278: Listen and Learn -- Partnership Liability

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. Hello, and welcome back to the "Listen and Learn" series.

This is the second installment of our episodes covering partnerships. In part one, we focused on the three main types of partnerships - general partnerships, limited partnerships, and limited liability partnerships, and the creation of all three. Today we will cover the power and liability of partners in a partnership. Understanding these concepts is crucial for anyone interested in business law, but is also highly tested on the MEE.

So, if you're preparing for the bar exam, this topic is important for you too. So let's get started with part two. As I mentioned, we'll cover the power and liability of partners in a partnership. Basically, what does a partner get to do, and what are they stuck with? We'll look at different scenarios affecting partnerships in the three main types of partnerships we covered in an earlier episode - general partnerships, limited partnerships, and limited liability partnerships.

One tip on this topic: The bar exam usually tests the formation of LPs and LLPs in conjunction with a partner's personal liability. So, be sure you understand and analyze both. Feel free to listen to the prior partnerships episode now, if a review of those three types would be helpful before diving into part two. Let's start out on a positive note. What authority does a partner have because they are involved in a partnership?

First, a partner has the authority to bind a partnership - that is, commit a partnership to something. In general, each partner is an agent of the partnership and generally has authority to bind the partnership for the purpose of its business, including entering into contracts. More specifically, a partner has three types of authority, depending on the situation - express actual authority, implied actual authority, and apparent authority.

First, a partner has express actual authority to bind the partnership upon receiving that authority from the partners. Differences among the partners as to acts within the ordinary course of the partnership business need only to be approved by a majority of the partners. Acts outside the ordinary course of business must be approved unanimously.

If the partnership agreement is silent on the scope of the partner's authority, a partner has authority to bind the partnership to usual and customary matters, unless the partner knows that, a) other partners might disagree; or b) for some other reason consultation with fellow partners is appropriate. Hiring an employee, for example, is normally within the ordinary course of partnership business, unless the partnership agreement states otherwise.

In sum, if the partners give another partner authority to bind the partnership, they have express authority. That is easy to remember, because the authority has to be expressed by the other partners. But what if it hasn't? A partner has implied actual authority - also known as incidental authority - to take actions that are reasonably incidental or necessary to achieve the partner's authorized duties. I know that sounds a little vague, but it's fairly straightforward.

Basically, if a partner has been authorized to carry out certain duties, they have implied authority to take reasonable and necessary steps to carry out those duties. And finally there is apparent authority. A partner has apparent authority to bind the partnerships for all acts apparently conducted within the ordinary course of the partnership business, or the kind of business carried on by the partnership.

However, a partner's act will not bind the partnership if, [1] the partner lacked authority; and [2] the third party knew [actual knowledge], or had notice that the partner lacked authority. This makes sense, right? The partner didn't have apparent authority if they knew they didn't have the authority. So, what makes an action within the ordinary course of business? How do you know?

The rule states that an action or transaction is within the ordinary course of business if it is normal and necessary for managing the business. That is, a person would reasonably conclude the act is directly and necessarily embraced within the partnership business. That still isn't super clear, I know. So, as you might guess by now, that's where the legal argument often lies.

If you get a question like this on an exam, flex your legal analysis muscles and make your best argument for why the action is, or is not, within the ordinary course of business. Before we move on, I have one more thing to mention. If the act conducted is outside the scope of business, there must be a manifestation by the partnership that the partner had authority in order to bind the partnership. If not, the partner did not have authority to act.

Apart from the three types of authority we just covered, which govern a partner's authority during the course of a partnership's business, there are also rules guiding a partner's authority during a partnership's winddown or dissolution. We don't have time to cover those today, but I wanted to flag them for your review. Now that we know what a partner can do, let's discuss what they are stuck with, or must do. That is, what are they liable for because of their role as a partner?

That answer depends on the type of partnership. If the partner is part of a general partnership, their liability is different than if they are a part of a limited partnership or limited liability partnership. We touched on this a bit in the prior episode, but one of the main considerations in choosing to form a general partnership, limited partnership, or limited liability partnership hinges on the liability each partner takes on in the partnership.

So, let's dive into the different ramifications. For general partnerships, the rule is that general partners are personally liable for all obligations of the partnership, unless otherwise agreed by the claimant or provided by law. Let's stop here for a second. You may be thinking, "Wow, that's really broad", and you'd be right. Unless the law states otherwise, or the person suing has otherwise agreed, partners are completely personally liable.

