McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 21 Partnerships

21-2 Chapter 21 Case Hypothetical The accounting firm of Cooper, Anderson and Young had fallen on “hard times” in recent months. Several clients had left the firm, and in a slow economy, it was difficult to generate new clients. Cooper, Anderson and Young was a general partnership with three (3) partners (Andrew Cooper, Thomas Anderson, and Marvin Young), and six (6) employees (four associate accountants, an office manager, and a secretary/receptionist). Meeting payroll was especially challenging for the partnership this month. In order to compensate the firm’s employees, Marvin Young went to The Bank of the Americas and obtained a $23,000 business loan, signing his name to the loan agreement as well as the name of the partnership. Marvin used the proceeds of the loan to compensate the employees their full monthly salaries. Upon discovering what Marvin had done, Andrew and Thomas were furious. Both felt that since the firm had experienced a financial downturn, the employees should have to take a substantial reduction in their salaries for the month, or forego their salaries for the month altogether (Andrew, Thomas, and Marvin had not received any profit distribution for the current month; their partnership agreement did not provide for partner salaries, and even if it had, there were no other monies to distribute). Further, Andrew and Thomas were concerned about partnership liability for the $23,000 loan, as well as their own personal liabilities for the loan. Is the general partnership Cooper, Anderson and Young responsible for the $23,000 loan? Are Andrew Cooper and Thomas Anderson personally liable for the loan?

21-3 Chapter 21 Case Hypothetical The year 2002 was a nightmare for James Littleton. In January 2002, Littleton was diagnosed with “Type 2” (adult onset) diabetes; in June, Littleton’s physician expressed concern with the lack of circulation in his left leg, and in October, a circulatory specialist recommended that the left leg be amputated to the knee; reluctantly but resigned to his fate, James agreed. On November 1, Littleton was admitted to Pinecrest General Hospital for surgery. In what can only be described as a horrible and catastrophic mistake, the surgeon misreads the diagnosis and surgical instructions, and amputates Littleton’s right leg by mistake. Littleton’s left leg is amputated the next day. Confined to a wheelchair, but supported by the love, care and concern of his family, Littleton is taken to a local Pinecrest law firm, Stephenson, Gordon, and Ratcliff, a general partnership. Stephenson and Gordon agree to represent Littleton in the medical malpractice lawsuit, and sign a contract of representation with Littleton, agreeing to represent him for the standard one-third contingency fee, plus associated expenses. The statute of limitations for medical malpractice actions in the state is three years. Due to oversight and neglect (rumor has it that both Stephenson and Gordon have substance abuse problems,) the firm fails to file a complaint against the attending surgeon and Pinecrest General Hospital within the three-year period. Even though he lacks legal training, Littleton knows he will be forever barred from bringing a lawsuit against the doctor and the hospital. Having experienced catastrophic neglect from two professions he once respected, Littleton focuses his remaining “life energy” on bringing Stephenson, Gordon, and Ratcliff to justice. He sues the general partnership, as well as individual attorneys Stephenson, Gordon, and Ratcliff for legal malpractice. Ratcliff’s attorney moves for dismissal of the claim against his client individually, arguing that Ratcliff was not an “attorney of record” for Littleton, and as a result, should be dismissed personally from the lawsuit. Will Ratcliff succeed in his motion for dismissal?

21-4 Chapter 21 Case Hypothetical Morrison, Manzarek and Huxley is a general partnership law firm located in Los Angeles, California. The partnership was formed in 1967, the year Robbie Morrison, John Manzarek and Raymond Huxley graduated from the University of California at Los Angeles (UCLA) School of Law. Robbie Morrison’s desk had sat empty for the past two (2) weeks. John and Raymond had no idea where he was. The day before he left, Robbie had told his fellow partners he was tired of the practice of law, and wanted to do something else with his life. Concerned about their partner, especially since he had never “disappeared” like this before, John and Raymond drove to Robbie’s house on Love Street, where he lived with his common-law wife, Pamela Kennealy. Pamela answered the door. When asked of Robbie’s whereabouts, Pamela responded that she did not know where he was. She did say that he had said something about going to the desert, and had left in his 1967 Shelby GT500 Mustang. He had not returned home in the past two (2) weeks, nor had she seen him since he left. John and Raymond consider Robbie’s disappearance strange, and given the fact that he had, by Pamela’s account, chosen to leave, they considered his absence inexcusable. They are considering partnership dissolution. Do John Manzarek and Raymond Huxley have the legal right to dissolve the Morrison, Manzarek and Huxley general partnership?

