Tuesday, October 30, 2018
Many farming and ranching operations are structured in the partnership form, and many of them operate simply on an oral basis. The lack of a written partnership agreement can cause numerous problems. One of those problems can be uncertainty that results when a partner dies. What happens to the deceased partner’s partnership interest? Is it allocated among the surviving partner(s)? Does it pass to the deceased partner’s spouse or other heirs? Does something else happen to it?
The passage of a deceased partner’s partnership interest into the “wrong” hands can create various problems – not the least of which is possible discontinuation of the partnership business and farm business assets, including land, falling into hands of persons that have no interest in continuing the farming or ranching business. Even if a written partnership agreement exists, lack of clear language can also create uncertainty as to what happens when a partner dies.
Partnerships and the death of a partner – That’s the focus of today’s post.
What Is A Partnership?
First things first – when does a partnership exist? A partnership is an association of two or more persons to carry on as co-owners a business for profit. Uniform Partnership Act, § 6. As an estate planning device, the partnership is generally conceded to be less complex and less costly to organize and maintain than a corporation. A general partnership is comprised of two or more partners. There is no such thing as a one-person partnership, but there is no maximum number of partners that can be members of any particular general partnership.
If there is a written partnership agreement, that usually settles the question of whether the arrangement is a partnership. A partnership agreement (or articles of partnership) is a contract among the parties in which they agree to certain arrangements about income, rights to decision making, and accounting procedures. These are the practical kinds of problems that are addressed in a partnership agreement.
If there is no written partnership agreement, questions may arise as to whether a landlord/tenant lease arrangement constitutes a partnership. Because a partnership is an agreement between two or more individuals to carry on as co-owners a business for profit, a partnership generally exists when there is a sharing of net income and losses. There are numerous factors for determining partnership existence, but one of those involves the sharing of net income – an issue that can arise in oral lease arrangements.
Is a lease a partnership? A crop-share lease shares gross income, but not net income because the tenant still has some unique deductions that are handled differently than the landlord's. For example, the landlord typically bears all of the expense for building maintenance and repair, but the tenant bears all the expense for machinery and labor. Thus, there is not a sharing of net income and the typical crop-share lease is, therefore, not a partnership. Likewise, a livestock share lease is usually not a partnership because both the landlord and the tenant will have unique expenses. But, if a livestock share lease or a crop-share lease exists for some time and the landlord and tenant start pulling out an increased amount of expenses and deducting them before dividing the remaining income, then the arrangement will move ever closer to partnership status. When the arrangement arrives at the point where there is a sharing of net income, a partnership exists.
For written farm leases where partnership treatment is not desired, it is often suggested to have written into crop-share and livestock-share leases a provision specifying that the arrangement is not to be construed as a partnership. In addition, it’s advisable for the landlord and tenant to not hold themselves out publicly as being in a partnership.
Death of a Partner
As mentioned, if a partnership arrangement exists, the death of a partner can create issues. For example, in In re Estate of Humphreys, No. E2009-00114-COA-R3-CV, 2009 Tenn. App. LEXIS 716 (Tenn. Ct. App. Oct. 28, 2009), a farmer died intestate and an implied partnership was deemed to exist with the decedent’s surviving spouse which entitled the surviving spouse to one-half of the assets of the farm business with the balance distributed to the decedent’s estate. While the couple filed Schedule F only in the decedent’s name, the Schedule F included the incomes of both the decedent and the surviving spouse.
Similarly, in a case from Montana in 1985, In re Estate of Palmer, 218 Mont. 285, 708 P.2d 242 (1985), the court determined that a partnership existed even though title to the real estate and the farm bank account were in joint tenancy. As such, the surviving spouse of the deceased “partner” was entitled to one-half of the farm assets instead of the land and bank account passing to the surviving joint tenant.
A recent North Dakota case involving the death of a partner illustrates what can happen in the written partnership agreement doesn’t clearly address the matter of a partner’s death. In, Estate of Moore v. Moore, 2018 N.D. 221 (2018), two brothers were co-equal partners in a farming partnership. Under the written partnership agreement, upon the death of a partner, the partnership continued, but the estate of a deceased partner could not make business decisions without the surviving partner’s approval. Also, the written partnership agreement stated that, “Land owned as tenants in common by [the partners] is contributed to the partnership without charge.
The partnership was responsible for all of the costs and management associated with the land and treated the land as if it were owned by the partnership. This contribution could not be retracted except on dissolution of the partnership or agreement by both partners. The partnership agreement also specified that, “Any land owned [by] other persons operated by the partnership is leased by the partnership and not by individual partners.”
One of the partners died in 2012, and his will devised part of his land to his brother and the rest to his step children and nephew. The land that was devised to the step-children and nephew was burdened with a condition stating that the property should, "be sold in a commercially reasonable manner so as to derive the most value therefrom within six (6) months of my death." In 2012 this land was conveyed to the children and they also requested partition and sale of the land held as co-tenants. The defendant challenged the conveyance stating the estate should have sold the property rather than conveying it.
In 2014 the trial court agreed and vacated the conveyance and returned the property to the deceased partner’s estate. The surviving partner continued to farm, and the deceased partner’s estate sued for rent due on the partnership property. The trial court denied the estate rent, stating that partnership was not liable for rent six months after the decedent’s death. It also determined that the agreement continued the partnership for six months so that the surviving partners could decide what to do. The trial court also held that the partnership lacked standing during the litigation between 2012 and 2014 over the conveyance because the estate did not own the property. Finally, the trial court held that the estate did not show that they were due relief as they could not show that the defendant was unjustly enriched.
On appeal, the appellate court affirmed in part, reversed in part, and remanded the case. The appellate court, based on the partnership agreement, determined that the partnership was not dissolved upon death, but that the estate became a partner that was owed profits and losses. The appellate court determined that the district court erred when interpreting the statement in the partnership agreement that, "the partners intend… that there be an extended time to deal with a partner leaving or the death of a partner before the necessary wind up of the partnership or its continuation by the remaining partners." The appellate court held that this did not invoke a dissolution and winding up period after one of their deaths. Because the appellate court held that the partnership was not dissolved, and the land was held as co-tenants, there was no rent due. The partnership was still valid, and the land was being used within the guidelines of the agreement. As a result, the use of the land was correct, the surviving partner was not unjustly enriched, bur was merely continuing the business as a partner.
The ultimate holding of the appellate court affirmed that the estate was not due any rent between the decedent’s death and sale of the property. However, the estate may be still owed profits from the partnership. Since the estate became a partner, with limited abilities, the court remanded the case for an accounting of profits or losses after the decedent’s death.
A partnership is often a preferred form of business organization for a farm or ranch business. It’s best to formalize the arrangement with a carefully crafted written agreement. Death of a partner is one of those issues that a written agreement should address. If it doesn’t, or the arrangement is an oral one, unexpected consequences can result.