirm that Pinnacle-Bahamas is registered in Nassau but do not investigate its financial health or independent ownership structure. Relying on the apparent affiliation with Pinnacle Global LLP and the legitimacy that relationship conferred, they transfer $5 million into the fund.

Within six months, the fund collapses. Pinnacle-Bahamas ceases operations, and the principals disappear. The investors sue Pinnacle Global LLP in U.S. federal court, alleging that the U.S. firm is liable under a theory of partnership by estoppel (or faux partnership). They argue that the U.S. firm either held itself out—or allowed itself to be held out—as a partner of the Bahamian firm and that they reasonably relied on that representation to their detriment.

Pinnacle Global LLP denies any partnership, pointing out that the two firms have no shared finances, control, or formal affiliation agreement. It claims the unauthorized use of its name and denies any intent to mislead.

Partnership Via Express Agreement

While partnerships can arise informally through conduct, they can also be formed intentionally through express agreement. The statutory default rules—such as equal sharing of profits, losses, and control—provide a low-cost framework for those who do not bargain. But when partners have different levels of capital, risk, or expertise, those rules may misallocate control or rewards. In such cases, bargaining allows the parties to tailor their relationship to the realities of the business.

Default rules serve an important function in shaping these negotiations. They reduce transaction costs by supplying a legal backdrop, which creates leverage and structure. For example, a partner contributing most of the startup capital might demand a larger share of profits or control. But unless the others agree, the law defaults to equality. Knowing this, each partner can strategically trade default entitlements—like equal control or veto power—for other contractual benefits.

This dynamic—often described as bargaining in the shadow of the law—means that default rules do not just fill gaps, they shape how deals are made. Public choice scholars would note that these defaults often reflect compromises intended to balance fairness, simplicity, and administrability, rather than economic efficiency in every case. Express agreements allow parties to depart from one-size-fits-all defaults, opting instead for rules that promote efficiency, protect investment, or reflect negotiated trust.

Moreover, formal agreements create clarity, reduce future litigation risk, and allow parties to allocate rights in areas not covered by statute—like intellectual property, decision-making, dispute resolution, and partner exit. These agreements are themselves governance tools, designed to reduce uncertainty and opportunism within the firm.

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Exercise: Express Partnerships

The hypothetical partnership agreement below offers a simple example. As you read it, imagine advising a client who is either about to enter the deal—or litigate it after things have gone wrong. The agreement is short and appears straightforward, but every clause carries assumptions, tradeoffs, and risks worth scrutinizing. Consider what happens if something goes wrong; look for silence in the document—what situations aren’t covered, and where disputes might arise. Consider what assumptions are built into the agreement. What do you think the parties must have believed about each other’s contributions, control, and trust. Do you think those assumptions would be realistic or risky? How does the agreement interact with the default rules in the UPA or RUPA? Are there places where the agreement overrides the defaults? Are there gaps the statute will fill in? If you were one of the partners, what would worry you most? What protections would you want? What terms would you push for—and what would you be willing to give up to get them?

This agreement is intentionally minimal. Your task is twofold: read it for what it says, and imagine how it could evolve, break down, or be improved.

PARTNERSHIP AGREEMENT

This Partnership Agreement (“Agreement”) is made and entered into by and between Riley Chen and Morgan Patel (collectively, the “Partners”) effective as of August 1, 2025.

1. Formation

The Partners hereby form a general partnership under the name LaunchPad Tech Partners (the “Partnership”) for the purpose of developing and marketing mobile productivity applications.

2. Capital and Labor Contributions

Riley Chen shall contribute $20,000 in startup capital. Morgan Patel shall contribute full-time development and design labor for a period of at least 12 months, valued at an equivalent of $20,000. Additional contributions, whether capital or labor, shall require mutual written agreement.

3. Intellectual Property

All software, trademarks, and other intellectual property developed in connection with the business shall be owned jointly by the Partnership unless otherwise agreed in writing. Use of partnership IP by either Partner outside the business is prohibited without written consent.

4. Profits and Losses

Profits and losses shall be shared equally between the Partners. Profit distributions shall not occur until the Partnership has generated at least $30,000 in net revenue or upon mutual agreement.

5. Management and Decision-Making

Each Partner shall have equal rights in the management and conduct of the business. Day-to-day technical decisions shall be delegated to Morgan Patel. Financial and strategic decisions (including borrowing or investor engagement) require unanimous consent.

6. Banking and Records

The Partnership shall maintain a dedicated business account. Financial records shall be maintained using standard accounting software and shall be available for inspection by either Partner on request.

7. Withdrawal, Expulsion, and Exit

A Partner may withdraw with 60 days’ notice. In the event of withdrawal, the remaining Partner shall have the option to purchase the departing Partner’s interest at fair market value, as determined by an independent appraiser. If no agreement is reached, the Partnership shall be dissolved.

8. Non-Compete

For one year following withdrawal, a departing Partner shall not engage in any business that directly competes with the Partnership within the United States, unless otherwise agreed in writing.

9. Dispute Resolution

All disputes arising under this Agreement shall first be submitted to mediation. If unresolved, disputes shall be subject to binding arbitration in the state of formation under the rules of the American Arbitration Association.

10. Entire Agreement

This Agreement constitutes the entire agreement between the Partners. Amendments must be in writing and signed by both Partners.

IN WITNESS WHEREOF, the Partners have executed this Agreement on the date first written above.

[Notes & Questions]{.smallcaps}

1. How does this agreement modify the default rules for capital contributions and profit sharing under UPA/RUPA?

2. Would the IP clause be enforceable under the default rules? What would happen without it?

3. Does the agreement give either partner more control? How does it handle tie-breaking?

4. Would you give up veto power over financial decisions in exchange for equity protection?

5. Would you accept a narrower non-compete in exchange for more favorable buyout terms?

6. Would you agree to deferred profit distributions in exchange for a guaranteed salary?

7. How would you add in the following clauses: 1) A vesting schedule for equity interests; 2) A “drag-along” or “tag-along” provision if the company is acquired; 3) A clause covering investor admission or conversion to a corporate entity; 4) A founder expulsion mechanism for misconduct or nonperformance.

Partnership Property

One of the clearest places where individual and collective interests collide in a partnership is in the treatment of property. Every partner faces competing incentives: to contribute as little as possible to the collective venture, while extracting as much as possible for personal benefit. Left unchecked, these incentives would lead to underinvestment, opportunism, and ultimately, partnership failure. The legal framework governing partnership property helps manage those risks by defining what belongs to the partnership, how it can be used, and who has authority over it.

Ownership and Management of Partnership Property

Under RUPA §201(a), a partnership is a legal entity distinct from its partners. This entity status means the partnership—not the individual partners—owns its assets, and that property cannot be claimed, used, or sold by individual partners acting alone. Even valuable property originally contributed by a partner becomes partnership property once transferred to the firm. This structure reduces transaction costs in two directions: it limits internal disputes among partners over asset control, and it provides external clarity to third parties who transact with the partnership. Entity status allows counterparties to rely on the firm itself as the owner of property, rather than investigating the personal rights or intentions of individual partners.

The default rules about property ownership also reduce monitoring costs among partners. If property belongs to the firm, and fiduciary duties prohibit self-dealing or misappropriation, then partners can collaborate without having to constantly police one another’s use of shared assets. This, in turn, facilitates trust and efficient operation—key goals of both transactional law and economic efficiency.

Still, disputes over property can and do arise—especially during dissolution, bankruptcy, or financial distress. At these moments, it becomes tempting for partners to reclaim property they once contributed or assert control over assets they use most frequently. But the law makes clear that once property is contributed, it belongs to the firm, not the individual. That principle helps avoid destructive scrambles for resources and instead channels conflicts into orderly processes guided by the partnership agreement or statutory defaults.

Importantly, partners who wish to avoid this outcome can structure their contributions accordingly. Rather than transferring ownership of a beloved or strategic asset to the firm, a partner can lease or license it instead. This protects personal interests while still allowing the business to benefit from the asset. In this way, the rules on partnership property preserve both equity and flexibility: they reduce the transaction costs of collaboration, while allowing customized arrangements where appropriate.

__________

The following case illustrates how these principles play out when a partnership ends and the key asset in dispute—intellectual property—is governed by both a partnership agreement and the statutory defaults. As you read, consider how the partnership agreement describes the contribution of the intellectual property and process for determining ownership. How does the court handle a conflict between the partnership agreement and the UPA? What justifies the court’s choice? Do the majority and dissenting opinions agree about what partnership property is? Where do they diverge?

Pav-Saver Corp. v. Vasso Corp.
493 N.E.2d 423 (Ct. App. Ill. 1994)

Justice BARRY delivered the opinion of the court.

1. The matter before us arises out of the dissolution of the parties’ partnership, the Pav-Saver Manufacturing Company. . .

1. . . . In 1974 Dale, individually, together with PSC and Meersman formed Pav-Saver Manufacturing Company for the manufacture and sale of Pav-Saver machines. Dale agreed to contribute his services, PSC contributed the patents and trademark necessary to the proposed operation, and Meersman agreed to obtain financing for it. The partnership agreement was drafted by Meersman and approved by Attorney Charles Peart, president of PSC. The agreement contained two paragraphs which lie at the heart of the appeal and cross-appeal before us: . . .

   “3. . . . [PSC] grants to the partnership exclusive license without charge for its patent rights . . . for the term of this agreement. . . It being understood and agreed that same shall remain the property of [PSC] and all copies shall be returned to [PSC] at the expiration of this partnership. . .”

   “11. It is contemplated that this joint venture partnership shall be permanent, and same shall not be terminated or dissolved by either party except upon mutual approval of both parties. If, however, either party shall terminate or dissolve said relationship, the terminating party shall pay to the other party, as liquidated damages, a sum equal to four (4) times the gross royalties received by PAV–SAVER Corporation in the fiscal year ending July 31, 1973, as shown by their corporate financial statement. Said liquidated damages to be paid over a ten (10) year period next immediately following the termination, payable in equal installments.”

2. . . . On March 17, 1983, Attorney Charles Peart, on behalf of PSC, wrote a letter to Meersman terminating the partnership and invoking the provisions of paragraph 11 of the parties’ agreement.

3. . . . PSC then sued in the circuit court of Rock Island County for a court-ordered dissolution of the partnership, return of its patents and trademark, and an accounting. Vasso counterclaimed for declaratory judgment that PSC had wrongfully terminated the partnership and that Vasso was entitled to continue the partnership business, and other relief pursuant to the Illinois Uniform Partnership Act. . . The trial court ruled that PSC had wrongfully terminated the partnership; that Vasso was entitled to continue the partnership business and to possess the partnership assets, including PSC’s trademark and patents. . .

4. Initially we must reject PSC’s argument that the trial court erred in refusing to return Pav-Saver’s patents and trademark pursuant to paragraph 3 of the partnership agreement, or in the alternative that the court erred in refusing to assign a value to PSC’s property in valuing the partnership assets. The partnership agreement on its face contemplated a “permanent” partnership, terminable only upon mutual approval of the parties (paragraph 11). It is undisputed that PSC’s unilateral termination was in contravention of the agreement. The wrongful termination necessarily invokes the provisions of the Uniform Partnership Act so far as they concern the rights of the partners. Upon PSC’s notice terminating the partnership, Vasso elected to continue the business pursuant to section 38(2)(b) of the Uniform Partnership Act. . . Ergo, despite the parties' contractual direction that PSC's patents would be returned to it upon the mutually approved expiration of the partnership (paragraph 3), the right to possess the partnership property and continue in business upon a wrongful termination must be derived from and is controlled by the statute. Evidence at trial clearly established that the Pav-Saver machines being manufactured by the partnership could not be produced or marketed without PSC's patents and trademark. Thus, to continue in business pursuant to the statutorily-granted right of the party not causing the wrongful dissolution, it is essential that paragraph 3 of the parties' agreement—the return to PSC of its patents—not be honored.

5. . . . [T]he Uniform Partnership Act specifically states that “the value of the good will of the business shall not be considered” (Ill.Rev.Stat.1983, ch. 106½, par. 38(2)(c)(II)), we find that the trial court properly rejected PSC’s good will evidence of the value of its patents and trademark in valuing its interest in the partnership business.

Justice STOUDER, concurring in part—dissenting in part:

1. . . . I cannot, however, accept the majority's conclusion the defendant is entitled to retention of the patents. . .

1. The partnership agreement entered into by PSC and Vasso in pertinent part provides:

“3.B.(2) [PSC] grants to the partnership exclusive license without charge for its patent rights * * * for the term of this agreement. * * * [I]t being understood and agreed that same shall remain the property of [PSC] * * * and shall be returned to [PSC] at the expiration of this partnership * * *”

1. The majority holds this provision in the contract is unenforceable. The only apparent reason for such holding is that its enforcement would affect defendant's option to continue the business. No authority is cited to support such a rule. . .

