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Partnership

PARTNERSHIP

An association of two or more persons engaged in a business enterprise in which the profits and losses are shared proportionally. The legal definition of a partnership is generally stated as "an association of two or more persons to carry on as co-owners a business for profit" (Revised Uniform Partnership Act § 101 [1994]).

Early English mercantile courts recognized a business form known as the societas. The societas provided for an accounting between its business partners, an agency relationship between partners in which individual partners could legally bind the partnership, and individual partner liability for the partnership's debts and obligations. As the regular English courts gradually recognized the societas, the business form eventually developed into the common-law partnership. England enacted its Partner-ship Act in 1890, and legal experts in the United States drafted a Uniform Partnership Act (UPA) in 1914. Every state has adopted some form of the UPA as its partnership statute; some states, however, have made revisions to the UPA or have adopted the Revised Uniform Partnership Act (RUPA), which legal scholars issued in 1994.

The authors of the initial UPA debated whether in theory a partnership should be treated as an aggregate of individual partners or as a corporate-like entity separate from its partners. The UPA generally opted for the aggregate theory in which individual partners ("an association") comprised the partnership. Under an aggregate theory, partners are co-owners of the business; the partnership is not a distinct legal entity. This led to the creation of a new property interest known as a "tenancy in partnership," a legal construct by which each partner co-owned partnership property. An aggregate approach nevertheless led to confusion as to whether a partnership could be sued or whether it could sue on its own behalf. Some courts took a technical approach to the aggregate theory and did not allow a partnership to sue on its own behalf. In addition, some courts would not allow a suit to go forward against a partnership unless the claimant named each partner in the complaint or added each partner as an "indispensable party."

The RUPA generally adopted the entity approach, which treats the partnership as a separate legal entity that may own property and sue on its own behalf. The RUPA nevertheless treats the partnership in some instances as an aggregate of co-owners; for example, it retains the joint liability of partners for partnership obligations. As a practical matter, therefore, the present-day partnership has both aggregate and entity attributes. The partnership, for instance, is considered an association of co-owners for tax purposes, and each co-owner is taxed on his or her proportional share of the partnership profits.

Formation

The formation of a partnership requires a voluntary "association" of persons who "coown" the business and intend to conduct the business for profit. Persons can form a partnership by written or oral agreement, and a partnership agreement often governs the partners' relations to each other and to the partnership. The term person generally includes individuals, corporations, and other partnerships and business associations. Accordingly, some partner-ships may contain individuals as well as large corporations. Family members may also form and operate a partnership, but courts generally look closely at the structure of a family business before recognizing it as a partnership for the benefit of the firm's creditors.

Certain conduct may lead to the creation of an implied partnership. Generally, if a person receives a portion of the profits from a business enterprise, the receipt of the profits is evidence of a partnership. If, however, a person receives a share of profits as repayment of a debt, wages, rent, or an annuity, such transactions are considered "protected relationships" and do not lead to a legal inference that a partnership exists.

Relationship of Partners to Each Other

Each partner has a right to share in the profits of the partnership. Unless the partnership agreement states otherwise, partners share profits equally. Moreover, partners must contribute equally to partnership losses unless a partnership agreement provides for another arrangement. In some jurisdictions a partner is entitled to the return of her or his capital contributions. In jurisdictions that have adopted the RUPA, however, the partner is not entitled to such a return.

In addition to sharing in the profits, each partner also has a right to participate equally in the management of the partnership. In many partnerships a majority vote resolves disputes relating to management of the partnership. Nevertheless, some decisions, such as admitting a new partner or expelling a partner, require the partners' unanimous consent.

Each partner owes a fiduciary duty to the partnership and to copartners. This duty requires that a partner deal with copartners in good faith, and it also requires a partner to

account to copartners for any benefit that he or she receives while engaged in partnership business. If a partner generates profits for the part-nership, for example, that partner must hold the profits as a trustee for the partnership. Each partner also has a duty of loyalty to the partnership. Unless copartners consent, a partner's duty of loyalty restricts the partner from using partnership property for personal benefit and restricts the partner from competing with the partnership, engaging in self-dealing, or usurping partnership opportunities.

Relationship of Partners to Third Persons

A partner is an agent of the partnership. When a partner has the apparent or actual authority and acts on behalf of the business, the partner binds the partnership and each of the partners for the resulting obligations. Similarly, a partner's admission concerning the partnership's affairs is considered an admission of the partnership. A partner may only bind the partnership, however, if the partner has the authority to do so and undertakes transactions while conducting the usual partnership business. If a third person, however, knows that the partner is not authorized to act on behalf of the partnership, the partnership is generally not liable for the partner's unauthorized acts. Moreover, a partnership is not responsible for a partner's wrongful acts or omissions committed after the dissolution of the partnership or after the dissociation of the partner. A partner who is new to the partnership is not liable for the obligations of the partnership that occurred prior to the partner's admission.

Liability

Generally, each partner is jointly liable with the partnership for the obligations of the partnership. In many states each partner is jointly and severally liable for the wrongful acts or omissions of a copartner. Although a partner may be sued individually for all the damages associated with a wrongful act, partnership agreements generally provide for indemnification of the partner for the portion of damages in excess of her or his own proportional share.

Some states that have adopted the RUPA provide that a partner is jointly and severally liable for the debts and obligations of the partnership. Nevertheless, before a partnership's creditor can levy a judgment against an individual partner, certain conditions must be met, including the return of an unsatisfied writ of execution against the partnership. A partner may also agree that the creditor need not exhaust partnership assets before proceeding to collect against that partner. Finally, a court may allow a partnership creditor to proceed against an individual partner in an attempt to satisfy the partnership's obligations.

Partnership Property

A partner may contribute personal property to the partnership, but the contributed property becomes partnership property unless some other arrangement has been negotiated. Similarly, if the partnership purchases property with partnership assets, such property is presumed to be partnership property and is held in the partnership's name. The partnership may convey or transfer the property but only in the name of the partnership. Without the consent of all the partners, individual partners may not sell or assign partnership property.

In some jurisdictions the partnership property is considered personal property that each partner owns as a "tenant in partnership," but other jurisdictions expressly state that the partnership may own property. The tenant in partnership concept, which is the approach contained in the UPA, is the result of adopting an aggregate approach to partnerships. Because the aggregate theory is that the partnership is not a separate entity, it was thought that the partnership could not own property but that the individual partners must actually own it. This approach has led to considerable confusion, and the RUPA has expressly stated that the partnership may own partnership property.

Partnership Interests

A partner's interest in a partnership is considered personal property that may be assigned to other persons. If assigned, however, the person receiving the assigned interest does not become a partner. Rather, the assignee only receives the economic rights of the partner, such as the right to receive partnership profits. In addition, an assignment of the partner's interest does not give the assignee any right to participate in the management of the partnership. Such a right is a separate interest and remains with the partner.

Partnership Books

Generally, a partnership maintains separate books of account, which typically include records of the partnership's financial transactions and each partner's capital contributions. The books must be kept at the partnership's principal place of business, and each partner must have access to the books and be allowed to inspect and copy them upon demand. If a partnership denies a partner access to the books, he or she usually has a right to obtain an injunction from a court to compel the partnership to allow him or her to inspect and copy the books.

Partnership Accounting

Under certain circumstances a partner has a right to demand an accounting of the partnership's affairs. The partnership agreement, if any, usually sets forth a partner's right to a predissolution accounting. State law also generally allows for an accounting if copartners exclude a partner from the partnership business or if copartners wrongfully possess partnership property. In a court action for an accounting, the partners must provide a report of the partnership business and detail any transactions dealing with partnership property. In addition, the partners who bring a court action for an accounting may examine whether any partners have breached their duties to copartners or the partnership.

