The Fiduciary Duties of Partners in a Business Partnership

Partners in a business partnership, other than limited partners, have legal obligations to the partnership that are called the Fiduciary Partnership Duties. In this post, we’ll look at these duties and, hopefully, clarify what they mean.

What Is a Fiduciary Duty?

The word “fiduciary” means a duty relating to trust. Can you always trust your business partner? Interesting enough, business partners have legal obligations. These aren’t just good ways to live, they are legal terms that govern partnerships.

If you are merely investing in a business or if you are a so-called “silent partner”, these duties do not apply to you unless you have a governing role in the company.

The Duty of Good Faith and Fair Dealing

This duty says that the partners will always deal with each other fairly and honestly. The duty of Good Faith takes effect the moment the partnership is formed and remains in effect until the partnership ends. Being honest with each other as partners is the basis of the other duties.

Think about this. If a partner is trying to buyout one of the other partners, she will try to make her best deal. There is nothing wrong with that. But what if there is a huge new sale pending and the selling partner doesn’t know about it. Failure to disclose everything a partner should know would violate the Duty of Good Faith. The legal consequences could be having to pay the selling partner some serious compensation.

What I see most often happens when a dispute breaks out between partners and one partner will close the bank accounts and move the money. That too is a legal violation of the Duty of Good Faith. Yes, a partner might do something irresponsible and break one of the Partnership Duties, but that does not justify breaking your duty in return.

The Duty of Loyalty

This duty means that partners must place the best interest of the partnership ahead of personal interests. This is commonly cited as the “conflict of interest” duty. Partners may not double deal or even compete with a business in which they participate as a partner.

A partner breaks the Duty of Loyalty if they start a business that potentially hurts the business partnership, obviously. They can be in violation if they give preference to a supplier that helps one of their friends when their own business could do better with a different supplier. Pay attention. Notice that a partner doesn’t have to directly profit to violate the loyalty clause.

A partner isn’t breaking the Duty of Loyalty if the personal relationship between partners breaks down and a partner no longer wants to play golf with the other partner. The loyalty duty applies to all business dealings only.

The Duty of Care

The care referred to in the Duty of Care doesn’t mean the same as “caring” about your partner. It refers to taking proper care of the business and the partnership by keeping good records, not harming company property, and meeting the general obligations. If we got a bill saying that we owed State Sales Taxes and I threw it away, I would violate the Duty of Care (and a few other laws).

Here’s an interesting example. You work in our store 7 days a week, 8 hours a day. I refuse to work on weekends. I am not going to do it, ever. If you are sick on a Saturday, I say, “close the store for the weekend.” A customer comes in on Sunday and asked for me. You say, “Chris is so lazy, he never will work on a weekend.”

Who broke the Duty of Care?

Both did! Refusing to work weekends breaks the Duty of Care. And, “bad mouthing” a partner also breaks the Duty of Care. That doesn’t mean that you have a responsibility to work weekends, but if it’s essential that the store is open on Saturday and Sunday, that should be handled in a better way than just refusing to work. If, as partners, we are taking equal salaries but you work 7 days a week and I only work 5, we can make a salary adjustment that is fair.

Equal partners do not have to make equal money. As long as we agree, we can do this however we wish. I may not see value in opening the store on Sunday. If you work Sunday by choice, there is no breach of duty. But, making negative comments about a partner is a clear breach of the Duty of Care even if those comments are true.

When I work with partnerships experiencing tension, I always try to get agreements on the differences that partners express. We can find compensation, work duty, and responsibility agreements that work.

The Duty of Disclosure

This one is pretty easy. If a partner has information that affects the partnership, there is a duty to disclose it. This duty is pretty broad. If you know that a business we are working with is owned by a friend of yours, you need to disclose that. If a potential customer wants a big discount and has given you a golf weekend, you have a duty to disclose it. Anything that affects the business that is known by one partner must be disclosed to the other partners.

Is this a violation of the Duty of Disclosure?

We (you and I are partners) just quoted a big project. I reviewed the quote and realized we didn’t charge enough on a particular item. We won’t lose money and we really need the deal, but if I tell you, you’ll want to change the quote and we won’t get the project. I don’t care if we make less money on this one because we really need the work. Any problems?

Yes. Any time one partner has information that the other doesn’t, there is a Duty of Disclosure. We should be able to discuss the quote and agree on a course of action. But it’s wrong to not disclose what was discovered.

Summary

How do you like to be treated? Most of the time, if you ask yourself that question, you’ll know whether you are violating a Fiduciary Duty in your partnership.

Are there consequences? Nobody will kick in the door if you find an error on a quote and don’t tell your partner. But should you end up in court over partnership tension and you are found to have violated your Fiduciary Duty, you can lose your partnership interest. What I see often is that as the hostility rises, both (or all) partners breach their duties. One bad-mouths a partner to an employee, the other one changes the bank account. As the heat rises, the violations mount. If they end up in court, a judge can order the business closed.

If you experience tension in your partnership, call me. We can work it out. Keep these duties in mind. They are legal obligations and not just guidelines for a healthy partnership.

“How do you like to be treated? Most of the time, if you ask yourself that question, you’ll know whether you are violating a Fiduciary Duty in your partnership.”