2. Here, express terms of the partnership agreement deal with the status of the patents and measure of damages, the question is settled thereby. I think it clear the parties agreed the partnership only be allowed the use of the patents during the term of the agreement. The agreement having been terminated, the right to use the patents is terminated. The provisions in the contract do not conflict with the statutory option to continue the business and even if there were a conflict the provisions of the contract should prevail. . .

3. . . . I would vacate that part of the judgment providing defendant is entitled to continue use of the patents and provide that use shall remain with plaintiff.

[Notes & Questions]{.smallcaps}

1. Can partners contract around the default rules of the Uniform Partnership Act?
   Are there limits to that ability?

How did the majority justify allowing Vasso to retain use of PSC’s patents, despite the agreement? What role did the Uniform Partnership Act play in that conclusion?

What practical importance is there in the partners’ declaring their partnership to be “permanent?” What are the risks associated with agreeing to a “permanent” partnership? Under what circumstances would you recommend that a client agree to such a partnership?

If you were PSC’s attorney, how could you have altered the partnership agreement in order to avoid this outcome?

Partners’ Authority

The flexibility of the partnership form allows parties to design businesses that meet their specific needs—but that flexibility comes with a cost: ambiguity about decision-making authority. Unlike a sole proprietorship, where control is centralized, partnerships inherently involve shared governance. This raises practical concerns: Who decides when partners disagree? How are tie-breakers resolved? What happens when authority is unclear or unevenly exercised?

These governance questions become especially urgent when a partnership has only two partners, risking deadlock, or when it has several, inviting shifting coalitions and instability. Without clear rules, partnerships may suffer from internal gridlock, erratic policy shifts, or opportunistic decision-making. The result is increased transaction costs—both internally among partners and externally with third parties who rely on clear lines of authority.

To address these risks, partnership law supplies a set of majoritarian default rules—rules that reflect what most investors would have agreed to had they negotiated in advance. These defaults allocate equal management rights to all partners, RUPA §401(f), and grant each partner the apparent authority to bind the firm in the ordinary course of business, RUPA §301. But these defaults can be—and often should be—modified by agreement.

This combination of structured defaults and freedom of contract reflects both economic and public choice principles. Defaults reduce initial transaction costs by offering a ready-made framework, while private ordering allows partners to reallocate authority based on capital contributions, expertise, or risk preferences. A well-drafted partnership agreement can clarify who controls what, mitigate agency costs, and avoid costly disputes before they arise.

Good lawyers guide clients through this terrain by anticipating where conflicts are likely to occur and drafting governance terms that resolve them efficiently. To do so effectively, lawyers must understand not only what the default rules are, but how they shape bargaining—and what happens if the parties remain silent.

The Scope of Authority of Individual Partners

Determining exactly what authority each partner has begins with the default rules, as modified by any agreements between the partners. As you read the next case and accompanying materials, consider what the default rule is for who makes what kind of decisions in a partnership. Does the law treat some kinds of decisions differently? How does the court deal with conflicts between partners with equal authority? Does it matter if the third party knows about the dispute between the partners?

National Biscuit Co. v. Stroud
106 S.E.2d 692 (N.C. 1959)

1. In March 1953 C. N. Stroud and Earl Freeman entered into a general partnership to sell groceries under the name of Stroud's Food Center. Thereafter plaintiff sold bread regularly to the partnership. Several months prior to February 1956 the defendant Stroud advised an agent of plaintiff that he personally would not be responsible for any additional bread sold by plaintiff to Stroud's Food Center. From 6 February 1956 to 25 February 1956 plaintiff through this same agent, at the request of the defendant Freeman, sold and delivered bread in the amount of $171.04 to Stroud's Food Center. . .

PARKER, Justice.

1. C. N. Stroud and Earl Freeman entered into a general partnership to sell groceries under the firm name of Stroud’s Food Center. There is nothing in the agreed statement of facts to indicate or suggest that Freeman’s power and authority as a general partner were in any way restricted or limited by the articles of partnership in respect to the ordinary and legitimate business of the partnership. Certainly, the purchase and sale of bread were ordinary and legitimate business of Stroud’s Food Center during its continuance as a going concern.

1. Several months prior to February 1956 Stroud advised plaintiff that he personally would not be responsible for any additional bread sold by plaintiff to Stroud’s Food Center. After such notice to plaintiff, it from 6 February 1956 to 25 February 1956, at the request of Freeman, sold and delivered bread in the amount of $171.04 to Stroud’s Food Center. . .

1. G.S. § 59-39(1) . . . reads: “Every partner is an agent of the partnership for the purpose of its business, and the act of every partner, including the execution in the partnership name of any instrument, for apparently carrying on in the usual way the business of the partnership of which he is a member binds the partnership, unless the partner so acting has in fact no authority to act for the partnership in the particular matter, and the person with whom he is dealing has knowledge of the fact that he has no such authority.” . . .

1. G.S. § 59-48 . . . Subsection (e) thereof reads: “All partners have equal rights in the management and conduct of the partnership business.” Subsection (h) hereof is as follows: “Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners.”

2. Freeman as a general partner with Stroud, with no restrictions on his authority to act within the scope of the partnership business so far as the agreed statement of facts shows, had under the Uniform Partnership Act “equal rights in the management and conduct of the partnership business.” Under G.S. § 59-48(h) Stroud, his co-partner, could not restrict the power and authority of Freeman to buy bread for the partnership as a going concern, for such a purchase was an “ordinary matter connected with the partnership business,” for the purpose of its business and within its scope, because in the very nature of things Stroud was not, and could not be, a majority of the partners. Therefore, Freeman’s purchases of bread from plaintiff for Stroud’s Food Center as a going concern bound the partnership and his co-partner Stroud. . .

3. The judgment of the court below is

4. Affirmed.

[Notes & Questions]{.smallcaps}

1. What does it mean that “all partners have equal rights in the management” of the business? As this case shows, equal rights for all partnerships can cause conflicts that interfere with important business decisions. Why, then, is “equal rights” the default rule?

2. The court says that Stroud could not interfere with Freeman’s purchase of bread from Nabisco because Stroud “was not, and could not be, a majority” of a two-person partnership. Are two-person partnerships inherently unstable, or susceptible to this kind of conflict?

3. This dispute led to the dissolution of an otherwise profitable partnership and a legal fight that went to the state Supreme Court, all for a dispute amounting to $171.04 worth of bread ($1,961.93 in 2025). What could a smart lawyer have done, in advance, to resolve this dispute before it destroyed the partnership? What options were there during the formation of the partnership? What about afterward, during operation of the partnership?

4. The court held that when two equal partners disagree about an ordinary business decision—like whether to keep buying bread for a grocery store—neither party can unilaterally block the other’s authority to bind the partnership. What if, instead, one partner had hired a new employee? Would it matter if the other partner expressly objected to the hiring?

5. What rules would you design if you were advising co-founders who trust each other now but may later disagree? How do you strike the right balance between flexibility and clarity, authority and accountability?

Partners’ Duties to the Partnership

Fiduciary duties play a central role in minimizing the risks that arise when individuals co-own and co-manage a business. In employment relationships, owners are principals, and employees are agents—an arrangement that reduces transaction costs by creating incentives for workers to act diligently and honestly. Employers still must monitor employees, but fiduciary duties help lower the costs of oversight and the risk of opportunistic behavior.

In partnerships, those same risks are heightened: each partner has management rights and, under both UPA §15 and RUPA §306, can bind the firm in contract and expose all partners to joint and several liability. A careless or self-interested partner can inflict serious harm—not just on the firm, but on the other partners personally. Fiduciary duties reduce those risks by legally requiring partners to act in the collective interest, rather than pursuing purely private gain.

Under the common law, partners were considered each others’ fiduciaries. UPA §21 shifted that structure by explicitly recognizing fiduciary duties as owed primarily to the partnership itself:

[E]very partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property.

But it would be an oversimplification to conclude that the UPA entirely abrogated the common law understanding of fiduciary duties among partners. The UPA did not abolish that rule so much as re-channel it through the newly emphasized concept of the partnership as a separate legal entity rather than merely an aggregate of its individual partners.

Yet this shift did not erase the mutual responsibilities that flow among the partners themselves. Actions taken by a partner that bind the partnership simultaneously bind all other partners, affirming the mutual agency inherent within partnership structures.

In short, the UPA clarified and structured fiduciary duties more explicitly toward the partnership, but did not negate common law principles of mutual fiduciary responsibility among partners. A partner’s acts bind the firm and every other partner. RUPA § 404 provides that each partner owes the duties of loyalty and care “to the partnership and the other partners.” Courts continue to describe every partner as an agent both of the entity and of the co-partners, and they impose joint and several liability for obligations incurred in the ordinary course of business.¹

Yet in most respects, the distinction is semantic, as suggested in Basciano v. L & R Auto Parks, Inc., 2011 WL 6372455 (E.D. Pa. Dec. 20, 2011), which cited California’s version of the RUPA in the following passage:

In California, all partners are jointly and severally liable for partnership debts, and thus, any action the partnership takes within the scope of the partnership binds all of the partners individually. For more than 130 years, California courts have followed the traditional law of partnership whereby the acts of the partnership—and/or its partners²—can bind all general partners; in other words, the partnership is an agent for all of the general partners in California. ”[E]ach partner acts as principal for himself or herself and as agent for the copartners in the transaction of partnership business.” “[One partner] can bind the other partners without obtaining their written consent.” “‘Each partner is the agent of the other partners in all transactions relating to the partnership business.’”

Entity-focused duties still leave room for opportunistic behavior between partners. For instance, a partner could harm another partner’s interests in ways that do not clearly harm the partnership itself. Recognizing this, RUPA § 404 makes fiduciary duties owed both to the partnership and the other partners:

RUPA §404 – General Standards of Partner’s Conduct

(a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c).

(b) Duty of Loyalty includes:

(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;

(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and

(3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.

(c) A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.

(d) A partner shall discharge the duties to the partnership and the other partners under this [Act] or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing. Duty of Care requires refraining from gross negligence, reckless conduct, willful misconduct, or knowing violation of the law.

By default, then, partners are expected to prioritize the shared enterprise over their own competing interests. This reduces transaction costs by limiting the need for constant monitoring and dispute resolution among partners. But the rules also allow flexibility: through express agreement, partners can define the scope of the partnership, narrow fiduciary obligations, or clarify what activities are off-limits. In this way, the law balances reduced oversight costs with contractual freedom.

__________

The next case, Meinhard v. Salmon, is well known, particularly for its flowery language regarding the duty allegedly owed by one partner to the other. As you read the case, consider what Salmon did that, according to Justice Cardozo, breached fiduciary duties. Were these the kind of actions that fiduciary duties were designed to discourage? Is there anything Salmon could have done to avoid breaching his fiduciary duties? Does Justice Andrews, in dissent, disagrees with Cardozo’s representation of the facts, the legal principles Cardozo applies, or both?

Meinhard v. Salmon
164 N.E. 545 (N.Y. 1928)

CARDOZO, C.J.

1. On April 10, 1902, Louisa M. Gerry leased to the defendant Walter J. Salmon the premises known as the Hotel Bristol at the northwest corner of Forty-Second street and Fifth avenue in the city of New York. The lease was for a term of 20 years, commencing May 1, 1902, and ending April 30, 1922. The lessee undertook to change the hotel building for use as shops and offices at a cost of $200,000. Alterations and additions were to be accretions to the land.

2. Salmon, while in course of treaty with the lessor as to the execution of the lease, was in course of treaty with Meinhard, the plaintiff, for the necessary funds. The result was a joint venture with terms embodied in a writing. Meinhard was to pay Salmon half of the moneys requisite to reconstruct, alter, manage, and oprate the property. Salmon was to pay to Meinhard 40 per cent. of the net profits for the first five years of the lease and 50 per cent. for the years thereafter. If there were losses, each party was to bear them equally. Salmon,, however, was to have sole power to “manage, lease, underlet and operate” the building. . .

3. The two were coadventurers, subject to fiduciary duties akin to those as partners. As to this we are all agreed.

1. When the lease was near its end, Elbridge T. Gerry had become the owner of the reversion. He owned much other property in the neighborhood. . . He had a plan to lease the entire tract for a long term to some one who would destroy the buildings then existing and put up another in their place. . . [I]n January, 1922, with less than four months of the lease to run, he approached the defendant Salmon. The result was a new least to the Midpoint Realty Company, which is owned and controlled by Salmon, a lease covering the whole tract, and involving a huge outlay. The term is to be 20 years, but successive covenants for renewal will extend it to a maximum of 80 years. . .

2. The lease between Gerry and the Midpoint Realty Company was signed and delivered on January 25, 1922. Salmon had not told Meinhard anything about it.Whatever his motive may have been, he had kept the negotiations to himself. Meinhard was not informed even of the bare existence of a project. The first that he knew of it was in February, when the lease was an accomplished fact. He then made demand on the defendants that the lease be held in trust as an asset of the venture. . .The demand was followed by refusal, and later by this suit.

3. Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion” of particular exceptions. Wendt v. Fischer, 243 N.Y. 439, 444. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. . .

4. . . .To the eye of an observer, Salmon held the lease as owner in his own right, for himself and no one else. In fact he held it as a fiduciary, for himself and another, sharers in a common venture. If this fact had been proclaimed, if the lease by its terms had run in favor of a partnership, Mr. Gerry, we may fairly assume, would have laid before the partners, and not merely before one of them, his plan of reconstruction. The pre-emptive privilege, or, better, the pre-emptive opportunity, that was thus an incident of the enterprise, Salmon appropriate to himself in secrecy and silence. He might have warned Meinhard that the plan had been submitted, and that either would be free to compete for the award. If he had done this, we do not need to say whether he would have been under a duty, if successful in the competition, to hold the lease so acquired for the benefit of a venture than about to end. . .The trouble about his conduct is that he excluded his coadventurer from any chance to compete, from any chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency. This chance, if nothing more, he was under a duty to concede. The price of its denial is an extension of the trust at the option and for the benefit of the one whom he excluded.

5. . . .The very fact that Salmon was in control with exclusive powers of direction charged him the more obviously with the duty of disclosure, since only through disclosure could opportunity be equalized. If he might cut off renewal by a purchase for his own benefit when four months were to pass before the lease would have an end, he might do so with equal right while there remained as many years. He might seal a march on his comrade under cover of the darkness, and then hold the captured ground. Loyalty and comradeship are not so easily abjured. . .

6. We have no thought to hold that Salmon was guilty of a conscious purpose to defraud. Very likely he assumed in all good faith that with the approaching end of the venture he might ignore his coadventurer and take the extension for himself. He had given to the enterprise time and labor as well as money. He had made it a success. Meinhard, who had given money, but neither time nor labor, had already been richly paid. There might seem to be something grasping in his insistence upon more. Such recriminations are not unusual when coadventurers fall out. They are not without their force if conduct is to be judged by the common standards of competitors. That is not to say that they have pertinency here. Salmon had put himself in a position in which thought of self was to be renounced, however hard the abnegation. He was much more than a coadventurer He was managing coadventurer. For him and for those like him the rule of undivided loyalty is relentless and supreme. A different question would be here if there were lacking any nexus of relation between the business conducted by the manager and the opportunity brought to him as an incident of management. . .If Salmon had received from Gerry a proposition to lease a building at a location far removed, he might have held for himself the privilege thus acquired, or so we shall assume. Here the subject-matter of the new lease was an extension and enlargement of the subject-matter of the old one. A managing coadventurer appropriating the benefit of such a lease without warning to his partner might fairly expect to be reproached with conduct that was underhand, or lacking, to say the lease, in reasonable candor, if the partner were to surprise him in the act of signing the new instrument. Conduct subject to that reproach does not receive from equity a healing benediction.

ANDREWS, J. (dissenting).

1. . . .It may be stated generally that a partner may not for his own benefit secretly take a renewal of a firm lease to himself. Yet under very exceptional circumstances this may not be wholly true. . .

1. . . .[I] am of the opinion that the issue here is simple. Was the transaction, in view of all the circumstances surrounding it, unfair and inequitable? I reach this conclusion for two reasons.. There was no general partnership, merely a joint venture for a limited object, to end at a fixed time. The new lease, covering additional property, containing many new and unusual terms and conditions, with a possible duration of 80 years, was more nearly the purchase of the reversion than the ordinary renewal with which the authorities are concerned. . .

2. Under these circumstances the referee has found and the Appellate Division agrees with him, that Mr. Meinhard is entitled to an interest in the second lease, he having promptly elected to assume his share of the liabilities imposed thereby. This conclusion is based upon the proposition that under the original contract between the two men ‘the enterprise was a joint venture, the relation between the parties was fiduciary and governed by principles applicable to partnerships,’ therefore, as the new lease is a graft upon the old, Mr. Salmon might not acquire its benefits for himself alone.

3. Were this a general partnership between Mr. Salmon and Mr. Meinhard, I should have little doubt as to the correctness of this result, assuming the new lease to be an offshoot of the old. Such a situation involves questions of trust and confidence to a high degree; it involves questions of good, will; many other considerations. . .

4. The one complaint made is that Mr. Salmon obtained the new lease without informing Mr. Meinhard of his intention. Nothing else. There is no claim of actual fraud. No claim of misrepresentation to any one. Here was no movable property to be acquired by a new tenant at a sacrifice to its owners. No good will, largely dependent on location, built up by the joint efforts of two men. Here was a refusal of the landlord to renew the Bristol lease on any terms; a proposal made by him, not sought by Mr. Salmon, and a choice by him and by the original lessor of the person with whom they wished to deal .

5. . . .I think . . .that in the absence of some fraudulent or unfair act the secret purchase of the reversion even by one partner is rightful. Substantially this is such a purchase. Because of the mere label of a transaction we do not place it on one side of the line or the other. . . No fraud no deceit, no calculated secrecy is found. Simply that the arrangement was made without the knowledge of Mr. Meinhard. I think that is not enough.

[Notes & Questions]{.smallcaps}

1. Cardozo uses a lot of flowery language (“Not honesty alone, but the punctilio of an honor the most sensitive. . .”), but what is the exact standard that he is applying? As a lawyer, what advice could you give your client from this case that would be helpful in governing their behavior?

2. Cardozo suggests multiple things that Salmon might have done—“warning” Meinhard, allowing him to compete—but does not explicitly state what Salmon’s fiduciary duties required him to do. Ignoring Cardozo for a moment, what do you think fiduciary duties require of Salmon? Is Andrew’s formulation any better?

3. Cardozo repeatedly refers to the relationship between Meinhard and Salmon as being a “joint venture,” rather than a partnership. Cardozo treats the two as equivalent, for the purposes of fiduciary duties, but is that true? Courts traditionally define a joint venture as “an association of parties . . . to engage in a single business enterprise for profit” (McRoberts v. Phelps, 391 Pa. 591 (1958)). If a joint venture is just for a specific business opportunity, is it even possible for fiduciary duties to extend beyond the express terms of the 20-year term of the agreement?

4. Early in the case, Cardozo presents the relationship between Meinhard and Salmon as being a close one, almost akin to comrades in arms, but later treats this as a business venture. Are coventurers in business required to be close comrades, or should they be treated as sophisticated parties who are investing in businesses?

5. Near the end of his opinion (not in this excerpt), Cardozo reveals that Meinhard had, five years previous to the disputed actions, assigned all of his interest in the venture to his wife. Cardozo concludes that this has no effect on the analysis. Do you agree with his conclusion?

6. Recall, from Chapter 2, the case of Community Counseling Services, Inc. v. Reilly. The agent spent the last few weeks of employment attempting to convince his principal’s customers to leave and do business with him. The court stated that Reilly would have been fine competing against his former employer, but only once his employment was at an end. Is Cardozo drawing on the same intuition in Meinhard? Does the principle translate well from agency to partnership?

7. Would the following scenarios represent a violation of fiduciary duties, if they were partnerships? If they were joint ventures?

   a. MacDonald and Morgan agreed to work together to acquire and develop oil and gas leases. Morgan contributed capital, while MacDonald handled lease acquisition. MacDonald failed to disclose that he had used some of the joint funds to acquire additional leases in his own name and refused to share details with Morgan.

   b. Three investors formed a business venture to lease and redevelop a commercial property. One member, Thomas, later bought out the other two for a premium, without disclosing that he was in active negotiations to sell the property to a third party for a significantly higher amount.

   c. Two brothers and their father jointly operated a cattle business without a formal agreement. One brother sold cattle and deposited the proceeds into a personal account, using them to pay off unrelated debts. He also made decisions about ranch operations without consulting the other two family members.

   d. Two individuals jointly invested in a real estate purchase. Billings negotiated the deal and closed the sale, while Katz provided financing. After the purchase, Katz learned that Billings had received a secret rebate from the seller as part of the closing, which he did not disclose.

   e. Two sisters and a business associate formed a business venture to acquire and manage a hotel property. The associate represented that he was contributing matching equity, but he actually financed part of his share through an undisclosed commission on the sale and did not inform the sisters of the arrangement.

__________

Meinhard v. Salmon raises important questions about when someone currently involved in a partnership can begin planning for their future. Cardozo offers no legal precedent for his conclusion that Salmon was required to apply fiduciary standards not only to his behavior within the current partnership, but also to a business opportunity that was to begin after the termination of the current partnership.

Because partnerships are based on mutual assent, they must be allowed to withdraw or end the partnership. We will discuss the various ways that can happen in the next section, but Cardozo, in Meinhard, strongly implies that there are strict limitations on when and how a partner can begin making arrangements for life after the partnership.

The answer to that question has wider implications, because the logical extreme of Cardozo’s logic is that a partner’s fiduciary duties extend beyond the boundaries of the partnership. In Meinhard, the relevant boundaries were temporal, but a partnership has other boundaries within the same time period. For example, a partner might have multiple ventures ongoing at one time. Very few sophisticated investors would choose to join a partnership if the fiduciary duties that flowed from it encompassed all of their activities, rather than being applicable only to the subject of the partnership. How broad and deep are these fiduciary duties? The following case will help you consider that question, in a familiar context—a law firm.

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As you read the following case, consider the timeline of Meehan and Boyle’s preparations to leave the firm. For each step, consider what factors made the step objectionable (or not) to the court. Was it the fact that it took place before/after the separation? Was it the secrecy? Was it the deception? What resources of the firm did Meehan and Boyle use in planning and effectuating their departure? Why is that particularly troubling, from a fiduciary perspective?

Meehan v. Shaughnessy
535 N.E.2d 1255 (Mass. 1989)

HENNESSEY, Chief Justice.

1. The plaintiffs, James F. Meehan (Meehan) and Leo V. Boyle (Boyle), were partners of the law firm, Parker, Coulter, Daley & White (Parker Coulter). . .

2. Meehan and Boyle had become dissatisfied at Parker Coulter. . . On July 1, Meehan and Boyle decided to leave Parker Coulter and form their own partnership.

3. Having decided to establish a new firm, Meehan and Boyle then focused on whom they would invite to join them. [The court describes their efforts to convince certain junior partners, including the head of Parker Coulter’s appellate practice, and promising associates to join them at their new firm, MBC.]. . .

4. . . .Boyle prepared form letters to send to clients and referring attorneys as soon as Parker Coulter was notified of the separation. He also drafted a form for the clients to return to him at his home address authorizing him to remove cases to MBC. An outside agency typed these materials on Parker Coulter’s letterhead. Schafer prepared similar letters and authorization forms. . . .

5. . . .On November 30, 1984, a partner, Maurice F. Shaughnessy (Shaughnessy), approached Boyle and asked him whether Meehan and Boyle intended to leave the firm. Shaughnessy interpreted Boyle’s evasive response as an affirmation of the rumors. Meehan and Boyle then decided to distribute their notice that afternoon, which stated, as their proposed date for leaving, December 31, 1984. A notice was left on the desk of each partner. . .

6. Boyle had begun to make telephone calls to referring attorneys on Saturday morning, December 1. He had spoken with three referring attorneys by that date and told them of his departure from Parker Coulter and his wish to continue handling their cases. On December 3, he mailed his previously typed letters and authorization forms, and by the end of the first two weeks of December he had spoken with a majority of referring attorneys, and had obtained authorizations from a majority of clients whose cases he planned to remove to MBC. . . .

7. . . .Throughout December, Meehan, Boyle, and Schafer continued to communicate with referring attorneys on cases they were currently handling to discuss authorizing their transfer to MBC. . . .

8. . . .We agree that Meehan and Boyle, through their preparation for obtaining clients’ consent, their secrecy concerning which clients they intended to take, and the substance and method of their communications with clients, obtained an unfair advantage over their former partners in breach of their fiduciary duties.

9. A partner has an obligation to “render on demand true and full information of all things affecting the partnership to any partner.” G.L. c. 108A, § 20. On three separate occasions Meehan affirmatively denied to his partners, on their demand, that he had any plans for leaving the partnership. During this period of secrecy, Meehan and Boyle made preparations for obtaining removal authorizations from clients. Meehan traveled to New York to meet with a representative of USAU and interest him in the new firm. Boyle prepared form letters on Parker Coulter’s letterhead for authorizations from prospective MBC clients. Thus, they were “ready to move” the instant they gave notice to their partners.

10. On giving their notice, Meehan and Boyle continued to use their position of trust and confidence to the disadvantage of Parker Coulter. The two immediately began communicating with clients and referring attorneys. Boyle delayed providing his partners with a list of clients he intended to solicit until mid-December, by which time he had obtained authorization from a majority of the clients.

