Beware the Unintended Partnership

Photo of two teddy bears, symbolizing an unintended partnershipThis post uses a real-life example to explain how an unintended partnership is created and why it can be a problem.

Client was one of two founders of a website. She provided content; Co-founder developed, maintained and promoted the site.

Client and Co-founder had been working together for three months when Co-founder presented a business agreement that had been prepared by his paralegal friend. Client asked that I review the agreement on her behalf.

I saw right away a problem that frequently arises in this situation: The parties were characterized as participating in a joint venture under which they would split earnings from the site. The problem arises because under California Corporations Code Section 16202(c)(3), subject to certain exceptions (see discussion below), “[a] person who receives a share of the profits of a business is presumed to be a partner in the business”. This is true even if the parties did not intend to form a partnership (Section 16202[a]), in which case they have created an unintended partnership.

Why is a general partnership – especially unintended partnership – undesirable? Because, subject to certain exceptions, under Section 16301(1) “[e]ach partner is an agent of the partnership for the purpose of its business” Furthermore, under Section 16306(a) “all partners are liable jointly and severally for all obligations of the partnership”. Putting these two sections together, any partner can subject each of the partners to unlimited liability for partnership obligations!

Fortunately, there was a straightforward way to work around this problem, though it required that I prepare a completely new agreement. One of the exceptions to Section 16202(c)(3) is that an independent contractor who receives a share of the profits in payment for services is not presumed to be a partner.

So I adapted an Independent Contractor Agreement that I had prepared for another client, e-mailed it to Client for review, and made some small changes requested by Client the same evening. The parties signed the agreement the next day, and both now are pleased that they have the right agreement – and the right business relationship – in place.

Advice to individuals who are starting a new business together:

  • Educate yourselves about the types of business relationships and entities that are available.
  • Enter into an agreement that reflects the proper choices for your situation.
  • If you need help, use the services of a knowledgeable lawyer rather than a paralegal friend.

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Follow-up: If you already have created an unintended partnership and want to escape from it, see I Fell into the “Unintended Partnership” Trap – How do I Get Out?

Photo Credit: Steve Ford via stock.xchng

Dana H. Shultz, Attorney at Law? +1 510 547-0545? dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

4 comments

  1. [...] earnings from their venture can find that they have unintentionally created a general partnership (Beware the Unintended Partnership). The problem: Any partner can subject all of the partners to unlimited personal liability for [...]

  2. [...] Interestingly, I adapted this agreement, a year later, for use by another client to help get a website business off the ground – please see Beware the Unintended Partnership. [...]

  3. Quora says:

    Is a single-owner LLC “acting” as a multi-owner LLC taxed as a single-owner or multi-owner entity?…

    I will answer from the perspective of California law (not that I’m qualified to provide tax advice, but the legal analysis points to an answer to your question): Once the LLC and the individual decided to share profits, they created a general partners…