Taxation

One of the primary reasons to form a partnership is to obtain its favorable tax treatment. Because partnerships are generally considered an association of co-owners, each of the partners is taxed on her or his proportional share of partnership profits. Such taxation is considered "pass-through" taxation in which only the indimvidual partners are taxed. Although a partnership is required to file annual tax returns, it is not taxed as a separate entity. Rather, the profits of the partnership "pass through" to the individual partners, who must then pay individual taxes on such income.

Dissolution

A dissolution of a partnership generally occurs when one of the partners ceases to be a partner in the firm. Dissolution is distinct from the termination of a partnership and the "winding up" of partnership business. Although the term dissolution implies termination, dissolution is actually the beginning of the process that ultimately terminates a partnership. It is, in essence, a change in the relationship between the partners. Accordingly, if a partner resigns or if a partnership expels a partner, the partnership is considered legally dissolved. Other causes of dissolution are the bankruptcy or death of a partner, an agreement of all partners to dissolve, or an event that makes the partnership business illegal. For instance, if a partnership operates a gambling casino and gambling subsequently becomes illegal, the partnership will be considered legally dissolved. In addition, a partner may withdraw from the partnership and thereby cause a dissolution. If, however, the partner withdraws in violation of a partnership agreement, the partner may be liable for damages as a result of the untimely or unauthorized withdrawal.

After dissolution, the remaining partners may carry on the partnership business, but the partnership is legally a new and different partnership. A partnership agreement may provide for a partner to leave the partnership without dissolving the partnership but only if the departing partner's interests are bought by the continuing partnership. Nevertheless, unless the partnership agreement states otherwise, dissolution begins the process whereby the partnership's business will ultimately be wound up and terminated.

Dissociation

Under the RUPA, events that would otherwise cause dissolution are instead classified as the dissociation of a partner. The causes of dissociation are generally the same as those of dis-solution. Thus, dissociation occurs upon receipt of a notice from a partner to withdraw, by expulsion of a partner, or by bankruptcy-related events such as the bankruptcy of a partner. Dissociation does not immediately lead to the winding down of the partnership business. Instead, if the partnership carries on the business and does not dissolve, it must buy back the former partner's interest. If, however, the partnership is dissolved under the RUPA, then its affairs must be wound up and terminated.

Winding Up

Winding up refers to the procedure followed for distributing or liquidating any remaining partnership assets after dissolution. Winding up also provides a priority-based method for discharging the obligations of the partnership, such as making payments to non-partner creditors or to remaining partners. Only partners who have not wrongfully caused dissolution or have not wrongfully dissociated may participate in winding up the partnership's affairs.

State partnership statutes set the procedure to be used to wind up partnership business. In addition, the partnership agreement may alter the order of payment and the method of liquidating the assets of the partnership. Generally, however, the liquidators of a partnership pay non-partner creditors first, followed by partners who are also creditors of the partnership. If any assets remain after satisfying these obligations, then partners who have contributed capital to the partnership are entitled to their capital contributions. Any remaining assets are then divided among the remaining partners in accordance with their respective share of partnership profits.

Under the RUPA, creditors are paid first, including any partners who are also creditors. Any excess funds are then distributed according to the partnership's distribution of profits and losses. If profits or losses result from a liquidation, such profits and losses are charged to the partners' capital accounts. Accordingly, if a partner has a negative balance upon winding up the partnership, that partner must pay the amount necessary to bring his or her account to zero.

Limited Partnerships

A limited partnership is similar in many respects to a general partnership, with one essential difference. Unlike a general partnership, a limited partnership has one or more partners who cannot participate in the management and control of the partnership's business. A partner who has such limited participation is considered a "limited partner" and does not generally incur personal liability for the partnership's obligations. Generally, the extent of liability for a limited partner is the limited partner's capital contributions to the partnership. For this reason, limited partnerships are often used to provide capital to a partnership through the capital contributions of its limited partners. Limited partnerships are frequently used in real estate and entertainment-related transactions.

The limited partnership did not exist at common law. Like a general partnership, however, a limited partnership may govern its affairs according to a limited partnership agreement. Such an agreement, however, will be subject to applicable state law. States have for the most part relied on the Uniform Limited Partnership Act in adopting their limited partnership legislation. The Uniform Limited Partnership Act was revised in 1976 and 1985. Accordingly, a few states have retained the old uniform act, and other states have relied on either revision to the uniform act or on both revisions to the uniform act.

A limited partnership must have one or more general partners who manage the business and who are personally liable for partnership debts. Although one partner may be both a limited and a general partner, at all times there must be at least two different partners in a limited partnership. A limited partner may lose protection against personal liability if she or he participates in the management and control of the partnership, contributes services to the partnership, acts as a general partner, or knowingly allows her or his name to be used in partnership business. However, "safe harbors" exist in which a limited partner will not be found to have participated in the "control" of the partnership business. Safe harbors include consulting with the general partner with respect to partnership business, being a contractor or employee of a general partner, or winding up the limited partnership. If a limited partner is engaged solely in one of the activities defined as a safe harbor, then he or she is not considered a general partner with the accompanying potential liability.

Except where a conflict exists, the law of general partnerships applies equally to limited partnerships. Unlike general partnerships, however, limited partnerships must file a certificate with the appropriate state authority to form and carry on as a limited partnership. Generally, a certificate of limited partnership includes the limited partnership's name, the character of the limited partnership's business, and the names and addresses of general partners and limited partners. In addition, and because the limited partnership has a set term of duration, the certificate must state the date on which the limited partnership will dissolve. The contents of the certificate, however, will vary from state to state, depending on which uniform limited partnership act the state has adopted.

further readings

Gow, Niel. 2000. A Practical Treatise on the Law of Partnership. Buffalo, N.Y.: W.S. Hein.

Gregory, William A. 2001. The Law of Agency and Partnership. 3d ed. St. Paul, Minn.: West Group.

Hamilton, Robert W., and Jonathan R. Macey. 2003. Cases and Materials on Corporations, Including Partnerships and Limited Liability Companies. 8th ed. St. Paul, Minn.: West Group.

Hynes, J. Dennis. 2001. Agency, Partnership, and the LLC in a Nutshell. 2d ed. St. Paul, Minn.: West Group.

Moye, John E., ed. 1999. The Law of Business Organizations. 5th ed. Albany, N.Y.: West Legal Studies.

Partnerships, LLCs, and LLPs: Uniform Acts, Taxation, Drafting, Securities, and Bankruptcy. 12th ed. Vol. 1. 1996. Philadelphia: American Law Institute–American Bar Association Committee on Continuing Professional Education.

cross-references

Joint and Several Liability; Limited Liability Partnership.

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Partnership

Partnership

MAJOR TYPES OF ORGANIZATIONS

Various forms of business organizations are differentiated by the tax and other liabilities borne by their investors. Three major forms in the mid-2000s were corporations, partnerships, and limited liability companies (LLCs).

In a corporation an investor only risks the value of his or her investments in the company in the case of failure and only owes taxes on dividend income received. The corporation is legally a "person" and pays its own taxes. It is also at liberty to pay or not to pay dividends, although it is technically governed by the will of a majority of stockholders. The stockholder, in effect, is taxed twice: first on the net income of the corporation that he or she owns (in part) and then on the dividends. The investor, of course, never sees the first tax but gets less in dividends because it is paid by the company.

In a partnership each partner is an equal co-owner of the entity, pays an equal share of taxes due, and, in case of failure, equally shares in all of the liabilities of the partnership. Thus, in a partnership, liabilities are shared but not limited. The benefit of partnerships is that general partners are only taxed once. The partnership itself pays no taxes.

In an LLC the structures of a corporation and of a partnership are combined. Participants are "exposed" only to the extent of their investment because the LLC is treated as a corporation for purposes of liability; at the same time, the taxes owed by the LLC are paid by the participants in proportion to their share in the revenues. They are taxed once, not twice, as in corporations. LLCs, described in more detail elsewhere in this volume, are a relatively recent form of organization and growing rapidly because of the advantages that they offer. Because LLCs are limited in various ways, their growth appears above all to impact partnershipsthe form of organization described in this article.