11. Finally, the content of the letter sent to the clients was unfairly prejudicial to Parker Coulter. . . The ABA Committee on Ethics and Professional Responsibility, in Informal Opinion 1457 (April 29, 1980), set forth ethical standards for attorneys announcing a change in professional association. . . The ethical standard provides that any notice explain to a client that he or she has the right to decide who will continue the representation. Here, the [trial] judge found that the notice did not “clearly present to the clients the choice they had between remaining at Parker Coulter or moving to the new firm.” By sending a one-side announcement, on Parker Coulter letterhead, so soon after notice of their departure, Meehan and Boyle excluded their partners from effectively presenting their services as an alternative to those of Meehan and Boyle.

12. Meehan and Boyle could have foreseen that the news of their departure would cause a certain amount of confusion and disruption among their partners. The speed and preemptive character of their campaign to acquire clients’ consent took advantage of their partners’ confusion. By engaging in these preemptive tactics, Meehan and Boyle violated the duty of utmost good faith and loyalty which they owed their partners. Therefore, we conclude that the judge erred in deciding that Meehan and Boyle acted properly in acquiring consent to remove cases to MBC. . .

    [Notes & Questions]{.smallcaps}

1. Most of the problematic actions in this case were communications with other parties—associates, partners, clients. If you were planning on leaving a partnership, does the law prohibit all communications, or only certain types? How would you have changed the communication strategy of Meehan and Boyle, in order to avoid losing the case?

2. The court echoes some of Cardozo’s language, in referring to the “utmost good faith and loyalty” required of partners. A strict standard like that reduces certain transaction costs—oversight by other partners—but there are always tradeoffs. What is the cost of adopting a strict standard of loyalty? Does it increase or decrease the cost when the standard is also somewhat ambiguous (what does it mean to give “utmost” loyalty and good faith)?

3. Consider the perspective of those who remained at the law firm. You know that, someday, you might want to leave the firm, as well, but you want to avoid the kind of disruption that was caused by Meehan and Boyle’s chaotic departure. How would you change the partnership agreement, to minimize the future risks?

4. Consider the interests of the firm’s clients. Would siding with the law firm or with the departing partners better protect the interests of those clients? If the goal of business law is to minimize transaction costs, should we consider the interests of clients, or just those of the partners?

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Both Meinhard v. Salmon and Meehan v. Shaughnessy illustrate that there are certain actions that partnership fiduciary duties do not permit. An important question remains—do those duties require partners to take specific actions? In other words, might a partner get into trouble for not doing something? The following case illustrates one possible scenario where affirmative action might be required.

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As you read the following case, consider how the purpose of the partnership might create an affirmative duty to act under certain circumstances. How would a court go about determining when to invoke that affirmative duty?

Sandvick v. Lacrosse
747 N.W.2d 519 (N.D. 2008)

SANDSTROM, Justice.

1. Monte Sandvick and Joedy Bragg appeal the district court judgment dismissing their lawsuit against William LaCrosse and Frank Haughton following a bench trial in which the court found neither a partnership nor a joint venture existed between the parties in regard to oil and gas leases held by the parties. We reverse and remand, concluding . . . that there was a joint venture and that LaCrosse and Haughton breached their fiduciary duties of loyalty to Sandvick and Bragg.

1. In May 1996, Sandvick, Bragg, LaCrosse, and Haughton purchased three oil and gas leases in Golden Valley County, North Dakota. The leases were . . . standard, paid-up leases with terms of five years and did not contain any provision for extending or renewing them. Empire Oil Company, owned by LaCrosse, held record title to the leases. . . Sandvick testified the parties’ initial intent was to try to sell the leases during the five-year term. . .

2. In November 2000, Haughton and LaCrosse purchased three oil and gas leases on the [same] property. These leases were . . . set to begin at the expiration of the initial [leases]. . . The [new] leases covered the same acreage as the [original leases] and had a five-year term, with the title in the name of Empire Oil Company. . . Prior to purchasing the [new] leases, LaCrosse and Haughton twice offered to purchase Sandvick’s and Bragg’s interests in the [original] leases, but Sandvick and Bragg refused. Haughton testified he did not inform either Sandvick or Bragg that he and LaCrosse had purchased the [new] leases.

3. In 2004, Sandvick and Bragg sued LaCrosse and Haughton, claiming they breached their fiduciary duties by not offering Sandvick and Bragg an opportunity to purchase the top leases with them. The trial was limited to the issues regarding the existence, life span, and scope of a partnership or joint venture. Following the bench trial, the district court concluded no partnership or joint venture existed. . .

II

1. On appeal, Sandvick and Bragg argue the district court erred in concluding the parties were not partners. In North Dakota, a partnership is “an association of two or more persons to carry on as co-owners a business for profit.” The crucial elements of a partnership are (1) an intention to be partners, (2) co-ownership of the business, and (3) a profit motive. . . 

2. [The North Dakota Supreme Court stated that, under North Dakota law, a business requires a “series” of acts, and that the purchase of the leases was a single occurrence. Without a series of acts by the purported partners, there was no business and, therefore, no partnership]

III

1. Sandvick and Bragg argue the district court erred in concluding a joint venture did not exist. A joint venture is similar to a partnership but is more limited in scope and duration, and principles of partnership law apply to the joint venture relationship. “For a business enterprise to constitute a joint venture, the following four elements must be present: (1) contribution by the parties of money, property, time, or skill in some common undertaking, but the contributions need not be equal or of the same nature; (2) a proprietary interest and right of mutual control over the engaged property; (3) an express or implied agreement for the sharing of profits, and usually, but not necessarily, of losses; and (4) an express or implied contract showing a joint venture was formed.” There is, however, no fixed formula for identifying the joint venture relationship in all cases, and each case will depend upon its own unique facts. . .

2. [The North Dakota Supreme Court reviewed the district court’s conclusion that no joint venture existed, but held that certain actions by the parties were evidence of the existence of a joint venture, including that]:

3. . . .(1) LaCrosse opened a checking account under the name Empire Oil JV Account; (2) the leases were purchased from the parties’ credits in the Empire Oil Company JV account in equal shares; (3) title to the leases was held in Empire Oil Company’s name; and (4) the parties’ intent in acquiring the leases was to sell them. At trial, Bragg, LaCrosse, and Haughton testified that any profits would have been shared had the [original] leases been sold. This testimony, along with the court’s findings above, demonstrates the existence of a joint venture. We conclude a joint venture did exist in regard to the parties’ purchase of the Horn leases, because the leases were purchased out of the parties’ checking account funds in equal shares, they were titled in Empire Oil’s name rather than each of the parties’ names, and profits were going to be shared if the leases were sold.

IV

1. Having concluded a joint venture exists, we look to the scope of the venture and decide whether any fiduciary duties were breached by LaCrosse and Haughton. The existence and scope of a fiduciary duty depends upon the language of the parties’ agreement. . .

2. Under N.D.C.C. § 45–16–04(1), a partner owes duties of loyalty and care to the other partners. The duty of loyalty is set forth in N.D.C.C. § 45–16–04(2):

   a. To account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;

   b. To refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and

   c. To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.

3. “Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty.” . . .

4. In this case, the scope of the venture was to purchase and then attempt to sell the [original] leases. Approximately six months prior to the expiration of the leases, LaCrosse and Haughton purchased [the new] leases, . . . that were set to begin upon the expiration of the [original] leases. The [new] leases were nearly identical in all respects to the original [original] leases. The [new] leases had the same duration and acreage and were titled in Empire Oil Company’s name. An important difference, however, between the original leases and the top leases was that Sandvick and Bragg were not informed of the acquisition of the [new] leases.

5. Although the original . . . leases did not contain an extension or renewal provision, the [new] leases purchased by LaCrosse and Haughton were effectively extensions of the original . . . leases. . .

6. LaCrosse and Haughton created a conflict of interest by purchasing the [new] leases prior to the expiration of the original leases without notifying Sandvick and Bragg. It was in LaCrosse’s and Haughton’s best interest not to sell the original leases during the remaining six months of the original term. Having excluded Sandvick and Bragg, LaCrosse and Haughton potentially stood to benefit more by waiting to sell the leases until after the original term expired. We conclude LaCrosse and Haughton breached their fiduciary duties of loyalty by taking advantage of a joint venture opportunity when they purchased the [new] leases without informing Bragg and Sandvick. Bragg and Sandvick should have had an opportunity to purchase the top leases with LaCrosse and Haughton. . .

VI

The district court judgment is reversed and remanded for further proceedings consistent with this opinion.

[Notes & Questions]{.smallcaps}

1. Like in Meinhard v. Salmon, this case presents a joint venture, rather than a partnership. The court here says that a partnership requires more than a single act—such as the purchase of an oil and gas lease—but not so for a joint venture. Are the possibilities for opportunistic behavior the same for a joint venture as for a partnership, given this key difference? Could something less than the strict duty of loyalty inhibit opportunism in a joint venture? Would the less formal nature of a joint venture make it easier or harder for the venturers to contract for their own protection?

1. The court points out that it was in the defendants’ interest to not sell the original leases, once they had purchased the new leases. Could the failure to sell the original leases, itself, ever be a breach of fiduciary duty? What circumstances would make that outcome more likely? What circumstances would make it less likely?

2. Imagine Lacrosse had waited until the old leases had expired, and then negotiated with the sellers for the new leases. Would that path have been free from the taint of fiduciary breach? Would such a path have satisfied Cardozo, in Meinhard?

3. Do the fiduciary rules announced in Meinhard, Meehan, and Sandvick raise or lower transaction costs? Do these rules increase or decrease the need for detailed contracts? Might these rules deter individuals from entering into loosely defined partnerships, for fear of complex legal entanglements?

4. If the court had approved of Lacrosse’s behavior in this case, how would it have impacted future partnerships and joint ventures? Would more up-front negotiation have been needed? More detailed exit strategies?

Dissolution, Dissociation, and Winding Up a Partnership

At common law, partnerships were fundamentally voluntary relationships. Because mutual trust and consent were central to their operation, any partner could dissolve the partnership simply by withdrawing. This default rule carried forward into UPA §31, which states that dissolution occurs “[b]y the express will of any partner when no definite term or particular undertaking is specified.” Once a partner exited, the partnership would enter the winding-up phase, where assets were liquidated and obligations settled.

This may seem destabilizing, but it helped control transaction costs and collective action problems. First, the ability to exit deterred opportunism. A partner who was being marginalized or excluded—facing a “freeze-out”—could force liquidation rather than continue in an abusive arrangement. Second, the rule reduced litigation and renegotiation costs by providing a clear escape mechanism when the partnership relationship broke down.

To protect against opportunistic exit, the law allowed partners to contract around this default by forming a partnership for a definite term or particular undertaking. In those cases, a partner could still withdraw, but doing so would not dissolve the partnership, and the withdrawing partner would lose managerial rights and risk forfeiting profits or facing penalties. Courts would also look to the structure and purpose of the venture when deciding whether a term or purpose-based partnership existed, even in the absence of explicit agreement.

This regime balanced flexibility and stability: partners retained the right to leave, but were encouraged to formalize their expectations ex ante. That is, if they did not formalize the details of their relationship via a partnership agreement, they were stuck with default rules that may not reflect the nuances of their arrangement Still, the underlying assumption persisted that changes in partner composition necessarily disrupted the business and required winding up.

The RUPA altered this framework by introducing the concept of “dissociation.” Under RUPA § 601, a partner can leave the partnership, but this no longer triggers automatic dissolution. Instead, the remaining partners may choose to continue the business. This preserves the going-concern value of the firm, reduces disruption, and limits the potential for rent-seeking behavior through strategic withdrawal. Dissolution remains available in limited circumstances, including judicial dissolution when the business becomes impracticable or the economic purpose is frustrated.

The shift from dissolution to dissociation reflects a broader evolution in partnership law: away from fragile, person-based associations and toward durable, enterprise-based entities. It reduces transaction costs for third parties and internal stakeholders alike, preserves business continuity, and encourages clearer up-front contracting. But the core tensions between autonomy and commitment, flexibility and stability, and exit and fairness, remain. Courts continue to mediate those tensions.

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The following two cases demonstrate the process employed by courts when determining whether, in the absence of an express provision in the partnership agreement, a partnership is at will or for term or purpose. As you read through these cases, consider the evidence courts consider when determining whether a partnership is at-will or for a term or particular undertaking. What language in oral or written agreements help the courts decide? Do the parties’ financial expectations play a role in how the courts address these questions? Also, what prompted one partner to seek dissolution? Do the actions of the other partner(s) play a role in the courts’ decision on whether a partnership is at-will or for a term or particular undertaking?

Owen v. Cohen
119 P.2d 713 (Cal. 1941)

CURTIS, Justice.

1. This is an action in equity brought for the dissolution of a partnership and for the sale of the partnership assets in connection with the settlement of its affairs.

