Types and formation of partnerships
Sources of partnership lawWhat is the statutory basis for partnerships, and partnership-like structures in your jurisdiction? To what extent do these laws overlap or share features with company law?
The form and organisation of partnership-like structures are controlled at the state level, with laws structured and codified similar to state laws governing other corporate forms. Each state typically delegates the administration of these laws to one or more government agencies within the state executive branch, who ultimately report to the state governor. Governing agencies may establish further regulations, guidance and rules related to the registration, governance, reorganisation or termination of partnerships and companies.
Where a state’s relevant partnership laws are silent, the relationship between partners is generally governed by the state’s laws pertaining to contracts.
A partnership may be governed by the laws of a state other than those it primarily transacts business in.
Types of partnershipsIdentify the types of partnerships or other partnership-like structures permitted in your jurisdiction. What are they typically used for?
General partnerships are used where each partner will take an active role in the organisation’s management and operations. Unless the partners agree otherwise (typically in writing), a partnership will be legally considered to be a general partnership.
Limited partnerships are used where one or more ‘limited partners’ will not take an active role in management and operations, but will otherwise contribute capital, assets or some other value. One or more ‘general partners’ actively manage the organisation.
Limited liability partnerships (LLPs) allow each partner to engage in the management of the business while limiting liability to his or her own actions. This form may be restricted within a state to regulated professions, typically lawyers and accountants.
Limited liability companies (LLCs) are quasi-corporate partnership structures that allow owner ‘members’ to directly manage the operations of the organisation, or to designate one or more employee ‘managers’ to do so. LLCs have the benefit of insulation from liability afforded a body corporate, with fewer filing and formal governance obligations.
Joint ventures are partnerships of one or more businesses, typically for a limited period or purpose. Joint ventures are most typically organised as general partnerships, limited partnerships or LLCs.
Team or teaming arrangements may be joint ventures or contractual relationships between one or more parties (natural persons or organisations), typically for a limited period, for the purpose of winning and performing on contracts with government entities. Teams can be formally administered under government-sponsored mentorship programmes or they may be privately arranged.
C corporations are formal business structures that may include one or more classes of shareholders, or part-owners, who delegate management decision-making to a board of directors (each of whom may also be a shareholder). Directors may further delegate management and operations to one or more employee executives (who may also be shareholders or directors).
S corporations are corporations who must limit their shareholders to no more than 100 natural persons of United States citizenship.
Benefit corporations are for-profit corporations that also serve one or more public benefits or agree to abide by a designated code of conduct. Benefit corporations are not recognised in all states.
‘Tax-exempt’, ‘charitable’, ‘non-profit’ or ‘not-for-profit’ organisations are LLCs or corporations recognised by a state or federal government entity for serving a specified purpose that benefits the public. These organisations typically include schools, churches, museums and arts programmes, social welfare and environmental services, labour unions, guilds, and industry or professional consortia.
Differences between types of partnershipWhat are the key differences between the various types of partnerships (and similar entities) available in the jurisdiction? Are partnerships treated as bodies of persons or bodies corporate?
A partner’s liability is generally proportionate to the level of control he or she will exert over the management and operations of the business.
General partnerships, limited partnerships and LLPs are not typically treated as bodies corporate. General partners in either structure have no limitation on liability, and are jointly and severally liable as natural persons for the acts of the partnership. Limited partners’ liability is limited to the proportionate value of their contribution.
LLCs are treated as bodies corporate and, as such, liability to the partner ‘members’ is limited.
Liability to partners in joint ventures, teams or teaming arrangements depend on the form and nature of the arrangements between the partners.
C corporations, S corporations and benefit corporations are bodies corporate with limited liability to owners.
Reasons for choosing a partnership structureWhat are the typical reasons that businesses choose to operate through a partnership structure in your jurisdiction? Do any factors discourage adopting a partnership structure?
Partnerships have historically been attractive for the ease of their creation, lack of taxation as a corporate entity and the ability to conduct business with relative informality in comparison with corporations. However, personal liability is often the greatest factor in deciding to not adopt a partnership structure.
LLCs combine the advantages of the partnership structure with the limitation of personal liability associated with a body corporate. Since laws enabling the creation of LLCs have become widespread, partnership forms have waned in popularity.
Formation (formalities and bars to formation)How are partnerships and the similar structures available in your jurisdiction formed?