WHAT PARTNERSHIPS ARE

In the words of the Uniform Partnership Act, a partnership is "an association of two or more persons to carry on as Co-owners of a business for profit." The essential characteristics of this business form, then, are the collaboration of two or more owners, the conduct of business for profit (a nonprofit cannot be designated as a partnership), and the sharing of profits, losses, and assets by the joint owners. A partnership is not a corporate or separate entity; rather it is viewed as an extension of its owners for legal and tax purposes, although a partnership may own property as a legal entity. While a partnership may be founded on a simple agreement, even a handshake between owners, a well-crafted and carefully worded partnership agreement is the best way to begin the business. In the absence of such an agreement, the Uniform Partnership Act, a set of laws pertaining to partnerships that has been adopted by most states, governs the business.

There are two types of partnerships:

General Partnerships In this standard form of partnership, all of the partners are equally responsible for the business's debts and liabilities. In addition, all partners are allowed to be involved in the management of the company. In fact, in the absence of a statement to the contrary in the partnership agreement, each partner has equal rights to control and manage the business. Therefore, unanimous consent of the partners is required for all major actions undertaken. It is well to note, however, that any obligation made by one partner is legally binding on all partners, whether or not they have been informed.

Limited Partnerships In a limited partnership, one or more partners are general partners, and one or more are limited partners. General partners are personally liable for the business's debts and judgments against the business; they can also be directly involved in the management. Limited partners are essentially investors (silent partners, so to speak) who do not participate in the company's management and who are also not liable beyond their investment in the business. State laws determine how involved limited partners can be in the day-today business of the firm without jeopardizing their limited liability. This business form is especially attractive to real estate investors, who benefit from the tax incentives available to limited partners, such as being able to write off depreciating values.

ADVANTAGES

Collaboration. As compared to a sole proprietorship, which is essentially the same business form but with only one owner, a partnership offers the advantage of allowing the owners to draw on the resources and expertise of the co-partners. Running a business on your own, while simpler, can also be a constant struggle. But with partners to share the responsibilities and lighten the workload, members of a partnership often find that they have more time for the other activities in their lives.

Tax advantages. The profits of a partnership pass through to its owners, who report their share on their individual tax returns. Therefore, the profits are only taxed once (at the personal level of its owners) rather than twice, as is the case with corporations, which are taxed at the corporate level and then again at the personal level when dividends are distributed to the shareholders. The benefits of single taxation can also be secured by forming an S corporation (although some ownership restrictions apply) or by forming a limited liability company (a new hybrid of corporations and partnerships that is still evolving).

Simple operating structure. A partnership, as opposed to a corporation, is fairly simple to establish and run. No forms need to be filed or formal agreements drafted (although it is advisable to write a partnership agreement in the event of future disagreements). The most that is ever required is perhaps filing a partnership certificate with a state office in order to register the business's name and securing a business license. As a result, the annual filing fees for corporations, which can sometimes be very expensive, are avoided when forming a partnership.

Flexibility. Because the owners of a partnership are usually its managers, especially in the case of a small business, the company is fairly easy to manage, and decisions can be made quickly without a lot of bureaucracy. This is not the case with corporations, which must have shareholders, directors, and officers, all of whom have some degree of responsibility for making major decisions.

Uniform laws. One of the drawbacks of owning a corporation or limited liability company is that the laws governing those business entities vary from state to state and are changing all the time. In contrast, the Uniform Partnership Act provides a consistent set of laws about forming and running partnerships that make it easy for small business owners to know the laws that affect them. And because these laws have been adopted in all states but Louisiana, interstate business is much easier for partnerships than it is for other forms of businesses.

Acquisition of capital. Partnerships generally have an easier time acquiring capital than corporations because partners, who apply for loans as individuals, can usually get loans on better terms. This is because partners guarantee loans with their personal assets as well as those of the business. As a result, loans for a partnership are subject to state usury laws, which govern loans for individuals. Banks also perceive partners to be less of a risk than corporations, which are only required to pledge the business's assets. In addition, by forming a limited partnership, the business can attract investors (who will not be actively involved in its management and who will enjoy limited liability) without having to form a corporation and sell stock.

DRAWBACKS

Conflict with partners. While collaborating with partners can be a great advantage to a small business owner, having to actually run a business from day to day with one or more partners can be a nightmare. First of all, you have to give up absolute control of the business and learn to compromise. And when big decisions have to be made, such as whether and how to expand the business, partners often disagree on the best course and are left with a potentially explosive situation. The best way to deal with such predicaments is to anticipate them by drawing up a partnership agreement that details how such disagreements will be dealt with.

Authority of partners. When one partner signs a contract, each of the other partners is legally bound to fulfill it. For example, if Anthony orders $10,000 of computer equipment, it is as if his partners, Susan and Jacob, had also placed the order. And if their business cannot afford to pay the bill, then the personal assets of Susan and Jacob are on the line as well as those of Anthony. And this is true whether the other partners are aware of the contract or not. Even if a clause in the partnership agreement dictates that each partner must inform the other partners before any such deals are made, all of the partners are still responsible if the other party in the contract (the computer company) was not aware of such a stipulation in the partnership agreement. The only recourse the other partners have is to sue.

The Uniform Partnership Act does specify some instances in which full consent of all partners is required:

  • Selling the business's good will
  • Decisions that would compromise the business's ability to function normally
  • Assigning partnership property in trust for a creditor or to someone in exchange for the payment of the partnership's debts
  • Admission of liability in a lawsuit
  • Submission of a partnership claim or liability to arbitration

Unlimited liability. As the previous example illustrated, the personal assets of the partnership's members are vulnerable because there is no separation between the owners and the business. The primary reason many businesses choose to incorporate or form limited liability companies is to protect the owners from the unlimited liability that is the main drawback of partnerships or sole proprietorships. If an employee or customer is injured and decides to sue, or if the business runs up excessive debts, then the partners are personally responsible and in danger of losing all that they own. Therefore, if considering a partnership, determine which of your assets will be put at risk. If you possess substantial personal assets that you will not invest in the company and do not want to put in jeopardy, a corporation or limited liability company may be a better choice. But if you are investing most of what you own in the business, then you don't stand to lose any more than if you incorporated. Then if your business is successful, and you find at a later date that you now possess extensive personal assets that you would like to protect, you can consider changing the legal status of your business to secure limited liability.

Vulnerability to death or departure. Unlike corporations, which exist perpetually, regardless of ownership, general partnerships dissolve if one of the partners dies, retires, or withdraws. (In limited partnerships, the death or withdrawal of the limited partner does not affect the stability of the business.) Even though this is the law governing partnerships, the partnership agreement can contain provisions to continue the business. For example, a provision can be made allowing a buy-out of a partner's share if he or she wants to withdraw or if the partner dies.

Limitations on transfer of ownership. Unlike corporations, which exist independently of their owners, the existence of partnerships is dependent upon the owners. Therefore, the Uniform Partnership Act stipulates that ownership may not be transferred without the consent of all the other partners. (Once again, a limited partner is an exception: his or her interest in the company may be sold at will.)

FORMING A PARTNERSHIP

Reserving a Name

The first step in creating a partnership is reserving a name, which must be done with the secretary of state's office or its equivalent. Most states require that the words "Company" or "Associates" be included in the name to show that more than one partner is involved in the business. In all states, though, the name of the partnership must not resemble the name of any other corporation, limited liability company, partnership, or sole proprietorship that is registered with the state.

The Partnership Agreement

A partnership can be formed in essentially two ways: by verbal or written agreement. A partnership that is formed at will, or verbally, can also be dissolved at will. In the absence of a formal agreement, state laws (the Uniform Partnership Act, except in Louisiana) will govern the business. These laws specify that without an agreement, all partners share equally in the profits and losses of the partnership and that partners are not entitled to compensation for services. If you would like to structure your partnership differently, you will need to write a partnership agreement. The subject is covered more fully in this volume under Partnership Agreement.

