A partnership is a business operated by two or more persons. The partners form an agreement to contribute to the operation of the business. The contribution may be in the form of labor, skill, or money. The profits and losses of the business are shared equally among the partners.

Each state has statutes governing the operation of partnerships in that state. These statutes are based on the Uniform Partnership Act (UPA), which has been adopted by all states. The provisions of the UPA will control the operation of the partnership unless the partners agree otherwise.

Partnerships are unique among the business organizations in that a partnership is considered a separate legal entity for some purposes, but not for others. A partnership is a separate legal entity that may sue, be sued, and operate under a name different from that of the partners. The income from the operation of the partnership, however, is not attributable to the partnership entity. Rather, this income is “passed through” to the individual partners for federal income tax purposes.

Formation of Partnerships

The crucial element of a partnership is the agreement to share in the risks and rewards of operating a business. This agreement is a contract, and the common law of contracts requires certain partnership agreement be in writing to be enforceable. For example, partnerships intended to last more than one year or partnerships formed to buy and sell real estate must be in writing to satisfy the statute of frauds. The partners create a written partnership agreement.

Advantages and Disadvantages of Partnerships

The primary advantage of a partnership over a sole proprietorship is the ability to share the responsibility of operating the business. Partners can use the business organization to leverage their investment in the business and to secure investors and financing.

Unfortunately, a partnership does not protect the partners from personal liability. Most financial arrangements require each partner to acknowledge individual responsibility for the obligations of the partnership. This responsibility extends beyond the assets of the partnership to the personal assets of the partner.

Worse, each of the partners is responsible for the obligations of the other partners. This means that a partner who sexually harasses an employee exposes all the members of the partnership to liability for any damages award against that partner. This concept is called joint and several liability. The concept of joint and several liability applies even if the partners did not know of, participate in, or authorize the action that created the claim.

Another disadvantage of a partnership is the requirement of equal control. Each partner has an equal say in the operation of the business. In most instances, decisions regarding the partnership can be made by majority vote. Decisions that alter the basic structure of the business, such as a change in the terms of the partnership agreement, require unanimous consent.

Termination of Partnerships

The parties who form a partnership also have the power to terminate the partnership. A partnership can be terminated due to the expiration of the duration of the partnership as specified in the partnership agreement, the withdrawal of one of the partners from the partnership, the death of one of the partners, or when one of the partners becomes unable to perform the duties of the partnership.

As with any contract, the parties may specify the duration of the agreement. A partnership automatically expires when the specified time frame passed. Such a clause also prohibits the partners from exiting the partnership prior to the specified date. A partner who wishes to withdraw early can be required to pay the other partners any losses caused by the early withdrawal.

If allowed by the partnership agreement, any partner may withdraw from a partnership at any time. When withdrawal is not prohibited by the agreement, the withdrawing partner is not responsible for resulting losses.

The death of a partner automatically terminates the partnership. The remaining partners may choose to carry on the business operations of the partnership. If this occurs, a new partnership is formed. The financial insolvency of a partner or any supervening illegality has a similar effect — a new partnership can be formed without the affected partner.

A partnership is terminated if a partner is declared mentally incompetent or is otherwise unable to perform partnership responsibilities. These situations usually involve a judicial declaration of incapacity and a finding that the incapacity is permanent. As with other involuntary terminations of a partnership, the remaining partners can form a new partnership.

The termination of a partnership triggers a “winding-up” period. A terminated partnership continues to exist for a reasonable period to allow the partners to conclude the business of the partnership. The only partnership activities permitted during the winding-up period are the collection and distribution of assets.

Limited Partnerships

The partnerships described to this point are known as general partnerships because each partner shares equally in the risks and rewards of the business. Another form of partnership is the limited partnership. A limited partnership requires an additional type of partner — the limited partner — in addition to one or more general partners. A limited partner has no right to participate in any of the management decisions made by the general partners. In return, the liability of a limited partner is restricted to the amount of capital contributed to the partnership. Limited partnerships are popular forms of investment, because the gain or loss from the business is treated as individual income for federal tax purposes.

A limited partnership requires a written agreement. The agreement must define the purpose of the partnership and identify the specific role of each type of partner. A certificate of partnership must be filed with the secretary of state to create a limited partnership.