Tuesday, February 16, 2016

The Contrarian Contractarian: Every Partnership is Formed by Contract

My co-blogger Joan Heminway a short while back wrote a great article, The Ties That Bind: LLC Operating Agreements as Binding Commitments, 68 SMU L. Rev. 811 (2015). (symposium issue)

I often (and perhaps even usually) agree with Joan on issues of law and life, but there’s a spot in Joan’s article with which I disagree.  Joan says:

Although partnership law varies from state to state, as a general matter, partners are not expressly required to contract to form a partnership,88 and a partnership agreement is not defined in a manner that mandates adherence to the common law elements of a contract.89

  1. Under the Revised Uniform Partnership Act, a partnership exists when two or more persons associate as co-owners to carry on a business for profit. REVISED UNIFORM PARTNERSHIP ACT § 101(6), 202(a) (1997).
  2. See, e.g., Sewing v. Bowman, 371 S.W.3d 321, 332 (Tex. App.-- Houston [1st Dist.] 2012, no pet.). The Revised Uniform Partnership Act provides the following definition for a partnership agreement: “the agreement, whether written, oral, or implied, among the partners concerning the partnership, including amendments to the partnership agreement.” REVISED UNIFORM PARTNERSHIP ACT § 101(7).

Joan has case law support, so at least in some jurisdictions, she’s right (as usual), but I think the opinion she relied on got it wrong.  That is, I disagree with the idea that "partners are not expressly required to contract to form a partnership” because I think the partnership definition — see footnote 88 above — satisfies (and must satisfy) the requisites for a contract. Unlike an LLC, partnerships can be formed by mere agreement of the parties, which is an agreement I think must rise to the level of a contract.

Partnership law is such that "the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.”  § 202. Formation of Partnership., Unif. Partnership Act 1997 § 202. There must be an agreement to associate for a purpose. To me, that requires consideration and assent.  If one has associated sufficiently under the law to make one both a partner and an agent of another (and thus liable for the partner), I don’t see how there is a lack of sufficient consideration or assent to form a contract.  

Another Texas case, which the Sewing court decided not to apply, provided:

Clearly, an offer and its acceptance in strict compliance with the offer's terms are essential to the creation of a binding contract. American Nat'l Ins. Co. v. Warnock, 131 Tex. 457, 114 S.W.2d 1161, 1164 (1938); Smith v. Renz, 840 S.W.2d 702, 704 (Tex.App.—Corpus Christi 1992, writ denied). However, even if an offer and acceptance are not recorded on paper, dealings between parties may result in an implied contract where the facts show that the minds of the parties met on the terms of the contract without any legally expressed agreement. Smith, 840 S.W.2d at 704; City of Houston v. First City, 827 S.W.2d 462, 473 (Tex.App.—Houston [1st Dist.] 1992, writ denied). Accordingly, the parties' conduct may convey an objective assent to the terms of an agreement, and whether their conduct evidences their agreement is a question to be resolved by the finder of fact. Estate of Townes v. Townes, 867 S.W.2d 414, 419 (Tex.App.—Houston [14th Dist.] 1993, writ denied). If the finder of fact determines that one party reasonably drew the inference of a promise from the other party's conduct, then that promise will be given effect in law. E–Z Mart Stores, Inc. v. Hale, 883 S.W.2d 695, 699 (Tex.App.—Texarkana 1994, writ denied).

Ishin Speed Sport, Inc. v. Rutherford, 933 S.W.2d 343, 348 (Tex. App. 1996)

I see the formation of a partnership—the agreement to carry on a business as co-owners for profit—to be a higher level agreement than a contract (i.e., contract plus), not less than a contract.  We view partnership as a more significant connection between parties than an agency relationship, which does not require consideration. How would it be possible for me to agree with another person to carry on a business as a co-owner seeking profit, without meeting the minimal requirements contract formation? I simply can’t see it.  Once a court finds there is a partnership, the agreement that satisfied the partnership threshold carried reciprocal obligations that I must have agreed to, even if I did not knowingly agree at the time to all the obligations that then occur by operation of law because I made the agreement.  

A partnership is more than just a contract, and I might even be willing to concede that some of the obligations of a partnership under partnership law are outside or independent of contract law. But to me, if there is a partnership, somewhere, there is an underlying contract.  Thus, the question is not whether there is a contract where there is a partnership.  The question is what is the scope of the contract?

https://lawprofessors.typepad.com/business_law/2016/02/the-contrarian-contractarian-every-partnership-is-formed-by-contract.html

Joshua P. Fershee, Partnership | Permalink

Comments

Josh, Even if the statutory definition of a “partnership” already entails the requirements of mutual assent and the exchange of consideration, are there not other requirements of a true “contract” that are not required of partnership formation?

For one, to be a valid contract, the parties need not only assent and exchange consideration, but they must also express their intentions with reasonable certainty (RSC §33). If the parties truly have a bare agreement to “to carry on as co-owners a business for profit,” without agreement any other details, then as a matter of contract law, that agreement might well be too indefinite to be enforceable. It is true that RUPA fills the gaps in their agreement and makes it enforceable as a matter of partnership law, but that type of partnership agreement would fail as an ordinary “contract.”

