Wednesday, September 20, 2017

Professor Leahy on "Loftium Unwittingly Forms General Partnerships with Homebuyers"

Friend of the blog and South Texas College of Law (Houston) Professor Joe Leahy sent over the following post he authored. It is cross-posted at UberLaw.Net and Medium. Embarrassingly, I had not heard about Loftium before reading this post, though at least I know of and have used Airbnb. Joe has some interesting thoughts, and I am happy to include his post on this blog. 

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Yesterday, the New York Times trumpeted a new internet company, Loftium, and its interesting, new-economy business model (which, for the time being, operates only in Seattle):

Loftium will provide prospective homebuyers with up to $50,000 for a down payment, as long as they are willing to continuously list an extra bedroom on Airbnb for one to three years and share most of the income with Loftium over that time.

At first glance, the arrangement between Loftium and participating homebuyers might sound like a loan.  (Indeed, the Times even describes it as such in an infographic.)  But upon a closer look, the arrangement that Loftium contemplates with homebuyers clearly is not a loan.  First of all, Loftium says it is not a loan; rather, according to Loftium, the down payment assistance it provides to homebuyers is “a part of a services agreement” lasting 12-36 months.  Second, and more important, the arrangement between Loftium and homebuyers has none of the characteristics of a traditional (term) loan.  There is no “principal” amount that the homebuyer is required to repay in a set period of time, and Loftium does not charge the homeowner any “interest.”  In fact, the homebuyer is not required to make anypayments to Loftium in return for the company’s cash (unless the homeowner breaches the parties’ agreement and stops renting on Airbnb before the term expires).

All the homebuyer must do in exchange for Loftium’s money is (1) list her spare room on Airbnb continuously through the term of her agreement with Loftium, (2) be a decent host (i.e., “not be[] rude to guests”) and (3) split her Airbnb  rental revenue with Loftium (with two-thirds going to the company.)  If, at the end of the term, Loftium has not been repaid its initial investment, the homeowner is not required to repay Loftium’s initial contribution. Hence, if renting out the homeowner’s spare room is not profitable during the term of the parties’ agreement, “Loftium takes full responsibility for that loss.”

Of course, Loftium expects that the total income from renting out a homeowner’s spare room will greatly exceed the amount that it originally provided to the homebuyer, so that both will profit.  If Loftium makes more in rental income than it pays towards the homeowner’s down payment, Loftium will make a profit.

Further, by all appearances, there is no cap on Loftium’s potential profit is its business arrangement with homebuyers.  In fact, Loftium makes clear that it wants to maximize the income that it splits with homebuyers:  Loftium promises that it will work with them “to increase monthly bookings as much as possible, so both sides can benefit from the additional income.”  To that end, Loftium provides homebuyers with some start-up supplies for their spare bedroom (and a keyless entry lock), access to advice and know-how regarding how to rent an Airbnb room, and online tools to help maximize their rental income.

So, if the business arrangement between Loftium and homeowners is not a loan, what is it?  It is almost certainly a general partnership for a term (i.e., a “joint venture”).

[Post continues after the page break]

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What is a Partnership?

Both the original Uniform Partnership Act (UPA) (adopted uniformly by almost every state, but now in effect in only around 13 states) and its successor, the revised Uniform Partnership Act (RUPA) (variations of which have been adopted by perhaps 37 states) define a partnership as an “association of two or more persons to carry on as co-owners a business for profit.”  UPA § 6(a); RUPA § 202.

Hence, creation of a partnership has four elements: (1) an association of two or more (2) persons; (3) who carry on as co-owners; a (4) for-profit business.

The Easy Elements

There can be no doubt that Loftium and the homebuyer are legal persons under the statute.  See UPA § 2 (defining “person” to include corporations like Loftium).  Further, it is clear that leasing an Airbnb apartment year-round is a for-profit business. (Indeed, Loftium advises homebuyers that they must obtain a business license from the city of Seattle.)

