A partnership agreement - Essay Example

A partnership agreement Introduction A partnership agreement is a deal entered upon by two or more persons who voluntarily pool together capital, labor, and skills in a business undertaking. A partnership agreement is important in that it spells out the rights and responsibilities of all the members in the partnership and hence is a useful tool in prevention of later conflicts. While founding partners may prefer to make an agreement that is less flexible, changing circumstances and the instance of conflict necessitate the making of flexible partnership agreements. Partners in many instances may set up businesses with little planning for unforeseen circumstances. Morse (2001, pp.56-7) asserts that Partnerships set up on rigid rules of the partnership agreement soon find out that conflicts emerge due to differences of running the business or changes in the circumstances of the partners involved . Differences in the running of the business such as the divisions of losses and profits, management and the opting out of the business are all issues, which need to be taken into account when the partnership agreement is being drafted. Changing circumstances for instance the selling of one’s shares or the transfer of the same to a spouse or family member also need to be included in the agreement if conflict is to be avoided. Such pertinent issues usually require the existence of a particular framework, which will be followed in instances of disagreement (Morse, 2001, pp. 59). While such procedure will be effective in prevention of future conflicts, it has been found that conflicts are inevitable due to changes in laws and circumstances. It is also impossible to document every aspect of the partnership and as such, the document needs to be flexible enough to allow the inclusion of changing needs and circumstances of the partnership. Partnership agreements may need to be modified in the instance of divorce settlements, which may lead to the family members of a partner receiving shares, bankruptcy, death, retirement, disability, translocation of a partner, a partner intending to sell after getting a nice offer, debts taken out on the partnership. All of these reasons make strong the argument for the partnership agreement to be made flexible. Divorce Settlements At the time of getting into marriage, many partners overlook many of the provisions of a partnership agreement. In most instances, it is assumed that divorce or separation will not occur.. However, it has to be acknowledged that divorce and separation are an inevitable occurrence of modern life. It is thus important that since the marital circumstances of the partners may change in the future the partnership agreement be flexible enough to allow the inclusion for the changing circumstances. It s estimated that about a million of the businesses in the US are co owned by wife and husbands in a partnership. That being said it is inevitable that conflicts will arise in instances of divorce or separation of the couple. To add on to that many of the people who enter into business partnerships with other people other than their spouses are usually married. The resources brought into the business may thus be considered to belong to the family. Upon divorce, the couple may be required by law to divide the shares in the business in the interests of justice. A partnership agreement that does not take into account such things as divorce may thus need to be amended in order to accommodate the new dispensation. This is best exemplified in Estate of Cohen v. Booth Computers in which Cohen was suing her husband over shares held jointly by both of them. The judge ruled that Cohen was entitled to a share in the company by virtue of marriage since there was no express provision in the partnership agreement that was against such as scenario (Mahler, 2011). Bankruptcy Bankruptcy is the inability of a person to pay back his debts or loans. It is different from insolvency, which is usually a status of having fewer assets than liabilities. Bankruptcy entails the legal status that is attained by applying to the court in order for one to be allowed to rearrange a repayment plan and to prevent his assets from being sold to repay the debt. Upon the entry of persons into a partnership agreement, they do not normally consider bankruptcy. While partners usually enter the partnership with an air of trust and confidence, some partners may not reveal their true financial status which may prove detrimental to the business in future. Bankruptcies may also happen even with the most stable of partners, which would put the assets of the business in jeopardy. Many times the partnership agreement is written without taking into consideration the probability of partner bankruptcy which results into the enactment of the 1890 Partnership Act of 1890 (Mahler, 2011). While the bankruptcy act will be a good thing in voiding the rights of the bankrupt partner on the business, it also presents other problems with trusteeship. In the absence of a clause in the partnership agreement, the act mandates that the interest of the bankrupt partner be taken care of by a trustee, which will make the partnership automatically dissolved. A trustee who is imposed upon the partnership may not be interested in keeping the business afloat but rather in getting the most that they can out of the business as exemplified in the case of All Properties Terrain Inc v. Hoy (Mahler, 2011). In instances