August 31, 2015
A Tale of Four Sillies
This is a parable about a partnership. If you need a quick introduction to Partnerships, please see our article, “Business Formation: Forming a Partnership.” You can also refer to the Partnership section of our free White Paper, “Choosing the Right Business Structure.” Specifically, you’re going to want to know what “joint and several liability” means before reading on; also, keep in mind that a Partnership is two or more entities operating a business together for profit. Notice the intent to be a “Partnership,” per se, is not a required element of a Partnership. Prepared with this brief introduction, let us continue.
Our Story Begins…
Donald and Daisy are siblings. Donald wants to start a business giving aerial tours in a blimp, but he doesn’t have enough money. Daisy lends Donald $150,000.00 to help him start his business. Donald promises to pay back the loan from Daisy, plus give her 10% of his profits for the first two years. Because Donald is paying Daisy in profits, Daisy may have just become an accidental business partner, who is entitled to part ownership of the business.
Donald is also friends with Mickey, who has a successful marketing and graphic design firm. Mickey thinks Donald’s blimp tours business idea probably isn’t going to take off, but he helps Donald by creating a website, some videos, and other marketing material for Donald to use in advertising his business. Mickey does all this work as a favor to Donald, doubting Donald’s idea has any potential to ever be profitable.
After six months of operating the business, Donald’s blimp tours company becomes a wild success, and Donald is making huge profits. Observing his friend’s success, Mickey decides he wants a piece of the pie. Mickey sues Donald, claiming his early contributions to Donald’s business entitle him to a portion of Donald’s profits, as a partner in the business. Donald and Mickey never signed a contract stating Mickey’s help did not confer to Mickey any interest in Donald’s business. Mickey, therefore, wins his case, and is awarded a partnership interest in the company. Oops! Another accidental business partner for Donald.
Donald’s business is so successful in its first few months he decides to get a second blimp. Because he’s already pretty strapped for cash, despite his recently successful enterprise, Donald approaches his wealthy uncle, Scrooge, to help him negotiate the sale of a fancy airship from the notoriously snooty Lady Tremaine. Scrooge, hoping to impress Lady Tremaine, tells her, “My partners and I are expanding our airship business, and I would love to see about purchasing the fine vessel you have moored to your tower.” Tremaine agrees to let Scrooge take her airship for a test flight the next day.
That night, Donald is speaking with Scrooge about his business, and says he’s getting tired of working so hard. Donald informs his uncle he’s going to take a vacation, and won’t be purchasing a second airship after all. Scrooge, still very keen on the idea of taking Tremaine’s airship out for a flight decides he’s going to have a bit of fun the next day anyway (after all, he’s not under any obligation to actually buy Tremaine’s airship). Unfortunately, during Scrooge’s test flight of Tremaine’s airship, a terrible storm appears out of nowhere, and Scrooge is forced to abandon the airship in a small glider to avoid going down in a ball of flame along with the vessel, narrowly escaping with his life. Lady Tremaine, believing Scrooge is in business with Donald, Daisy, and Mickey, sues all four of them, and wins, because Scrooge became an accidental business partner (for the purpose of the airship transaction) when Scrooge represented himself that way to Lady Tremaine.
What’s more, Lady Tremaine can collect 100% of her damages from any one of the partners, each of whom will have to collect contribution from their partners for any damages in excess of their share, if Tremaine is unable to collect from all of the partners according to their shares of ownership in the partnership. For example, if Donald and Daisy run off to Costa Rica together, leaving Scrooge (who the Court says had a 20% interest in the partnership) and Mickey (who the Court held had a 10% interest in the partnership), both Scrooge and Mickey may end up having to pay 50% of the total debt, each, to Tremaine. Scrooge will have to seek contribution from Donald and Daisy for 30% of the total debt to Tremaine he had to pay; Mickey will have to seek contribution from Donald and Daisy for 40% of the total debt to Tremaine he had to pay.
The Moral of the Story
Operating a partnership can be perilous–especially in the case of a General Partnership! Using written agreements drafted by a competent business attorney to protect yourself is the wisest and best way to avoid creating an accidental partnership and unintentionally becoming liable for the costs related to your partners’ business mistakes. Here are three tips to help you decide whether a transaction warrants use of a written agreement:
- If you are engaging the services of an independent contractor or an employee, use a written contract. For independent contractors, use a Contract for Services; for employees, use a Contract for Employment. Make sure you know and respect the differences between an independent contractor and an employee. Failing to do so could cost you a lot of money! In each of these contracts, ensure your lawyer includes a provision expressly stating no partnership is created by virtue of the contract between you and the independent contractor or employee. Failing to use a written agreement may result in the creation of an accidental partnership.
- When borrowing or lending money between yourself or your business and a borrower or lender, use a written Lending Agreement and Promissory Note(s), which expressly state the terms of the transaction(s). In your Lending Agreement, ensure your lawyer includes a provision expressly stating no partnership is created by virtue of the Lending Agreement. Failing to use a written Lending Agreement may result in the creation of an accidental partnership.
- Hire a business attorney to be your business’s General Counsel. Your General Counsel should be a leader, not a mere paper-pusher and rule-maker. General Counsel attorneys protect and serve a company by guiding its leadership through complicated decision-making processes. And General Counsel legal services, such as Signet™ General Counsel from Executive Legal Professionals, are not prohibitively expensive.
There is no one-size-fits-all business organization structure that will work for every business. General Partnerships have their place, as do Limited Partnerships and Limited-Liability Partnerships. For many, Limited Liability Companies provide an attractive alternative to partnerships. Corporations are still another option to consider. Whatever type of company you have, you need to consult with a business attorney to make sure you are not creating accidental partnerships. Your attorney can often use preventive legal services to keep your legal issues from becoming expensive legal problems.
If you don’t yet have a business attorney to help you make legally sound strategic business decisions and to draft the contracts and other legal documents your business needs, please contact us online or by phone at (615) 669-6566. An polite, competent Executive Legal Professionals attorney will respond to you quickly, and give your legal matter the attention it deserves.
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