As a result, the only elements in question are (1) whether the parties have voluntarily “associated” and (2) whether they are “co-owners” of the for-profit business of renting out the homeowner’s spare room on Airbnb.

The Element of “Co-Ownership”

It might seem, since the homebuyer owns the spare room and Loftium does not, that the two are not “co-owners.”  However, the relevant question is not whether the two are co-owners of the property used to operate the business, but rather, whether the two are co-owners ofthe Airbnb business.  It is quite common for a partnership to operate a business using the real property of only one partner.  See, e.g.,Lupien v. Malsbenden, 477 A.2d 746 (Me. 1984); Peed v. Peed, 325 S.E.2d 275 (N.C. Ct. App. 1985). Indeed, absent express contrary intention, RUPA presumes that personal property of a partner which she allows the partnership to use for the business remains her own property, and is not contributed to the partnership.  See RUPA § 204(d).

UPA and RUPA also provide some guidance for courts in assessing whether persons who operate a business are “owners” of that business.  First, both statutes effectively presume that anyone who shares the profits of a business is an owner of—and thus, a partner in—the business.  See UPA § 7(4) & RUPA § 202(c).  However, that presumption has an important caveat: Receiving a share of the profits of a business is not presumed to make one a partner in that business if “the profits were received in payment … of a debt by installments or otherwise … or of interest … on a loan, even if the amount of payment varies with the profits of the business.” RUPA § 202(c)(1)(i) & (v); accord UPA § 7(4)(a) & (d).  Hence, if Loftium shared the profits of each homeowner’s Airbnb rental business as repayment of a loan to the homeowner, the law would not presume that Loftium was a co-owner of (and partner in) the homeowner’s business.

Yet here, not only has Loftium explicitly denied that it is lending money to homebuyers, its arrangement with homebuyers looks nothing like a traditional loan.  Accordingly, if Loftium were to argue that it was not a homebuyer’s partner because it simply loaned the homebuyer money for the homebuyer’s business, a court would probably reject that argument.  See, e.g., Lupien, supra (holding that an alleged “banker” who took over the business of his “borrower,” and whose “loan” to the business “carried no interest and no fixed payments, but was to be repaid only” out of revenues from the business, was in fact a partner).

Admittedly, Loftium and a homeowner do not exactly split “profits” of their Airbnb rental business; rather, they each contribute different things to the partnership and then split the revenues.  The homeowner contributes some labor, plus the use of her spare room, furnishings and bathroom; Loftium puts in cash, some supplies, its know-how about renting on Airbnb, and other online resources.  Yet, it is not uncommon for one partner to contribute property (or the use thereof) to the partnership while another partner contributes something else to the partnership—and both partners split the partnership’s revenues.  For example, it is common for one partner (the “money partner”) to provide capital (and sometimes, agree to accept all capital losses) and the other partner (the “service partner”) to provide labor and/or expertise.  Accordingly, Loftium and each homebuyer are undoubtedly sharing “profits” of the partnership, not the “gross” (which does not lead to a presumption of partnership, see UPA §7(3)).  Although they do not share the profits (or the losses) from the business equally, that is not required of partners (although it is the default rule in the absence of a contrary agreement).  See RUPA § 401 cmt. 3.

In addition, if one stops to consider why the statutes deem sharing profits as a critical gauge of co-ownership, one realizes that sharing profits—i.e., revenues net expenses—means sharing fully in the risks and rewards of the business.  Unlike a lender, who is paid “off the top,” an equity owner who is paid from the “net” shares the risk that the business’s expenses will exceed its revenues.  However, also unlike a lender, an equity owner shares in any profit that occurs if revenues exceed expenses.

