One day, Jeff and Ashley, long-time friends from college, met for lunch at a restaurant and Ashley started to talk about the chlorine problems she was having with her swimming pool. Jeff, a chemical engineer, was intrigued and started offering possible solutions. As they were talking, they started to get excited with the prospect that Jeff’s pool ideas could actually be a basis for a real pool chemical business. A few days later, Ashley, who has a background in marketing and business, emailed Jeff her suggestion for a business model that she believed would work for the pool business. On a phone call soon afterward, Jeff told Ashley that he was serious about starting the pool business. Ashley responded that she would love to be part of it, and would be willing to lead the marketing side of the business. Jeff and Ashley agreed to share profits and losses and they both contributed money to set up the business.
In this example, have Ashley and Jeff formed a partnership?
In Texas, a general partnership is formed when two or more persons associate to carry on a for-profit business as owners[1]. The law sets out five factors for determining whether a partnership has been formed including:
(1) receipt or right to share in profits of the business;
(2) participation or right to participate in control of the business;
(3) expression of an intent to be partners;
(4) agreement to share or sharing losses of the business or liability for third party claims against the business; and
(5) agreement to contribute or contributing money or property to the business[2].
Critically, no one of these factors alone is sufficient to establish a partnership, and they do not all have to be accounted for[3]. Courts have generally found that the most important of these factors are sharing profits and participating in the control of the business[4]. Assuming everyone agrees on the facts, it looks like Jeff and Ashley from our example probably have a general partnership, whether it’s a good idea or not.
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[1] Tex. Bus. Org. Code § 152.051(b) (2006).
[2] Id. § 152.052(a); See Ingram v. Deere, 288 S.W.3d 886, 896-98 (Tex. 2009) (The Texas Supreme Court has applied these factors in a totality of the circumstances test to determine whether a partnership was created in the business).
[3] Ingram, 288 S.W.3d 886 at 896-98.
[4] Big Easy Cajun Corp. v. Dallas Galleria Limited, 293 S.W.3d 345, 348 (Tex. App. 2009).
The Trouble with a General Partnership
At first blush, a general partnership might sound like a good idea. After all, it is one of the most common legal entities to form a business because it is easy to establish, flexible to manage, less expensive to form, has a simple tax structure[5], and can easily be dissolved at any time. However, this ease and convenience brings with it significant risk. In a general partnership all general partners face unlimited liability in the partnership[6]. In other words, all partners are completely and personally liable for all the partnership’s debts and obligations incurred to outside parties, even those caused entirely a just one partner’s wrongful actions[7].
Going back to our example, if Jeff was later found to have stolen the chemistry ideas used in the general partnership pool business, the original idea owner could seek to collect the entire judgment for intellectual property infringement against Ashley individually. A similar scenario plays out the other way if Ashely were found to have caused a car accident on the way to make a sales pitch for the pool business; Jeff could end up paying the entire judgment individually, even though he was not even there. In either case, the innocent partner will not be able to limit or avoid his or her liability to the outside party by saying “it wasn’t me, it was my partner…” General partners face unlimited liability for their partners’ actions in connection with the business.
Can I form a Partnership without knowing it? Implied Partnership
What, you might wonder, is to stop someone from just calling you their partner? You are right to wonder this as Texas law allows scenarios for general partnership to be implied even if one or more of the people alleged to have formed the partnership never express any intent to create one. The term implied partnership describes situations when the law treats a partnership as having been formed without the mutual knowledge or consent of the constituent partners. Such implied partnerships generally arise to protect outside parties who reasonably believed the partners to be in a partnership arrangement and whose recovery in a lawsuit should not be limited to the resources of the smaller and less financially viable partner. Partnerships can also be implied to protect one partner who presents evidence that it expended resources or contributed money to what it reasonably believed was a joint enterprise in which the parties would share control and profits.
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[5] IRS, Tax Information For Partnerships, https://www.irs.gov/businesses/partnerships (partnerships are not taxed at the entity level but all profits and losses are passed through to the individual partners in their income taxes).
[6] Tex. Bus. Org. Code § 152.304(a) (2006) (amended 2011).
[7] Id. § 152.303(a).
[8] Tex. Bus. Org. Code § 152.051 (b)(1) (2006) (amended 2007).
The threat of having a court imply that you are in a partnership you never intended to join is a real one of which to be mindful, particularly if your business dealings are vague on distinction between opportunity and execution when it comes to joint opportunities. Parties can avoid accidental partnerships by drafting contractual provisions such as clear prerequisite conditions to the formation of a partnership in their preliminary agreements[9].
