Partnership is in many ways similar to a sole proprietorship, except that two or more individuals are the owners, or “partners.” Partnerships are relatively easy to form, and provide great flexibility for the owners and management. In fact, no written agreement is required to form a partnership, but a written partnership agreement is highly recommended.

Partnerships normally begin when two or more individuals contribute money or property into the partnership. Each partner has a right to an equal share of the profits, unless specified otherwise in an agreement. In many cases, not all partners contribute the same amount of capital or property. Partners usually establish, in a written partnership agreement, that profits will be shared in the same proportions that capital contributions are made. Losses are normally shared in the same proportion as profits. While partnerships existed under common law, nearly every state has now enacted the Uniform Partnership Act (UPA). When a partnership is formed, the UPA states that each partner has three separate property rights:

  1. Rights to the property owned by the partnership. This generally includes all property originally brought into the partnership, purchased at a later date, or otherwise acquired by the partnership. This can be tricky, as individuals sometimes purchase property without clearly stating whether the partnership owns it. Property acquired with the partnership’s funds is almost always partnership property.
  2. Rights to the interest in the partnership. The UPA states that the partner’s interest in the partnership is an intangible, economic right. Like other individual property rights, it is assignable, can be taken by creditors, and becomes part of the estate when a partner dies.
  3. Rights to participate in the management of affairs. The partners can elect a managing partner to carry out the basic business of the partnership. Otherwise, all partners have equal rights in the management of the partnership business. Normally, a majority of the partners decide partnership matters, and it’s usually established in a written agreement that each partner’s voting authority is equal to its capital account.

Each partner is essentially an agent for the partnership. Like any other agent, a partner can do things that create obligations for the partnership as a whole. If a partner makes a contract within the scope of his or her real or apparent authority, the partnership and all of its members are usually liable.

For example, if a partner takes out a loan in the name of the partnership, every partner is obligated for the loan repayment even though the other partners may not have signed the note. However, if a partner gives a lender a promissory note for the partner’s personal obligation, the partnership and the other partners are not liable. All partners are jointly and severally liable for all torts committed by an employee, or one of the partners, within the scope of partnership business. In other words, if a partner commits fraud (a tort) in an effort to secure partnership business, the partnership may be liable for damages. If the partnership cannot pay the damages, then each partner is individually liable for the entire amount. It is this aspect of personal liability that makes the partnership form unattractive for many business owners. In the absence of a written partnership agreement, the UPA automatically establishes the following rights and obligations of each partner:

  1. Each partner has a fiduciary duty to act in good faith towards the partnership and the other partners. A fiduciary is someone in a position of trust, acting for someone else’s benefit. The partners are required to give undivided time and energy to the business of the partnership, and cannot promote or work for a competing business.
  2. Each party has the duty to inform the partnership of matters relating to the partnership.
  3. Each partner is entitled to inspect the books and records of the partnership.
  4. No partner is entitled to compensation for services performed for the partnership, but is entitled to a share of the profits.
  5. A partner who advances money to the partnership in the form of a loan may collect interest paid by the partnership. (True capital contributions do not draw interest.) A partner who pays more than his or her proportionate share of partnership debts can receive contributions from the other partners. Partnerships do not pay income taxes. Instead, the partnership files an “informational return” with the IRS and one or more states. Each partner is then obligated to pay taxes based upon his or her share of the partnership income (if any), regardless of whether the partnership actually distributed any amount to the partner.

Important Tip: Make sure that you have a written partnership agreement and it clearly identifies the partnership’s assets and liabilities separate from the partners’ personal assets and liabilities.

Several special rules also govern the dissolution of partnerships. The UPA establishes three phases for ending a partnership:

  1. Dissolution: The point and time when the partners cease being associated with one another as partners.
  2. Winding up: The process of completing the partnership affairs.
  3. Termination: The point at which the partnership is legally and, for practical purposes, over.

Under the UPA, dissolution of the partnership occurs automatically when any partner withdraws for any reason, such as retirement, death, physical disability, or being forced out by the other partners. It is important to have a written partnership agreement to continue the partnership when an act of dissolution occurs. Dissolution also can occur when a partner sells or assigns its partnership interest.