The Perils of Partnership
The importance of written agreements with business “partners”
“Partnership” and “joint venture” are terms often thrown around casually in business relationships, but they have very serious legal ramifications business executives frequently overlook. Under Florida Statue § 620.8202, all it takes to form a general partnership is an “association of two or more persons to carry on as co-owners a business for profit.” The parties do not even have to intend to form a partnership and can form one merely through their actions and representations to each other or third parties. The same goes for a joint venture, which is simply a type of partnership formed for a specific purpose.
The consequences of an unintended partnership can be harsh, which is why it is always best to formalize a business relationship in some form of an agreement early on, before making any commitments to each other or third parties.
When in doubt, a business attorney can advise you on the best structure to accomplish your business goals.
Partners in a general partnership are jointly and severally liable for all obligations of the partnership, and each partner is an agent of the partnership for the purpose of its business. Id. at §§ 620.8306; 620.8301. Moreover, each partner has equal rights in the management and conduct of the partnership business. Id. at § 620.8401. This means each partner can bind the partnership and create unlimited liability for the other partners in the business, even if the other partners never knew about or approved the obligations creating the liability. Even in circumstances where the parties do intend to form a formal business partnership, the general partnership is almost never an advantageous choice of legal entity specifically because of the personal liability of partners.
In the absence of an agreement otherwise, profits are split equally by the partners. In situations where one partner contributes substantially more capital, assets or sweat equity to the business than the other partners, the equal profit allocation can come as a costly surprise. A written agreement should address how profits are to be distributed.
Each partner owes the partnership fiduciary duties of loyalty and care, similar to directors in a corporation. These duties act effectively as unwritten non-competition covenants. The partners cannot compete with the business and must offer all opportunities presented to them in the partnership’s line of business to the partnership first. The partners also owe a duty of good faith and fair dealing to the other partners. Other types of business relationships generally require a written non-competition agreement with strict time and geographical limits in order to be enforceable — not so with a partnership.
Under federal tax law, although a partnership itself does not have to pay tax, it is still required to file an annual tax return and issue a schedule K-1 to each partner reporting the partner’s share of profits. Failure to do so carries hefty penalties. Even if the partnership manages to file a return, each partner must report its share of gain or loss on its personal tax return and pay tax on the profit, even if no money was actually distributed, which can be another costly surprise come tax time.
If one of the partners is a foreign partner, the partnership is required to withhold tax at the highest rate applicable to the particular type of income, and the foreign partner must file a U.S. tax return. Again, failure to withhold can carry hefty penalties, which all of the partners are liable for, jointly and severally.
Alternatives to Partnership
For the reasons above, a general partnership formed by default under Florida’s partnership statute is generally the least desirable form of business vehicle, and careful planning is needed to avoid that default vehicle. Fortunately, there are many alternatives to address these issues, most at a relatively low cost when compared with the risk of the unintended partnership.
A common solution when the parties desire a less formal business relationship and want to avoid creating a separate legal entity is to form the relationship as an independent contractor arrangement, as Florida law provides that an independent contractor or employee who receives a share of profits is not presumed to be a partner. An independent contractor agreement can (and should) address all of the above issues.
If the parties do intend to work together in a formal business partnership, the business could be formed as a limited partnership, a limited liability company or corporation to address the joint and several liability issues described above.
When in doubt, a business attorney can advise you on the best structure to accomplish your business goals. ◆
Alexandrea “Alex” R. Simser graduated magna cum laude with a Bachelor of Arts in History and Political Science from Florida State University and received her Juris Doctorate (J.D.) with a Certificate of Concentration in Advocacy from Stetson University College of Law. She also holds a Master of Business Administration from Stetson University.