Thought Leaders: Beware of the Unintended Partnership

By Lee J. Morehead, Esq. - Otis and Bedingfield, LLC — 

To many, the legal threshold to form a partnership is surprisingly low. Under Colorado law, a partnership is created by the association of two or more people who carry on, as co-owners, a business for profit. No formal documents are required. Not even the words “partnership” or “partner” are required. Partnerships can be created even when no one was trying to create one. So long as the nature of the relationship between two or more parties is what the law considers a partnership, a partnership is formed.  Whether a partnership was formed is based exclusively on the conduct of the parties. For example, if parties share profits, the law presumes a partnership was created. It does not matter that the parties may not have considered themselves partners.

For a relationship that can be created unintentionally, the implications can be severe. Not only does the status of partnership affect taxes, but one partner can be held personally responsible for the debts of the partnership. For general partnerships, unlike corporations or limited liability companies, each partner has unlimited liability for the partnership’s debts. In addition to unlimited liability, each partner is an agent of the partnership. Thus, one partner can bind the partnership to a debt in which each and every partner is liable. When a partnership has no assets from which to collect, creditors can pursue each partner’s assets to satisfy the debt. The creditor can pursue one, some, or all the partners because each partner under partnership law is jointly and severally liable. This can leave one partner holding the proverbial bag for a debt that they otherwise knew nothing about.

There are additional consequences resulting from creating a partnership. Each partner is entitled to the books and records of the partnership along with accountings, and any partner can demand these from the other partners. Further, each partner owes fiduciary duties, like loyalty and to avoid self-dealing, to the other partners. As a result, each partner is exposed to liability that they may otherwise not know they have.

Engaging an attorney you trust is an important first step to defending yourself and your business from unintended partnerships. Among other tools, carefully defining the relationship and managing the relationship to avoid the legal elements of partnership formation can be effective in avoiding the unintended partnership.