in which the business was profitable, the remaining partners may be required by law to pay capital gains tax out of the proceeds of dissolution. A partnership having a flexible agreement would be able to amend it as soon as bankruptcy is declared in order to avoid the provisions of the 1890 Partnership Act from being enforced. Death Death in partnership is also one area, which may bring conflict in future if the partnership has an inflexible partnership agreement. While many states in the United States have adopted the Revised Uniform Partnership Act (RUPA) of 1994, there are still some issues, which need to be taken into consideration in drawing up the partnership agreement. The RUPA’s default rules provide that a partnership will continue in operation following the decease of a partner. The partners will however be obligated to buy out the interest of the dead partner at rates which are equal or greater than the going concern or insolvency price of the business (Morse, 2001.pp76-84). While the legislation is law in many states in the US, it is only applied in instances in which the partnership lacks a clear framework, which deals with the death of a partner. The most poignant of conflicts is usually because of the valuation of the value of the shares that are held by the deceased in the partnership. There are usually dissenters when it comes to the valuation of the shares held according to interest sought. A case in point is the Vick v. Albert case in which Vick sued Albert for wrongful valuation of the shares held by his father in a partnership with his father. Albert was sued of taking control of the business instead of winding it up and paying Vick her dues as required by law. Since there was no written agreement there was a conflict in the determination of the value of the shares held (Mahler, 2011). A partnership, which has a flexible agreement, would find it easier to modify such agreements in order that such issues like valuation upon death and trusteeship are clearly spelt out in the agreement. Retirement Retirement is an inevitable part of life and every partnership therefore has to make provisions for it. Retirement in the partnership agreement is usually written from the perspective which many a time overlooks the possibility of changed circumstances of the business in future. Many partnership agreements are written in such a manner that gives the partners who are retired a specified amount of money. Benefits may be given to the retiring partner by fixed monthly stipends, yearly distribution of profits or by a one off payment. The issue of retirement is thus one issue that calls for a partnership agreement that is flexible enough since it may lead to conflicts in enforcement due to changed circumstances. In the course of a business partnership, changed circumstances may lead to conflicts in a retiring partner claiming more money or the remaining partners desiring to give less. A business that has been performing well may have more money in its accounts and yet have more money available to offer its retiring partners. While the partners may no object to such a plan, an inflexible partnership agreement may make it impossible to do so. This may also be the case in instances in which a partner believes that his contribution to the business, deserves more than what was initially agreed on in the partnership agreement. Conflicts may arise when partners do not believe that a retiring partner ought to have the retirement package revised to reflect his contribution to the success of the business as was the case in Phillips Gold & Co v. Speiser (Morse, 2001, pp145-54). A flexible partnership agreement would thus be very beneficial since it would allow for a modification to solve the current impasse while also making provisions for future conflicts of the same nature. Disability Disability of a partner in the business is one event that most partnerships would wish never to happen to the. That being said there are many conflicts and problems, which result from an inflexible partnership agreement. Problems may arise with regard to the disability of a partner who plays a major role in ensuring the success of the business. Issue may also arise with regard to how to deal with the disability. Most agreements usually offer a prescription on what is to happen should one of the members become incapacitated such that performance of his obligation is not possible. A disability of a partner is usually tied to the length upon which the incapacitation would last. Payments of interest for an incapacitated partner are usually calculated upon the length of incapacitation. Incapacitation that is for an extended period usually requires that the remaining partners buy out the interest of the incapacitated partner. Issues usually arise with the valuation following the incapacitation. While some of the partners may opt for payment based on book value, others may prefer payment based on true value. A good example of this scenario is the case of Blue Chip Emerald v. Allied Partners in which the incapacitated partner disputed the valuation of the firm after dissolution. Another issue in the incapacitation of the partner is concerning the length of period for which the partner can be declared to be totally incapacitated to perform his duties (Mahler, 2011). Duties of the partners may have been modified since the agreement was drawn up and hence the duty of the incapacitated partner may be so crucial as to severely affect the business. Having