What Is a Partnership?
A partnership, in the legal sense, is a type of business arrangement.
Partnerships are formed when two or more people come together to share ownership of a business, pooling resources together in order to forward the partnership and sharing the profits and losses collectively.
Partnerships are one of several different types of business structures permitted by law in the United States, including sole proprietorships, LLCs, and corporations. Partnerships differ from sole proprietorships in that there is more than one owner, and they differ from corporations and LLCs in that there is no limited liability protection (although some limited liability partnerships can be formed, particularly in high-risk fields such as medicine or real estate).
Partnerships have certain benefits, including the fact that they are pass-through entities and therefore avoid the problem of double taxation that affects corporations. However, partnerships also have one major downside: they are particularly prone to disputes.
Why Partnership Disputes Are So Common
Given the nature of partnerships, it is no surprise that disputes arise easily.
With a sole proprietorship, there is only one person making major decisions, and with business structures such as corporations, there is typically an established hierarchy and a formalized process for decision-making.
With a partnership, on the other hand, you have two or more individuals who are roughly equals. This makes it particularly likely that a dispute will arise, and if one does arise, it had unique potential to caused headaches for everyone involved.
But if you found our article by searching for information about partnership disputes, you probably already know this.
In this article, we will explain how partnership disputes arise, how to avoid them, and what to do if a partnership dispute does occur, up to and including dissolution of the partnership.
What Causes Partnership Disputes?
There are as many different types of partnership disputes as there are partnerships, but these disputes tend to fall within a few broad categories. Some are more severe than others.
Business Disputes
Many disputes arise over the direction of the business. Partners will frequently have different visions for where to take the partnership. One partner, for instance, might want to take some risks in order to grow the business, while another partner might want to play it safe and keep the business smaller so that it can focus on the customers it already has. Sometimes these differences in vision can be worked out amicably, but other times they cannot.
Personal Disputes
Other disputes are more personal. Partnerships are made up of human beings, after all, and even in the most professional of settings, personal and family issues can become a problem. Conversely, partners might have differences in managerial styles, or one partner might not be pulling their own weight. When these types of issues occur, the resulting disputes can be even messier than purely professional disagreements.
Ethics Violations
The worst disputes, however, involve deliberate bad conduct by the partners. While most people can be relied upon to act in good faith, and any ethical concerns should ideally be spotted before partnering with someone, malicious actions do occur. A partner may commit fraud or embezzlement, make important deals or business decisions without consulting the other partners, or even go public with sensitive information.
Nobody wants to be betrayed by a trusted business partner, but it does happen. If any of these things occur, you have the right to stand up for yourself and ensure that your partner is held accountable for their actions, up to and including filing a lawsuit (and, depending on the severity of their actions, perhaps criminal charges as well).
The Number One Way to Avoid Partnership Disputes
The number one way to eliminate partnership disputes before they occur is to create a strong partnership agreement. The partnership agreement is the contract that all parties must sign when they enter into a partnership, laying out their powers and duties respective to each other.
Technically, you don’t need to create a partnership agreement at all. Some partners never draft one, or else they draft only a cursory partnership agreement without putting a lot of thought into it. Needless to say, we don’t recommend this! If you are going into a partnership, you need an agreement, and the stronger you make it the better.
While you may be able to draft a simple partnership agreement on your own, you will likely need the assistance of an attorney in order to make the agreement as strong as possible.
A good partnership agreement will include:
- The rights and duties of each partner in relation to the others.
- The manner in which profits and losses will be distributed between the partners.
- The circumstances under which partners can make capital contributions to the partnership.
- The ways in which control and decision-making power will be divided.
In order to most effectively decrease the likelihood of disputes, a partnership agreement must also include plans for all sorts of complications and worst-case scenarios, including:
- How one partner can leave the partnership.
- How one partner can buy or sell their share in the partnership.
- How one partner can be removed from the partnership against their will.
- How new partners can be added.
- How the partnership can be dissolved altogether.
- What to do it a partner dies, retires, become disabled, or declares bankruptcy.
The provision of a partnership agreement which deals with these eventualities is known as the buyout agreement. It lays out the process by which one partner can buy or sell their share in the business, and how much they should be compensated. It can also prepare for what will happen in other circumstances which lead to the dissolution of the partnership or to one partner leaving.
It may be awkward to talk out some of these issues with a business partner. But if you can do this, it will save you a lot of complications if and when a conflict arises.
Creating a partnership agreement also gives you a good chance to see how your partner handles negotiation and conflict and to look for red flags. When drafting a partnership agreement, the goal is to create something that will work for all partners’ mutual benefit, and you will have to be willing to cooperate and make concessions. However, you should accept just any terms. Be willing to say no to a partnership agreement which will clearly disadvantage you.
