Rigos CPA Review Course - Sample Chapter

Most states have adopted provisions of the 1994 ALI’s Uniform Partnership Act (UPA) and Uniform Limited Partnership Act (ULPA). These statutes, like the UCC, contain default provisions which determine the treatment of terms that the parties do not specifically address in the partnership agreement. The ALI will not allow a partnership provision eliminating the partner’s duties of good faith, fair-dealing, loyalty, or the right of a partner’s access to books and records.

UPA 6(1) defines a (general) partnership as an association of two or more persons to carry on and manage, as co-owners, a business for profit.

1. Co-Owner Requirement: The co-owner requirement distinguishes a partnership from an agency relationship where the agent receives a share of the business profits.

2. Joint Venture: A joint venture is a partnership for a particular undertaking rather than an ongoing business. The joint venture term is “at will” unless agreed to the contrary.

3. No Presumption: A joint tenancy, tenancy in common, tenancy by the entireties, joint property or common property does not of itself establish a partnership. [UPA 7(2)]

4. Share of Profits: The receipt of a share of profits is prima facie presumptive evidence of partnership status (and thus potential personal liability). Profits do not include sharing of gross receipts, distributions for wages, proceeds of a sale, rents, or principal or interest on a loan.

5. Capital and Profit Sharing: All partners have the same percentage interest in capital, profit and loss allocations and distributions unless agreed to the contrary. [UPA 7(4)]

In Morrissey v. Commissioner, 296 U.S. 344 (1935), the Supreme Court itemized the distinguishing characteristics which determine whether the entity is a corporation or a partnership. This characterization becomes important where an owner is trying to escape liability as a shareholder or an owner is trying to share in the tax benefits of a large entity loss as a partner. An acronym that will help you remember the characteristics is CCATL:

	CORPORATION	PARTNERSHIP
Centralized Management	Yes. Shareholders elect Directors who appoint Officers.	No. All general partners participate in day-to-day management.
Continuity of Existence	Yes. Potentially forever. Shareholders merely change.	No. Duration is limited. Dissolution upon withdrawal, death or bankruptcy of general partner.
Agency Character	Shareholder or promoter can’t bind corporation.	General partners are agents and bind the partnership.
Transferability of Interests	Yes, except reasonable restrictions on stock transfers are OK.	No, without approval may cause dissolution. UPA modifies this treatment.
Limited Liability	Yes, except watered stock or veil-piercing situations.	No, except limited partners. General partners limited to contribution for past partnership debts.

The 2004 Content Specification Outline has added year-end tax decision detail in the BEC entity chapters. Briefly, a partnership must adopt a tax year of the majority of the partners. Certain partnerships are allowed to make a Code Section 444 election but any income deferred must be deposited by May 15. Corporations are allowed to elect a non-calendar year-end but income tax must be deposited on a quarterly basis using an annualized method of computation. See also our detailed coverage in the tax chapter of the REG section.

There are no formal requirements for a general partnership, but a limited partnership must file its articles of partnership with the state. The partnership agreement usually specifies the partnership name, partners identities, date business began, business purpose, capital, profit/loss and distributions treatment and other information about the details of the partnership. A partnership operating under a fictitious name other than the true partners’ names must register with the appropriate state agencies.

The common law rules apply to capacity. Infants may disaffirm their partnership interest but cannot withdraw contributed capital to the detriment of creditors. Corporations may be a partner in most states. Either spouse can be a partner in a non-realty partnership without the other’s consent.

1. Express: An express agreement must be written if the term is specified as over one year. If the partnership is for an indefinite term (“at will”), an oral agreement is allowed. Some states require a writing if the purpose of the partnership is to purchase real property or the partnership purpose cannot be completed within one year. Unless specified to the contrary, all partners own the same percentage capital interest and share profits equally.

2. Implied: A partnership may be implied by the owners sharing profits. This is prima facie evidence under UPA 7(4), which establishes a rebuttable presumption. The burden of proof shifts to the owner to show he was not a partner but rather an independent contractor, employee, or creditor. Depending upon the facts and circumstances, partnership liability may also extend for situations of sharing in management, contribution to capital, or other activity that strongly indicates a partnership.

