Our Chicago Commercial Litigation Attorneys have substantial experience in resolving disputes between partners of a partnership.
Like most states Illinois has enacted the Uniform Partnership Act, 805 ILCS 206. The Uniform Partnership Act attempts to make partnership law uniform in all 50 states so that those who do business as partners can easily understand the applicable law.
One problem with the partnership as an entity is that you may become a partner of a partnership without intending to be a partner. How could that happen?
If you form a business with another person and you do not choose an entity, the court may deem you to be partners. By not choosing to form a corporation or an LLC, the choice of entity has been made for you. Under the common law, each partner is liable for the debts of the partnership. The partnership provides absolutely no liability protection for its owners. Instead, each partner is at the mercy of the other partner and the role of chance.
Section 306 of the Partnership Act provides in part:
Sec. 306. Partner's liability.
(a) Except as otherwise provided in subsections (b) and (c) of this Section, all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law.
(b) A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person's admission as a partner. (805 ILCS 206/306).
One other potential problem with a general partnership is that each partner can bind the other partners and the partnership. This means if Partner A borrows money from the bank and signs on behalf of the partnership, the other partners may be liable for that loan. Section 301 provides:
(805 ILCS 206/301)
Sec. 301. Partner agent of partnership. Subject to the effect of a statement of partnership authority under Section 303 of this Act:
(1) Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.
In litigation it is very difficult to prove that the creditor knew that the partner had no authority to enter into the transaction.We Don’t Recommend That Anyone use a General Partnership!
We do not recommend that any client use a general partnership to conduct business. If you own an interest in a general partnership, we may be able to assist you in converting it to a limited liability company or a corporation.Every Partner Owes the Partnership and the Other Partners a Fiduciary Duty
Under Illinois law, every general partner owes a fiduciary duty to the partnership and to the other partners.
That duty is set forth in Section 404 of the Act. It provides in part:
(805 ILCS 206/404)
Sec. 404. General standards of partner's conduct.
(a) The fiduciary duties a partner owes to the partnership and the other partners include the duty of loyalty and the duty of care set forth in subsections (b) and (c) of this Section. (b) A partner's duty of loyalty to the partnership and the other partners includes the following:
(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;
(2) to act fairly when a partner deals with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and
(3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.
(c) A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
(d) A partner shall discharge his or her duties to the partnership and the other partners under this Act or under the partnership agreement and exercise any rights consistent with the obligation of good faith and fair dealing.
(e) A partner does not violate a duty or obligation under this Act or under the partnership agreement merely because the partner's conduct furthers the partner's own interest.
(f) This Section applies to a person winding up the partnership business as the personal or legal representative of the last surviving partner as if the person were a partner.
The first three subsections of Section 404 are the most important. A partner cannot compete with the partnership – to do so is a breach of the duty of loyalty. A partner must deal fairly with the partnership. This provision requires the partner to pay market value for any partnership asset he or she purchases. The best way to do this is to have the property appraised. Under the law, any other partner can challenge a transaction between the partner and the partnership – the most common allegation would be that the partner was self-dealing or that the partner did not pay market value for the asset. The partner also has a duty to account to the other partners – that means you need to keep written records of any transactions with partners or third parties.Conclusion
It is easy to form a partnership – an oral agreement and the commencement of business activity will probably suffice. Partner A may not know what Partner B agreed to with Creditor C. Partner B may have executed a personal guarantee with Bank A that causes Bank A to sue the partnership. Sometimes the court has to appoint a receiver to wind up a partnership.
The problems with the law of partnerships make business lawyers nervous and causes them to worry. The best solution to this problem is to form a limited liability company or a corporation.
Our Chicago Commercial Litigation Lawyers have significant experience in representing individual partners and partnerships. We have handled partnership lawsuits and have negotiated successful partnership settlements. If you are a member of a partnership and you have an issue, please call us for a free consultation. We have experience in dealing with these issues and can often help you resolve them.
For further information, please review our Shareholder Disputes webpage.Also, please review our webpage on the differences between various entities.