1. On or about January 2, 1940, plaintiff and defendant entered into an oral agreement whereby they contracted to become partners in the operation of a bowling-alley business in Burbank, California. The parties did not expressly fix any definite period of time for the duration of this undertaking. For the purpose of securing necessary equipment, plaintiff advanced the sum of $6,986.63 to the partnership, with the understanding that the amount so contributed was to be considered a loan to the partnership and was to be repaid to the plaintiff out of the prospective profits of the business as soon as it could reasonably do so. . . .

2. Plaintiff and defendant opened their partnership bowling-alley on March 15, 1940. From the day of its beginning until the institution of the present action on June 28, 1940—a period of approximately three and one-half months—the business was operated at a profit. . . However, shortly after the business was begun differences arose between the partners with regard to the management of the partnership affairs and their respective rights and duties under their agreement. [The court describes these differences later in the opinion, generated, as the court notes, by Cohen’s “persistent endeavors to become the dominating figure of the enterprise and to humiliate plaintiff before the employees and customers of the bowling-alley.” Cohen refused to do any work, telling Owen to do all the manual labor, and that Cohen would “act as manager and wear the dignity.” Cohen told a mutual friend that Owen would not be around long, and appeared to take actions intended to achieve that outcome.] This continuing lack of harmonious relationship between the partners had its effect on the monthly gross receipts, which, though still substantial, were steadily declining, and at the date of the filing of this action much of the partnership indebtedness, including the aforementioned loan made by plaintiff, remained unpaid. . .

3. . . .Defendant’s objection to the finding that the partnership was one at will is fully justified by the uncontradicted evidence that the partners at the inception of their undertaking agreed that all obligations incurred by the partnership, including the money advanced by plaintiff, were to be paid out of the profits of the business. While the term of the partnership was not expressly fixed, it must be presumed from this agreement that the parties intended the relation should continue until the obligations were liquidated in the manner mutually contemplated. These circumstances negative the existence of a partnership at will, dissoluble at the election of a member thereof, and demonstrate conclusively that the assailed finding is without support in the record. . . .

4. [The court affirmed dissolution on other grounds related to misconduct, despite disagreeing with the trial court’s finding that the partnership was at-will.]

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Comparing Dissolution Standards. The case that follows, Page v. Page, also concerns the right to dissolve. Compare the grounds analyzed in Owen with those in Page. Are the courts applying consistent standards, or does each case reflect a different judicial attitude toward unwinding a partnership over a co-partner's objection?

Fault and Comparative Conduct. The court does not expressly assign fault to either partner. Should courts be required to identify the partner primarily responsible for the breakdown before granting dissolution? What remedy, if any, should a dissolving partner have against the partner whose conduct precipitated the dissolution?

Grounds for Dissolution. In ¶ 3, the court identifies persistent friction and economic dysfunction as grounds warranting judicial dissolution. Is the statutory standard — that a partner's conduct makes continuation 'reasonably impracticable' — evaluated from an objective standpoint, or does a partner's subjective intent matter? Who bears the burden of proving that dissolution is warranted?

Notes & Questions

The Page brothers operated a linen supply business as partners; when the business finally turned profitable after years of losses, one brother sought dissolution. As you read, consider: what evidence would establish that a partnership was formed for a definite term or particular undertaking, rather than at will? The court observes that a partner who dissolves in bad faith may be liable in damages — how does the bad-faith inquiry interact with an otherwise valid at-will dissolution right?

Page v. Page
359 P.2d 41 (Cal. 1961)

TRAYNOR, Justice.

1. Plaintiff and defendant are partners in a linen supply business in Santa Maria, California. Plaintiff appeals from a judgment declaring the partnership to be for a term rather than at will.

1. The partners entered into an oral partnership agreement in 1949. Within the first two years each partner contributed approximately $43,000 for the purchase of land, machinery, and linen needed to begin the business. From 1949 to 1957 the enterprise was unprofitable, losing approximately $62,000. The partnership’s major creditor is a corporation, wholly owned by plaintiff, that supplies the linen and machinery necessary for the day-to-day operation of the business. This corporation holds a $47,000 demand note of the partnership. The partnership operations began to improve in 1958. The partnership earned $3,824.41 in that year and $2,282.30 in the first three months of 1959. Despite this improvement plaintiff wishes to terminate the partnership.

2. The Uniform Partnership Act provides that a partnership may be dissolved “By the express will of any partner when no definite term or particular undertaking is specified.” Corp. Code, § 15031, subd. (1)(b). The trial court found that the partnership is for a term, namely, “such reasonable time as is necessary to enable said partnership to repay from partnership profits, indebtedness incurred for the purchase of land, buildings, laundry and delivery equipment and linen for the operation of such business.” Plaintiff correctly contends that this finding is without support in the evidence. . . .

3. [Defendant testified that the understanding was similar to past partnerships in which profits would be retained until obligations were paid, and that the partnership was to continue until that point.]

4. Upon cross-examination defendant admitted that the former partnership in which the earnings were to be retained until the obligations were repaid was substantially different from the present partnership. The former partnership was a limited partnership and provided for a definite term of five years and a partnership at will thereafter. Defendant insists, however, that the method of operation of the former partnership showed an understanding that all obligations were to be repaid from profits. He nevertheless concedes that there was no understanding as to the term of the present partnership in the event of losses. He was asked: “(W)as there any discussion with reference to the continuation of the business in the event of losses?” He replied, “Not that I can remember.” He was then asked, “Did you have any understanding with Mr. Page, your brother, the plaintiff in this action, as to how the obligations were to be paid if there were losses?” He replied, “Not that I can remember. I can’t remember discussing that at all. We never figured on losing, I guess.”

5. Viewing this evidence most favorably for defendant, it proves only that the partners expected to meet current expenses from current income and to recoup their investment if the business were successful. . . .

6. In the instant case, however, defendant failed to prove any facts from which an agreement to continue the partnership for a term may be implied. The understanding to which defendant testified was no more than a common hope that the partnership earnings would pay for all the necessary expenses. Such a hope does not establish even by implication a “definite term or particular undertaking” as required by section 15031, subdivision (1)(b) of the Corporations Code. All partnerships are ordinarily entered into with the hope that they will be profitable, but that alone does not make them all partnerships for a term and obligate the partners to continue in the partnerships until all of the losses over a period of many years have been recovered. . . .

7. The judgment is reversed.

   [Notes & Questions]{.smallcaps}

1. If a partnership is at-will, that means it can be dissolved at any time. Do you see how the ability to dissolve a partnership can give one partner unanticipated power in the partnership, if dissolution will be harmful to the other partners? You might be able to make that argument if it came to trial, but many partners might give in to the coercion, not realizing the legal arguments at their disposal. Are there ways that you could structure the partnership agreement to limit this kind of opportunistic behavior, in advance?

1. If a partner wishes to dissolve the partnership agreement, and doing so is generally permissible under the law, but doing so would also violate fiduciary duties, what kind of remedy would be available to the injured partner? Would a court offer injunctive relief, halting the dissolution? Would a court award damages and, if so, what would the measure of damages be?

2. What language or provisions would you include in the partnership agreement if you wanted to provide clarity and certainty for your clients, regarding the term of their partnership?

Judicial Dissolution

Even when a partner wants to exit a dysfunctional partnership, doing so voluntarily may come at too high a cost. A partner might be locked into a term or purpose-based partnership, with penalties for early withdrawal. Or they may be in an at-will partnership, but winding up the business could be financially or reputationally damaging. In such situations, judicial dissolution offers an escape: a court can dissolve the partnership when continuation becomes impracticable or the business purpose is unreasonably frustrated.

Both UPA § 32 and RUPA § 801(5) authorize judicial dissolution in cases of partner misconduct, mental incapacity, persistent breaches of duty, or business frustration. While the RUPA’s language is broader and more flexible, both statutes empower courts to intervene when trust and functionality break down.

From an economic perspective, judicial dissolution serves two functions. First, it protects vulnerable partners from abusive tactics like freeze-outs, where majority partners exclude a minority from management or profits. Second, it reduces transaction costs by giving partners a legal recourse when private negotiation fails. This backstop helps deter opportunistic behavior, as abusive partners know they may face court-ordered dissolution.

Still, the doctrine carries risks. If too easily invoked, it may encourage frivolous lawsuits or strategic threats by minority partners hoping to extract concessions. To guard against this, courts require more than mere dissatisfaction—they demand real evidence of misconduct or impracticability. Dissolution is an equitable remedy, so the standard is flexible, but it is not to be taken lightly.

The doctrine also incentivizes ex ante planning. Well-drafted partnership agreements can reduce the need for judicial intervention by specifying grounds for expulsion, dispute resolution processes, and buy-sell clauses that defuse deadlocks. These tools internalize dispute resolution, lower costs, and preserve the firm’s value. Buy-sell agreements, in particular, create self-executing mechanisms that encourage good faith offers and discourage holdout behavior. Even so, no agreement can prevent all conflict.

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The cases that follow illustrate how disputes unfold when planning fails, partners behave badly, or the relationship simply breaks down. As you read, think about the role that timing, trust, and good lawyering play in resolving partnership disputes—or in making them worse. As you lay out the timeline of each case, identify the moment the partnership ended. Consider whether good lawyering could have helped avoid negative outcomes for clients. How does wrongdoing by a partner color the courts’ analysis.

Prentiss v. Sheffel
513 P.2d 949 (Ariz. Ct. App. 1973)

HAIRE, Judge.

1. The question presented by this appeal is whether two majority partners in a three-man partnership-at-will, who have excluded the third partner from partnership management and affairs, should be allowed to purchase the partnership assets at a judicially supervised dissolution sale. We hold that on the facts of this case, such a purchase is proper, and affirm the judgment entered by the trial court.

1. Suit was originally brought by plaintiffs-appellees seeking dissolution of a partnership they had formed with defendant-appellant. The partnership was created for the purpose of acquiring and operating the West Plaza Shopping Center. . .

2. As grounds for dissolution the plaintiffs contended that the defendant had in general been derelict in his partnership duties, and in particular that he had failed to contribute the balance of his proportionate share ($6,000) of the operating losses incurred by the Center. . .

3. Defendant filed a counterclaim seeking a winding up of the partnership and the appointment of a receiver. He contended that his rights as a partner had been violated in that he had been wrongfully excluded from the partnership. . .

4. [The court summarized the trial court’s findings of fact, including that 1) there was no partnership agreement, 2) that plaintiffs eventually told defendant that any further communication should be through attorneys, 3) that defendant had never been denied physical access to the location, 4) that defendant was delinquent in his required payments, and 5) that there was a freeze-out or exclusion of the defendant from partnership management and affairs.]

5. Based upon these and other findings of fact the trial court concluded that a partnership-at-will existed. . .which was dissolved as a result of a freeze-out or exclusion. . . A receiver was appointed. . . The trial court expressly refused the defendant’s request that an order be entered forbidding the plaintiffs from bidding at the contemplated judicial sale. . . .

6. The principal contention urged by the defendant is that he was wrongfully excluded from the management of the partnership, and therefore. . .the plaintiffs should not be allowed to purchase the partnership assets at a judicial sale. The record, however, does not support the defendant’s position. . .[T]here was no indication that such exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith. . .

7. Moreover, the defendant has failed to demonstrate how he was injured by the participation of the plaintiffs in the judicial sale. . .[F]rom all the evidence it appears that if the plaintiffs had not participated, the sales price would have been considerably lower. Absent the plaintiffs’ bid, there would have been only two qualified initial bids, which were $2,076,000 and $2,040,000 respectively. However, which the participation of plaintiffs, whose initial bid was $2,100,000, the final sales price was bid to $2,250,000. Thus it appears that defendant’s 15% interest. . .was considerably enhanced by the plaintiffs’ participation.

8. . . .The defendant characterizes the sale to plaintiffs as a forced sale of his partnership interest. However, defendant was not forced to sell his interest to the plaintiffs. He had the same right to purchase the partnership assets. . .by submitting the highest bid at the judicial sale. His argument that the plaintiffs were bidding “paper” dollars due to their 85% partnership interest is without force. He too could have bid “paper” dollars to the extent of his 15% interest. . .

9. The defendant has cited no cases, nor has this court found any, which have prohibited a partner from bidding at a judicial sale of the partnership assets. . .

10. The judgment of the superior court is affirmed.

__________

Statutory Buyout Rights. Modern partnership statutes provide for statutory buyout rights that allow a dissociating partner to receive the value of her interest without forcing a full dissolution. Would such a provision have changed the outcome here, and is a statutory buyout right generally more or less protective of minority interests than a court-supervised sale?

Fair Market Value as the Measure of Fairness. The majority paid the appraised fair market value for the assets. Is fair market value always the correct measure of fairness in an involuntary dissolution sale? What other valuation theories — going-concern value, liquidation value, replacement cost — might a minority partner legitimately invoke?

