A partnership is when 2 or more people operate a business as co-owners and share income. All co-owners (i.e. partners) act on behalf of each other in the business. Like the sole trader structure, a partnership entity is not separate from its operators.
The formation of a partnership requires a voluntary "association" of persons who "coown" the business and intend toconduct the business for profit. Persons can form a partnership by written or oral agreement, and a partnership agreementoften governs the partners' relations to each other and to the partnership. The term person generally includes individuals, corporations, and other partnerships and business associations. Accordingly, some partner-ships may contain individuals aswell as large corporations. Family members may also form and operate a partnership, but courts generally look closely atthe structure of a family business before recognizing it as a partnership for the benefit of the firm's creditors.
Certain conduct may lead to the creation of an implied partnership. Generally, if a person receives a portion of the profits from a business enterprise, the receipt of the profits is evidence of a partnership. If, however, a person receives a share of profits as repayment of a debt, wages, rent, or an Annuity, such transactions are considered "protected relationships" and do not lead to a legal inference that a partnership exists.
Relationship of Partners to Each Other
Each partner has a right to share in the profits of the partnership. Unless the partnership agreement states otherwise, partners share profits equally. Moreover, partners must contribute equally to partnership losses unless a partnership agreement provides for another arrangement. In some jurisdictions a partner is entitled to the return of her or his capital contributions. In jurisdictions that have adopted the RUPA, however, the partner is not entitled to such a return.
In addition to sharing in the profits, each partner also has a right to participate equally in the management of the partnership.In many partnerships a majority vote resolves disputes relating to management of the partnership. Nevertheless, some decisions, such as admitting a new partner or expelling a partner, require the partners' unanimous consent.
Each partner owes a fiduciary duty to the partnership and to co partners. This duty requires that a partner deal with co-partners in Good Faith, and it also requires a partner to account to co partners for any benefit that he or she receives while engaged in partnership business. If a partner generates profits for the partnership, for example, that partner must hold the profits as a trustee for the partnership. Each partner also has a duty of loyalty to the partnership. Unless co-partner sconsent, a partner's duty of loyalty restricts the partner from using partnership property for personal benefit and restricts the partner from competing with the partnership, engaging in self-dealing, or usurping partnership opportunities.
Advantages of partnerships
• Partnerships are easier and less expensive than companies to set up.
• Partners may carry on business under a trading (business) name.
• Partnerships combine the resources and expertise of a number of people.
• Partnerships are simple to administer. Profits and losses are shared between partners according to his/her share (as specified in the 'partnership agreement').
• Unlike companies, partnerships do not have to disclose their profits to the public (i.e. greater privacy).
• Changing the legal structure is relatively simple (i.e. changing from a partnership into a company at a later stage).
Disadvantages of partnerships
• All partners together are personally responsible for business debts. Each partner is individually liable for debts incurred by the other partners. This is known as being 'jointly and severally' liable (i.e. unlimited liability).
• All partners have a right to participate in the management of the partnership (unless otherwise agreed).
• Tax is charged at the personal tax rate. As business earnings increase, so does the tax rate.
• Partners cannot transfer their ownership to someone outside the partnership unless the other partner(s) agree.
• Personal differences may interfere with business.
A partner's interest in a partnership is considered personal property that may be assigned to other persons. If assigned,however, the person receiving the assigned interest does not become a partner. Rather, the assignee only receives the economic rights of the partner, such as the right to receive partnership profits. In addition, an assignment of the partner's interest does not give the assignee any right to participate in the management of the partnership. Such a right is a separateinterest and remains with the partner.
Under certain circumstances a partner has a right to demand an accounting of the partnership's affairs. The partnership agreement, if any, usually sets forth a partner's right to a pre dissolution accounting. State law also generally allows for an accounting if co partners exclude a partner from the partnership business or if co partners wrongfully possess partnership property. In a court action for an accounting, the partners must provide a report of the partnership business and detail any transactions dealing with partnership property. In addition, the partners who bring a court action for an accounting may examine whether any partners have breached their duties to co partners or the partnership.
One of the primary reasons to form a partnership is to obtain its favorable tax treatment. Because partnerships are generally considered an association of co-owners, each of the partners is taxed on her or his proportional share of partnership profits.Such taxation is considered "pass-through" taxation in which only the individual partners are taxed. Although a partnership is required to file annual tax returns, it is not taxed as a separate entity. Rather, the profits of the partnership "pass through"to the individual partners, who must then pay individual taxes on such income.
A dissolution of a partnership generally occurs when one of the partners ceases to be a partner in the firm. Dissolution isdistinct from the termination of a partnership and the "winding up" of partnership business. Although the term dissolution implies termination, dissolution is actually the beginning of the process that ultimately terminates a partnership. It is, in essence, a change in the relationship between the partners. Accordingly, if a partner resigns or if a partnership expels a partner, the partnership is considered legally dissolved. Other causes of dissolution are the Bankruptcy or death of a partner, an agreement of all partners to dissolve, or an event that makes the partnership business illegal. For instance, if a partnership operates a gambling casino and gambling subsequently becomes illegal, the partnership will be considered legally dissolved. In addition, a partner may withdraw from the partnership and thereby cause a dissolution. If, however, the partner withdraws in violation of a partnership agreement, the partner may be liable for damages as a result of the untimely or unauthorized withdrawal.
After dissolution, the remaining partners may carry on the partnership business, but the partnership is legally a new and different partnership. A partnership agreement may provide for a partner to leave the partnership without dissolving the partnership but only if the departing partner's interests are bought by the continuing partnership. Nevertheless, unless the partnership agreement states otherwise, dissolution begins the process whereby the partnership's business will ultimately be wound up and terminated.
Winding up refers to the procedure followed for distributing or liquidating any remaining partnership assets after dissolution.Winding up also provides a priority-based method for discharging the obligations of the partnership, such as making payments to non-partner creditors or to remaining partners. Only partners who have not wrongfully caused dissolution or have not wrongfully dissociated may participate in winding up the partnership's affairs.
State partnership statutes set the procedure to be used to wind up partnership business. In addition, the partnership agreement may alter the order of payment and the method of liquidating the assets of the partnership. Generally, however,the liquidators of a partnership pay non-partner creditors first, followed by partners who are also creditors of the partnership.If any assets remain after satisfying these obligations, then partners who have contributed capital to the partnership are entitled to their capital contributions. Any remaining assets are then divided among the remaining partners in accordance with their respective share of partnership profits.
Under the RUPA, creditors are paid first, including any partners who are also creditors. Any excess funds are then distributed according to the partnership's distribution of profits and losses. If profits or losses result from a liquidation, such profits and losses are charged to the partners' capital accounts. Accordingly, if a partner has a negative balance upon winding up the partnership, that partner must pay the amount necessary to bring his or her account to zero.