RIGHTS AND RESPONSIBILITIES OF PARTNERS

The Uniform Partnership Act defines the basic rights and responsibilities of partners. Some of these can be changed by the partnership agreement, except, as a general rule, those laws that govern the partners' relationships with third parties. In the absence of a written agreement, then, the following rights and responsibilities apply:

Rights

  • All partners have an equal share in the profits of the partnership and are equally responsible for its losses.
  • Any partner who makes a payment for the partnership beyond its capital, or makes a loan to the partnership, is entitled to receive interest on that money.
  • All partners have equal property rights for property held in the partnership's name. This means that the use of the property is equally available to all partners for the purpose of the partnership's business.
  • All partners have an equal interest in the partnership, or share of its profits and assets.
  • All partners have an equal right in the management and conduct of the business.
  • All partners have a right to access the books and records of the partnership's accounts and activities at all times. (This does not apply to limited partners.)
  • No partner may be added without the consent of all other partners.

Responsibilities

  • Partners must report and turn over to the partnership any income they have derived from use of the partnership's property.
  • Partners are not allowed to conduct business that competes with the partnership.
  • Each partner is responsible for contributing his or her full time and energy to the success of the partnership.
  • Any property that a partner acquires with the intention of it being the partnership's property must be turned over to the partnership.
  • Any disputes shall be decided by a majority vote.

see also Limited Liability Company

BIBLIOGRAPHY

Clifford, Denis, and Ralph E. Warner. The Partnership Book: How to Write A Partnership Agreement. Nolo, 2001.

Gage, David. The Partnership Charter: How to Start Out Right With Your New Business Partnership. Basic Books, 2004.

Mancuso, Anthony. Form Your Own Limited Liability Company. Nolo, 2005.

Thompson, Margaret Gallagher. "Where We Were and Where We Are in Family Limited Partnerships." The Legal Intelligencer. 1 August 2005.

                         Hillstrom, Northern Lights

                           updated by Magee, ECDI

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Partnership

PARTNERSHIP


A partnership is a legal organization in which two or more individuals own and operate the business. Partnerships are not limited as to the number of possible partners or the number of employees. Generally, however, partnerships are small in size. Partnerships are a common form of organization in the professions (businesses such as retail shops and service trades like car repair shops) and in wholesale firms (which buy from producers and sell to retailers).

Businesses organized as partnerships are advantageous for several reasons. No formal legal process is required to start a partnership, but most are based on signed agreements between partners as to how the costs and profits will be divided. Although certain licenses or permits may be required, few fees are to be paid or papers filed with government agencies. Owners may have a great deal of flexibility and freedom in decision making. Also, instead of working for someone else and receiving a salary, the owners may keep all the profits to do with as they see fit. The talents and abilities of more than one person will be available to the business, and, with several individuals backing the firm, bank loans may be easier to obtain.

The largest economic disadvantage of partnerships is unlimited liability. The owners are personally responsible to the full extent of whatever wealth they own for all the debts of the business, both jointly and separately. This means that if one individual owns 1/4 of a firm and the firm goes out of business with debts of $400,000, the individual is liable for $100,000. However, if the other three partners disappear, the one remaining would be liable for the entire $400,000 (and even personal possessions may be taken to satisfy creditors). The actions of any one partner are the legal, unlimited responsibility of all partners. Another disadvantage is the limited ability to raise enough capital for the business to grow, be efficient, and highly profitable. In most cases raising sufficient investment capital is problematic.

In the United States during the 1980s and the 1990s, the percentage of total firms organized under partnerships and their sales remained relatively constant. In 1993 partnerships made up 6.9 percent of all U.S. firms and represented 1,467,000 businesses; they received 4.8 percent of total sales, about $627 billion.

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partnership

part·ner·ship / ˈpärtnərˌship/ • n. the state of being a partner or partners: we should go on working together in partnership. ∎  an association of two or more people as partners: an increase in partnerships with housing associations. ∎  a business or firm owned and run by two or more partners. ∎  a position as one of the partners in a business or firm.

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Partnership

Partnership

an association of two or more persons for carrying on business; the persons collectively Wilkes.

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Partnership

PARTNERSHIP

Formation

The earliest form of commercial partnership in Jewish law was partnership in property, or joint ownership. Craftsmen or tradesmen who wished to form a partnership were required to place money in a common bag and lift it or execute some other recognized form of kinyan for movables (Ket. 10:4; Yad, Sheluhin 4:1). The need for executing a kinyan precluded an agreement concerning a future matter (Maim., ibid. 4:2), since there can be no *acquisition of a thing that is not yet in existence. In later times this difficulty was overcome when the halakhot concerning the need for acquisition formalities were interpreted as having reference only to the formation of the partnership and not to matters in continuation thereof (Maharik Resp. no. 20).

From the tenth century onward, new developments became acknowledged with regard to the manner of forming a partnership. Thus the German and French scholars recognized formation of a partnership by mere agreement between the contracting parties (Ha-Ittur, vol. 1, s.v.Shittuf; Mordekhaibk 176; Resp.Rosh no. 89:13). A second development was recognition of each partner as the agent of his other partners (Haggahot Maimuniyyot, Gezelah 17:3 n. 4), which offered the possibility of partnership formed solely by verbal agreement (see *Agency, Law of). A further development, that of recognizing each partner as the hireling of his other partners (Hassagot Rabad, Sheluḥin, 4:2), facilitated partnership agreement with reference also to further activities. The drawback of partnership by way of agency or hire is that each partner has the power to dissolve the partnership at any time. Another method was formation of a partnership by personal undertaking, each partner taking a solemn oath to perform certain acts on behalf of the partnership (Ribash Resp. no. 71).

Partnership formation by agreement alone was most prevalent from the 16th to the 19th centuries, particularly in the communities of the Spanish exiles, in reliance on the principle of accepted trade *customs (e.g., kinyan sitomta: see bm 74a and codes). It was on the basis of a trade custom that formation of a partnership through verbal agreement alone was recognized, even by the mere recital of the single word "beinenu" (Rosh Mashbir, Ḥm no. 31; Kerem Shelomo, Ribbit, 8) or by implication (Shemesh Ẓedakah, Ḥm 35). Texts of the standard partnership deeds developed over the years indicate that, in general, formation of the partnership agreement rested on a number of elements, mainly kinyan sudar (acquisition by the kerchief), personal undertaking, and hire (see, e.g., Darkhei No'am, Ḥm, 54). In this way it was possible to form a partnership with a minimum of formalities, valid also in respect of future activities, and not retractable from prior to expiry of the specified period (see *Contract).

It may be noted that the fraternal heirs are deemed to be partners until the inheritance is divided among them (see *Succession).

Distribution of Profits and Losses

In the earliest discussions of partnership in Jewish law, the question of distribution of profits was treated in cases of an unequal capital investment by the individual partners (Ket. 10:4). In the first halakhot two conflicting opinions were expressed: in the Mishnah, distribution in proportion to the amount invested; in the Tosefta, equal distribution of the partnership profits. In the Talmud, application of the mishnaic halakhah was limited to cases of capital gain or those in which it was impossible to make a physical division (tj, bk 4:1, and Ket. 10:4; Ket. 93). Talmudic sources reflect no hard and fast rule concerning the distribution of profit deriving from commercial activity. For a long period of time, from the geonic period until the 19th century, these halakhot were applied by the scholars in both fashions discussed above. In centers of Jewish life where there was a great deal of activity in commerce and the crafts, the tendency was to decide in favor of an equal distribution of profits in all cases; in centers where there were many loan transactions the tendency was to decide in favor of a distribution pro rata to investment. Thus in the 12th and 13th centuries the principle of an equal distribution was followed in Spain, whereas the German and French scholars took the view that, in general, the gain, whenever divisible, should be shared in proportion to the investment of each partner.

