269: Listen and Learn -- Creation of Partnerships

Alison also runs The Girl's Guide to Law School. If you enjoy the show, please leave a review on your favorite listening app, and check out our sister podcast, the Law School Toolbox podcast. If you have you have any questions, don't hesitate to reach out to us. You can reach us via the contact form on BarExamToolbox.com, and we'd love to hear from you. And with that, let's get started. Hi, and welcome back to the "Listen and Learn" series from the Bar Exam Toolbox podcast.

Today, we will be discussing partnerships. We'll focus on the creation of partnerships. And there are three types we'll need to cover - general partnerships, limited partnerships, and limited liability partnerships. Understanding these concepts is crucial for anyone interested in business law. But it's also a highly tested area on the MEE. So, if you're preparing for the bar exam, this topic is important for you too. So, let's get started.

As I mentioned, we'll cover the formation of three types of partnerships - general partnerships, limited partnerships, and limited liability partnerships. Let's begin by breaking down the formation and characteristics of general partnerships. A general partnership is established when two or more individuals come together as co-owners to carry on a business for profit.

The three key things you're looking for to identify a general partnership are, [1] at least two people; [2] co-owners; and [3] a for-profit business. Unlike some other business entities, a formal agreement or intent to form a partnership is not required to form a general partnership. As long as the individuals are co-owners, share profits, and conduct business together, a general partnership exists.

It's important to note that simply sharing profits or engaging in a joint venture doesn't automatically create a partnership. However, if a person receives a share of the profits, they are presumed to be a partner, unless the profits were received for certain reasons: a) payment of a debt; b) for wages as an employee or independent contractor; c) payment of rent; d) as annuity or other retirement benefit; e) an interest or a loan charge; or f) for the sale of the goodwill of a business.

Before we move on to other types of partnerships, I want to circle back to something I mentioned earlier - that intent is not necessary to form a general partnership. That means individuals may inadvertently create a general partnership, even if they expressly intended not to - for example, if they do not meet the required formalities to form a limited partnership or limited liability partnership. So, general partnerships are basically the fallback.

If individuals in a profit-making enterprise don't properly form the more stringent LP or LLP, they are likely in a general partnership. So, what is required to form a limited partnership? Well, let's take a look. A limited partnership consists of both limited partners and at least one general partner. Limited partners contribute capital to the partnership, but have a limited liability, meaning their personal assets are protected from the partnership's debts and obligations.

On the other hand, general partners manage the business and have unlimited liability. You can see why someone might want to have a limited partnership over a general partnership, right? So, how do you form a limited partnership? To form a limited partnership, the general partners must file a certificate of limited partnership with the secretary of state.

That certificate must include six things: [1] the partnership's name; [2] the address of their principal office; [3] the name and address of the partnership's registered agent, which must be within the state of the certificate's filing; [4] the name and address of each general partner; [5] whether the partnership is an LLLP - that is, a limited liability limited partnership; and [6] it must be signed by all general partners. This filing formalizes the partnership's existence and structure.

If the certificate does not contain all six requirements, it is not a validly formed LP, and instead, a general partnership is created, without the cover or limited liability. One note on the name of an LP: If the partnership is an LP, the name must contain "limited partnership" or the abbreviation LP. If it is an LLLP, the name must signal that by containing the phrase "limited liability limited partnership" or the abbreviation LLLP.

We have one more partnership type to cover before we get into some hypos, and that is limited liability partnership. Limited liability partnerships, or LLPs, offer partners limited personal liability - similar to that of limited partners in a limited partnership. However, it is even better for partners than an LP. In an LLP, all partners have limited liability, protecting their personal assets from the partnership's debts and obligations. Any partnership can become an LLP.

To do so, partners must obtain approval through the same vote necessary to amend the partnership agreement, and then file a statement of qualification with the secretary of state. Unless otherwise agreed, a unanimous vote is required to amend a partnership agreement. So typically a unanimous vote is required to become an LLP. Back to this statement of qualification for a minute.