Hence, in assessing whether one co-owns a business and therefore is a partner in it, courts often consider whether she shares fully or only superficially in the risks of the business. See In re KeyTronics, 274 Neb. 936 (2008) (describing co-ownership as whether the parties “share the benefits, risks…of the enterprise” such that they “subjectively view themselves as members of the business rather than as outsiders contracting with it”).  Here, there can be no doubt that Loftium is a co-owner of each homeowner’s Airbnb rental business because—as Loftium freely admits—it takes on all of the risks. If, upon expiration of the term, the Airbnb rental has made no money, the owner owes nothing to Loftium and gets her spare room back; Loftium, by contrast, loses its entire investment.  Further, Loftium’s marketing materials make clear that the company  intends to maximize the Airbnb revenues that it shares with the homeowner  This stands in stark contrast to a lender who only cares whether the business makes enough money to repay its principal with interest (which come “off the top”).

Finally, in assessing whether one is co-owner a business—and as such, is a partner in that business—courts also consider whether the person in question has a right to manage the business.  Cf. UPA § 6 cmt. (“To state that partners are co-owners of a business is to state that they each have the power of ultimate control.”). Loftium satisfies this requirement in spades.  While the owner furnishes and takes care of the premises (and can, if she decides, clean it herself), Loftium plays a critical role in managing the business by setting (and constantly adjusting, to suit market conditions) the price for the homeowner’s spare room on Airbnb.  Further, as described above, Loftium provides some supplies (like the keyless entry lock) and advice for hosting on Airbnb; Loftium also requires homeowners to provide its guests with certain amenities.  Moreover, while the homeowner sets rules for the apartment on Airbnb, Loftium can veto the rules if it considers them “overly restrictive.”

Yet, even if Loftium had no role in managing the Airbnb business, that would not prevent it from being a partner.   The history of “silent” partners in a real estate ventures who merely provide funds (and share profits), but allow another partner to manage the business is a venerable one.  See, e.g., Meinhard v. Salmon, 249 N.Y. 458 (1928) (Cardozo, J.) (perhaps the most famous case in partnership law) (silent partner in New York’s Hotel Bristol provided cash; managing partner operated the business and functioned as its sole public “face”). Donald Trump himself has been involved in similar partnerships (albeit a limited partnership): Back when he actually built buildings, but after he nearly went bankrupt, he sold 70% of his interest in Riverside South to partners from Hong Kong; while The Donald built, operated and was the public face of these buildings, his partners put in the real money.  (Ironically, while he oversaw development, he left himself with no control over key important aspects of the business, including its sale. But I digress.) 

In sum, since Loftium and the homebuyers to whom it provides down payment cash are co-owners of a for-profit business, they undoubtedly are partners.

The Element of “Association”

Yet, what of the final element, “association”?  It means that the parties must partner voluntarily.  See Gangl v. Gangl, 281 N.W.2d 574 (N.D., 1979) (explaining that “association” element “connotes…voluntariness.”).

At first glance, this element seems easily satisfied, because on its website, Loftium repeatedly describes itself as “partnering” with homebuyers to rent out their spare room on Airbnb.  This is a red herring, though. Business people often use the term “partner” colloquially, so labeling oneself a partner in a business does not automatically make one a partner in that business.  See, e.g., Gangl, supra.  Or, as one Texas court famously put it when holding that two people were not partners simply because they described themselves as such: “a duck which is called a horse does not become a horse; a duck is a duck.” City of Corpus Christi v. Bayfront Assocs., Ltd., 814 S.W.2d 98  (Tex. App.—Corpus Christi 1991).

Digging deeper, one discovers that, contrary to Loftium’s careless use of the word “partner” on its website, the company actually has attempted to protect itself from being deemed a partner with homebuyers by contract.  According to the “terms of service” that governs the arrangement between Loftium and homebuyers:

No agency, partnership, joint venture, or employment relationship is created…, and neither party has any authority of any kind to bind the other in any respect.

In short, Loftium and homebuyers will agree by contract that their arrangement is not a partnership.  Although judges often write that the parties’ “intent” is critical to the formation of a partnership, this language is misleading because it does not specify the precise subject of the parties’ intent.  That is to say, this language fails to state exactly what the parties must intend in order to be partners.