In general, profit earned by a partner in an unlawful manner, for example, through theft, has not been considered as belonging to the partnership (Ha-Ittur, vol. 1, s.v.Shittuf; Siftei Kohen, Ḥm, 176 n. 27). A contrary ruling with regard to partnership gains from theft was laid down in Germany and France in the 14th century, as an outcome of the persecution of the Jews (Haggahot Maimuniyyot, Sheluḥin 5:9 no. 4; see also *Contract, on the attitude of Jewish law to illegal contracts). From the 17th century onward the application of this halakhah came to be confined to cases of necessity on account of danger (Siftei Kohen, loc. cit.), or those in which an act, although illegal, falls within the scope of the partnership business (Arukhha-Shulḥan, Ḥm 176:60).

A tax waiver in favor of one partner benefits the whole partnership, except when a waiver is granted at the taxing authority's own initiative (Ḥm 178:1). A condition that all profits shall belong to the partnership has been interpreted in accordance with the ejusdem generis rule, so as to exclude there-from all unusual or unforeseeable profits (Rosh, Resp. no. 89:15). A partner who salvages part of the partnership assets from a robbery does so for the benefit of the partnership in the absence of his prior stipulation to the contrary (bk 116b and codes). The partners may not deal in goods whose use is prohibited, for example, for reasons of ritual impurity (Maim. Yad, Sheluḥin 5:10).

Until the end of the 12th century, any loss attributable to a partner's personal fault had to be borne by the partner himself, on the principle that an agent is liable for the consequences of a departure from his mandate (Yad, Sheluḥin 5:2; see also *Agency). From the 13th century onward, the general trend has been toward collective partnership responsibility for a loss occasioned by one of its members. At first it was laid down that the partnership bear such a loss as if the member's liability were that of *bailee for reward; later it was ruled that a partner be regarded as a gratuitous bailee for this purpose; and later still that the partnership bear the loss occasioned by a member even if it was the result of his own negligence (Mordecai bb 538). The partner himself must bear any loss occasioned through his own acquiescence or active participation (Mabit, Resp. vol. 2, pt. 2, no. 158).

Each partner is responsible as a surety for the undertakings made by his other partners in respect of a partnership matter (Yad, Malveh 25:9). This liability is secondary, however, as is usual in simple *suretyship in Jewish law, and effective only upon default of the principal debtor (Sefer ha-Terumot, 44). According to another opinion, one partner is a surety for the other only when he has expressly subjected his person and assets as a surety for the undertaking, in which event he becomes the principal debtor (Rosh, Resp. no. 89:3).

Powers and Duties of the Partners

The rule is that a partner may not deviate from the regular course of activities of the partnership, and his powers, if not defined by agreement, are governed by trade custom (Ha-Ittur, vol. 1, s.v.Shittuf; Yad, Sheluhin 5:1; Rosh. Resp. no. 89:14). When the intention of the partners cannot be ascertained, a number of activities have been recorded as constituting deviation from the partnership. In the course of time the early partnership halakhot came to be interpreted in favor of wider powers for the individual partner. Thus, with regard to the rule that a partner might not transact partnership business away from the place of the partnership (Yad, loc. cit.), it was decided that the restriction did not apply to a market place situated in the same area (Netivot ha-Mishpat, Mishpat ha-Kohanim 176 n. 35) nor to the case in which one partner provided the other partners with suitable indemnities against possible loss (Arukh ha-ShulḥanḤm 176:46–47).

The question of whether a partnership member has power to execute credit transactions was already disputed in geonic times. One approach tended to recognize the power of a partner to sell on credit in all cases, because it was considered that he was bound to be careful about securing the repayment of money in which he had a personal stake (Sha'arei Ẓedek, 4:8, 4). A second approach denied a partner the power to sell on credit unless this accorded with a custom followed by all local traders (Rif., Resp. no. 191) and, by way of compromise, it was laid down that it sufficed if the custom was followed by a majority of local traders (Rosh. Resp. no. 89:14). It was also laid down that a partner is exempted from liability if an overall profit results from all his transactions (Ḥokhmat ShelomoḤm 176:10).

A partner may not introduce outsiders into the partnership activities as partners (Yad, Sheluḥin 5:2), but may employ them on his own behalf and at his own responsibility (Rashdam, Ḥm, 190). It was ruled that a member of a partnership might not engage in private transactions (ibid.), but this was later permitted when the same kind of merchandise as the partnership dealt in was involved (Matteh Yosef vol. 1 Ḥm no. 9) or in association with an outsider (Sma, Ḥm 176 n. 32). Partnership merchandise may not be sold before the appointed season for its sale (Git. 31b and codes).

In general, a partnership member is not entitled to remuneration for his services (Reshakh, Resp. pt. 1 no. 139), but some of the posekim allowed this in the case of unusually onerous services (She'ilat Yaveẓ no. 6; Simḥat Yom Tov no. 23). Similarly, a partner is not entitled to a refund of the amount expended on his subsistence while on partnership business (Ḥm 176:45), except for extraordinary expenses (Taz, ad loc.). A partner who is unable to participate in the partnership activities on account of illness, or for some other personal reason, is not entitled to share in the profits earned by the partnership during his absence and must also defray his medical expenses, etc., out of his own pocket, unless local custom decrees otherwise (bb 144b and codes). If partnership property is later found in the possession of one of the partners, his possession will not avail against any of the other partners (Alfasi, bb 1; see *Ḥazakah). Each partner may compel the other to engage in the partnership activities and also to invest additional amounts therein (Netivot ha-Mishpat, Mishpat ha-Urim, Ḥm 176:32).

The act of a partner may be validated by subsequent ratification, which may also be implied from the silence of the remaining partners (Maharik, Resp. no. 24). Far-reaching powers are afforded a partnership member through application of the principle that an act may be "for the benefit of the partnership." In the opinion of a number of scholars, a partner may deviate from the customary framework of the partnership activities when he considers this to be necessary in the interests of the partnership, provided that the terms of the partnership agreement expressly permit him to trade in all kinds of merchandise, and that there is no radical departure from the customary partnership practices (Resp. Maharashdam, Ḥm 166; Ne'eman Shemu'el no. 100). One partner may oblige another who is suspected of an irregularity with regard to a partnership matter to deliver an oath in accordance with a rabbinical enactment (Shevu. 7:8). For this reason it was originally forbidden for a Jew to take a gentile as a partner, as the latter was likely to make an idolatrous reference in swearing his oath, but this is permissible now because of "their belief in the Maker of heaven and earth" (Ran on Rif, Git. 5).

Representation of the Partnership by One of its Members

In talmudic law the principle was established that only when all the partners are in the same town can they be represented by the partner who is plaintiff in an action, this even without their express power of attorney (Ket. 94a and codes). From the 13th century onward, the following guiding rules came to be laid down: one partner represents the others when there is an equal division of profits between them; partners who have not been joined as plaintiffs may not thereafter renew the action in their own names unless they plead new issues; one partner represents the others only when he makes a claim against the defendant and not a waiver in his favor (Shitah Mekubbeẓet, Ket. 94). Other scholars expressed opinions in favor of the reverse situation, i.e., that one partner represents the others only if there is no denial of liability on the defendant's part and there is no dispute between them (Maharit, Resp., vol. 2 Ḥm no. 16); the plaintiff partner represents the remaining partners once the latter have knowledge of the suit, even if they are not all present in the same town (Resp. Solomon b. Isaac ha-Levi, Ḥm no. 41); the partner who is on the scene may sue in all cases, but may not recover the shares of his absent partners (Piskei ha-Rosh, Ket. 10:12); the absent partners have the right to sue in their own names if they do so immediately after their return to the town in question, but lose this right after a certain period of delay (Mikhtam le-David, Ḥm no. 31; Edut bi-Yhosef vol. 2 no. 38). The partners may each plead in turn, or empower one of them to represent all (Maharam of Rothenburg, Resp., ed. Prague, nos. 332, 333). A partner has authority to collect debts owing to the partnership in terms of a bond of indebtedness of which he is the holder (Rashba, Resp. vol. 1, no. 1137). One partner generally does not represent the remaining partners as defendant in an action unless empowered by them to do so (Mordekhai, Ket. 239). The defendant does, however, represent his absent partners if he is in possession of the subject matter of the claim (Tur, Ḥm 176:31). See also *Agency; *Practice and Procedure.