Conflict of Interest in Dissolution Sales. Majority partners who purchase partnership assets at a dissolution sale occupy a dual role: as partners winding up the business, they have a fiduciary obligation to maximize sale proceeds; as buyers, they have an economic incentive to minimize the price. Does the court's approval of the judicial sale process adequately address this structural conflict?

Notes & Questions

A limited partner's conduct — actively participating in management decisions — allegedly converted her status from limited to general partner, exposing her to unlimited personal liability. As you read, consider: what specific acts are sufficient under the ULPA to trigger general-partner liability for a limited partner? Does the result suggest that the formal limited/general distinction is more fragile than investors typically assume?

G & S Investments v. Belman
700 P.2d 1358 (Ariz. Ct. App. 1984)

HOWARD, Judge.

1. This case involves a partnership dispute arising out of the misconduct and subsequent death of Thomas N. Nordale. There are two principal issues in this case: whether the surviving general partner, G & S Investments, is entitled to continue the partnership after the death of Nordale, and how the value of Nordale’s interest in partnership property is to be computed. . . .

2. . . .Century Park, Ltd., is a limited partnership. . . In 1982 the general partners were G & S Investments (51 per cent) and Nordale (25.5 per cent). The remaining partnership interest was owned by the limited partners, Jones and Chapin.

3. In 1979 Nordale began using cocaine, which caused a personality change. He became suspicious of his partners and other people, and he could not communicate with other people. . .He stopped returning phone calls and became hyperactive, agitated and angry toward people for no reason. Commencing in 1980 he made threats to some of the other partners, stating that he was going to get them and fix them.

4. Nordale lived in the apartment complex. This led to several problems. He sexually solicited an underage female tenant. . . [and] refused to give up possession or pay rent on an apartment that the partnership had allowed him to use temporarily. . . His lifestyle in the apartment complex created a great deal of tension and disturbance and frightened the tenants. At least one tenant was lost because of the disturbances.

5. . . .Nordale irrationally insisted upon converting the apartment complex into condominiums despite adverse tax consequences and mortgage interest rates that were at an all-time high. He also insisted on raising the rents despite the fact that recent attempts to do so had resulted in mass vacancies which had a devastating economic effect on the partnership enterprise.

6. By 1981. . . G & S Investments. . . concluded that Nordale was incapable of making rational business decisions and that they should seek a dissolution of the partnership which would allow them to carry on the business and buy out Nordale’s interest. . .

7. After the filing of the complaint. . . Nordale died. . . [and] appellees filed a supplemental complaint invoking their right to continue the partnership and acquire Nordale’s interest under article 19 of the partnership’s Articles of Limited Partnership. The key provisions of article 19 are as follows:

“(a) In the interest of a continuity of the partnership it is agreed that upon the death, retirement, insanity or resignation of one of the general partners. . . that the surviving or remaining general partners may continue the partnership business. . .

(e). . . In the event the surviving or remaining general partner shall desire to continue the partnership business, he shall purchase the interest of the retiring or resigning general partner. . ..”. . .

1. Appellant contends that the mere filing of the complaint acted as a dissolution. . . Appellees contend that the filing. . . did not cause a dissolution but that the wrongful conduct of Nordale. . . gave the court the power to dissolve the partnership and allow them to carry on the business. . . We agree with appellees.

2. Contrary to appellant’s contention, Nordale’s conduct was in contravention of the partnership agreement. Nordale’s conduct affected the carrying on of the business and made it impracticable to continue in partnership with him. His conduct was wrongful. . . allowing the court to permit appellees to carry on the business. . .A.R.S. § 29–232(A) authorizes the court to dissolve a partnership when:

“(2) A partner becomes in any other way incapable of performing his part of the partnership contract.

(3) A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business.

(4) A partner. . . so conducts himself. . . that it is not reasonably practicable to carry on the business in partnership with him. . .”. . .

1. Article 19(e)(2)(i) contains the following buy-out provision:

“The amount shall be calculated as follows: By the addition of the sums of the amount of the. . . partner’s capital account plus an amount equal to the average of the prior three years’ profits and gains actually paid to the general partner. . .”

1. Appellant claims that the term “capital account”. . . is ambiguous. . .

2. Appellant contends. . .that fair market value should have been used instead of the balance in the capital account [which “showed a negative balance of $44,510.09]. . .

3. The words “capital account” are not ambiguous and clearly mean the partner’s capital account as it appears on the books of the partnership.

4. . . .Modern business practice mandates that the parties be bound by the contract they enter into. It is not the province of this court to act as a post-transaction guardian for either party. . . .

5. Judgment affirmed.

   [Notes & Questions]{.smallcaps}

1. Both of these cases arose out of requests for judicial dissolution, yet neither court ordered a dissolution, because dissolution had already occurred. The same behaviors that lead to the disintegration of the partnership relationship often justify a suit for judicial dissolution and generate retaliation that counts as a voluntary dissolution. Consider the advice you would give a client who reports a deterioration of partnership relations. Under what circumstances would you advise attempting to salvage the partnership, and when would you advise precautionary measures to avoid losses upon dissolution?

1. In Prentiss, the court did not declare the exclusion to be wrongful. What actions by the defendants might have altered that outcome? What advice could you have given to the defendants when things started to go bad, in order to avoid wrongful exclusion but also resolve the issues of the partnership?

2. How a partnership ends financially is as important as how it ends legally. In Prentiss, the court allowed the defendants to bid on the partnership property. In G & S Investments, the court refused to grant Nordale’s estate any part of the net value of the business, even though he has a 15% stake. Why did these outcomes not violate equitable principles?

3. What principles seem to be guiding the courts’ decisions? Is it freedom of contract? Equity? Efficiency? Finality? Some combination of all of these?

__________

Note: Buy-Sell Agreements

Deadlocks can lead to judicial dissolution, but there are contract tools that, if used appropriately, can resolve deadlocks before it gets that far. One tool that deserves special attention is the buy-sell clause. Their purpose is to end deadlocks by providing a method by which one of the deadlocked parties is bought out of the partnership. In other words, the dispute ends because one half of the dispute sells their ownership interest and leaves the partnership.

Buy-sell clauses can be quite sophisticated, but consider the following simple example: Partner A and B have reached an impasse regarding how to run the business. Partner A decides to trigger the clause, and offers Partner B $10,000 for Partner B’s ownership interest. Partner B now has only two options. Option 1 is to accept the offer and sell to Partner A for $10,000. Option 2 is to pay the $10,000 and buy out Partner A’s ownership interest.

Importantly, the buy-sell agreement provides incentives for the triggering partner to make a good faith offer for the other partners’ interests. If her offer is too low, the other partners will reject the offer and buy the triggering partner out for less than the value of the interest. If the triggering partner makes an offer that is too high, the other partners will gladly accept and she will be unnecessarily poorer. Either way, however, the dispute is at an end, and the partnership, itself, can continue to operate without the disruption that would have come with deadlock or litigation.

Winding Up

When a partnership dissolves—either by voluntary withdrawal, mutual agreement, judicial decree, or the expiration of a term or completion of a purpose—it enters a final phase: winding up. The winding up process can be complex, given the need to make sure that not only the partners, but also many third parties, have their interests protected as the business ends. Partners, creditors, contractual counterparties, and others have a right to some portion of the partnership value. The potentially large number of claimants requires great care in dividing that value.

The winding up process has a set of priorities, so that certain claimants get paid first. As you consider the list of priorities, consider why the list exists in its current form. Because the process is statutory, some of the status quo might be the result of rent-seeking, as well-connected groups influenced the lawmaking process that led to the list. However, there are other rational reasons for certain groups to have priority. Consider that some groups might not be willing to do business with the partnership if the risk of not getting paid is higher because they are closer to the top of the list.

Winding up often looks like ordinary business operations: collecting debts, completing contracts, and selling assets. But every action must be directed toward closure. Once assets are liquidated and liabilities are known, the remaining funds are distributed according to a statutory priority scheme. The UPA establishes the order of priority for paying off debts:

1. Debts to outside creditors, including non-partner third parties

2. Debts to partners other than for capital and profits, such as loans made by a partner to the firm

3. Repayment of capital contributions to each partner

4. Distribution of remaining profits to the partners according to their profit-sharing ratios

But if there are insufficient funds, partners may bear losses. If profits are exhausted, only capital is repaid. If even capital can’t be repaid fully, partners share the shortfall. If outside creditors remain unpaid, partners must contribute additional funds based on their profit- and loss-sharing ratios.

This order reflects basic fairness and risk allocation. Outside creditors are paid first to protect the firm’s ability to contract and attract financing. Partners then begin to receive payment; first, for non-partnership claims they have against the business (e.g., a partner who leased office space to the partnership would receive lease payments); second, for their monetary or in-kind contributions to the partnership; and third, for their pro-rata share of accumulated profits. If there are sufficient funds at any step, partners share according to their agreed ratios. This includes sharing, proportionally, in the obligation to pay off non-partner creditors, if the aggregated assets of the partnership are insufficient.

One exception to the loss-sharing rules arose in Kovacik v. Reed, 315 P.2d 314 (Cal. 1957), where the court held that a service-only partner (who contributed no capital) need not contribute toward monetary losses upon dissolution. The rule, adopted in many states despite its inconsistency with UPA’s text, reduced the risk burden on those with only labor to offer. However, this also shifts more risk onto capital-contributing partners and can discourage such contributions.

The RUPA, adopted in 1997, modernized this approach. It requires each partner to maintain a capital account that tracks contributions and financial activity:

initial contribution

+ share of profits

– share of losses

[– withdrawals]{.underline}

Capital Account Balance

When it comes to priority in dissolution, the RUPA clarifies and reorganizes the winding-up rules in § 807, but retains the same basic structure:

1. Pay all partnership liabilities to creditors, including partners who are creditors

2. Repay capital contributions to each partner

3. Distribute surplus to partners in accordance with their share of profits

Unlike the UPA, RUPA treats partner and non-partner creditors equally, to the extent allowed by state law (§ 807(a)), paying all debts before any return of capital. This shifts risk onto third parties, but it increases predictability by aligning expectations with accounting records. Importantly, RUPA § 807 cross-references the capital accounts maintained under § 401. This approach promotes accounting clarity and transaction-cost minimization. Rather than litigating over who is entitled to what, the winding up can proceed based on the partners’ running capital balances.

Finally, when it comes to distribution, liquidation into cash is the default. Unless otherwise agreed, courts presume that assets will be sold and partners paid in cash. This approach avoids valuation disputes, uses markets to determine asset value, and ensures fairness through fungibility. Partners who want in-kind distribution must agree in advance or persuade the court that it is warranted.

__________

The following case illustrates what happens when those agreements are absent—and how disputes over distribution method can shape the outcome of dissolution. Consider, as you read, why the two brothers wanted in-kind distribution. Would their answer to that question be different from what the third brother would say? Why would it matter that there is no partnership agreement? Is the court adopting a bright-line test or a multi-factor balancing test? Why would it matter?

The Dreifuerst brothers dissolved their partnership but disagreed on how to distribute its assets; the trial court ordered a sale rather than a partition of specific assets in kind. As you read, consider: under what circumstances may a court order a sale of partnership assets upon dissolution rather than a distribution in kind to the partners? Is a forced sale necessarily more equitable to all partners than a physical partition of specific assets?

Dreifuerst v. Dreifuerst
280 N.W.2d 335 (Wis. Ct. App. 1979)

BROWN, Presiding Judge.

1. The plaintiffs and the defendant, all brothers, formed a partnership. The partnership operated two feed mills, one located at St. Cloud, Wisconsin and one located at Elkhart Lake, Wisconsin. There were no written Articles of Partnership governing this partnership.

2. On October 4, 1975, the plaintiffs served the defendant with a notice of dissolution and wind-up of the partnership. The action for dissolution and wind-up was commenced on January 27, 1976. . .

1. . . .At the March 4, 1977 hearing, the defendant requested that the partnership be sold pursuant to sec. 178.33(1), Stats., and that the court allow a sale, at which time the partners would bid on the entire property. By such sale, the plaintiffs could continue to run the business under a new partnership, and the defendant’s partnership equity could be satisfied in cash.

2. On February 20, 1978, the trial court. . . denied the defendant’s request for a sale and instead divided the partnership assets in-kind according to the valuation presented by the plaintiffs. . .

3. . . .The sole question in this case is whether, in the absence of a written agreement to the contrary, a partner, upon dissolution and wind-up of the partnership, can force a sale of the partnership assets. . .

4. Section 178.33(1), Stats., provides:

“When dissolution is caused in any way, except in contravention of the partnership agreement, each partner, as against his copartners and all persons claiming through them in respect to their interests in the partnership, Unless otherwise agreed, may have the partnership property applied to discharge its liabilities, and the surplus applied to pay In cash the net amount owing to the respective partners.”. . .