The case Energy Transfer Partners, L.P. v. Enterprise Products Partners, L.P. serves as an instructive example[10]. There, the trial court found an implied partnership on the basis of the parties’ dealings. Eventually, after many months of briefing and argument, the Court of Appeals overturned the trial court ruling, and the Texas Supreme Court affirmed the Court of Appeal’s decision. In its ruling, the Texas Supreme Court reasoned that a partnership could not have been formed because the potential partners had written out express conditions in their preliminary agreement that would have had to occur first in order for a partnership to be formed. It was the non-waiver and failure of these express written conditions precedent that let the defendant avoid being trapped in an unintentionally formed implied partnership[11]. If no clear preliminary agreement had been signed, it is likely that the initial ruling would had been upheld, and the court would have implied that the innocent partner faced full general partner liabilities for all of the misdeeds of the other partner.
How can I create a Partnership in Texas?
As you may have concluded, there are only very few examples where a general partnership is a suitable business structure. Most examples where sophisticated parties use general partnerships involve the formation of other related entities. There no formal filing or registration requirement for creating a general partnership in Texas[12]. In fact, it is only the more desirable partnership structures, such as a limited partnership, that actually require much in the way of documentation to exist. In those instances, the partnership agreement would also contain clauses committing the partners to their investments and limiting their respective liability to outside parties to the amount of their investments. Whether you are in a unique position where a general partnership is advisable, or more likely, you decide to use a limited partnership or other type of partnership entity, depending on your situation, here are some recommended steps you should consider:
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[9] Energy Transfer Partners, L.P. v. Enterprise Products Partners, L.P., 593 S.W.3d 732 (Tex. 2020).
[10] Id.
[11] Id. at 740-42.
[12] Texas Secretary of State, Selecting a Business Structure, https://www.sos.state.tx.us/corp/businessstructure.shtml.
1. Choose a business name and register.
A partnership may use individual partners’ surnames or an assumed name (a name other than the surnames of the partners). If you choose to use an assumed name, you are required to register the name with the local county clerk’s office. A limited partnership requires filing with the Texas Secretary of State.
2. Draft and sign a Partnership Agreement.
A partnership generally operates in accordance with a partnership agreement, but there is no requirement that the agreement should be a formal document in writing. In other words, it can be formed through oral agreements over the phone or informal written statements in emails discussing business operations. In fact, as you now know, a general partnership can happen without anyone ever signing anything.
To avoid a court deciding for you what the essential terms of the partnership are, it is therefore advisable to formally discuss, record., and sign your partnership terms, in writing, to prevent future conflicts amongst the partners. Especially if you select a limited partnership arrangement or other partnership type other than the troublesome general partnership, your partnership agreement should set out clauses at least addressing the partnership’s structure and operation, the partners’ responsibilities and rights of control, the ownership and profit interests, and the limits of liability. A suitably tailored partnership agreement will not only provide clear guidance to the two or more partners in operating the business, it will also protect the partners from unknown liabilities to outside parties down the line.
3. Obtain an Employer Identification Number (EIN)
Partnerships are required to obtain an Employer Identification Number (EIN) in Texas. This is a nine-digit number issued by the IRS for tax reporting purposes. Registering for an EIN can be done online at the IRS website.
4. Open a bank account and obtain a general liability insurance.
Open up a bank account in your business’s name to separate personal and business assets. Consider obtaining a general liability insurance for your business to protect yourself and your business from unforeseen events.
Leaving aside the trouble of general partnership, the overall partnership concept can be a promising path to create a successful business. Written agreements are nearly always key.
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[13] Id.
[14] See Malone v. Patel, 397 S.W.3d 658 (Tex. App. 2012) (an existence of a partnership was questioned at the court where three parties orally agreed to form a partnership and started their own business, however, one of them later claimed sole ownership to the business and refused to acknowledge the partnership with the other parties).
Leaving aside the trouble of general partnership, the overall partnership concept can be a promising path to create a successful business. Written agreements are nearly always key. However, as with any agreement, care must be taken to avoid foreseeable traps. Therefore, it is crucial to consult with a commercial lawyer to discuss your business and analyze your situation to determine the best path forward to minimize your risks. Discuss with our competent and experienced team of lawyers to learn more about how you can successfully manage and grow your business and avoid these future complications.
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