Today we continue on in our Business Entity Selection Series. If you missed any prior posts, click here.
What Is a General Partnership? Texas law defines a general partnership as “an association of two or more persons to carry on a business for profit as owners…regardless of whether the persons intend to create a partnership or whether the association is called a ‘partnership.'” See Texas Business Organizations Code Section 152.051. Importantly, the definition of “persons” is not limited to individuals, meaning that other legal entities such as an LLC or a trust may serve as a partner of a general partnership. As is discussed below, the main advantages of a general partnership–the ease for formation and flexibility in management–are often outweighed by liability concerns, which are unlimited under a general partnership structure.
Governing Law: In Texas, general partnerships are governed by the Business Organizations Code, Chapter 152. In the absence of contrary provisions in a partnership agreement, the statute serves to provide the default terms governing partnerships.
Formation: General partnerships are an interesting business structure in that they are often formed even when the parties have no intent to form the partnership or knowledge of the formation. Unlike other business organizational structures like a limited partnership or an LLC, there is no requirement that any paperwork be filed in order to create a partnership. Whether parties intend to or not, if they meet the definition of a partnership, they are treated as one under the law.
Texas law sets out various factors to be considered in determining whether a partnership has been formed including: (1) right to share in profits of the business; (2) expression of an intent to be partners; (3) right to participate in control of the business; (4) agreement to share losses of the business or liability for third party claims against the business; and (5) agreement to contribute money or property to the business. See Texas Business Organizations Code Section 152.052. Courts applying these factors use a totality of the circumstances test to determine whether a partnership was created. See Ingram v. Deere, 288 S.W.3d 886 (Tex. 2009).
Additionally, the Code provides certain actions which are not, alone, sufficient to create a partnership, including the right to share in profits, payment of rent, co-ownership of property, sharing gross revenues, and ownership of mineral property under a joint operating agreement. See Texas Business Organizations Code Section 152.051.
For purposes of this example, consider two brothers who farm a piece of property inherited by their grandfather. The mere fact that they own the property as co-tenants does not, alone, create a partnership. If, however, other factors were also present–the brothers shared profits, both participated in control, agreed to share losses and both contributed money to the operation–they may well be considered partners.
Management: A positive feature about general partnerships is the flexibility in selecting who will be involved with day-to-day management of the business. There is no requirement that managers be appointed or that certain partners refrain from actively managing the operations. See Texas Business Organizations Code Section 152.203. Unless the parties agree otherwise, each partner has equal rights to participate in the management of the business. See Texas Business Organizations Code Section 152.203.
Partners are not, however, required to be paid compensation for services to the partnership other than winding up the partnership business. See Texas Business Organizations Code Section 152.203. Further, partners owe each other various non-waivable duties, including the duty of care and duty of loyalty. See Texas Business Organizations Code Section 152.204.
Decision-making: Absent an agreement otherwise, all decisions made in the ordinary course of business may be made with the consent of a majority of the partners. See Texas Business Organizations Code Section 152.209. All decisions made outside the ordinary course of business, however, require unanimous consent from the partners, unless the partners have agreed otherwise. See id.
Liability: A major downside to general partnerships is the fact that there is no limited liability. Additionally, each partner generally has the right to bind the partnership. See Texas Business Organizations Code Section 152.302. This means that each partner is jointly and severally liable for the debts and obligations of the partnership. See Texas Business Organizations Code Section 152.303. The law does require, however, that generally, a creditor of the partnership exhaust its collection efforts using partnership assets first before collecting partnership debts from an individual partner. See Texas Business Organizations Code Section 152.306.
Going back to our example of brothers who farm property as a partnership, if one brother purchased a brand new combine in the partnership’s name to cut wheat without the other brother’s knowledge or permission, both brothers would be jointly and severally liable for the combined debt. Similarly, suppose one brother was driving the same combine down the road and was involved in an accident. Again, both brothers could be liable if a personal injury lawsuit was filed against the partnership by the other driver.
Sharing Profits/Losses: Absent an agreement otherwise, partnership profits and losses are shared equally by the partners. See Texas Business Organizations Code Section 152.202. This is an important default rule to understand and consider, particularly if each partner contributed a different amount of capital to the partnership. Regardless of contributions, absent an agreement otherwise, each partner shares equally in the profits and losses.
Partnership Property: Because the partnership is a separate legal entity, all partnership property is owned by the partnership rather than by the individual partners. See Texas Business Organizations Code Section 152.101. The classification of property as belonging to the partnership or individual partners can be complicated and is governed by the Texas Business Organizations Code Section 152.102.
Tax Treatment: Although a partnership is a legal entity separate from the individual partners, partnerships are not taxed at the entity level, meaning that each member is responsible for paying the income taxes of the partnership. See Texas Business Organizations Code Section 152.056; Motheral v. Motheral, 514 S.W.2d 475 (Tex. Ct. App. – Corpus Christi 1974).
Farm Program Payments: One potential advantage to organizing as a partnership is that each individual partner is able to receive his or her full individual limit for farm program payments. So, under the 2014 farm bill, the individual payment limit in the ARC and PLC commodity programs for a person actively engaged in farming is $125,000. If the two brothers above were a general partnership, then each brother would be eligible to receive payments up to the $125,000 payment limit and each of the brothers’ wives, if actively engaged in the farming operation, would also be eligible to receive payments up to the $125,000 limit. On the contrary, if the two farmers formed an LLC and were each members of that entity, the payment limit that is applicable to the ARC and PLC programs would not apply to them individually, but the LLC, as an entity, would be subject to the ARC and PLC payment limit applicable to a “person,” limiting the possible total payments made available to the farming brothers on an annual basis to $125,000.
Governing Documents: Parties who form a general partnership often sign a contractual agreement that will govern their interactions, commonly called a Partnership Agreement. With limited exceptions, the parties are free to agree to whatever terms and conditions they desire. See Texas Business Organizations Code Section 152.002. Absent an agreement to the contrary, partnership agreements may be amended only with the consent of all parties. See Texas Business Organizations Code Section 152.208.
Transfer of Ownership/Addition of Partner: Generally, partners are permitted to transfer their partnership interest, but the transferee is not entitled to participate in the management of the partnership business. See Texas Business Organizations Code Section 152.402. Absent agreement otherwise, only upon unanimous consent from all partners is a new partner added to the partnership. See Texas Business Organizations Code Section 152.201. Thus, back to our example of the brothers, if one brother wanted to transfer his partnership interest to a third party, he would be allowed to do so, but that third party would not be a true partner such that he or she could participate in making business decisions without consent of all other partners.
Termination of Partnership. Under Texas law, the following events trigger the “winding up” of a partnership: (1) expiration of a period of duration or completion of the particular undertaking stated in the partnership agreement; (2) voluntary decision to wind up the partnership; (3) events identified in the partnership agreement as requiring winding up; (3) an event that makes the continuation of the partnership illegal; or (4) a court order requiring the partnership to wind up. See Texas Business Organizations Code Section 11.051; 11.057. If the partnership was for a set purpose or duration, voluntary winding up requires consent of all parties. See Texas Business Organizations Code 11.057. If, on the other hand, the partnership was not for a set duration or undertaking, only a majority vote is required to voluntarily wind up. See Texas Business Organizations Code 11.057. Absent agreement otherwise by the parties, the death or withdrawal of a partner does not terminate the partnership.
Summary: The general partnership is created–whether intentional or not–when two or more persons engage in a business for profit. Advantages include ease of management, flexible decision making, and ease of formation. The biggest downsides to a general partnership are the unlimited joint and several liability for debts of the partnership and the fact that each partner can bind the partnership without the express consent of all other partners.