1. A partnership at will is a partnership which has no definite term or particular undertaking and can rightfully be dissolved by the express will of any partner. In the present case, the respondents wanted to dissolve the partnership. This being a partnership at will, they could rightfully dissolve this partnership with or without the consent of the appellant. . . Therefore, neither the appellant nor the respondents have wrongfully dissolved the partnership.

2. Unless otherwise agreed, partners who have not wrongfully dissolved a partnership have a right to wind up the partnership. Winding-up is the process of settling partnership affairs after dissolution. Winding-up is often called liquidation and involves reducing the assets to cash to pay creditors and distribute to partners the value of their respective interests. Thus, lawful dissolution. . . gives each partner the right to have the business liquidated and his share of the surplus paid in cash. In-kind distribution is permissible only in very limited circumstances. If the partnership agreement permits in-kind distribution. . . or if, at any time prior to wind-up, all partners agree to in-kind distribution, the court may order in-kind distribution. . .

3. . . .[E]ven assuming the respondents in this case can show that there are no creditors to be paid, no one other than the partners are interested in the assets, and in-kind distribution would be fair to all partners, we cannot read [the statute] as permitting an in-kind distribution under any circumstances, unless all partners agree. . .

4. We therefore must hold the trial court erred in ordering an in-kind distribution of the assets of the partnership. . . .

5. . . .Since the statutes provide that, unless otherwise agreed, any partner who has not wrongfully dissolved the partnership has the right to wind up the partnership and force liquidation, he likewise has a right to force a sale, unless otherwise agreed. . .While judicial sales in some instances may cause economic hardships, these hardships can be avoided by the use of partnership agreements.

6. Judgment reversed and cause remanded for further proceedings not inconsistent with this opinion.

   [Notes & Questions]{.smallcaps}

1. The court says that judicial sales might, “in some instances,” cause “economic hardships.” What type of scenarios would give rise to economic hardships, and what kind of hardships might arise? If you can anticipate the ways that dissolution can destroy value, generally, for your client, or for the other partners, it can help you draft a partnership agreement that will make dissolution more efficient.

1. The court describes liquidation and cash disbursement as the default, “unless otherwise agreed.” Can the partners agree to something other than the default in ways other than through the partnership agreement?

2. If diverging from the default requires an agreement between the partners, would a court be justified in intervening to award in-kind distribution when there is a power imbalance in the partnership?

__________

Note: Winding Up and Goodwill

Partners may override the default rule of liquidation and cash distribution by agreement. This often occurs when specific assets—like family property—have unique, non-monetary value to one or more partners. Another common scenario involves goodwill, which includes a firm’s reputation, brand recognition, and other intangible value.

Goodwill can be difficult to value, so partners often address it explicitly in their agreements. It's also treated differently under the UPA and RUPA. Under UPA § 38(2)(c)(II), a partner who wrongfully dissolves the partnership is not entitled to any share of the business’s goodwill. This rule discourages opportunistic exits by withholding value from those who impose costs on others.

RUPA, in contrast, takes a more flexible approach. Section 701(c) allows goodwill to be included in the buyout price for a disassociating partner—even one who disassociates wrongfully—while § 701(h) permits the partnership to deduct damages caused by that disassociation. This “carrot and stick” model balances incentives: it preserves goodwill value for partners who maintain the firm’s reputation, but it also holds them accountable for any resulting harm.

From Dissolution to Dissociation

Under the UPA, dissolution was the default consequence of any partner’s departure. Whether a partner left voluntarily, was expelled, or died, the result was the same: the partnership ended, triggering the winding-up process. While this approach gave departing partners a clear path to exit and claim their share, it often came at a high price. Winding up could be disruptive and expensive, especially for partnerships that otherwise could have continued.

These costs created opportunities for rent-seeking. A partner dissatisfied with management or profits might threaten dissolution not because they truly wanted to exit, but to gain leverage in negotiations. The threat of winding up imposed costs on everyone, creating pressure to concede. In public choice terms, the high transaction costs of dissolution allowed one partner to extract private gain at collective expense.

Beginning in 1997, the RUPA addressed this problem by shifting the default rule from dissolution to disassociation. Under RUPA § 601, a partner’s departure—whether voluntary, involuntary, or automatic—removes the partner from the business, but does not automatically dissolve the partnership. The remaining partners can continue operating, and the departing partner is entitled to a buyout under § 701, unless the disassociation meets specific criteria under § 801 that justify full dissolution.

This change reflects a deeper shift in how the law conceptualizes partnerships. The UPA treated the partnership as a fragile, trust-based relationship—any disruption in its composition was presumed to require termination. RUPA treats the partnership as a more durable business entity, capable of surviving membership changes without liquidation.

This evolution reduces transaction costs in several ways:

• It preserves going-concern value by avoiding unnecessary liquidation.

• It minimizes disruption for third parties, who can continue doing business with the same entity.

• It reduces the need for litigation by supplying a clear buyout process for the exiting partner.

RUPA’s default rule is particularly beneficial in multi-partner firms or professional practices, where turnover is common and operational continuity is essential. It also mitigates collective action problems by limiting the ability of one partner to hijack the firm’s fate.

Still, disassociation is not a cure-all. A premature withdrawal from a term or purpose-based partnership may be a wrongful disassociation under § 602(b), entitling the partner to a buyout but delaying payment or triggering liability for damages. And in cases involving misconduct or severe breakdowns in relations, disassociation may be inadequate—courts may still order dissolution under § 801(5).

Finally, as with all default rules in partnership law, disassociation can be altered by agreement. Partners are free to adopt stricter or more flexible rules in their partnership agreement. That freedom allows for tailored solutions—but also requires careful planning, since deviating from the default can reintroduce the very transaction costs and strategic behavior the RUPA regime is designed to minimize.

__________

The following case illustrates the benefits of disassociation as a default rule—specifically, how it allows a partnership to remove a disruptive partner without destroying the enterprise. Consider what standard the court uses to determine whether involuntary dissociation is permissible. What evidence does the court consider in making its determination?

Members of the Giles family allege that the controlling general partner of a family limited partnership engaged in self-dealing, excluded minority partners from financial information, and mismanaged partnership property. As you read, consider: what procedural and standing requirements must a plaintiff satisfy before a court will hear a derivative claim on behalf of the partnership itself? How do courts balance the general partner's broad management authority against the minority partners' right to judicial protection from self-dealing?

Giles v. Giles Land Co.
279 P.3d 139 (Kan. Ct. App. 2012)

GREEN, J.

1. Kelly Giles (Kelly), a general partner in a family farming partnership, filed suit against the partnership and his partners, arguing that he had not been provided access to partnership books and records. The remaining members of the partnership then filed a counterclaim requesting that Kelly be dissociated from the partnership. . . The trial court held that Kelly should be dissociated from the partnership. Kelly, however, contends that the trial court’s ruling regarding his dissociation from the partnership was improper. We disagree. . . .

2. . . .The trial court . . . held that Kelly should be dissociated from the partnership under K.S.A. 56a–601(e)(3) or, in the alternative, K.S.A. 56a–601(e)(1). The trial court found that due to Kelly’s threats and the total distrust between Kelly and his family, it was not practicable to carry on the business of the partnership so long as Kelly was a partner. . . .

3. The trial court relied primarily on K.S.A. 56a–601(e)(3) to dissociate Kelly; therefore, the record must demonstrate that (1) Kelly engaged in conduct relating to the partnership business and (2) such conduct makes it not reasonably practicable to carry on the business in partnership with Kelly. . .

4. Kelly first contends that there is no evidence that he engaged in conduct relating to the partnership business. Kelly argues that the trial court erroneously relied on evidence that he had threatened his family members and that the familial relationship was broken. Kelly maintains that this evidence is not related to the partnership business and, therefore, is not relevant. . .

5. . . .[T]he trial court found that Kelly did not trust the other general partners and that he did not trust some of his sisters who are limited partners in the partnership. The trial court also found that the general partners as well as all of the other partners did not trust Kelly.

6. The trial court further found that the relationship between Kelly and the other family members was irreparably broken. In reaching that conclusion, the trial court focused on a meeting between the partners in 2006. Kelly turned to each of the general partners and said that they would each die, in turn, and that he would be the last man standing and that he would then get to control the partnership. Although Kelly testified that this was not a threat and that he was simply trying to explain the right of survivorship, the trial court believed the testimony of the rest of the family that it was taken as a threat. The trial court also relied on evidence that Kelly had said that “paybacks are hell” and that he intended to get even with his partners. The trial court also found this to be a threat. Another fact that the trial court relied on in finding that the family relationship was irreparably broken was that it was impossible for any of the family members to communicate with Kelly regarding the partnership. Each family member testified that he or she believed that it was in the best interest of the partnership to not have Kelly remain a partner.

7. In finding that Kelly should not longer be a partner, the trial court stated:

“This court finds that the testimony of the counterclaimants regarding the plans of Kelly Giles to take over Giles Land Company, L.P., [the partnership], predicting the deaths of the other General Partners, the statement of Kelly Giles that ‘paybacks are hell’ and that he would get even, is credible. . . The Court further finds that given the lack of trust between Kelly Giles and his siblings who are General Partners, the partnership cannot operate in a meaningful fashion, and certainly cannot operate as intended, as a family business where there is cooperation, as long as Kelly Giles is a partner in [the partnership].”. . .

1. In light of the animosity that Kelly harbors toward his partners and his distrust of them (which distrust is mutual), it is clear that Kelly can no longer do business with his partners and vice versa. Indeed, the partnership has reached an impasse regarding important business because of a lack of communication between Kelly and his partners. . .

2. Under this alternative theory of dissociation [under 56a–601(e)(1)], the record must demonstrate (1) that Kelly engaged in wrongful conduct and (2) that the wrongful conduct adversely and materially affected the partnership business. . .

3. In applying the alternative theory of dissociation, the trial court held the following: “In addition, Kelly Giles’ conduct toward the General Partners who own the largest General Partnership interests by far, his parents, would also constitute wrongful conduct that materially affected the partnership business under 56a–601(e)(1), and the Court so finds.” . . .

4. . . .Kelly had created a situation where the partnership could no longer carry on its business to the mutual advantage of the other partners. . . There was also testimony . . . that . . . Kelly yelled and cursed at his father and his father was in tears by the end of the conversation. Norman further testified that it would be better for everyone if Kelly were no longer in the partnership because it was clear that Kelly did not agree with what the other partners were wanting to do with the future of the partnership. . .Thus, even though there is no evidence that Kelly has been dishonest, and even though the partnership has continued to be successful, this does not mean that the other partners should be forced to remain in partnership with an uncooperative and distrustful partner. . . .

5. Affirmed.

   [Notes & Questions]{.smallcaps}

1. Should it be easy or difficult to involuntarily disassociate another partner? Both options have tradeoffs. If it is easier, you would expect it to happen more often; how would you behave if you knew that your partners could get rid of you without meeting a high burden? If you would be better behaved, then perhaps an easier standard wouldn’t lead to more involuntary disassociations. On the flip side, if it were harder, partners might behave worse. Taken in isolation, the question of what the “right” standard should be is a complicated, and possibly indeterminate, one. Would it be easier to select the right standard if you considered it in connection with the rules for compensating the disassociated partner?

1. The trial court concluded that Kelly did not trust his partners, nor they him. Trust, when it exists in a group, reduces transaction costs because members of the group don’t need to constantly monitor each other. Trust is therefore really helpful to a functional partnership. That said, is it really true that lack of trust necessarily means a partnership cannot function? Could all other transaction costs be low enough that the partnership could function even without trust?

2. The statements, by Kelly, at the 2006 meeting seem pretty appalling. If you were counsel for Kelly, what arguments would you have used to counter the negative impression those 2006 statements almost certainly gave the trial court?

3. What does it mean for it to be “not reasonably practicable to carry on the business?” Is there any way to quantify that test, or is the outcome dependent solely on the discretion of the court? Here, the court concluded that the disintegration of family relationships met the standard. Would a non-family partnership have been subject to the same analysis? Is it easier to have involuntary dissolution when the partners are family members?

Evolution of the Partnership

The general partnership, as explored in the preceding sections, is grounded in principles of mutual agency, shared control, and unlimited liability. Each partner participates in management by default, and each is personally liable for the debts and obligations of the firm. This link between management and liability makes moral and economic sense; those who are making decisions for the business suffer the consequences if those decisions are poorly considered.

The general partnership form is well-suited to small, trust-based enterprises. Partnerships are easily formed, function as a separate entity, and impose fiduciary duties that, because the partners have reason to trust each other, can be abided by at a relatively low cost. But, as business ventures grew more complex and capital-intensive, the limitations of the general partnership form became apparent. Investors who lacked the time, expertise, or inclination to manage a business were understandably reluctant to expose their personal assets to the risks of a venture they did not control.