That statement, again, filed with the secretary of state, declares the partnership's election to become an LLP and contains basic information about the partnership. That information must include, [1] the name and address of the partnership; [2] a statement that the partnership elects to become an LLP; and [3] a deferred effective date, if any. Similar to an LP and an LLLP, the name of an LLP must end with "registered limited liability partnership", "limited liability partnership", RLLP, or LLP.

The personal liability of its partners is the driving force behind the decision to create a GP, LP, or LLP. With that in mind, it's important to understand that converting an existing general partnership or limited partnership to an LLP doesn't create a new entity. Instead, the LLP continues to be the same partnership entity that existed prior to the filing.

Thus if any liability arose before the LLP was created, the LLP remains liable for any unfulfilled obligations of the partnership entity before it becomes an LLP. Said another way, forming an LLP can not be a shield from prior liability; it only covers partners from liabilities incurred going forward. Now that we have covered the three types of partnerships, let's look at a few hypos so we can see how this might play out on an exam.

If you're studying for the bar exam, I will note that questions about partnerships more often than not arise in the context of liability. We aren't able to cover the personal liability of the partners in each type of partnership in today's episode, but keep in mind that liability is really the second half of this lesson, and will fill out your understanding of partnerships and why it matters that someone has formed an LLP instead of an LP or a GP.

But before we get there, let's make sure we understand what the three types of partnerships are and how to form them. We'll start with a question adapted from the February 2022 California bar exam: "Arnold and Betty agreed to launch a business, selling a durable paint that Arnold had developed and patented. They agreed to share all profits and to act as equal owners. Betty agreed to contribute $100,000 to the business venture. Arnold agreed to contribute his patent for durable paint.

Arnold told Betty that he thought the patent was worth $100,000. He did not tell Betty that he had previously tried to sell the patent to several reputable paint companies, but was never offered more than $50,000. Arnold and Betty agreed that Betty would be responsible for market research and Arnold would be responsible for incorporating the business and taking care of any other steps needed to start the enterprise.

Arnold first located a building within which to operate the business, owned by Landlord Co., and entered into a one-year lease in the name of Durable Paint LP. Subsequently, after Arnold took the necessary steps, Durable Paint LP was incorporated. At the corporation's first board of directors meeting, Arnold and Betty were named as sole directors and officers.

During that meeting, Arnold and Betty voted for the corporation to assume all rights and liabilities for the lease, and to accept assignment of Arnold's patent rights. Over the next six months, Durable Paint LP faced unforeseen and costly manufacturing and supply problems. At the end of the first six months, the corporation had exhausted all its capital and was two months behind on rent.

To make matters worse, a competitor developed a far superior product, making Durable Paint LP's patent effectively worthless. Durable Paint LP had no other assets. Landlord Co. sued Arnold and Betty personally for damages, for breach of the lease. Are Betty and Arnold personally liable to Landlord Co. for Durable Paint LP's damages?" What do you think? Let's start with the underlying questions we need to ask and answer to know whether Arnold and Betty are personally liable.

To me, the most important question is, what type of partnership, if any, was formed by Arnold and Betty, and whether that partnership ever changed. Remember, depending on the type of partnership, the partners may be personally liable for the partnership's damages. So first, did Arnold and Betty enter into a partnership before incorporating the business? If so, what kind? Remember, Arnold found a building and signed a one-year lease first, before incorporating Durable Paint LP.

So, did a partnership exist when the lease was signed? There are three types of partnerships - general partnerships, limited partnerships, and limited liability partnerships. There are no formalities necessary to create a general partnership. Remember, a general partnership is an association of two or more persons who as co-owners carry on a business for profit. For a general partnership to form, intent to carry on a business for profit is required, but intend to form a partnership is not.

Sharing profits establishes a presumption that a business is a partnership. Equal management rights further add to such presumption. No formalities are required, and there need be no written partnership agreement. A general partnership is a separate entity from its partners. However, the partners are jointly and severally liable for all obligations and liabilities of the partnership.

Here, before the business was incorporated as a corporation, Arnold and Betty agreed to launch a business, selling durable paint that Arnold had developed and patented. They agreed to share all profits and act as equal owners. This created a presumption that they intended to carry on a business for profit. Accordingly, before Arnold and Betty signed the lease, they entered into a partnership, whether they meant to or not. That partnership was a general partnership.