3. Estoppel: As between partners, an agreement is usually required. But UPA 16 specifies that a person who represents himself as a partner or knowingly allows his name to be used in the partnership’s tradename may become a partner by estoppel. This provision is intended to protect third parties who have extended credit on the faith of such representation.

In general, a transfer of assets to a partnership in exchange for an interest in the partnership is nontaxable to the partnership and to the partners under IRC 721. The partnership takes, as a basis in the assets, the same adjusted basis of the contributing partner immediately prior to the transfer.

A partner has property rights in (1) the partnership as an entity and (2) the right to participate in management. [UPA 24]

The partnership entity holds partnership property as a “tenancy in partnership.” Such partnership property is not owned by the partners personally. Partnership property is neither assignable by an individual partner nor subject to attachment or execution by his separate creditors. Upon a partner’s death, his rights in specific partnership property vest in the surviving partners who must account to the estate for its fair value. [UPA 25] Real property acquired in the partnership name can be conveyed only in the partnership name. [UPA 8]

A partner’s interest in the partnership is his share of profits and surplus and the right to receive distributions. [UPA 26] A conveyance of this partnership ownership interest under the common law dissolved the partnership. Under the model statute, a conveyance merely entitles the assignee to receive his assignor’s share of profits. The assignee has no right to participate in the management or administration of the partnership unless all the other general partners agree to the admission. [UPA 27]

A partner’s judgment creditor can request a court issue an order charging the interest of the partner with payment of the unsatisfied amount of the judgment. Any distribution, share of profits, or money due the debtor partner must thereafter be paid directly to the judgment creditor. A receiver may be appointed to liquidate the partner’s interest. The statute allows the charge on the ownership interest to be redeemed at any time before foreclosure. [UPA 28]

All partners are fiduciaries with a duty of good faith, fair dealing, loyalty, and due care in their dealings with one another and the partnership. They must account to the partnership for any benefit and hold any profits as trustees. A managing or general partner can be held to an even higher standard. Liability extends for taking a partnership opportunity or actions taken outside the partner’s actual authority. A partner’s failure to act in accordance with terms of the partnership agreement may result in liability to both the partnership and the other partners for breach of contract. [UPA 21]

Each partner shares equally in profits and surpluses unless otherwise agreed through contractual special allocations. Profit sharing ratios are applicable to loss allocation unless otherwise agreed. Interest on payments or advances by a partner is required. No partner is entitled to compensation for partnership activities, except for “winding up” activities (dissolving the partnership). The partnership may reimburse and indemnify all the partners for expenditures and personal obligations incurred in the ordinary and proper conduct of its business. [UPA 18]

1. Majority Rule: All partners have equal rights in day-to-day management. Ordinary partnership decisions are to be determined by the majority vote of the general partners. [UPA 9]

2. Unanimous Approval: Admitting a new general partner requires unanimous approval of all the partners. Likewise, expelling a general partner requires unanimous approval.

3. Fundamental Changes: Fundamental business changes include confessing judgment against the partnership or submitting a claim for arbitration; such acts may increase all the partners’ legal exposure and therefore require unanimous approval. The UPA also includes as fundamental changes an assignment for the benefit of creditors or any act which would make it impossible to carry on the partnership business, such as a bulk sale of assets or a sale of the business’s goodwill.

Each partner shall have a right to inspect and copy partnership books and records. This must be exercised at a reasonable time in a reasonable manner at the partnership office. Reasonable prior notice is required. All partners are also entitled to an annual accounting. [UPA 19]

The managing partner must render to all partners true and full information of all matters affecting the partnership. UPA 22 states any partner shall have the right to a formal account as to partnership affairs if he is wrongfully excluded from the partnership business. [UPA 20]

Partnership taxation is accomplished annually through Form 1065. The partnership is not treated as a separate entity; for tax purposes it is a mere conduit. All tax items are passed through to the partners. The entity allocates distributive items on Form K1 according to the partnership agreement or equally, if unspecified. Actual distributions are only taxable if in excess of a partner’s adjusted basis and share of recourse debt. A partnership is recognized as a legal entity for employment tax purposes.