Dissolution of Partnership

The activities of a partnership formed for an unspecified period of duration may be terminated at any time at the instance of any of its members, except if this is sought when it is not the season for the sale of its merchandise, and provided there are no outstanding partnership debts for which all partners are liable. A partnership formed for a specified period may not – according to the majority of the posekim – be dissolved before the stipulated date (Yad, Sheluhin 4:4). The existence of a partnership is also terminated when its capital has been exhausted, its defined tasks completed, and on the death of any of its members. Improper conduct on the part of a member – such as theft – does not, in the opinion of the majority of the posekim, serve to terminate the partnership. On dissolution of a partnership, division of its monies – if in the same currency – may be made by the partner in possession thereof, and this need not necessarily be done before the court. Division of the partnership assets must be made before three persons, who need only be knowledgeable in the matter (Yad, Sheluḥin 5:9).

Iska ("In Commendam" Transactions)

Freedom to contract a partnership is limited to some extent in the case where one party provides the capital and the other the work. In order to avoid a situation in which the party furnishing the capital ultimately receives an increment on his investment which is in the nature of interest, there was evolved a form of transaction known as iska, i.e., "business," in which half of the furnished capital constitutes a loan to the "businessman," or active partner, and the other half is held by him in the form of a deposit (bm 104b and codes). The parties to an iska are free to stipulate as they please, provided that they observe the principle that the "businessman" must enjoy some greater benefit than the "capitalist," by way of remuneration for his services (bm 5:4). It would seem that the profits from the loan part of the capital belong to the businessman, and the profit from the deposit part, after deduction of the former's remuneration, belong to the capitalist. Unless otherwise agreed upon, the businessman is to receive wages as a regular worker if he devotes himself entirely to the affairs of the business, and if not, he may be paid a token amount. Another possibility, if nothing is stipulated, is that the businessman receives two-thirds of the profits, and bears one-third of the losses (Yad, Sheluḥin 6:3) or, according to another opinion, one-half of the losses (Hassagot Rabad thereto). The businessman's liability in respect of the loan half of the capital is absolute, whereas his liability in respect of the deposit half is that of a gratuitous bailee (Yad, Sheluḥin 6:2), or, according to another opinion, that of a bailee for reward (Hassagot Rabad, ibid.).

According to one school, an iska is constituted whenever the partnership arrangement involves an active as well as an inactive partner, and it makes no difference whether the inactive partner alone or both of them contribute the capital (Yad, Sheluḥin, 6:1); according to another school, there is no iska unless the distinction between an investing but inactive and an active but noninvesting partner is clearly maintained in the partnership arrangement (Beit Yosef, yd 177). The capital-investing partner takes no share in the profits of a prohibited iska (Piskei ha-Rosh, bm 8:7).

That an iska is essentially a legal device designed to avoid the prohibition against *usury may be seen from the fact that a nominal remuneration may be agreed upon for the active partner, and from the rule that the latter may not distinguish between the loan and the deposit parts but must put to work the whole amount of the capital invested (Yad, Sheluḥin 7:4). In most respects the law of iska follows the law of partnership, but the following basic differences may be noted: the "businessman," unlike a partner in a regular partnership, may retract from the contract at any time, as in the case of a worker (Tur Ḥm 176:28), and he must receive remuneration for his services (Mishpat Ẓedek, vol. 2, no. 16, et al.).

Joint Ownership

As already indicated, the halakhot of partnership developed mainly from the law of joint ownership. Characteristic of this is the power of each part-owner to compel the others to carry out the usual and required activities with regard to the common property – such as the construction of a gate to the premises – or to refrain from any unusual use of the property, such as keeping an animal on the premises; similarly, each part-owner may bring about a dissolution of the partnership by compelling a partition of the common property, provided that thereupon each share still fits the original description of the property and, in the case of immovable property, that it is possible to erect a partition against exposure to the sight of neighbors. If the common property does not allow for proper subdivision, the interested partner may offer to sell his share to the remaining partners or to purchase their shares from them; if the matter cannot be settled in this manner, the property must be sold, or let to a third party, or an arrangement must be made for its joint use by the partners, simultaneously or successively, all in terms of detailed rules on the subject (bb 1–3, and codes).

A Legal Persona

A cooperative body in modern legal systems is an entity with rights and obligations quite apart from those of its component members (see G. Procaccia, Ha-Ta'agid Mahuto… vi-Yẓirato (1965), p. 39). According to the law of the State of Israel, a registered partnership is a legal persona, capable of suing and being sued (The Partnerships Ordinance, 1930, sec. 61 (1)). However, this approach is foreign to Jewish law, the halakhah recognizing man alone – whether individually or in cooperation with others – as the subject-matter of the law, so that it does not accord an association a separate personality (see Gulak, Yesodei (1922), 50). It is for this reason that the word "partners" rather than "partnership" is the more commonly employed halakhic term. Thus a suit brought by the partners against one of their number, e.g., arising out of fraud (see *Ona'ah), is not the suit of the partnership but of its individual members (Yad, Sheluḥin, 5:6; Sh. Ar. Ḥm 176:4). Nevertheless, even though the partnership as such does not have the status of an independent legal persona, the moment a person is recognized as a partnership member his rights and obligations change and no longer correspond to those attaching to the individual or to an agent. Thus one partner represents his fellow partners vis-à-vis third parties, and unlike an agent, renders them bound by the consequences of his acts in certain circumstances, even without having been appointed as their representative (Yad, Sheluḥin, 3:3). Similarly, if jointly owned property is later found in the possession of one of the co-owners, the latter's possession will not be recognized, despite the rule that the onus of proof is on the person seeking to recover from the neighbor (bb 4a and codes); subsequent ratification of a fellow partner's acts amounting to deviation from the customary partnership activities suffices to absolve the latter from liability for such deviation – according to some of the posekim even if they are only passed over in silence without protest (Shenei ha-Me'orot ha-Gedolim no. 26). Thus the special standing which the law affords a partner to some extent lends a partnership the coloring of a legal persona.

In the State of Israel

The laws of partnership are governed by the above-mentioned mandatory partnership ordinance, which is based on the British Partnership Act, 1890, but differs from it mainly in that it necessitates registration of a partnership to which it lends the character of a legal persona (sec. 61 (1)). Still unclear is the position as regards the standing of an unregistered partnership (pd 15:1246; Pesakim Meḥoziyyim, 56:362). Case law shows that the halakhah is sometimes quoted with regards to problems left unresolved within the framework of the Partnership Ordinance (e.g., on the questions of dissolution of partnership (pd 21:576) and the share of each of the spouses in the profits and losses deriving from their common enterprise (Pesakim Meḥoziyyim, 23:418)). In cases where the parties agree to submit their dispute to a rabbinical court, the issue will be decided in accordance with Jewish law (see pdr 2:376, 5:310).

[Shmuel Dov Revital]

Partnership of Members of a Professional Association

The laws of partnership in Jewish Law have also been used by members of a professional association. The Tosefta states that "the wool workers and the dyers are allowed to say: 'We will all be partners in any business that comes to the city'" (Tosef., bm 11, 24). In such a case, unlike the normal manner of creating partnership detailed above, the partnership is created pursuant to an internal regulation of a particular professional association. This method of forming a partnership is similar to other internal regulations mentioned in the Tosefta regarding an arrangement for mutual insurance among members of the association of donkey drivers and sailors. In Jewish Law, the laws of partnership also influence various aspects of the public law, especially in tax law; see *Taxation.

