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Chapter 38 – Operation of Partnerships and Related Forms

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

CHAPTER 38

OPERATION OF PARTNERSHIPS AND RELATED FORMS

I. OBJECTIVES

This chapter is intended to acquaint students with the rules regarding the management of

partnerships, especially the rights, duties, and liabilities of partners. Students should:

A. Know the duties partners owe each other.

B. Understand how partners are compensated.

C. Appreciate the powers of partners to act for the partnership.

D. Learn how to construct a partnership agreement that will meet the needs of the partners.

E. Know the liability of partners and partnerships for torts and crimes.

II. ANSWER TO INTRODUCTORY PROBLEM

A. The default rules for management of the LLP are that each partner is a general manager of

are also default management rules.

B. These default rules are inappropriate for an LLP with 21 partners. Having 21 general

demand the bulk of management power. Also, it is inappropriate that the 15 junior partners

breaching the duty of care.

default fiduciary duties that meet the needs of the partners; 2) a statement of the

partnership’s duties to the partners; 3) a section listing the actions that may be taken only

partners in a designated area of practice; 7) a section listing the actions that my be taken only

by the managing partners’ committee, including the election and removal of managing

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partner or by designated individual partners, such as expense account purchases; 9) the

procedure for amending this section of the partnership agreement, being sure to protect any

profits, making it difficult for partners to pay personal expenses, such as a mortgage payment

on a partner’s personal residence. In addition, if there is a loss, partners are not entitled to

any distributions, so they have nothing to live on. Finally, if there is a loss, some partners

may have more outside income and be better able to use those losses to reduce their tax

liability.

area of practice, number of clients and revenue generated by them, and the number of hours

billed. 2) A section on the partners’ share of profits after draws. Although some partners

share profits according to their capital contribution only, often the profit–sharing agreement

is more complex than the draw-sharing agreement. The profit allocation is typically made

competency. 3) The partnership agreement will also have subsections regulating partners’

vacations, leaves and sabbaticals, health and other insurance, and expense accounts.

III. SUGGESTIONS FOR LECTURE PREPARATION

A. Nature of Relations between the Partners.

trust and loyalty.

B. Duties Partners Owe to Each Other. List all the duties of partners and give examples of each.

Below are listed the most important fiduciary duties. Note that the RUPA has different

names for some of the duties than does the UPA.

1. Duty Not to Have an Interest Adverse to the Partnership. Explain the conflict of interest

especially in the context of kickbacks.

2. Duty Not to Compete with the Partnership. Note the essence of this breach: a partner is

taking business away from the partnership.

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competing business in determining the profits lost by the partnership with which the

business competed.

Points for Discussion: Ask your students, especially your finance and accounting

majors, whether this decision surprised them. Of course, it did not. Standard

understand how the trial court could have concluded that the second business’s

profits were not probative to the lost profits of the partnership, until you understand

b. Additional Example: Problem Cases ## 1 and 2.

3. Duty to Serve. Explain this duty and point out the remedy for its breach: hiring a person

account for the expense.

4. Duty of Care. This is a good time to introduce students to the business judgment rule,

being reluctant to substitute their judgments for those of business managers is that judges

possessed by judges.

6. Duty to Account. Explain this duty as a partner’s duty to tell his partners how has he has

used partnership funds and property.

partnership resources is, in effect, theft.

Example: Problem Cases ## 1, 2, 3, and 4.

7. Duty of Confidentiality. List the various kinds of confidential information that partners

operation, secret formulae, and business plans.

inform.

9. The Global Business Environment (p. 1015): Note that fiduciary duties vary little

worldwide, as the basic principle behind fiduciary duties, trust, is universally valued

among business partners.

10. Spector v. Konover (p.1016): This case is more fully explained in the compensation

section. It has several fiduciary duty issues. The court held that Konover breached his

Chapter 38 – Operation of Partnerships and Related Forms

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C. Compensation of Partners

1. A partner is not entitled to a salary, but only to his share of the profits, absent an

Example: Problem Case # 5.

2. Profits and Losses. Note that losses are shared as profits are shared, absent a contrary

are shared unequally.

3. Spector v. Konover (p. 1016): The court held that Konover breached his fiduciary duty

by diverting partnership funds to other entities that he controlled, by refusing to

paid to another Konover entity.

Points for Discussion: Most of what Konover did wrong was self-dealing. Ask students

why self-dealing by a partner is wrong in a partnership context. It is because the partner

managing the partnership, was not entitled to any compensation for such management

work. It is because the default rule is that partners share profits equally. This is the

partners never had meetings or votes to give Konover the right to receive compensation.

Konover was entitled only to his share of profits and to reimbursement for out-of-pocket

expenditures on behalf of the partnership.

5. Similarly, no profit-sharing or loss-sharing agreement between the partners will affect

D. Management Powers of Partners.

1. Allocation of Management Powers

a. State the power that an individual partner holds.

Note that if partners disagree about how to exercise the power each holds

individually, majority rule determines what action the partnership shall take.

by fax or email.

Chapter 38 – Operation of Partnerships and Related Forms

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c. Note that partners have express, implied, and apparent authority, just as agents have

under agency law. Note that ratification may occur also. Refer to Chapter 36 for a

discussion of these agency concepts.

d. Conveying Real Property. Note that partners may want to change the default rules

regarding when a partner may convey partnership real property. Partners may want

to expand or restrict the normal power of partners.

