Holmes PLLC regularly consults with business people who do not understand that they’ve become partners, or potential partners, with the people they’ve done business with. “I thought we were doing business together – I didn’t think we were partners!” – is a common reaction when business people learn that their informal interactions with others, in a common pursuit of a business opportunity, can create a “partnership” at common law. The consequences of a common-law partnership are high: business people owe their partners considerably more legal duties than they own non-partners. If they don’t comply with those heightened duties, their partners will sue them in tort for breach of fiduciary duty.
A good example of this dynamic appears in the business movie “The Founder” starring Michael Keaton. Keaton plays Ray Kroc, the alleged “founder” of the McDonald’s restaurant empire. According to the movie, Kroc befriended and then betrayed the trust of Dick and Mac McDonald, two brothers who’d begun McDonald’s in California in the 1940s. After some early franchising efforts by Kroc and the McDonald brothers, Kroc implemented the secret of McDonald’s success in the late 1950s and 1960s – to own the land on which franchisees would operate the restaurants and to lease the land to the franchisees. Kroc formed a real estate company, which evolved in the McDonald’s Corporation of today, for this owning-and-leasing business function. Kroc did not invite the McDonald brothers to participate in the real estate company and later took actions to keep them out of it.
If Kroc had become the McDonald brothers’ partner – by way of a state’s common law – then he would be liable to the brothers for breach of fiduciary duty. The law would have required him to disclose the real estate company to the brothers and probably would have required him to let them participate as owners in that company. Because the real estate company went on to become worth billions, Kroc’s potential liability to the brothers would be enormous.
How does a businessperson avoid the kind of trouble that Ray Kroc flirted with in “The Founder” movie? First, by understanding how the common law creates a partnership around a business activity. Below Holmes PLLC surveys Texas law on this subject, which is well developed and which likely would influence courts outside of Texas.
Plainly put: a partnership can arise without any formal agreement. It is important to keep in mind though that the Legislature does not like to spring surprise or accidental partnerships on independent businesspersons. For example, if an employee is paid out of business profits with no other indicia of a partnership – that does not make him a partner. The Texas Business Organizations code sets forth the following factors that courts will consider in assessing if parties have become partners:
(1) receipt or right to receive a share of profits of the business;
(2) expression of an intent to be partners in the business;
(3) participation or right to participate in control of the business;
(4) agreement to share or sharing:
(A) losses of the business; or
(B) liability for claims by third parties against the business; and
(5) agreement to contribute or contributing money or property to the business.
Tex. Bus. Orgs. Code § 152.052(a).
The issue of whether a partnership exists is decided under a totality-of-the-circumstances test. Ingram v. Deere, 288 S.W.3d 886, 896 (Tex. 2009). No single factor is controlling, and more than one factor is necessary to establish a partnership. Shafipour v. Rischon Dev. Corp., No. 11-13- 00212-CV, 2015 WL 3454219, at *6 (Tex. App. – Eastland May 29, 2015, pet. denied) (mem. op.). “Even conclusive evidence of only one factor normally will be insufficient to establish the existence of a partnership.” Ingram, 288 S.W.3d at 898. To hold otherwise “would create a probability that some business owners would be legally required to share profits with individuals or be held liable for the actions of individuals who were neither treated as nor intended to be partners.” Id.
Today, we explore the first two factors in depth and hope to give you a better understanding of the communications and transactions that can trigger an accidental or unwanted legal partnership relationship.
The first factor deals with the right to receive a share of profits of the business. This factor has led courts to an ultimate decision of whether a partnership existed or not. The court stated that the right to share profits and control of the business is generally considered the most important factor in establishing the existence of a partnership. MetroplexCore, L.L.C. v. Parsons Transportation, Incorporated, 743 F.3d 964 (5th Cir. 2014). It is so important that, although courts use a “totality of the circumstances test,” satisfying this factor along with only one other can create a partnership. In Eagle TX I SPE LLC v. Sharif & Munir Enterprises, Inc., the Court concluded that although only two factors weighed in favor of finding a partnership, the party’s right to participate in the control of the business and the agreement to share losses established that the parties created a partnership. 2014 WL 696523 (N.D. Tex. Feb. 24, 2014).
For example, in Valero Energy Corp. v. Teco Pipeline Co., a Texas court of appeals held there was no partnership, despite Teco’s argument that a partnership in fact existed, when there was no agreement to share profits and losses. 2 S.W.3d 576 (Tex. App. – Houston [14th Dist.] 1999, no pet.). Teco claimed an implied partnership between the reluctant co-owners of a natural gas pipeline; Valero, in contrast, argued that the sum total of the relationship between the parties arose from a collection of agreements, such as the operating agreement and ownership agreement for the pipeline. Id. at 580. The court ultimately held these arms-length contractual arrangements governed the parties’ relationship – there was no agreement to split profits or losses – and therefore there were no partnership duties owed to one another, because there was no partnership. Id. at 584-586. Even testimony from Teco that it believed it was in a partnership with Valero did not create the implied relationship. Id. at 586.
The second factor in the partnership analysis is an important one. When considering whether the parties expressed intent to be partners, an inquiry that is “separate and apart from the other factors,” courts look at the parties’ speech, writings, and conduct. Ingram, 288 S.W.3d at 899. “Evidence of expressions of intent could include, for example, the parties’ statements that they are partners, one party holding the other party out as a partner on the business’s letterhead or name plate, or in a signed partnership agreement.” Id. at 900. Significantly, however, the mere reference to one another as “partner” is not enough to show intent without proof that the statement was made for a legally significant reason: “words used by the parties in a contract do not necessarily control the substance of the relationship, the terms used by the parties in referring to the arrangement do not control.” Coastal Plains Dev. Corp. v. Micrea, Inc., 572 S.W.2d 285, 288 (Tex. 1978).
It is essential to look at the context in which statements are made, in assessing whether they are evidence of a legal partnership; this is crucial because business people often will use the words “partner” and “partnered” to mean any sort of close business relationship, and not strictly to mean a legal partnership. Ingram, 288 S.W.3d at 900. “The terms used by the parties in referring to the arrangement do not control . . . and merely referring to another person as ‘partner’ in a situation where the recipient of the message would not expect the declarant to make a statement of legal significance is not enough.” Ingram, 288 S.W.3d at 900.
Outlining just the first two elements demonstrates the importance of caution and care when entering into business deals and creating commercial relationships. Understand and plan ahead to know exactly what type of relationship you want and make sure you have the appropriate legal support to accomplish it.