How Big Is My Partnership Agreement?

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When parties intend to become partners, they typically enter into a written agreement with the terms of their arrangement; “handshake” deals are few and far between. This is certainly advisable, as people forget facts, corporate employees leave, partners fall out, or persons die (making their heirs, who were not party to the handshake, left figuring out what the deal actually is). However, putting the agreement in writing is not a requirement to form a partnership. In fact, persons can unintentionally enter into a partnership, and in such an event they obviously will not have a written agreement. Whatever arrangement the partners have made, whether written or oral, will constitute their “partnership agreement,” and the general partnership statute of the applicable state will fill in any gaps. The applicability of the statute could result in unintended requirements or consequences, but may be hard to refute in the absence of an adequate written agreement.

The Delaware general partnership statute states that a partnership agreement includes any written, oral or implied agreement among the parties concerning the partnership. A written partnership agreement customarily contains a provision that there are no other agreements with respect to the partnership, that the written partnership agreement governs the relationship, and that the agreement may only amended in writing. Nonetheless, a partnership agreement typically does not cover every situation that arises and may not include substantial detail or procedures on some matters. Partners may also act in a manner that does not conform to the partnership agreement, whether overtly or tacitly. Therefore, over time the manner in which partners interact may constitute an oral or implied amendment to the partnership agreement, even if not intended as such.

The manner in which partners, particularly general partners, interact with each other is generally governed by the fiduciary duties of care and loyalty, which bring into play years of court cases defining these duties. Partnership statutes may expressly permit partners to define the parameters and standards by which this is measured, and some statutes permit the fiduciary duties to be eliminated entirely. While Delaware, for example, permits fiduciary duties to be disclaimed, it does not permit the partners to eliminate the “implied covenant of good faith and fair dealing.” Despite the wording, however, this is not a standard for interpreting the language of the existing agreement, but applies to unanticipated situations or implied provisions not addressed by a partnership agreement.  

For tax purposes, the Internal Revenue Code does not define a partnership agreement. Instead, the Treasury Regulations cast a broad net to include oral or written agreements, modifications to oral or written agreements, and local non-tax law where the partnership agreement is silent. In addition, other arrangements between the partners, or persons related to a partner, can be considered part of a partnership agreement. These can include puts, options, buy-sell agreements, indemnitee agreements and any other “stop-loss” arrangement, and the title of the agreement or arrangement does not matter. If a lease or lending arrangement is considered to constitute a partnership, then the documents for that transaction can be considered part of a partnership agreement. And while state law does not typically limit the ability or timing of amendments to partnership agreements, for tax purposes an amendment to whatever is considered part of a partnership agreement is effective only if made no later than the date on which the tax return for the applicable partnership year is due.

 

Topics:  Business Taxes, Partnership Agreements, Partnerships

Published In: Business Organization Updates, General Business Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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