Accidental Partnership: Are You in a De Facto Business Partnership? | Attorney Aaron Hall

Accidental Partnership: Are You in a De Facto Business Partnership?

Overview

This story illustrates how two entrepreneurs can accidentally find themselves in a partnership. A partnership doesn’t need to be registered with the state. A partnership can begin whenever two or more people carry on as co-owners a business for profit.

Story

Amber and Jen discussed opening a business together. They never established a formal agreement. Amber started building the business. Jen did nothing, while Amber did all the work.

During this time, Amber and Jen did brainstorming together. Together, they came up with a business name. Using that name, Amber registered a domain name and social media accounts.

Then Jen changed her mind and decided not to be part of the business.

Can Amber keep the business name, website, and social media accounts? Jen wants Amber to pay Jen something for the business name, website, and social media accounts. Jen claims that Jen came up with some of the ideas, and since there is value to those ideas, Jen is entitled to payment.

Legal Analysis

When analyzing this scenario, the first question is whether there was a common law partnership. If there was no partnership, the assets belong to whoever got them first and the analysis is over. In general, a “partnership” is defined as “an association of two or more persons to carry on as co-owners a business for profit.” In this case, I believe the facts are sufficient to establish a partnership.

If there was a partnership, the partnership would own the business opportunities and other assets of the business. The partners would owe the partnership and each other fiduciary duties. Also, there should be some value put on the contributions of each partner, especially the labor.

The next question is whether a partner wrongfully withdrew from the partnership and the consequences of that under state partnership laws.

Finally, the question is how to liquidate the assets of the partnership and divide the proceeds between the partners. There should be some adjustment for the labor contributed by Amber.

Practically speaking, these types of cases rarely are worth the expense of hiring attorneys for full litigation. Thus, the partners are incentivized to negotiate and settle their differences outside of court.

Additional Resources

Most states have partnership laws enacted into statute. These are usually based on some version of the Uniform Partnership Act. Each state has variances in their partnership laws. For example, Minnesota’s partnership statute can be found in Minnesota Statutes chapter 321.

Video Transcript

What is the defacto partnership or an accidental partnership? That’s when two people carry on a business as co-owners for profit. They don’t do any registration. They’ve never set up a formal partnership. They don’t have an LLC or an S corporation or a C corporation. Instead, it’s two people who are working in business together for profit.

The law says that if you do that, you are in a partnership. It’s often called an accidental partnership or defacto partnership because the people don’t realize all of a sudden this happens. Now when does this happen? Well, this might be two people who are working together on a business. That’s a simple example. It also often arises when two companies work together.

Now, what happens if you have a contract? It’s possible that contract would clarify that this is not a partnership, and an attorney could make sure that it doesn’t have the elements of a partnership, but it’s important to remember that where two people or two organizations or two companies are working together as co-owners, sharing the profit, that can be deemed a defacto partnership or an accidental partnership under Minnesota law.

This is a common law partnership. It’s not a registered partnership. It’s not a limited partnership. And why does this matter? Because the partners are personally liable for the acts of their other partner. In other words, you might find yourself personally liable for that which your other partner does. And since there is no limited liability, this isn’t a limited liability company, also known as an LLC, it’s not an S corp. So since there’s no limited liability, you are personally liable for the acts of your partner. That’s a big deal.

That’s why whenever you go into business with somebody else, you should consider whether it makes sense to set up a business entity that will limit liability. Generally, that’s going to be an LLC or a corporation. I’m Aaron Hall, a business attorney in Minnesota. For additional information, see the links below.

Video Transcript

Did your contract accidentally create a partnership? That’s the question I’m going to be talking about today. I’m Aaron Hall, a business attorney in Minneapolis, Minnesota.

A partnership is where two or more people carry on a business with the intention of sharing profit, essentially as owners. But what happens is you can find parties are accidentally in a partnership, a de facto partnership, if you will, without ever realizing it. And here’s the problem with a partnership. In a partnership, both parties are liable for the acts of the other. They are personally liable. So let’s say, for example, that John and Kim decide they’re going to sell lemonade together, and they both pool their money to buy lemons and sugar and water and a little lemonade stand. And then they decide that any of the profits they’ll get out of it will be split.

They didn’t go register a partnership. They didn’t go through any formal process. They didn’t sign a partnership agreement. The question is, are they a partnership? Well, very clearly they are and here’s why. You have two or more people who are doing business together with the expectation of sharing the profits. That’s a partnership. It’s a de facto partnership. It’s an accidental partnership. That means that if John leaves and Kim stays there and Kim accidentally hurt somebody… maybe she drops the lemonade pitcher on a baby in a carriage and the baby is hurt… the family of the baby can sue Kim and John because they are both personally liable for the acts within the business. That is why an LLC or a corporation is so important. Where multiple people are going into business together, it’s especially important to have a limited liability shield that separates liability of the business from the liability of the individuals.

Here’s how that works. If John and Kim set up a corporation or a limited liability company, also known as an LLC, then John and Kim would not be liable personally for the acts that happen within the business. Now if Kim was the one to accidentally drop a pitcher of lemonade on a child and the child was injured, Kim would be responsible for her own acts. You’re always responsible for your own acts or your own negligence, but John would be protected from liability because in an LLC, liability is limited. Only the company is liable. The individual owners are not. Similarly with a corporation, you have a limited liability shield or veil in a corporation, and unless you’ve done something to violate that limited liability veil, you are not personally liable.

Now you might be wondering what could you do to violate that? Well, the most common example is commingling funds. In other words, your personal funds and your business funds are commingled. You’re treating the company’s finances like your personal piggy bank. That’s a great example of where even though you have a corporation or an LLC, the court will say, look, you didn’t respect the formalities of having separate finances. So the court’s not going to respect the separation that would normally be available between a corporation and a shareholder. So back to the topic. Can you accidentally find yourself in a partnership? Absolutely. It’s called a de facto partnership or an accidental partnership. What about two businesses that are working on an event together? That is a great example of where businesses can accidentally find themselves mutually liable for each other’s acts.

So there you have it. That is an accidental partnership. To learn more, see the description below. There’s a URL linking to my article at aaronhall.com. Please keep in mind that I do these educational videos as a public service to help you spot issues to talk with an attorney, but this shouldn’t replace talking with an attorney, and that is elaborated on more in the disclaimer below. If you want to hear more videos like this, you can subscribe to this channel or sign up for our email list. Again, I’m Aaron Hall, a business attorney representing business owners in Minnesota.

Next Steps

To learn more, visit my website at aaronhall.com