Recently in General Partnerships Category

June 30, 2014

Partnership Dissolved, but Partner Still Liable

iStock_000023649013Small.jpgLast year the Indiana Court of Appeals decided a case that illustrates some of the hazards of operating a business as a general partnership. The case is Curves for Women of Angola vs. Flying Cat, LLC.

In 2001, a married couple, Dan and Lori, purchased a fitness and health franchise known as Curves for Women that they intended to operate in Angola, Indiana. The franchise agreement, which Dan and Lori both signed, contained the following affirmation:

We the undersigned principals of the corporate or partnership franchisee, do as individuals jointly and severally, with the corporation or partnership and amongst ourselves, accept and agree to all of the provisions, covenants and conditions of this agreement[.]

At no time did Dan and Lori form a corporation or limited liability company to own the franchise - not before signing the franchise agreement and not after.

At about the same time, Dan and Lori leased space in which to operate the business, known as Curves for Women of Angola. The landlord was Flying Cat, LLC. Both Dan and Lori signed the lease, each in the capacity of "Owner." The lease was for a term of three years, with options to renew for additional three-year terms.

After the lease was signed, the business began operation. Lori managed the day-to-day operations, and Dan handled the responsibilities for accounting and equipment maintenance. The profits from the business were treated as joint marital property, available to both Dan and Lori.

In 2004, Dan and Lori exercised the option to renew the lease. As with the original lease, they both signed the renewal agreement.

In 2005, Dan and Lori separated. Over the next two years, they made several attempts to reconcile, but in 2007 Lori filed for divorce.

After she filed for divorce, Lori signed a second lease extension with Flying Cat, LLC. Dan did not sign the renewal agreement. At the time the second lease extension was signed, the business was already behind in its rent, and over the next two to three years, it fell even further behind. In 2010, Flying Cat, LLC sued Curves for Women of Angola, Lori, and Dan, claiming that, as partners, Lori and Dan were both personally liable for the back rent owed by the partnership.

First, the Court of Appeals held that a partnership existed between Dan and Lori. In doing so, the court cited Ind. Code § 23 4 1 7, which provides that, with certain inapplicable exceptions, the receipt by a person of a share of the profits of a business is evidence that a partnership exists. Once a partnership exists, each partner is personally liable for all the obligations and debts of the partnership. In addition, it requires the signature of only one partner to form a contract that binds the partnership and, by extension, binds all the partners.

However, Dan argued that he was not bound by the second lease extension that Lori signed after she filed for divorce, pointing to the fact that her petition clearly indicated her intent to terminate the business relationship with Dan. The Court of Appeals agreed with Dan that the partnership was dissolved when Lori filed her petition, but nonetheless held that Dan was liable for the second lease extension.

The basis for the holding lies in Ind. Code § 23 4 1 35(1)(b), which provides that a partner can bind the partnership after dissolution if the other party to the transaction knew that the partnership existed prior to dissolution and had no knowledge or notice that the partnership had been dissolved. Notice can be provided by publishing a notice of the dissolution in a newspaper of general circulation in the place where the partnership regularly conducted business. The Court of Appeals noted that the landlord knew of the partnership prior to dissolution, that the landlord had no knowledge or notice of the dissolution, and that no notice had been published in the local newspaper. Accordingly, Lori's signature on the second lease extension bound the partnership and, by extension, Dan, even though the partnership was already dissolved.

Because each partner to a general partnership is liable for all the obligations and debts of the business, including obligations and debts incurred by one partner even without the knowledge of the others, it is hard for us to imagine a situation in which we would advise a client to organize a business as a general partnership. Even so, general partnerships exist, and, as this case illustrates, a partner leaving the partnership must take appropriate measures - including publication of a notice of dissolution - to protect himself or herself from incurring further liability.

Continue reading "Partnership Dissolved, but Partner Still Liable" »

February 17, 2011

Just what IS a limited liability company? Part 4. It's a separate legal entity.

[This is the fourth post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

iStock_000005422636XSmall.jpgTo set the background for a discussion of the basics of limited liability companies, we've discussed sole proprietorships, partnerships, and corporations. As we'll see, a limited liability company shares some characteristics with corporations and other characteristics with sole proprietorships (if the LLC has one owner, called a member) or partnerships (if the LLC has more than one member).

The first thing to recognize about a limited liability company is that it is a separate legal entity, apart from its owners. How does that compare to the other structures? First, a sole proprietorship is NOT a separate legal entity apart from its owner. If you're running a business as a sole proprietorship, you really ARE the business, and the business is you.

At the other end of the spectrum, a corporation is a distinct legal entity, completely separate from its shareholders. For example a corporation can sue and be sued in its own name, It can enter into contracts in its own name. And it can go into bankruptcy without dragging its owners with it.

In the middle of the spectrum is a partnership. Without getting into all the details, I'll just say that for some purposes a partnership has the characteristics of a separate legal entity, and for other purposes a partnership is treated more like the aggregate of all the partners.

So in this sense, a limited liability company is just like a corporation. It is a separate legal entity, apart from its members. It can sue and be sued; it can enter into contracts; and it can go into bankruptcy, all apart from its members. And all that is true even if the LLC has only a single member.

Next we'll discuss another way that a limited liability company is like a corporation -- the liability shield.

Continue reading "Just what IS a limited liability company? Part 4. It's a separate legal entity." »

January 23, 2011

Just what IS a limited liability company? Part 2. It's not a partnership.

[This is the second post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

iStock_000000489267XSmall.jpgIn the last entry, I began a discussion of the basics of limited liability companies. To start that discussion, I began by describing the first of three other types of business structures: sole proprietorships. This entry is about partnerships, and the next will describe corporations.

In a sense, a general partnership is like a sole proprietorship, but with multiple proprietors. Each partner is liable for all of the obligations of the partnership. In other words, a creditor of the partnership can sue any or all of the partners to collect what the partnership owes. Income taxes are also similar, but things get a little more complicated with multiple owners.

For tax purposes, a general partnership is a "pass-through entity." Unlike a sole proprietorship, a partnership has to file a tax return, called Form 1065. However, the partnership itself does not have to pay taxes. Form 1065 is used to calculate the partnership's profits or losses and other "tax items," which are allocated to the partners, most often in proportion to their ownership interests. In other words, the tax items are "passed through" to the partners, and each partner receives a report from the partnership called a Schedule K-1 that tells the partner how much income, etc. to report on his or her own personal tax return. Then the partner pays income tax as an individual.

One more point worth noting about taxes. If the partner is actively involved in the operation of the partnership -- in essence, if the partner is "employed" by the partnership -- he or she is considered to be self-employed and must pay self-employment tax on his or her share of the partnership's income. Again, being a partner is very much like being a sole proprietor, except for the "sole" part.

The general partnership is an old form of business association. For instance, in Dickens's A Christmas Carol, Ebenezer Scrooge and Jacob Marley were partners. "The firm was known as Scrooge and Marley. Sometimes people new to the business called Scrooge Scrooge, and sometimes Marley, but he answered to both names. It was all the same to him." Id. at p. 3. Of course, I'm not holding out Scrooge and Marley as a typical partnership or as a model of customer service. The example came to mind only because last month our family attended the Indiana Repertory Theater's annual production of A Christmas Carol, and I've always liked that line.

In the next entry, I'll describe corporations, and then (finally!) get around to discussing limited liability companies.

Continue reading "Just what IS a limited liability company? Part 2. It's not a partnership." »