Example: Problem Cases ## 6 and 7.

apparent authority to borrow money.

1) A partner has implied authority to borrow money if the ordinary needs of the

partnership require it to borrow money.

2) A partner has apparent authority to borrow money if

a) it appears that the partnership is a type of business that needs to borrow

partnership.

3) Issuing Negotiable Instruments.

4) Negotiating Negotiable Instruments.

5) Example: Problem Case #6.

f. Effect of Partnership Agreement

the ability to dominate the management of the partnership. Ask your students why

NBN agreed to such a deadlock provision. It may have been a case of ignorance,

misplaced trust, or just wanting to make a deal so much that NBN agreed to a

provision that was not in its best interest.

designated period of time? That is the preferred resolution, although such a buy-out

agreement may encourage a deadlock by a partner who wants to be bought out or to

buy out the other partner.

E. Partnership Agreements on Management and Compensation

1. Make sure that students know that well planned partnerships modify the default rules of

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2. Go over the material in the text on pages 1020-1021 on how large partnerships change

students to write the partnership agreement that changes the default rules.

3. Chapter Introductory Problem (p. 1011). This problem mostly deals with management

compensation. See answers C and F to the Chapter Introduction Problem at the beginning

of this chapter in this manual.

4. Log On (p. 1023): Look at the sample partnership agreements at the listed websites,

especially at the management and compensation articles. Note that such model

agreements are not crafted for the special needs of partners. Point out that it is essential

F. Liability for Torts and Crimes

1. Torts

a. Remind students that the agency rules of vicarious liability under the doctrine of

respondeat superior apply to partners and partnerships. Note that most intentional

b. Note that under the RUPA, partners of a limited liability partnership have nearly

complete protection from liability. LLP partners have no liability for contracts of the

Ethics in Action (p. 1025): Ask your students whether they would be a partner in a

partnership when LLP status was available. Almost everyone will choose the LLP

partners’ right to escape liability. However, that conclusion would probably change

if a contract creditor knowingly lent money to the LLP and chose not to obtain the

partners’ individual promises to repay. Applying Rawls’s categorical imperative

Chapter 38 – Operation of Partnerships and Related Forms

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would probably result in a similar analysis, on the grounds that one would want a

rule that did not protect those who could protect themselves.

c. Ederer v. Gursky (p. 1024). This case is a good example of how some people

misconstrue what it means to be a partner in an LLP. Gursky’s argument that he has

no liability to his LLP partner for stealing profits seems to be and is, of course,

ridiculous. The purpose of an LLP is not to relieve partners of duties to each other,

but instead to limit the LLP partners’ liability to third parties who deal with the LLP.

Thankfully, the court in this case understood this distinction and found the law to

back it up.

d. Additional Examples: Problem Cases ## 8, 9, 10, and 11.

2. Crimes

Essentially, the rules regarding partners’ and partnerships’ intentional tort liability apply

to determine their liability for crimes. The crimes must be authorized or foreseeable

Note that under the RUPA the partnership may sue and be sued in its own name. This makes

IV. RECOMMENDED REFERENCES

See the references in Instructor’s Manual Chapter 37.

V. ANSWERS TO PROBLEMS AND PROBLEM CASES

and other business entities, because that doctrine is limited to a business opportunity which is

within the scope of the entity’s own activities and of present or potential advantage to it.

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Finally, the court rejected Szymanowski and Wheeling‘s argument that Brace’s development

of Danylko # 2 and # 4 breached a fiduciary duty not to compete with the partnership,

2009)

likely they will, as she is the most experienced and perhaps the most valuable partner. The

the partnership.

Ranzau and his wife access to and enjoyment of the house. Brosseau v. Ranzau. 81 S.W.3d

381 (Tex. Ct. App. 2002).

2013).

5. No. The default rules would allow them to receive as their sole compensation only a share of

are profit distributions and the amount. Instead, Carney and Protura should put in the LLP

necessary for its success.

6. No, for all three. Moving the offices is outside the ordinary course of business of the

purchased and too large in comparison to WH’s total assets to be in the ordinary course of

Therefore, both Wilmot and Harmeau must agree to the mall purchase and loan.

7. Yes. As a partner of the partnership, Paul Ballinger held the authority to bind the partnership

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real property of a partnership that was created for the purpose of developing the real

property. Ritz v. City of Findley, 2009 U.S. Dist. LEXIS 58894 (N.D. Ohio 2009),

8. Yes, possibly. The court held that the nuisance created by the swine could be grounds for the

929 F. Supp. 2d. 691 (W.D. Ky. 2013).

court was most impressed by the reason Nicole returned to the restaurant: she was asked by

shares in a portion of the liability to the extent it reduces the assets of partnership. Also, note

that the other partner is the mother’s sister. Did the sister really resist having the partnership

pay this claim of the son? No. The real defendant here was the partnership’s insurance

company. It didn’t want to pay under its insurance policy, and the only way it could avoid

pitching the 7.5% Program, Kersner did the type of work a law firm normally does for a

corporate client such as Capital. Since the partnership benefited by receiving legal fees from

Capital, the court concluded it was consistent with the goals of RICO to impose liability on

the partnership. Thomas v. Ross & Hardies, 9 F.Supp.2d 547 (D.Ct. Md. 1998).