Similarly, you should walk away if you see any evidence that your potential partner is unethical or untrustworthy. It is better to lose an exciting business opportunity than to go into business with someone who will act unethically, and when disaster strikes down the line, you will kick yourself for not having exercised more caution in your choice of business partner earlier.
When it comes to partnership agreements, an ounce of prevention is truly worth a pound of cure.
But if it’s too late to take this step, there are still many options open to you…
Solutions to a Partnership Dispute
Dissolution
One of the most common solutions to a partnership dispute is the dissolution of the partnership.
Dissolution can occur for a variety of reasons, not all of them acrimonious. Partners might simply decide to go their own way, having accomplished their goals in working together. The partnership might merge with another business, or decide to become a corporation or other structure. One partner might retire, die, or become incapacitated.
Other times, however, the dissolution of the partnership is less amicable. This is particularly the case when one partner is being terminated against their will, or if there are issues such as bankruptcy and fraud involved.
Partnership dissolution may come about as a result of a dispute. Often, however, the dissolution itself is a hotbed of new disputes. Even if you are leaving on friendly terms, there are many potential flash points of disagreement, and if you were already fighting before the dissolution began, things will be a lot worse.
As a result, partnership dissolution is frequently compared to a divorce. This is not a perfect metaphor, but partnership disputes, even the most professional, can easily become as messy and emotionally fraught as divorces.
However, a dissolution does not have to be unpleasant. This depends on a variety of factors, the largest of these being whether you have worked out a strong partnership agreement. If you did not, then you will have to work an agreement out with your partners right now, which may involve attorneys, a mediator, or even the courts.
Furthermore, without a written agreement you will often have to act in adherence to state law, and follow certain default legal procedures, including those outlined in the Uniform Partnership Act in states where this has been enacted.
Common Problems Associated with Dissolution
Division of Assets: Each partner should receive their capital contributions back from the partnership. Once this is done, each partner’s ownership interest will generally determine how much they receive of the remaining assets. Unfortunately, it is common for one partner to try to shortchange the other(s).
Payment of Debts: Before the division of assets can occur, the partners must pay off any debts of the partnership. Disputes at this stage may arise between the partners themselves or between the partners and their debtors.
Other Procedural Matters: There are a lot of steps partners must take during dissolution: closing accounts, notifying stakeholders such as employees, contractors, and customers, and notifying the proper state and federal authorities, including the IRS. There are all sorts of missteps that can occur at this stage, many of them unintentional, and it can help to have someone experienced seeing you through.
Alternatives to Partnership Dissolution
Dissolution is not the only way to solve a partnership dispute. While it is always an option on the table, dissolution can be an extremely costly and time-consuming process, and will necessitate having to start anew with your business.
If you want to resolve a partnership agreement, but would prefer to avoid the stress of dissolution, then it may be worth exploring a couple of other alternatives.
Renegotiating the Partnership Agreement. If you do not want to get rid of the partnership altogether, you can attempt to renegotiate the partnership agreement with your partner(s), to change your powers and responsibilities so that they are more mutually acceptable. These negotiations can be difficult and will likely involve a tradeoff, but they are often easier than a full dissolution… assuming you and your partner(s) are still on good enough terms to negotiate in good faith.
Buying Your Partner Out. Another option is for you to buy out your partner’s share in the business, or have them buy you out. Of course, if you have only one partner and you buy them out, or vice versa, then the partnership will be dissolved by default. If you buy your partner out, you might have to pay a lot of money, perhaps more than you can afford, and your partner might refuse to buy you out for the same reason. You will also have to go through a number of steps, including getting a valuation of your business. Despite the complications, however, there are some circumstances where this is the right solution and can save everyone the stress of a formal dissolution.
Again, these options will not work in every case. But before going straight to dissolution, they may be worth considering.
When to Consult a Partnership Dispute Attorney
Not all partnership disputes will require legal action. Some disputes can be resolved informally, with a bit of proactive communication and good faith on all sides of the dispute.
But sometimes it will be necessary for you to seek legal representation. The times you are most likely to need a lawyer are:
1) When you are first creating a partnership, in order to draft a strong agreement which will decrease the likelihood of disputes later on.
2) When a partnership dispute has grown to the point where it cannot be worked out, or a partner has engaged in unethical activity.
Are you unsure whether your partnership dispute is serious enough to require a lawyer? The best thing to do may be to give us a call and talk things over. You have nothing to lose, and perhaps a lot to gain, from hearing a professional opinion.
Bohm Wildish & Matsen LLP is widely recognized as one of the foremost firms for resolving complex partnership disputes, and we would be happy to talk to you and help you decide on the right course of action.