Further Developments in the State of Israel

Another case in which the civil court had recourse to the rules of partnership in Jewish law concerned the division of a partnership's assets equally among three brothers. The court considered the question of whether the parts should be distributed to the parties by way of lottery, or whether one of two partners should be given the priority in choosing a particular part of the partnership property for sentimental reasons. The court cited the Jewish Law principle, "when brothers or partners divide the field, and all of the shares are equal, and there is no good or bad location, the division is made exclusively by measurement. However, if one of the partners says: 'Give me my share on this side so that it will be close to my field and become like one big field,' his request is accepted and the others are compelled to oblige, for to refuse such a request is conduct suitable for Sodom" (Yad, Shekhenim 12, 1; Sh. Ar, Ḥm 174:1; see *Law and Morality). Accordingly, the Court ruled that when one of the partners has a preference for a particular part because he cultivated and cared it for years, that preference should be taken into consideration – at least to the same extent that the financial interest of one of the partners should to be taken into consideration, such as the fact that the field under consideration is adjoining to his field (Ḥm (Tel Aviv) 309/59 Re The Partnership of the Litvinsky Brothers, 18 pdm 65 per Judge Lamm).

Since 1975, matters of partnership are regulated in the Partnership Ordinance [New Version], 5735 – 1975.

Regarding partnership of spouses in spousal assets see *Matrimonial Property.

[Menachem Elon (2nd ed.)]

bibliography:

J.S. Zuri, Mishpat ha-Talmud, 4 (1921), 55–59; 5 (1921), 154–6; idem, Arikhat ha-Mishpat ha-Ivri… Ḥok Ḥevrat ha-Shutafut (1940); Gulak, Yesodei, 1 (1922), 135–7; 2 (1922), 192–8; Gulak, Oẓar, 147f., 217–23; E.E. Hildesheimer, Das juedische Gesellschaftsrecht… (1930); Herzog, Instit, 1 (1936), 213–23; 2 (1939), 155–66; Elon, Mafte'aḥ, 321–41. add. bibliography: M. Elon, Ha-Mishpat ha-Ivri (1988), 1:373, 559ff., 562, 586, 599, 603, 605, 626, 653, 663, 703, 745ff., 747, 755, 764, 765ff.; 2:1102, 1110ff., 1233; 3:1345, 1364.; idem, Jewish Law (1994), 1:451; 2:680 ff., 683, 722, 741, 746, 749, 774, 808, 819, 867, 919 ff., 921, 931, 941, 942 ff.; 3:1325, 1335 ff., 1477, 1606, 1627 ff.; M. Elon and B. Lifshitz, Mafte'aḥ ha-She'elot ve-ha-Teshuvot shel Ḥakhmei Sefarad u-Ẓefon Afrikah (legal digest) (1986), 486–501; B. Lifshitz and E. Shochetman, Mafte'aḥ ha-She'elot ve-ha-Teshuvot shel Ḥakhmei Ashkenaz, Ẓarefat ve-Italyah (legal digest) (1997), 326–39; Enẓiklopedyah Talmudit, s.v. "Gud o Iggud," 5:233 ff.; s.v. "Ḥalukat Shutafut," 15:409 ff.; S. Revital, "Pesikat Batei-Din Rabaniyyim be-Inyanei Shutafim," 13–14, in: Dinei Yisrael (1986), 91.

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Partnership

Partnership

What It Means

When two or more people combine resources to form a profit-seeking business, that arrangement is called a partnership. In this sort of organization all profits and debts are shared proportionately according to the resources that each partner put in at the beginning. Partners are also personally liable (responsible) for all losses and damages suffered by the business. For example, if two college students each invested $250 to begin a painting business, and they made $4,000 by the end of the first summer, each would receive $2,000. On the other hand, if on the first day of the job one of the painters broke a large window that cost $3,000 to replace, both partners would have to draw $1,500 from personal funds to cover the damages. In this way a partnership is different from a corporation, a kind of business in which the owners cannot be asked to draw from personal accounts to cover damages.

There are two basic types of partnership: general and limited. In a general partnership, such as the arrangement described above, partners own and manage the business together. In a limited partnership one or more general partners manage the business and assume personal liability for losses, while limited partners contribute money, work space, or other resources but are not involved in the management of the enterprise. This is why they are sometimes referred to as silent partners. Limited partners are only liable for the amount they invested in the business.

When Did It Begin

Business partnerships have existed since early civilization; the oldest known reference to such an arrangement dates back to the eighteenth century bc , with a law code of the ancient empire of Babylonia (in present-day Iraq). This evidence suggests that, for as long as there have been people willing to pool resources to make more money, there has also been a need for rules and written documents to settle disputes between partners.

In Europe partnerships (which were then called commendas ) first arose in the eleventh century, when trade relations between Italy and the eastern Mediterranean began to grow. These business partners created agreements based on a combination of Roman commercial law and Islamic religious law. Borrowing from this original model, the English business community of the 1600s had partnerships called societas. More modern versions of these businesses spread widely in England throughout the 1800s, and in order to regulate their activities, the country formally ratified the Partnership Act in 1890. The United States in 1914 passed its Uniform Partnership Act, which was adopted by all the states except Louisiana. The act underwent a series of modifications between 1994 and 1997. By the start of the twenty-first century most states had adopted the Revised Uniform Partnership Act of 1997.

More Detailed Information

A partnership is much easier to create than a corporation, which usually requires official authorization from a state government and a yearly licensing fee. To create a business partnership, no formal papers need to be filed with any state or federal agency, and there is no licensing fee. Two or more individuals just need to reach a verbal agreement and begin business.

Most partnerships, however, are formed through a written agreement called the articles of partnership, which outlines each party’s rights and obligations. In the absence of a written agreement, partnerships in the United States are governed by either the Uniform Partnership Act or the Revised Uniform Partnership Act, depending on the U.S. state that the partnership is in. The main provisions of both acts are the same. They say that partners must share profits, losses, and obligations and that the partnership must be a for-profit business. Charitable organizations and nonprofit groups can not legally be considered partnerships.

There are many advantages to structuring a business as a partnership rather than as a corporation. The primary advantage is flexibility: the partners themselves manage the business and need only consult each other to change daily operations. That is not often the case with traditional corporations, which consist of stockholders (people who have invested money in the company and therefore own it), a board of directors (elected by the stockholders to represent them), and officers (who run the daily operations). Each of these has a say in the company’s major decisions, so changes to corporations often involve layers of bureaucracy. Partnerships also offer an important tax advantage over corporations, which are, in effect, taxed twice: the corporation itself is taxed for all profits, and individual stockholders also pay taxes on their shares of the profits. With a partnership, however, all profits go directly to the partners, who only pay individual income tax on what they earn from the business.

There are some disadvantages to maintaining a partnership instead of a corporation. Most of these have to do with liability. To be liable means that each of the partners is personally responsible for covering any money the partnership owes. Furthermore, a decision made by one partner is binding to all partners, whether they know about the decision or not. For example, if three partners set up a small computer-merchandise shop and one of them agrees to pay a distributor $20,000 for equipment, then all partners are liable for that $20,000. If the three partners cannot pay the bill, the distributor can sue them for the money. If the partner who signed the agreement has no personal savings, the distributor can recover funds from either or both of the other partners.

Recent Trends

Because corporations experience what is called double taxation by the federal government (the corporation is taxed as an entity for its profits, and then individual shareholders are taxed), many entrepreneurs prefer to pay fewer taxes by running their businesses as partnerships or S corporations. The latter is a type of business entity that consists of 100 or fewer shareholders and receives the benefits of incorporation while being taxed as a partnership. Between 2000 and 2004 the number of partnerships in the United States grew by 23 percent, and the number of S corporations increased by 21 percent. Many states reacted by rewriting their business tax laws in an effort to raise revenues. States such as New Hampshire, Ohio, and Tennessee, for instance, began to impose what have been called franchise taxes or commercial activities taxes on some partnerships and S corporations.