a flexible agreement would thus allow the partners to alter the provisions to take into account the changed circumstances and save the business from failure. Translocation of a Partner A partner may decide to go away from the area of business hence resulting into complications for the business in which he is a partner. Issue usually arise with partners who are moving away in general partnerships since such partnerships require that the business be wound up and the assets and liabilities be determined and allocated. In instances of businesses, which have been widely successful, the remaining partners may not view this clause favorably. The requirement of the law may however be voided in instances in which there are adequate provisions in the partnership agreement that would allow for alternative courses of action (Morse, 2011, pp.111-115). The leaving of a partner is usually treated the same way as death and disability of a partner. A partner who desires to leave the locality in which the business is taking place then has the option of applying for the winding up of the business. Under the RUPA, a partner will be dissociated from the partnership upon the submission of a withdrawal request to the partnership. Dissociation of the partner would however lead to undesirable consequences such as winding up of the business. Partners may find themselves saddled up with cost of registering the partnership anew and in some instances be required to pay capital gains tax (Morse, 2011, pp.168-172). A flexible partnership agreement would go along way in ensuring that, the partners to prevent winding up proceedings either by offering the dissociated partner terms or other alternatives can modify it. Tax Allocation Another component that would make a flexible partnership agreement more advantageous is the issue of tax allocation. Legislation usually offers partnerships flexibility in the allocation of income for taxation purposes. The partnership agreement usually has clauses, which govern how profits, deductions, credit, and losses. The Internal Revenue Commission rules in section 704 part a allow partnerships to decide on how they allocate these fiscal measures among partners. The allocation of these measures as such is part of the partnership agreement. Many a time, there have been conflicts over the allocation of tax due to perceptions of changed or changing circumstances in the business. Partnership agreements may in some instances not have taken into consideration allocation procedures or may have made them in a manner which would result into negative impact upon a partner (Morse, 2001, pp.275-279). In instance in which the partnership lacks a comprehensive provision for tax allocation, the IRS will step in order to provide partner interest in the partnership. Having a flexible partnership agreement would enable the partnership to make the necessary amendments according to prevailing conditions in order that a fair allocation of tax is achieved for all partners. A good example of the application of the flexibility of tax allocation is the Renkemeyer, Campbell & Weaver, LLP, Troy Renkemeyer, and Tax Matters Partner v. Commissioner of Internal Revenue. The petitioner sued for equitable allocation of tax on the basis that it had been allocated contrary to the partnership agreement. The court made a ruling for the petitioner asserting that the tax allocation was not a true reflection of the economic times. A flexible partnership agreement would have been an invaluable tool in reevaluating tax allocation according to the economic realities. Conclusion A partnership agreement that is easy to change is invaluable to the partnership in a variety of ways. Since partnerships just like all other businesses are affected by changing circumstances, which result from internal as a well as external occurrences, flexibility in the partnership agreement is to be highly desired. There are many circumstances, which may happen to the business such as death, retirement, translocation among other whose instance is never fully addressed in the initial partnership agreement. A partnership with an inflexible partnership agreement would encounter a lot of trouble in trying to respond to conflicts when these issues come up in the life of the partnership. While there is legislation that governs the operation of partnership agreements, an enforcement of this legislation in many instances would result into undesirable consequences. This legislation is in many instances used in instances of lack of the prerequisite clauses in the partnership agreement. A Partnership agreement that is easy to change would thus in many instances avoid the enforcement of such legislation by modifying its agreement to include the requisite provisions. Bibliography Mahler, P., 2011. New York Business Divorce [Online] Available at: http://www.nybusinessdivorce.com/ [Accessed 8 Novemeber 2011]. Morse, G, 2001, Partnership Law, 5th Ed, New York: Oxford University Press. Table of Cases Blue Chip Emerald LLC v, Allied Partners Inc., 299 2d 278 – NY: Appellate Div., 1st Dept 2002 Estate of Cohen v. Both Computers, Memorandum Decision, C.A. Docket No. BER-C-135-08 (N.J.Super. Ct. Aug. 4, 2009). Phillips Gold & Co., LLP v. Speiser, 2011 NY Slip Op 32555(U) (Sup Ct NY County Sept.28, 2011) Renkemeyer, Campbell & Weaver, LLP v Commissioner of Internal Revenue Case No. 18735-08 (U.S. Tax Ct, Feb. 9, 2011) Vick v Albert 2008 NY Slip Op 00336 [47 AD3d 482] January 17, 2008 Read More