The limited partnership emerged in response to this tension. First adopted in the United States in the early 19th century, the limited partnership form allowed for a hybrid structure: one or more general partners would manage the business and bear full liability, while limited partners could contribute capital, share in profits, and avoid personal liability—so long as they refrained from participating in control. This model reduced transaction costs for many potential investors, allowing businesses who chose the model to attract greater outside investment. It protected passive investors and maintained a clear managerial hierarchy.

Over time, limited partnerships became especially popular in industries requiring large capital infusions and professional management, such as real estate development, oil and gas ventures, and private equity. They allowed for sophisticated financial structuring and accommodated the differing expectations of capital providers and managers. Today, limited partnerships remain a key feature of modern business planning—though their liability rules and formalities continue to evolve.

Limited Partnerships

Unlike general partnerships, which may arise informally whenever parties share profits and agree to operate a business together, limited partnerships (LPs) are statutory creations with formal formation requirements. An LP does not exist until it is properly registered with the state, including filing a certificate of limited partnership, choosing a compliant name (e.g., “Limited Partnership,” “L.P.,” or “LP”), and satisfying any periodic reporting requirements. These formalities enable the state to confer liability protections for passive investors.

Limited partnerships feature two distinct roles:

• General partners manage the business, owe fiduciary duties to the partnership, and are personally liable for its obligations.

• Limited partners contribute capital and receive profits but generally do not manage the business and are not personally liable beyond their investment.

This structure presents an inherent tradeoff. General partners enjoy control but face personal liability. Limited partners enjoy liability protection but relinquish managerial authority. As a result, limited partners tend to be those lacking the time, expertise, or appetite for daily management. They contribute capital and trust that the general partner’s fiduciary duties, along with their own interest in the partnership’s success, will align incentives.

Yet this separation of roles raises policy questions. Should investors be allowed to reap the rewards of ownership while shielding themselves from downside risks? What happens when passive investors begin to exert influence over business decisions? If they behave like owners, should they be held accountable like owners?

Historically, the answer was yes. Under the original Uniform Limited Partnership Act (ULPA) of 1916, limited partners lost their liability shield if they “took part in the control of the business.” This strict rule was grounded in two core concerns:

1. Third-party protection: If a limited partner exercised control, outsiders might reasonably assume they were dealing with a general partner. Liability was imposed to prevent unfair surprise.

2. Deterring shadow control: Without the rule, a nominal general partner might serve as a figurehead while actual control resided with unaccountable investors.

These concerns were central in Holzman v. De Escamilla, 195 P.2d 833 (Cal. App. 1948), where two supposed limited partners (Andrews and Russell) exercised extensive control over a farming business. Although nominally “limited” partners, Russell and Andrews dictated crop choices, forced out the general-partner manager, controlled the farm’s marketing outlet, and held joint signing authority that let them block or drain every partnership bank account, leaving Ricardo de Escamilla unable to pay bills without their consent; by exercising this day-to-day dominion, the pair crossed ULPA § 7’s bright line, became de facto general partners, and were held personally liable so that creditors would not be misled and statutory policy against shadow control would remain intact.

While the ULPA rule aimed to protect third parties and maintain clear boundaries within the partnership, it also created inefficiencies:

• Over-deterrence: Limited partners risked personal liability for offering even helpful advice, discouraging productive collaboration.

• Strategic formalism: To preserve liability shields, parties often engaged in costly structuring—retaining practical control while avoiding formal responsibility.

• Litigation risk and uncertainty: The line between permissible advice and impermissible control was often unclear, leading to disputes.

Moreover, the rationale for strict liability in contract cases was not always compelling. A sophisticated lender can assess public filings and allocate risk accordingly. In contrast, tort victims cannot engage in due diligence before being harmed, so liability protections may be less defensible in tort contexts.

In response to these concerns, modern statutes like the Revised Uniform Limited Partnership Act (RULPA) and its successors adopt a more nuanced approach. Under RULPA § 303(b), limited partners retain their liability shield unless two conditions are met:

1. They actively participated in control of the business; and

2. A third party reasonably believed, based on that conduct, that the limited partner was a general partner.

This shift reflects a broader evolution in business law: a move away from rigid formalism toward transaction-cost minimization and investor participation, particularly in sophisticated or capital-intensive industries. But the tradeoff is real. By allowing limited partners to influence decisions without bearing full liability, modern law may decouple control from responsibility, distorting incentives and potentially increasing the likelihood of tort harm. This dynamic illustrates an enduring collective action problem: the more diffuse and protected the investor group, the weaker the deterrent against harmful conduct by those in control.

Policy Considerations: Is Limited Liability Always Justified?

The shift to the modern rule raises questions about the tradeoffs inherent in limited liability and when those tradeoffs are justified. While limited liability facilitates capital formation and encourages productive risk-taking, it also introduces moral hazard: when investors are protected against the downside of risk, they will tend to take more risky actions. When the costs of those risks get imposed on others—in what economists call “negative externalities”—investors will approve more risky behavior than they would otherwise. Over time, that additional risk will impose costs, and creditors, counterparties, and the public may suffer the consequences.

The ULPA rule offered that protection only to truly passive investors, so there were few-to-no decisions that those affected with moral hazard could make. The costs of moral hazard in the limited partnership context were therefore limited. The RULPA rule is more complex. The change to contractual liability is likely justified by a weighing of the tradeoffs. A commercial counterparty can investigate, negotiate protections, or walk away. As long as the limited partnership discloses the nature of its business structure, including the role that the limited partners are playing, then any additional risk imposed on counterparties will be priced into the contract. Those making risky decisions will therefore pay for that risk, balancing the tradeoffs.

In the tort context, however, it is less clear that the tradeoffs will be properly balanced. Expanded limited liability certainly will expand the pool of potential investors, raising the productive opportunities of the limited partnership. Similarly, the expertise, experience, and insights of the limited partners can be more easily accessed, so the full potential of the business is more likely to be unlocked and profits will be much easier to achieve.

Tort victims, however, do not choose their exposure and cannot contractually require the limited partnership to bear the cost of their risky choices. When those making decisions do not face the full cost of their decisions, they will take more risk than is justified by the costs and benefits of those actions. There will be an increased likelihood of tortious outcomes, but that does not necessarily mean that tort victims will not be compensated.

Recall that all the partnership is a separate entity, so as long as the partnership is not insolvent, tort victims will receive compensation out of the partnership assets. As a general rule, partners will not want the business to fail, so they will still be deterred from making decisions that could reasonably lead to tort liability. However, because they do not face personal liability, they might be willing to take a risky path that offers very high rewards with very high risks; if those risks include more than the value of the partnership, the limited partners will not be efficiently deterred.

Formation and Compliance

Unlike general partnerships, which can arise informally through conduct and mutual assent, limited partnerships are creatures of statute, and their formation requires compliance with specific filing and disclosure rules. To create a valid limited partnership, the parties must:

• File a certificate of limited partnership with the appropriate state agency (usually the Secretary of State);

• Identify the names and addresses of the general and limited partners (or at least the registered agent for service of process);

• Include the business name, which must typically include an “LP” or “Limited Partnership” designation to provide notice to third parties;

• Comply with ongoing reporting obligations, including updates to partner information, annual filings, and designation of a registered office.

These requirements provide clarity and reduce transaction costs. As a result of the required filing and naming conventions, third parties can determine whether they are dealing with a limited or general partner. That provides them with crucial information about the nature of the business and the risks associated with contracting with the partnership. Maintaining a database of all limited partnerships in the state also facilitates third-parties’ due diligence in this regard. Any ambiguity raised by the actions of the limited partnership can be clarified by resort to official state resources. If an entity chooses not to register, its investors would not receive the protection of the liability shield.

Limited Liability Partnerships

The limited partnership form has continued to experience change, as legislators have identified and enacted other potentially beneficial applications of the liability shield. One of those applications is the limited liability partnership (LLP). In an LLP, the traditional structure of the general partnership—mutual management, shared profits and losses—is maintained but individual oartners are protected from liability when that liability emerges from scenarios where they had no input or control.

Specifically, in an LLP, a partner is not personally liable for the wrongful acts or omissions of other partners (or their agents) simply by virtue of partnership status. Partners remain individually liable for their own malpractice or negligence, as well as for the acts of those under their direct supervision or control (e.g., associates, paralegals, or employees). This liability model recognizes that, in certain types of businesses—usually law firms, accountancy firms, and medical firms—there are two levels of control. At the level of the firm, all partners can participate fully in management and share in profits and losses. At the level of individual cases or clients, control is localized in a subset of partners and other related employees.

The LLP form reflects a policy judgment in businesses like this: a partner should be held accountable for what they do or directly oversee, but not for the independent conduct of colleagues in a shared firm. Those who make choices are held accountable for them, but the costs of those choices are not imposed on those who had no say, whether that means the public or other partners.

Like the original limited partnership form, the LLP is a statutory creation and, as such, has specific formation and registration requirements to enjoy its liability protections. These typically include:

• Filing a statement of qualification or registration with the Secretary of State;

• Paying a registration or renewal fee (often annually);

• Including the designation “LLP” (or its full form) in the firm’s legal name;

• Maintaining adequate insurance or demonstrating financial responsibility, where required by state law.

These formal requirements are designed not only to enforce discipline among firms seeking special protection, but also to give public notice to clients and third parties that they are dealing with a firm whose partners may not be individually liable for each other’s actions. Failure to comply with these statutory formalities may result in the loss of LLP status, and with it, the loss of the liability shield. Courts have generally held that without proper registration, a firm operates as a general partnership and partners remain fully liable.

The LLP form reflects a balancing act between competing goals. By protecting professionals from ruinous liability for acts they neither committed nor controlled, the form reduces transaction costs by freeing partners from the costs of providing oversight to other oartners outside of their control or, worse (in terms of transaction costs), requiring that partners make all decisions collectively. At the same time, by maintaining liability for controlled subordinates, the LLP form incentivizes oversight of subordinates and management of the risk they impose. Finally, by mandating registration and naming conventions, clients and the public are on notice about the scope of protection.

Limited Liability Limited Partnerships

Limited partnerships and LLPs are part of a broader trend toward limited liability entity forms. Some other examples are limited liability companies (LLCs), and professional limited liability companies (PLLCs), which we will discuss in future chapters, but the partnership form continues to generate new limited liability forms, as well. Those forms are largely statutory experiments at the boundaries of the limited partnership. One somewhat common—if unevenly enacted—form is the Limited Liability Limited Partnership (LLLP).

The LLLP builds upon the traditional limited partnership (LP) form but extends limited liability not just to limited partners, but also to general partners. It allows business organizers to retain the tiered control structure of a limited partnership—where general partners manage the enterprise and limited partners act as passive investors—while eliminating the personal liability exposure typically imposed on general partners.

Like an ordinary limited partnership, an LLLP must include at least one general partner and one limited partner. The general partner retains full authority to manage the business, and the limited partner generally remains passive, although modern statutes (as discussed earlier) relax the control limitations on limited partners.

The key experimentation of the LLLP form is extending the liability shield to the general partner. As a result, even though the general partner will be making decisions for the business, she will not be personally liable for the debts and obligations of the partnership solely by virtue of her status. Creditors of the business, therefore, can only look to the partnership's assets for recovery, not the general partner's personal assets.

LLLPs are available only in those jurisdictions that have adopted enabling legislation, typically based on the RULPA, as amended in 2001, or a comparable state-specific statute. In one of those states, someone desiring to form an LLLP must:

• Create a limited partnership in accordance with state law;

• File a statement of qualification or election designating the entity as an LLLP;

• Include the appropriate designation (e.g., “LLLP” or “Limited Liability Limited Partnership”) in the business’s legal name;

• Comply with other state-specific requirements, such as annual filings or publication.

Without proper filing, the partnership will be treated as a standard limited partnership, and general partners will retain personal liability.

The availability of a liability shield for general partners obviously makes the LLLP form an attractive one for potential general partners, but the business must still attract limited partners before any limited partnership form will be suitable. In what contexts, then, will the LLLP form be attractive to limited partners? The answer is wherever the desired level of risk-taking is higher than normal. Under a traditional limited partnership, unlimited liability will make the general partner relatively more risk-averse. In industries like real estate development, private equity, venture capital, or estate planning, the ability to be comfortable with a higher level of risk is necessary to succeed in a competitive environment. Savvy investors might want the general partner to increase the level of risk-taking beyond what would be acceptable in a standard limited partnership.

Of course, that raises many of the same concerns regarding the imposition of risk on third-parties and the public. Registration and naming requirements still put contractual counterparties on notice, allowing those who are paying attention to price any increased risk into their contracts. Potential tort victims and society at large might still bear additional burdens as a result of the legislative choice to allow LLLPs, but legislative choices are just as likely—possibly more so—to improperly balance the tradeoffs as the businesses they regulate.