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Partnership

Partnership

A partnership is defined simply as a contract, whereby two or more persons consent to combine assets or labor to realize common profits. Pooling resources to better exploit investment opportunities is so natural that there is evidence of partnerships in the earliest legal codes. For example, partnerships are referenced in the ancient Mesopotamian Code of Hammurabi, as well as in sixth-century Rhodian sea law. Yet, as even these ancient references imply, the simplest partnership can generate problems stemming from conflicting claims. This suggests that the history of the partnership may be best studied through the recognition of, on the one hand, the desire to exploit economies of investment, and on the other, the need to clarify rights and obligations to minimize conflicts not only between the firm and third parties but also between copartners.

In the eleventh century partnerships were introduced into Europe through Italy when Europe was experiencing increased trade. Of primary importance was renewed contact with the Eastern Mediterranean, through which Western merchants became aware of the business practices and commercial legal codes of Byzantium and the Islamic states. From the former, they were familiarized with the commercial laws of Rome as reflected in the Justinian Code, and from both they acquired the merchant law and its institutions. Regarding partnerships, Western merchants borrowed the commenda, as reflected in Islamic law and the Roman societas.

THE COMMENDA

The commenda contract had a sedentary investor, known as the commendator, who advanced capital to a traveling associate, known as a tractator. Its essential feature was that the commendator risked only the capital advanced because he was not liable for any other losses. The contract ended when profits were distributed after the merchant returned. As private partnerships carrying limited liability were unknown in classical Rome, the origin of the commenda is believed to be either Byzantium or Arabia.

The commenda flourished across Europe after its introduction into Italy, but it particularly was used in overseas trade. Its success has been attributed to its being a convenient tool used to circumvent restrictive usury laws, or as a convenience to reduce capital risk. Both explanations are suspect due to the presence of bottomry loans, which were not repayable if goods were damaged or lost. The bottomry loan, dating back to the Rhodian Sea Law, was tolerated under the canon law, which may explain its subsequent use in overland trade as well.

The success of the commenda is therefore attributable to its usefulness in combining capital with merchant entrepreneurship. When the merchant added only his own skill and knowledge, the partnership was known as a unilateral commenda, in which case the commendator received three-fourths of any profit and the tractator the rest. Under this type of contract, the commendator would be concerned that the merchant might opportunistically pursue his own interests. A more basic threat stemmed from the fact that the merchant was not personally liable for any losses, and therefore they were inclined to incur more risk than optimal. However, the amount of capital risked was limited to that required to purchase merchandise. In addition, merchants and capitalists generally formed lasting relationships, suggesting that merchant reputation played a crucial role.

The simple unilateral commenda of the early period eventually became a more efficient bilateral commenda, whereby the merchant also advanced some capital. If he invested a quarter of the total capital, he received 50 percent of the profits. In France and Italy during the fifteenth century a larger form of commenda developed, where several commendators contributed capital to one or more tractators, who increasingly operated with more independence. Under this arrangement, which known as a sociéte en commandite, its capital suppliers contributed only capital which carried limited liability, and its managers bore unlimited liability.

THE COMPAGNA

The compagna was introduced into Italy in the same period as the commenda. It was loosely based on the Roman societas, which included any association formed to exploit capital and labor. Whereas a societas partner was unable to bind his copartners for debts or to alienate any property for more than his share, partners belonging to a compagna were each responsible individually for the debts of the firm, and each could contractually bind the whole firm.

The compagna could own property and act under a common name. It could sue and be sued, and was even liable for any negligent or fraudulent acts committed by its members. It thus acquired a kind of legal personality. Consequently, as a general rule, each partner enjoyed a voice in partnership decision making. Decisions required a simple majority vote (in contrast with the societas, where unanimity was required), allowing the compagna to fully exploit its pooled resources and enabling it to undertake larger ventures requiring longer time horizons.

Note that the principle that any one partner could bind all partners originally applied only if extended to a partner by procurement. Otherwise, creditors could only make good a claim against the firm if a debt was recognized as a firm debt. Thus, partnership books were often examined. However, by the fifteenth century, the principle of one binding all was generally accepted. Also, in the formative period, individuals often denied to creditors that they were really partners: they claimed that they were really partners in some other partnership, or that they had previously dissolved their association. Consequently, the rule eventually became that agreements listing the partners had to be registered with their guild and city authority. Such deeds also typically noted the duration of the partnership, but if the latter was not mentioned, the partnership could be dissolved at the will of any partner. The deed also specified an agreed division of profits; otherwise, the split was even.

At first the compagna was based solely on the family, but increasingly it included outsiders, though in Venice family-based partnerships persisted well into the sixteenth century. Large partnerships were particularly vulnerable to agency and managerial difficulties. Banking partnerships were among the largest, having several distant branches specifically located to best service the financial needs of overland trade. Banks were based on wealthy families and originally, as in the case of the Peruzzi and Bardi partnerships, they were centrally governed by family partners located at home. As the distant branches were managed by agents called factors, local mangers were unable to contractually bind the firm. Consequently, these banks often could not seize profitable opportunities and were thus eventually eclipsed by the Medici bank, which formed separate partnerships with each local manager and thrived in the fifteenth century. Notably, under the merchant law, each branch was held to be totally separate.

SUMMARY AND EXTENSION

In the formative period of the partnership the essential features of both the limited-liability and general partnership evolved to form the basis of modern partnerships in Roman-law and common-law countries. The general partnership of both England and the United States was introduced into the common law of England through the merchant and equity courts. Its essential characteristics were simply those of the Italian compagna. Notably, Scottish partnership law was based on the civil law, and therefore more flexible from entrepreneur's perspective. After the Act of Union (1707), however, Scottish partnership law began to slowly resemble England's.

The commenda was widely used throughout Europe, including in England, where it was discouraged under the common law in the sixteenth century. But in many countries the modern form of limited partnership derives from the French commandite, which spread through much of continental Europe with the Napoleonic Code in the early nineteenth century. It was first introduced by statute into U.S. law in New York in 1822, and soon spread to other states. However, limited partnerships were not reintroduced into England until 1907. The end of the twentieth century witnessed somewhat controversial legal innovations in the United States and United Kingdom, which permitted managing partners to have limited liability. These limited liability partnerships (LLP) have become common in the legal and accountancy professions.

SEE ALSO Corporation, or Limited Liability Company; Law, Common and Civil.

BIBLIOGRAPHY

Berman, Harold J. Law and Revolution: The Formation of the Western Legal Tradition. Cambridge, MA: Harvard University Press, 1983.

Blomquist, Thomas W. "The Castracani Family of Thirteenth Century Lucca." Speculum 46 (1971): 459–476.

De Roover, Ramond. "The Decline of the Medici Bank." Journal of Economic History 7 (1947): 69–82.

Freedman, Charles E. Joint-Stock Enterprise in France, 1807–1867: From Privileged Company to Modern Corporation. Chapel Hill: University of North Carolina Press, 1979.

Hoover, Calvin B. "The Sea Loan in Genoa." Quarterly Journal of Economics 40 (1926): 495–529.

Howard, Stanley E. "Limited Partnership in New Jersey." Journal of Business 7 (1934): 296–317.

Lane, Frederic C. "Family Partnership and Joint Ventures in the Venetian Republic." Journal of Economic History 4 (1944): 178–196.

Morse, Geoffery. Partnership Law, 5th edition. London: Blackstone Press, 2001.

Postan, M. M. "Credit in Medieval Trade." The Economic History Review 1 (1928): 234–261.

Pryor, John H. "The Origins of the Commenda Contract." Speculum 52 (1977): 5–37.

Charles R. Hickson
John D. Turner

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