Partners in a general partnership have a lot on the line personally if something goes awry in the partnership. If you see a general partnership mentioned on the exam, you should immediately be thinking about the broad personal liability of its partners. But, timing is important when considering liability.

In general partnerships, incoming partners admitted into an already existing partnership are not liable for obligations incurred prior to their admission, even if the incoming partner has notice of a claim. Even though that partner is not personally liable for the debts of the partnership, he is still at risk of losing any capital contributions he made to the partnership that are used to satisfy partnership obligations.

That means though the claimant can't come after the new or incoming partner personally, if they had to make some sort of financial contribution to the partnership in order to join, that money, which is now property of the partnership, can be used to pay the claimant. Okay, so let's say there's a lawsuit and the general partnership loses. Now what?

Generally, a judgment creditor cannot levy execution of the judgment against a partner's personal assets for a partnership debt, unless, [1] a judgment has been rendered against the partner; and [2] the partnership assets have been exhausted or insufficient. In other words, the partner is protected unless the judge specifically holds them personally liable, and even then, the judgment must be paid out from the general partnership first.

Only if debt still remains at that point will the partner be personally liable. Okay, so that's pretty broad. We know from the previous episode that partners in a limited partnership are more protected. They're less liable than partners in a general partnership. But let's get more specific. Unlike in general partnerships, limited partners are generally not personally liable for the obligations of the limited partnership. However, certain exceptions to this rule exist.

First, limited partners are always liable for their own misconduct, or when they sign a personal guarantee for an obligation. That is, they aren't excused if they do something wrong or take the liability on explicitly. Second, even if a partner is not personally liable for the debts of the partnership, they are at risk of losing any capital contributions to make the partnership, just like in general partnerships.

Third, and finally, the partner's role in the limited partnership makes a difference. A limited partner may become personally liable if that partner participates in the management or control of the business. If a limited partner's control and management activities are so extensive as to be substantially the same as those of a general partner, then some jurisdictions have held the partner to be liable in the same manner as a general partner.

Whether the limited partner is liable and the extent of the liability depends on the applicable act enacted in the jurisdiction. We're not going to get into the nitty-gritty of the four different rules today; I just want you to know that different tests exist for partners involved in management, and it would be wise to study those four rules so you can apply them if they are relevant in your jurisdiction or in a particular question.

The rule for LLPs is this: An obligation incurred by a limited liability partnership is solely the obligation of the LLP - that is, a partner in an LLP is not liable for partnership obligations. However, certain exceptions to this rule exist. First, as in LPs, partners are always liable for their own misconduct or when they sign a personal guarantee for the obligation.

Second, and again like in LP or GP, even if a partner is not personally liable for the debts of the partnership, they are at risk of losing any capital contributions made to it. Third, obligations incurred before a partnership becomes an LLP are treated as obligations of the prior partnership entity - i.e. general partnership or limited partnership - meaning if the partnership converted from a GP to an LLP, the rules of GP liability apply to obligations incurred while the partnership was a GP.

Again, timing matters. One final rule to cover, and that is about the partnership's liability for the partner's actions- the flip side of what we've been discussing. A partnership is liable for loss or injury caused to a person, or for a penalty incurred because of, [1] the wrongful act, omission, or actionable conduct of a partner that is [2] acting in the ordinary course of partnership business.

Now that we've covered all the rules, let's check our knowledge by applying these rules to some hypotheticals. This first hypo is taken from the July 2023 California bar exam: "Amy, Bob, and Carl are partners in the ABC law firm, which operates under a general partnership agreement. ABC provides all firm attorneys with cell phones to facilitate prompt attorney-client communications.

ABC has a policy that all firm attorneys must carry their work-provided cell phones with them at all times, and that all client emails must be responded to immediately - at least with a personal acknowledgement of receipt. After work one day, Amy was driving in heavy traffic to attend a baseball game when she received an urgent email from an ABC client. While briefly stopped in traffic, Amy attempted to answer the email on her work-provided cell phone.

Due to this distraction, Amy negligently caused a car accident that was the actual and proximate cause of serious injuries to the other driver, Priya. Priya sued Amy, ABC, Bob, and Carl for damages arising from the car accident. The judge found Amy to be personally liable. Should she also find ABC, Bob, and Carl to be liable for Priya's injuries?" What do you think? Let's break it down a bit. Priya is suing the general partnership, ABC.

