When Does a Partnership Begin? And End?
Nothing Changes Until Things Change
I get calls from frustrated business partners all the time. Often, the level of tension is so high, that one partner will move the banking, hide the books, take out a lump sum of cash, close out all social media, or some other drastic measure before properly closing out the partnership. These actions all violate the Fiduciary Duties of a Business Partner. (To understand the Fiduciary Duties of a Business Partner, be sure to read this post: The Fiduciary Duties of Partners in a Business Partnership)
What if your business partner is harming the business? What if you’ve decided to go your own way? When are you legally free from the partnership? Let’s take a look at when a Partnership begins and ends. That’s important to understand because partners have all their rights until there has been a formal change to the partnership. Until that change you can’t cut somebody out of the accounting records or start a competing business. Partners must keep their Fiduciary Duties until there is a change even if there is agreement to talk about a buyout. Nothing changes until things change.
It Starts When It Starts
If you launch an LLC, the effective date will be on your filing documents. From that date, all Partners have legal responsibilities to each other. If your Partnership is less formally structured, it can begin as soon as the handshake when you agreed to form a partnership.
You may form a C-Corp or and S-Corp with specific duties enumerated in the incorporation articles. Pay attention to those responsibilities because breaking those obligations could cost you your stake in the business.
Keep in mind, absent a good Operating or Partnership Agreement, or specific definitions under your articles of incorporation, the terms set forth in law (RUPA=Revised Uniform Partnership Act) apply.
When Does a Partnership End?
A Business Partnership ends when a formal process to end it is completed. That doesn’t mean the partnership ends, everyone is freed from Fiduciary Duties, if a partner blows up and says, “that’s it! I can’t work with you.” It doesn’t end if a partner wants out and buyout negotiations begin. No matter how bad the relationship gets, the partnership is still operating until a formal execution of process.
I have inherited partnership separations that were in the negotiation phase for years. During that time, partners are entitled to participate in the decision-making processes of the business and to take their distribution of the profits. All partners are also responsible for liabilities.
If a big deal comes in, all partners may enjoy the fruit of that work product until the partnership ends.
What Is a Formal Process to End a Partnership?
The formal process of ending a partnership depends on the business structure. That might mean a surrendering of shares, signing a release, or closing the LLC with the respective state by filing the required closing documents. The important thing to remember is that the business cannot operate as though it is not a partnership until…it isn’t one.
When you get the email from your partner saying that she wants out, that does not mean that you are free to unilaterally change the bank accounts or lock your partner out of the business. If you want to take those kinds of actions, you should get your partner to sign off to protect you in the event your partner files a lawsuit. Remember, under the law, a partnership is a partnership until it legally isn’t one.
Consequences of Acting Like a Partnership Is Over Before It Is
What’s wrong with getting a flaky partner off the bank account? If you’re doing all the work, why can’t you keep all the money? Why not change the locks? Well, you never know when a business partner will find a lawyer willing to cause you a lot of money and stress. You might be right. You might even prevail in court. But, the law takes the Fiduciary Duties very seriously and I recommend not changing anything until you have formally modified the partnership.
There is an exception. If you draft an agreement that says you agree that the partnership will change and in the interim it is agreed that your partner will assume a silent position until the changes are accepted and executed, you will be covered. However, few partners actually agree to something like that.
My advice? Do things right and protect yourself.
“To protect yourself from having to compensate your partner for being wronged, remember that all partners have rights under the law until the partnership ends formally.”
Buyouts between partners are usually mired in things that people think are legal entitlements. Let’s look at the most common misconceptions around buyouts.