Also, a mere agreement plus exchange of consideration is not a “contract” in the sense of a creating an enforceable legal obligation if the parties to the agreement fail to comply with the statute of frauds (in the circumstances where the statute applies). RUPA contemplates that a “partnership agreement” may be completely oral or implied, which again makes an agreement enforceable as a matter of partnership law in circumstances where contract law would not.

Posted by: Mohsen Manesh | Feb 16, 2016 4:09:45 PM

I am not sure I agree with you. Partnerships may be contractual in nature, but they also require fiduciary duties to the partnership. Therefore, the partnership agreement is something quite different from a contract.

Posted by: Bernard S. Sharfman | Feb 16, 2016 4:27:25 PM

Mohsen and Bernie, I think you are both reading in more than I said (or at least intended to say). I did not say that a partnership agreement is a contract, nor did I say that a the contract forming the partnership entails all that the partnership act provides.

I believe that that the partnership agreement is different than the contract forming the partnership. I differentiate the two. What I'm saying (or trying to say) is that some kind of contract occurred when a partnership was formed.

Thus, what I am suggesting is that a decision “to carry on as co-owners a business for profit,” does have some specific and definable decision that creates a contract. It may be that the contract is small, and has long been performed by the time a dispute arises. The contract, in that sense, may come up short and the partnership law gap fillers create more obligations and extend them well beyond the contract.

I appreciate this may be an argument that only an academic could find value in, but I nonetheless maintain that every partnership originates with some kind of contract. That contract (in the “accidental partnership” sense) did not necessarily intend to form a partnership, but some act, however small, must be sufficient to form a contract to originate and trigger a partnership.

Thus, partnership law, in my view, says to (at least) two parties: You agreed to X. We think that tells the world Y. Therefore, whether you intended Y or not, your agreement (contract) X, means you are bound to Y (under partnership law).

Posted by: Joshua Fershee | Feb 16, 2016 4:44:31 PM

Hi Josh,

How about distinguishing between agreement and contract? That is, it sounds right to say that some sort of agreement forms the basis of every partnership, like it does for every contract. However, to say that a contract forms the basis of a partnership confuses (in my mind) what law is enforcing the agreement, contract or partnership law.

Best,

Bernie

Posted by: Bernard S. Sharfman | Feb 17, 2016 6:48:45 AM

Bernie,

That’s a good point. I think it’s right to say there could be confusion as to what document governs. My thinking on this has to do more with formation at the outset, and how we think about that formation, which I should probably have been more clear about in my post.

There is a broader method to my madness, though, too. I think that if we understand the origins of general partnership to be rooted in contract initially, as I believe it is, then we have a stronger basis for embracing the freedom of contract principles in the LLC context. That is, in partnership law, once you form the partnership, you are bound by not just the agreement to form, but also by what follows in partnership law.

LLCs in contrast, particularly Delaware LLCs, are working back toward that initial agreement (contract) between parties to form an entity. (Of course, LLCs have more formal requirements.) Then, if desired, we can embrace that LLCs are truly creatures of contracts, along with the idea that the duty of care and duty of loyalty can be disclaimed. All that remains is the implied duty of good faith and fair dealing – contract concepts.

Posted by: Joshua Fershee | Feb 17, 2016 7:12:45 AM

If the partners form a contract to operate together a business for profit, would a partner breach if she left the business? I guess my question is this: if it's a contract, what's the breach?

Posted by: Evan Nelson | Feb 17, 2016 2:30:23 PM

Evan,

Good question, and thanks. A partner would not breach by leaving unless that was a term of the contract. Partners who choose to operate a business as co-owners for profit don’t necessarily do so for a term. If there is an implied term, there could be a breach for separating, but if not, there would not be because a term was not part of our contract. The contract creating the business in which the two people agree to operate it as co-owners seeking profit might have a very narrow scope. Ad the contract may have been performed almost immediately. You and I might have agreed to operate a hot dog stand. I might choose to end it after that contract was formed before we even sell a hot dog. It doesn’t mean the contract wasn’t valid. Until I dissolved I was accountable to you under my contract, and to you as a partner. My contractual liability to to you could be less than my liability as a partner, but it does not mean a contract was not the origin of our partnership. It simply means that the contract originating our partnership was transformed by operation of law into a partnership with the rights and liabilities that come with that. My theory on this is not for finding a new way to liability under contract in the partnership realm. Rather, it is primarily a way of conceptualizing formation.

Posted by: Joshua Fershee | Feb 18, 2016 4:28:51 AM

As someone who has litigated a case on point, and then successfully defended the jury verdict on appeal (unreported) in Colorado, I can state with confidence that a partnership can be formed in the absence of an agreement sufficient to form a contract. (And furthermore, I can tell you that I believe that this interpretation of the law produced a just result in my case.)

My case involved two people who moved forward to develop real estate for profit without reaching an agreement on essential terms of the relationship such as the percentage of profits that were shared. But, the existence of the agreement to carry on the common venture for profit was demonstrated by payment of expenses and conduct of business on behalf of the partnership notwithstanding a lack of agreement on essential terms.

Posted by: ohwilleke | Feb 19, 2016 4:09:18 PM

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