She is suing the partner who caused the accident, Amy, who the judge has found to be liable. And she is suing the two other partners, Bob and Carl, who were not directly involved in the accident. Let's start with ABC. A partnership is not liable for every action taken by its partners. Nonetheless, a partnership will still be liable for the tortious conduct of its partners when the partners were acting in the ordinary course of the partnership business. Partners are the agents of the partnership.

Assuming Amy was acting in the ordinary course of business, ABC is still liable for her conduct, even though it was tortious. Here, Amy negligently caused a crash while attempting to answer an email from an ABC client. Though ABC may try to argue that ABC was acting outside the scope of the partnership business, that is unconvincing. As we were told, ABC provides all its attorneys with cell phones to facilitate prompt attorney-client communications.

Moreover, ABC has a policy requiring all firm attorneys to carry their work-provided phones with them at all times, and that all client emails must be responded to immediately. Therefore, in attempting to respond to an urgent email from a firm client while sitting in traffic - i.e. immediately, as per the firm policy - Amy was acting within the ordinary course of the partnership business.

She was performing the kind of work she performs for the partnership, dealing with client matters, and was acting to further the partnership business by responding to a firm client. This is true even though Amy was driving, and even though she was responding outside of work hours. Nothing in the rule indicates any excuses or valid reasons for violating the seemingly absolute policy. Therefore, ABC will likely be found liable for the damages Priya suffered.

So, what does that mean for Bob and Carl? Bob and Carl are Amy's partners in the ABC law firm, a general partnership. General partnerships do not provide its partners with limited liability. In other words, general partners are personally liable for the partnership obligations. Because ABC should be found liable for Amy's actions at issue here, Bob and Carl, as well as Amy - as partners in a general partnership - are personally liable for the obligations of ABC law firm.

Therefore, Priya may be able to recover from Bob and Carl in their personal capacity, assuming that ABC's assets are insufficient to cover its liability to Priya. If ABC's assets are insufficient, Priya can recover from Bob and Carl personally. Again, because they are general partners in a general partnership, Bob and Carl may be held personally liable to Priya. With that hypo, we can really see the risks of a general partnership to the personal assets of its partners.

Let's look at one more with another type of partnership before we sign off. This one is adapted from the July 2014 California bar exam: "Alice's and Bob's law firm, AB Law, is a limited liability partnership. The firm represents Sid, a computer manufacturer. In the course of representing Sid, Alice learned that Sid planned a tender offer for the publicly traded shares of chip maker, Chipco. Alice bought 10,000 Chipco shares.

By buying the 10,000 Chipco shares, she drove up the price that Sid had to pay by $1 million. When Alice sold the 10,000 Chipco shares, she realized a $200,000 profit. Sid sues Alice, AB Law, and Bob. Should they be found liable? Discuss." We know that AB Law is a limited liability partnership, and that an LLP is a special type of partnership that affords limited liability to all its partners, created by filing a statement of qualification with the secretary of state.

In an LLP, the individual partners are not personally liable for any damages sustained by the partnership itself. Alice, however, remains liable for her own misconduct, even though she is protected by the LLP structure. For that reason, if misconduct is found, Alice is likely to be found liable. Bob, on the other hand, is merely a partner in the LLP and has limited liability, even if AB Law is found to be liable. Sid likely won't prevail against Bob.

Finally, there is AB Law. A partnership is liable for its partner's wrongful actions if the partner is acting in the ordinary course of business. Alice's misconduct has led to a loss by Sid of $1 million and has resulted in a gain to Alice, not AB Law, of $200,000. The purchasing of shares for personal profit is outside the scope of a law firm's business activity.

And there is nothing in the facts indicating the firm gave Alice authority to conduct this transaction, nor that Alice thought she had such authority. Because Alice was acting in her personal capacity and for her personal gain, though she was using knowledge gleaned from her work at AB Law, AB Law's unlikely to be found liable for her malfeasance. Because the partnership is not liable, Bob is further insulated from any personal liability for Alice's actions.

I know that was a lot of ground to cover today, but I hope the hypothetical helped make some of these rules more concrete. There are a lot of moving pieces in these questions, so read carefully. Take your time and make sure you're answering each part of the question. You're well on your way to mastering partnerships. Okay, that's a wrap for today. Glad you could join me.

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