IS YOUR BUSINESS PUTTING YOUR ASSETS AT RISK? BUSINESS ORGANIZATIONS: THE GENERAL PARTNERSHIP

Are you putting all of your personal assets at risk every time you undertake any activity related to your business? If you operate as a sole proprietor or if you are a partner in a general partnership, you may be doing just that.
The law in most states allows for a number of different forms of business ownership. These forms of ownership fall into two general categories. The first category includes those in which the owner is personally responsible, or liable, for all of the obligations of the business. The second general category allows the owner to shield personal assets from most of the financial obligations of the business.
In this article, we will explore the characteristics of the form of business known as a general partnership. This series of articles on business forms will continue in the next issue with a discussion of limited partnerships.

What is a General Partnership?

The general partnership, also known as an ordinary partnership, is a form of business organization that has existed for thousands of years. It is a form controlled by the partnership laws of the individual states.
The general partnership is a created when two or more persons voluntarily create an association for the purpose of operating a business for profit as co-owners. The formation of the general partnership creates certain rights and obligations for the partners which are defined by the partnership agreement and state law.

Formation of a General Partnership

There is little required formality to creating a partnership. The most important factor is whether the parties share in the profits and responsibilities of managing the business. Evidence that the parties share in the profits of the business is prima facie evidence of the existence of the partnership. The degree of management responsibility of any party is not dispositive because employees are often given management roles. Care must be taken to ensure that employees do not become partners by compensating them with a share of the profits from the business. Many unintentional partnerships are created in this way.
A general partnership can operate under the names of its partners. It can also operate under a fictitious name by confirming that the name is unique and registering the fictitious name according to the requirements of the states in which it will conduct business.
A general partnership does need to acquire necessary business licenses, obtain federal and state tax identification numbers and an unemployment insurance account number. If the partnership sells products or services subject to the sales tax, it must register with the appropriate authority.

Taxation of General Partnerships

Partnerships do not pay federal income taxes. They are considered "pass-thru" entities so the income and losses from the operations of the partnership are reported on the partners' individual income tax returns. The partnership files an informational return enabling the government to trace whether the partners are accurately reporting their share of partnership income or losses.

The General Partnership Agreement

A partnership is easily formed - sometimes too easily. There is no requirement for a written agreement, for the parties to specifically agree to be partners, or to file an agreement with a government agency. The agreement may be oral, written, or implied by the conduct of the parties. In some states there may be registration requirements and certain activities of the partnership may require a written document so it is best to seek legal advice if there is any question about whether a partnership exists.
It is always good practice for partners to put the terms of their agreement into writing. Without working through the details of the partnership and having a written document as evidence of the agreement, the partnership laws of the state rather than the will of the partners may determine the resolution of any dispute that arises.
An extremely important component of the partnership agreement addresses the procedure for the dissolution of the partnership. There are many issues that are best decided when the partners are getting along including how the business will be valued, how a single partner leaves, how a new partner joins, and how the partnership is dissolved entirely. Many triggering events result in the need to address these issues including a partner's divorce, death, or personal bankruptcy.

Characteristics of a General Partnership

The Uniform Partnership Act provides states with guidance for drafting state partnership law. Individual states are free to adopt or adapt any or all of the articles of the UPA. The UPA forms the basis for partnership law in the majority of states and fills in any gaps not addressed by the partnership agreement. With few exceptions, partners are able to modify the provisions of state partnership law in their partnership agreement.
The general partners are personally liable for all of the debts and obligations of the partnership. This liability extends beyond the individual partner's contribution to the partnership to include all of the partnership's obligations.

Rights of General Partners

Partners share equally in the right, and the responsibility, for the conduct and management of the business. These rights are not weighted by individual capital or time contribution to the partnership. A simple majority vote decides most ordinary matters of the partnership with a tie vote operating to defeat the action being considered.
Unless the partners agree, partners are not entitled to a salary for services they provide to the partnership. It is assumed that partners devote all of their time and service to the partnership. Any income earned by a partner elsewhere is deemed to belong to the partnership. Expenses that a partner incurs personally while working on behalf of the partnership are reimbursable.
A partner who provides capital to the partnership becomes a creditor of the partnership. The partner is entitled to receive interest on the money loaned and is entitled to repayment. However, the partner's claim to repayment is subordinate to all claims by non-partner creditors.
Each partner has the right to demand from any other partner full and true information affecting the partnership. The records of the partnership must be kept accessible at the partnership's principle place of business and partners have unfettered rights to inspect and copy those records.

Duties of General Partners

Partners have specific duties to each other and to the partnership. The most important is the fiduciary relationship the partners have toward each other. A fiduciary relationship means that a partner has an obligation to act for the benefit of the other partners within the scope of the partnership. This relationship imposes a duty of loyalty which the parties cannot modify in their partnership agreement. A partner must inform the other partners before conducting any personal business with the partnership, cannot act personally on an opportunity offered to the partnership, and cannot compete with the partnership.
Partners must use reasonable care when conducting partnership business and could be held liable to the other partners for any damage caused by their actions. They must keep the other partners fully informed and adhere to the provisions of the partnership agreement and to the decisions made by the partnership.

Conclusion

A general partnership is created when two or more parties agree to operate a for-profit business together. It is easy to create - sometimes too easy. It is strongly recommended that partners have a written agreement defining the way in which they want the business to operate and their relationship to each other and to the partnership.
In the next article we will expand on the general partnership to look at the limited partnership and the limited liability partnership. Similar to the general partnership, these forms create different relationships between the partners and between the partners and the partnership. With the right business form, you can limit the exposure of your personal assets to business-related liabilities.

© Copyright 2009 by Bill Gschwind, inPURSUIT Consulting, LLC.