The English Common Law defined a partnership as “A Contract of two or more competent persons to place their money, effects, labor and skill, or some or all of them, in lawful commerce or business, and to divide the profit and bear the loss in certain proportions.”
Arizona Revised Statutes § 29-206(A) defines a partnership with the following language: “A partnership is an association of two or more persons to carry on as co-owners a business for profit.” A partnership, by definition, must have a business purpose. That such business purpose does not occupy anyone full time is not relevant.
A partnership agreement may be oral, although it is wiser to put the agreement in writing. An oral agreement is difficult to enforce because of the difficulty in proving the terms of the agreement. A written partnership agreement should cover, at a minimum, the following
Name of the Partnership
Nature of the Partnership
Relations Of Partners To Persons Dealing With The Partnership
Relations Of Partners To One Another Article
Property Rights Of A Partner Article
Dissolution And Winding Up
Generally, partnerships may be placed into the following categories:
A general partnership is an unincorporated association of two or more persons (or other entities) to carry on a business for profit. Most states have some version of the Uniform Partnership law which defines a partnership as follows:
A partnership is an association of two or more persons to carry on as co-owners a business for profit and includes a limited liability partnership….
A partnership may be formed without a written instrument. In other words, if two people decide to start a business together and share the profits, they have a partnership, even though they never used the word “partner” and even though they never created a written agreement. If there is no written agreement, then the basic principles of partnership law will apply.
When you start a partnership, it is wise to create a written agreement, because otherwise, you may later engage in an argument with your business associate about whether there was a partnership at all or what your respective rights and liabilities may be.
In Arizona, a partnership conducting business in a name other than the names of the all of the partners must record a fictitious name statement. This document identifies the name of the partnership, its address, and the name under which business is conducted.
The determination whether a business constitutes a partnership arises in many different contexts. It arises in connection with federal and state taxation, of course. The determination of whether an entity constitutes a partnership has important tax consequence, and the IRS maintains its own set of rules and principles for determining whether an entity will be treated as a partnership.
Whether an entity constitutes a partnership is important also in determining who is liable for company debt. If a business fails, the partners become individually responsible for the partnership debt except for certain types of properly created partnerships such as a limited partnership or a limited liability partnership. If the business is very successful, then partners are entitled to a share of the profits, and sometimes disputes arise over who is entitled to what share of the profits.
Sometimes, parties argue over whether an employer-employer relationship or partnership relationship exists. If a business fails, employees are entitled to be paid, but partners share the business losses. Payments made to an employee will be subject to social security and unemployment taxation and withholding. Payments made to an owner will be offset by partnership expenses, including depreciation, so there may be significant tax advantages to partnership treatment.
Since partners are jointly liable for business debt, sometimes plaintiffs in injury cases will allege that the defendants are partners, in order to increase the number of persons who may be liable for an ultimate verdict. It is no small matter to be someone else’s partner. Your partner may be able to borrow money for which you will be liable. If your partner does something wrong, you may be liable for the injury caused. Your partner may have the power to bind you to business deals or to sell partnership property.
Property acquired by the partnership belongs to the partnership, and not the individual partners. Obviously, if property is transferred into the name of the partnership, it is partnership property. But sometimes partners hold partnership property in their own name. If partnership assets are used to acquire property, then presumptively the property belongs to the partnership. It is better practice by far to keep all partnership property in the partnership name.
A properly drafted partnership agreement will have provisions for the following:
Description of partnership business;
Name of partnership;
Term of partnership existence;
Description of principal place of business;
Initial capital contribution of partners;
Additional voluntary capital contributions;
Interest on capital contributions;
Books and accounts;
Inspection of books;
Method of accounting;
Annual report to partners;
Determination of profit and loss;
Division of profit and loss;
Distribution to partners;
Admitting new partners;
Transfer of interest on death;
Removal of partner;
Right of first refusal;
A limited partnership differs from a general partnership in that limited partners are not subjected to personal liability for all of the partnership debts and liabilities. The extent of liability is limited by the terms of the partnership agreement. While a limited partnership is not subject to the tax code ownership restrictions of an S corporation, a limited partnership must have at least one general partner who is liable for all of the debts of the partnership.
Sometimes a corporation is used as a general partner of the limited partnership to avoid personal liability. When a limited partnership has a corporate general partner controlled by the limited partners, it is possible that a court could find the general partner to be a sham if it is too thinly capitalized, or could permit the general partner’s corporate veil to be pierced if its owners ignore corporate formalities. Either of these could result in a limited partnership with no general partner, thus triggering possible liquidation.
A limited partner’s interest is subject to a “charging order” in favor of a creditor and against the debtor’s interest in the partnership. The general partner owes to limited partners the duties of loyalty and care. The participation of limited partners in the management of a limited partnership can result in a loss of limited liability protection for that limited partner.
A limited liability partnership is a creature of statute and is similar to a limited partnership.