General partners are usually liable for all partnership debts. However, UPA 17 provides that an entering partner is liable only to the extent of her contribution for partnership obligations incurred prior to her admission. [UPA 15]

Every general partner is an agent for the partnership. The apparent authority of a partner in carrying on the usual business of the partnership binds the partnership in contract. Tort liability may be present if the partner was acting in the course and scope of the business. A partnership is not liable for acts where express, implied, or apparent authority is missing, such as an accounting firm partner buying an office building. There is also no partnership liability if the third party had knowledge that the acting partner lacked authority. [UPA 90]

In most states, a partner’s liability for partnership obligations to third parties is joint and several.

1. Joint Contract Liability: Liability is joint for contract liability to third parties. Joint means all partners must be named as Defendants (D). A contract judgment against less than all the partners effects a merger and the Plaintiff (P) may not later sue the unnamed partners.

2. Several Tort Liability: Tort liability for damages resulting from a wrongful act to third parties is several. All partners are individually severally liable. Several means a creditor can go against only one partner and not lose his rights against the others.

3. Proportionality: Under the joint and several liability doctrine there is no apportionment. If tortious conduct creates indivisible harm, all partners are liable for all the damages. A D may be found 100% liable to third parties even though only one of 10 causing actors.

4. Partnership Creditors: Partnership creditors must exhaust partnership assets before looking to the individual partners. Partnership creditors may then levy on any and all the partners’ assets who were individually named in the judgment. If a partner declares bankruptcy, partnership creditors will share pro rata with the partner’s personal creditors.

5. Partner’s Creditors: A partner’s personal creditors can’t levy on partnership property directly, but after registering a judgment against the partner may obtain a charging order. This charging order requires the managing partner to pay any distribution to the creditor.

Dissolution of a term partnership may be by agreement or breach. A court may order a formal partnership accounting and dissolution at the request of any partner who shows that the partnership agreement has been persistently breached, a partner has been wrongfully excluded, or that the business cannot be profitably operated (economic frustration). A partnership at will (no duration specified) may be dissolved by any partner at any time. [UPA 31 and 32]

Operation of law may dissolve the partnership if a general partner dies, goes bankrupt, is expelled, retires, or withdraws, or the business becomes illegal. The estate of a deceased partner may be liable, but does not automatically become a partner. Unless there is a contractual provision allowing continuation, a dissolution terminates all partners’ authority to act for the partnership.

An assignment of a partner’s ownership interest without permission of all the other partners caused a technical dissolution under the common law. UPA 27 specifies such a conveyance does not itself cause a dissolution, but that the assignee may not participate in the administration or management of the partnership. The assignee’s sole right is to receive his assignor’s share in profits and capital.

The remaining partners have the right to wind up the partnership affairs. This right extends automatically to the legal representative of the last surviving partner who is not bankrupt. [UPA 37]

A partner’s power to bind the partnership to third parties after dissolution is a heavily tested area.

1. Partnership Protection: A partnership desiring protection against a former partner continuing to deal with third parties must follow the rules we learned in the agency chapter.

2. Departing Partner’s Protection: Indemnification agreements, hold harmless contracts, and releases between the partnership and the retiring or withdrawing partner are not binding on third parties. They also do not terminate apparent authority. A departing partner desiring to escape personal liability for future firm obligations with third parties must give actual notice to ongoing partnership creditors and constructive notice by publication to future creditors. [UPA 34]

A dissolution requires a “winding up” and liquidation of assets. This includes the payment of debts and a final distribution to the partners or their assignees. Each class shares pro rata in a distribution priority as follows:

If the above distribution rules result in insolvency, the partners may be assessed a required contribution. The amount is what is necessary to bring their capital accounts up to the percent their profit and loss ratio bears to the net liability. This may include an allocation of an insolvent partner’s share. This procedure liquidates the obligations between the partners and the partnership into liabilities between the partners personally. If one partner pays more than his share, he has a right of contribution from the other partners. [UPA 34]

IRC 731 dictates nonrecognition treatment upon partnership dissolution. Gain may be recognized if money, unrealized receivables, and/or inventory received in the liquidation exceeds the partner’s adjusted basis. The partnership asset basis carries over to the individual partners under IRC 732.