Disclaimers of Partnership

According to the settled law, the relevant question is whether the parties intended to be coowners of a for-profit business, not whether they intended to form a relationship known as a “partnership.” See Byker v. Mannes, 641 N.W.2d 210 (Mich. 2002) (explaining that, if the parties “associated to ‘carry on’ as co-owners a business for profit, they will be deemed to have formed a partnership relationship regardless of their subjective intent to form such a legal relationship”; and that “the statute does not require partners to be aware of their status as ‘partners’ in order to have a legal partnership …. [In ascertaining the existence of a partnership, the proper focus is on whether the parties intended to…’carry on as co-owners a business for profit’ and not on whether the parties subjectively intended to form a partnership.”); Heck & Paetow Claim Service, Inc. v. Heck, 93 Wis.2d 349 (1980)(“The ultimate and controlling test as to the existence of a partnership is the parties’ intention of carrying on a definite businessas coowners.”); Bass v. Bass, 814 S.W.2d 38, 41 (Tenn. 1991) (“It is the intent to do the things which constitute a partnership that determines whether individuals are partners, regardless if it is their purpose to create or avoid the relationship.“)  

In short, not only is it possible for two people to form a partnership without any intent to do so, it is possible for two people to form a partnership despite that they intend not to do so.  See RUPA § 202, cmt. 1 (“[A] partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be “partners.” Indeed, they may inadvertently create a partnership despite their expressed subjective intention not to do so.”).

For this reason, courts have long held—particularly in cases involving claims by third parties against one or more partners (but, as I intend to argue in a subsequent article, also in claims between partners)—disclaimers of partnership are not dispositive if contrary to the facts.  As the New York Court of Appeals explained, in a celebrated case:

Mere words will not blind us to realities. Statements that no partnership is intended are not conclusive. If as a whole a contract contemplates as association of two or more persons to carry on as co-owners a business for profit, a partnership there is.

Martin v. Peyton, 246 N.Y. 213, 217-18 (1927) (Andrews, J.)

Although some cases hold (wrongly, I believe) that parties may define their own relationship by contract, there is little doubt that Martin (which involved a claim made by a creditor against alleged partners) is the rule in lawsuits by third parties.

In sum, even if a court were to decide, in a lawsuit by the homeowner, that the disclaimer of partnership in Loftium’s terms of service precludes formation of a partnership between Loftium and the homeowner, a court would nonetheless be likely to deem the disclaimer ineffective in a lawsuit by a third party. So, for example, if an Airbnb renter who slips and falls in a homebuyer’s spare room (and whose claim exceeds Airbnb’s $1 million liability insurance policy for its subscribers) could probably obtain damages from Loftium.  SeeUPA § 13(a) & 15(a) (partners are liable for the negligence of another).

A Simple Solution

Although this possibility of liability to third parties (and, if my interpretation of partnership law is correct, to homebuyers) may come as a shock to Loftium, the problem actually has an easy solution.  With respect to third parties, Loftium could substantially limit its potential liability by forming a limited liability company (LLC) with each homebuyer.  A member of (i.e., one with an ownership interest in) an LLC is not liable to third parties for debts of the LLC.  See, e.g., Tex. Bus. Orgs. Code § 101.114.  While this would not allow Loftium to escape liability for its own misconduct (or, if its disclaimers of partnership are ineffective as to homeowners, for lawsuits by homeowners), it would substantially reduce Loftium’s risk of being held liable to a third party for a homeowner’s torts or contractual debts.

http://lawprofessors.typepad.com/business_law/2017/09/professor-leahy-on-loftium-unwittingly-forms-general-partnerships-with-homebuyers.html

Business Associations, Contracts, Current Affairs, Haskell Murray, Partnership, Real Property, Technology | Permalink

Comments

What an interesting example of issue spotting. Loftium, Inc. is apparently a privately held company but I wonder if it has raised equity capital in a private placement. If so, the risk factor of being a general partner in a business not free of risk should have been discussed in the offering materials. I wonder . . . .

Posted by: Craig Sparks | Sep 20, 2017 10:15:19 AM

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