1. Hypothetical: A wants to start a restaurant business and needs capital.
a. First option is to borrow money from Bank in the form of a business loan. Low market risk. Bank will examine credit, collateral, and nature of the business. May be unwilling to lend to a start-up and will ask A to come back once it has acquired its own capital. Even if Bank is willing to lend, Bank will default on the loan if A misses an interest payment. A risks losing his business over a small payment.
b. Second option is to look for an individual investor, B, probably a relative, friend, or business acquaintance. On the one hand, A could structure this borrowing like a bank loan. Just like Bank, this eliminates B’s market exposure. However, this also prevents B from gaining any potential gain if the venture succeeds.
c. On the other hand, B may want to take on profits. In almost all situations, loss-sharing will accompany profit-sharing. Now, B will be concerned with A’s conduct; will make sure that the business is run properly, taxes paid, regulations met, etc. Also, conscious of own exposure to a suit of the partnership.
2. Issue: Whether there is a partnership?
a. Uniform Partnership Act. Different states have adopted different versions. Latest version, and the one that follows, is 1997.
b. Article 2.
i. 202(a). Except for an association formed under another statute, see (b), an association of two or more persons to carry on as co-owners a business for profit forms a partnership, regardless of what the parties intend.
ii. 202(c)(2). Sharing of gross returns alone does not establish a partnership.
(a) The other elements are loss-sharing (306) and control (401(f)).
(b) Fenwick v. Unemployment Compensation Committee
(i) Issue: Whether Cheshire was a partner or an employee of Fenwick’s business.
(ii) Holding: Although the parties intended Cheshire to be a partner through the Partnership Agreement, Cheshire was an employee. What was ostensibly profit-sharing was only an alternative method compensation.
a. Intention of the Parties. Parties intended to form a partnership, yet this factor is not conclusive.
b. Right to Share in Profits. Parties intended a share in profits, yet this factor is also not conclusive by itself.
c. Obligation to Share in Losses. This is entirely absent because the agreement specified that Cheshire would not share in losses.
d. Control of Partnership Property and Business. Fenwick contributed all of the capital, Cheshire contributed none, and Cheshire had no right to share in capital on dissolution.
e. Community of Power in Administration. Fenwick had exclusive control of operations and business in the Partnership Agreement, leaving Cheshire with none.
f. Language of the Agreement. Besides the labeling as partners, the Partnership Agreement does not provide Cheshire with any ordinary rights of partners.
g. Conduct Towards Third Parties. Parties hold themselves as partners only to the Commission from whom they desire a benefit. No one else.
h. Rights of Parties on Dissolution. On dissolution, Cheshire’s status will be the same as if she quit.
(c) Text implies that Fenwick’s counsel could have gotten around all of these issues with careful and precise drafting.
(d) See also Martin; Southex.
iii. 202(c)(3)(i). A person who receives profits is presumed to be a partner unless the profits were received by payment of debt.
(a) Hypothetical: A and B want more capital and approach Bank for a loan. In addition to earning intere
(v) Note that the issue of personal liability could have been avoided through the use of a corporation or a limited liability corporation.
(vi) Here, enough control was given for Peyton to protect his investment and own self-interest, but not enough to be a partner.
(e) With regard to the chef, Banks are hesitant to do this for bankruptcy reasons. If Bank is given too much control, it may be considered a principal at liquidation and perhaps even liable in a lawsuit. This makes sense: why shouldn’t Bank be required to absorb loss if it, in fact, contributed to this loss? As a result, for this reason banks are generally hesitant to get involved.
iv. 202(c)(3)(ii). Profits cannot come in the form of wages to an independent contractor or other employee.
(a) Hypothetical: Say that chef is offered a cut of profits. It seems that the intent would be to pay profits as wage. See Fenwick for relevant factors. Would chef be a partner or an employee? Seems that control is the most important aspect here; even in this example, chef is responsible for losses to a certain extent.
(b) In general, best idea is to contract for each side’s discrete wants. For instance, if you want chef to get profit, spell out clearly that you don’t want chef to share in losses or have any control. Note lack of clarity in Fenwick and Martin. In the example of the chef or others similarly situated, may actually be a good business decision to make him a partner.