A limited partnership is a hybrid entity that blends the tax advantages of a partnership with the limited liability of a corporation.

Limited partnerships are created under the authority of the state variety of the ULPA. This statute adds certain requirements to the general partnership rules. The ULPA was substantially revised in 1994 and a number of states still base their statutes on the original version of the Act.

1. Articles Filed: The written articles (some states call this a “certificate”) of limited partnership must be filed centrally in the Secretary of State’s Office. [ULPA 201]

2. Disclosure and Registered Agent: Detailed partnership disclosure is required in the articles. A registered agent must be appointed and her geographical address specified.

3. General Partner: The general partner and geographical address must be identified. The general partner has unlimited liability to third parties.

4. Security Registration: There is also usually security registration requirements. This would be determined by the SEC or an applicable state agency.

5. Tradename: The tradename must contain the words “limited partnership” or the abbreviation “L.P.”

6. Advantages: The chief advantage of a limited partnership compared to a general partnership is that a limited partner’s liability for the entity’s obligations extends only to the amount of their contributed capital. This is similar to a corporation’s shareholders, but with the advantages of partnership taxation and special allocations.

1. Management Participation: A limited partner cannot actively participate in the day-to-day management decisions of the partnership. For this reason, limited partners do not have the fiduciary duty found in corporate directors. [ULPA 303] In comparison, all member owners of a LLC may usually participate in management.

2. Limited Partner’s Name: A limited partner is also prohibited from allowing his name to be used as a part of the tradename. If this happens a third party may sue the limited partner in question as if they were a full general partner with unlimited liability.

3. Substantial Assets: There must be at least one general partner with substantial assets, but it can be a corporation. The IRS has established that the general partner must have a net worth of at least 10% of capital as the safe harbor for this classification.

4. Services: A limited partner’s contribution may not be personal services in most states.

1. New General Partner: The admission of new general partner(s) requires the consent of all the existing partners.

2. New Limited Partners: A limited partner can generally sell or assign his ownership interest without causing a partnership dissolution unless otherwise provided in the partnership agreement. In many states this rule is only valid if the assignee is a designated substitute limited partner and the general partner(s) consent.

3. Partner Bankruptcy: Bankruptcy of a general partner creates a withdrawal for that partner. This may also subject the entity to the claims of his/her creditors. Limited partner’s bankruptcy has no effect on the partnership entity.

4. Allocations: Absent a contrary agreement, profit and losses are allocated according to the capital contribution values as stated in the certificate of limited partnership. Notice this is different than the general partnership default rule of equal sharing.

5. Derivative Action: A limited partner may bring a partnership derivative action if the general partner having authority refuses to initiate such an action after demand. [ULPA 1001]

6. Other Partner’s Rights: Most other partners’ rights are the same as in a general partnership such as the right to receive annual financial statements and inspect partnership books.

7. Dissolution: Entity dissolution results when the last general partner dies or withdraws.

ULPA 804 specifies that upon the winding up and liquidation of a limited partnership, the assets shall be distributed as follows (each class shares pro rata).

LL entities (usually a Limited Liability Company or LLC) combine the tax advantages of a partnership with the legal protection of a corporation. The tradename must contain LLC to give third parties notice that their legal rights against the members are usually non-existent. Continuity of existence is not present and the LL entity must have termination criteria in its certificate of formation. This is unlike a partnership but very similar to corporate articles which usually provide for an unlimited potential existence.

An LLC adopts an operating agreement and files with the secretary of state in its home state. Unlike a limited partnership, all owner-members can participate in management. An exception is a manager-managed which operates similar to a limited partnership. This must be specified in the operating agreement; if so the manager may not bind the LLC.

Like a partnership, profits and losses are allocated equally in an LLC unless agreed to the contrary. Typically this is one of the terms specified in the operating agreement.

The LLC is a separate legal entity which may sue or be sued in his own name independent of the members. As to the liability of individual members, joint and several contract liability is eliminated. As to tort actions, only those owner-members personally involved in the negligence can have their personal assets seized.