They did not enter into a limited partnership or limited liability partnership, because each require filing for certification with the secretary of state, which they had not done at this time. The fact that they eventually called the partnership Durable Paint LP is irrelevant for purposes of establishing a partnership before the lease was signed. Thus Arnold and Betty were both personally liable for all obligations of the partnership created before the partnership was officially registered.

I hope the formation of general partnerships is clear after that hypo. Let's jump right into another one to really seal our knowledge of this area of partnership law. This one is taken from the February 2013 California bar exam: "In 2011, Molly and Lenny started a computer software business. Molly prepared marketing materials and Lenny made sales calls. During the first year, Lenny sold 10 copies of certain software programs for $50,000 each.

The business had a net profit of $480,000, and Molly and Lenny each received $240,000. In January 2012, Molly and Lenny hired an attorney to incorporate their business as a limited liability partnership under the name Software Pros LLP. The attorney properly prepared all necessary documents to incorporate the business and filed them with the secretary of state. Molly and Lenny voted unanimously for the change to take place. Lenny continued to make sales calls to sell the software.

He also sold a five-year service contract developed by Molly. Due to brisk sales, Software Pros LLP projected income of about $300,000 per year for the next five years from the service contracts alone. Software Pros LLP obtained a $100,000 business loan from National Bank, secured by the accounts receivable for the service contracts. In May 2012, Lenny had an automobile accident caused solely by his own negligence on the way to visit a prospective buyer. The accident injured a pedestrian.

As a result of the accident, Lenny stopped working and sales collapsed. In July 2012, Software Pros LLP went out of business, leaving negligible assets and the unpaid loan to National Bank. If Software Pros LLP is found liable, is Molly personally liable to the pedestrian for the injury, and to National Bank for the loan? Discuss." Okay, so again, we have foundational questions about what type of partnership was formed by Molly and Lenny, and when.

Let's start with 2011. The 2011 business has all the hallmarks of a general partnership. We know it isn't a limited partnership or limited liability partnership, because no documents were filed with the secretary of state. But since Molly and Lenny are co-owners, sharing in the for-profit business's profits, we have a general partnership. So if nothing else changes, Molly is personally liable for whatever liabilities her partnership incurs. But there was an intervening action here.

In 2012, Molly and Lenny hired an attorney to make their business a limited partnership under the name Software Pros LLP. From the question, we know the attorney did what they were supposed to do, and an LLP was created. Remember, converting a partnership into an LLP does not change the nature of the partnership before the LLP was created. So, if any liabilities arose before the formation date in 2012, Molly and Lenny would both be personally on the hook for those liabilities.

In this case, however, the car accident and loan took place after the partnership was converted into an LLP. So, what does that mean for Molly? Let's think back on our discussion of LLPs. Lucky for Molly, limited liability partnerships, or LLPs, offer partners limited personal liability, protecting their personal assets from the partnership's debts and obligations.

So, even though we're assuming Software Pros LLP has been found liable for Lenny's car accident, Molly is not personally liable for that liability, because she is a partner in an LLP with limited personal liability. I hope that general overview of partnership types, structures, and formations helped you as you make progress in partnerships law.

As I mentioned before, there is more to learn about the burden of liability under each of these structures, but this overview is an important building block. Make sure you're confident in the basics. It is tempting to skip right to an analysis of liability without first analyzing the partnership structure, but don't fall for that. You must first make sure you're operating in the correct framework, and then building your liability discussion from there. Alright, that's a wrap for today.

Glad you could join me. If you enjoyed this episode of the Bar Exam Toolbox podcast, please take a second to leave a review and rating on your favorite listening app. We'd really appreciate it. And be sure to subscribe so you don't miss anything. If you have any questions or comments, please don't hesitate to reach out to myself or Alison at [email protected] or [email protected]. Or you can always contact us via our website contact form at BarExamToolbox.com.

Thanks for listening, and we'll talk soon!