21-5 Chapter 21 Case Hypothetical and Ethical Dilemma Harris, Pendleton, and McRae, certified public accountants, have operated their general partnership accounting firm since the “disco ball and polyester” years of the 1970s. Harris is 68 years old, Pendleton is 66, and McRae is 65. They have operated their partnership by way of an “old-school” approach, a “handshake” agreement, since their professional association was first formed (in spite of strong advice from legal counsel to the contrary.) Harris has been acting rather strange in recent months. Clients and support staff have been asking questions. Six weeks ago, Harris was discovered standing on top of his desk singing the 1970s Rick Dees tune, “Disco Duck,” interspersing quacking sounds throughout his rendition of the disco classic. Harris no longer wears conservative business attire; instead, he has opted for a light blue leisure suit with white patent leather shoes. Currently, he can be found again standing on his desk, this time offering up his version of the 1979 Sister Sledge anthem, “We Are Family.” Pendleton and McRae are in the conference room, considering their options and the future of their accounting business. They would like to terminate Harris’ partnership, but they are unsure whether they have the legal right to do so. They are also struggling with the notion of an ethical obligation to “try to work things out” with Harris; after all, he has been their partner for over thirty years. Finally, they wonder whether they could end their professional relationship with Harris, without being required to dissolve the existing partnership and “wind up” the financial affairs of the business. Advise Pendleton and McRae of their legal rights, as well as their ethical responsibilities.

21-6 Partnership Uniform Partnership Act Definition: “Association of two or more persons to carry on as co-owners a business for profit”

21-7 Characteristics of Partnership Voluntary and consensual relationship Between two or more individuals, partnerships, corporations, or other forms of business organization Engaged in numerous business transactions over period of time Partners share profits and management of business

21-8 Situations Where No Partnership: Employer shares profits with employee as payment for work Landlord accepts share of profits for payment of rent Party receives share of profits for payment of debt Party receives share of profits for payment of annuity to widow/representative of deceased partner Party receives share of profits for payment from sale of goodwill of business/other property Party receives share of profits for payment of interest on a loan

21-9 Formation of Partnership Partnership agreement (“articles of partnership”) should include: Name of each partner Name of partnership Duration of partnership How profits/losses divided Division of management responsibilities Contributions from each partner

21-10 Partnership Duties Duty of Loyalty Duty of Obedience Duty of Care

21-11 Partnership Rights Right to Share in Management Right to Share in Profits Right to Compensation Rights to Partnership Property Right to Inspect Books Right to an Accounting

21-12 Circumstances “Triggering” Partner’s Right to an Accounting Whenever partnership agreement provides for an accounting Whenever co-partners wrongfully exclude partner from partnership/from access to partnership books Whenever partner fails to disclose profit/benefit from partnership (breach of “fiduciary duty”) Whenever circumstances render accounting “just and reasonable”

21-13 Interactions Between Partners and Third Parties If partnership has liability, each partner has unlimited personal liability (“joint and several” liability) -“Joint and several” liability: Third party can choose to sue partners separately, or all partners jointly in one action; partners are collectively, as well as individually, liable for partnership debts All partners jointly and severally liable for commission of tort by any partner Implied liability of partners when purchases made to perpetuate partnership’s business

21-14 The Revised Uniform Partnership Act (RUPA) Revised version of Uniform Partnership Act (UPA); use of RUPA varies from state to state

21-15 Partnership Termination Begins when partnership dissolves Once partnership dissolved and assets liquidated and distributed (“winding up”), partnership terminated

21-16 Partnership Dissolution Definition: Partnership cessation Partnership dissolution can result from: -Partner actions -Operation of law -Court action

21-17 Events Resulting in Partnership Dissolution Expiration of term (time period) stated in partnership agreement Fulfillment of established (agreed-upon) partnership objective Partner withdraws from “partnership at will” (partnership that does not specify objective/duration of partnership) Partner withdraws in accordance with partnership agreement Partner expelled from partnership in accordance with partnership agreement

21-18 Examples of Partnership Dissolution By “Operation of Law” Partner dies Partner adjudicated bankrupt Partnership engages in illegal activity

21-19 Examples of Partnership Dissolution By “Court Action” Partner adjudicated insane Impractical to continue partnership business Partner incapable of fulfilling his/her duties established by partnership agreement Partner disagreement as to how to conduct partnership business

21-20 “Winding Up” of Partnership Definition: Activity of completing unfinished partnership business, collecting and paying debts, collecting partnership assets, and taking inventory

21-21 Order of Distribution of Partnership Assets (Upon “Winding Up”) Payment to partnership creditors Payment of refunds/loans to partners for loans made to partnership Payment of partners for invested capital Payment of profits distributed to partners per terms of partnership agreement

21-22 Limited Partnership Definition: Agreement between at least one general partner and at least one limited partner Allows investor (limited partner) to share in profits of partnership Limited partner’s liability limited to amount he/she invests in business

21-23 Requirements for Limited Liability (of Limited Partner) Limited partner has complied in good faith with certificate of limited partnership filing requirement Limited partner does not participate in control of business Limited partner’s surname is not part of partnership name

21-24 Comparison of General Partners and Limited Partners General Partner –Has all rights associated with controlling business –Has unlimited personal liability for all partnership debts –Acts as agent of partnership Limited Partner –Has no right to participate in management and control of business –Liability limited to amount of capital partner has contributed to business –Is not an agent of the partnership

21-25 Reasons For Dissolution of Limited Partnership Expiration of term established in certificate of limited partnership Completion of objective established in certificate of limited partnership Unanimous written consent of all partners (limited and general) Withdrawal of general partner (unless certificate establishes that other general partners will continue operation of business) Court action