In most states, two or more persons conducting business together will be legally deemed a general partnership with respect to the business they transact, whether or not any formal registration is made with a governing agency.
To form a limited partnership, LLC or any type of corporation, the business must typically submit the following with an appropriate state government agency:
- business name, form, general purpose, term, and state and date of formation;
- any ‘DBAs’ (doing business as) or aliases under which the organisation is also transacting business;
- address of the business;
- address and identity of a person or business in the jurisdiction that may accept service of legal process;
- identity of all owners;
- identity of key management, if applicable (general partners, LLC managers, corporate officers); and
- number of shares, if applicable.
Businesses wishing to do business outside of the state in which they are organised must typically file the same information in each state in which they transact business.
Companies wishing to organise as S corporations may only admit US nationals as shareholders, and must file a formal election to organise with the US Internal Revenue Service (IRS).
Entities that will hire any employees must also file for an Employer Identification Number with the IRS.
Regulation
TaxationHow are partnerships taxed?
General and limited partnerships are taxed on income on a pass-through basis (ie, on the personal income taxes of each partner). The partnership as an entity is not subject to additional taxation. Partners are considered self-employed, and must pay a self-employment tax analogous to social security and Medicare taxes withholdings.
LLCs may elect whether to file federal taxes as a corporation or on the individual returns of members.
Foreign partners, members and owners, or persons physically located outside the United States, are generally not exempt from state or federal taxes.
LLC members or corporate shareholders, if natural persons, may also be employed by their organisation. Such employment is taxed separately from income received by right of their status as an owner (eg, partner or member distribution). Income received for employment is subject to both federal and state income withholding.
Non-profit organisations are exempt from taxation only with respect to income directly related to their tax-exempt purpose.
Reporting and transparency requirementsTo what extent must partnerships, LLPs and similar structures file accounts and other documents and information with a government agency?
Non-profit organisations must publicly file annual statements of income and expenses with the IRS to maintain tax-exempt status. These financials are subject to audit by the IRS, but need not be audited before submission.
For-profit organisations are not generally required to file financial information, with the exception of publicly traded C corporations. This information is typically considered a trade secret and in practice is shielded from public disclosure.
Ownership and membershipCan anyone be a partner, and, if not, who can and cannot? Can bodies corporate or other partnerships own a partnership?
Generally, unless specifically restricted by other statute or regulation, bodies corporate and other partnerships may be partners in partnerships, members in LLCs or shareholders in corporations.
Non-profit organisations do not have owners in the sense that no private individual or entity may benefit (ie, enjoy profits) from the operation of the organisation. Improperly conferring such private benefits upon the members of the non-profit organisation will result in loss of tax-exempt status and may result in civil and criminal liability.
Execution of documentsHow do partnerships and LLPs execute documents? Must all partners sign? Can the partnership or LLP sign in its own name?
Execution of documents is determined by the internal organising documents or agreement of the organisation (ie, a partnership’s ‘partnership agreement’, LLC’s ‘operating agreement’, or corporation’s ‘by-laws’). Day-to-day decision-making is reserved to one or more general partners in a limited partnership, or to managers in a manager-managed LLC.
Per statute or agreement, certain decisions may require a vote of all partners, members or shareholders to effect - typically regarding major divestments, acquisitions or company dissolution.
Benefits, employment rights and partners’ duties
Remuneration and benefitsTo what extent are partners free to agree how to share profits and what are the most common types of profit-sharing arrangements?
The division of profits and losses are specified by a partnership‘s partnership agreement or an LLC’s operating agreement.
Some organisations will apportion profits based solely on ownership interest. However, where partners or members actively and independently generate revenue, profits are often divided based on attributable revenue and rates of realisation (collection) of income. This is most commonly seen in organisations providing professional services or direct sales.
Norms in remuneration and benefits vary greatly by industry, size, organisation type and state of organisation.
Employment rightsTo what extent are partners considered employees? Do they benefit from statutory employment rights?
Partners are considered self-employed, and are subject to federal self-employment tax.
Statutory employment rights vary significantly by state. Neither partners nor LLC members are entitled to statutory employment rights by virtue of their status as partners or members. However, an LLC member who is also employed is entitled to statutory employment rights by virtue of his or her employment; and a partner or LLC member whose ownership rights are so practically limited that he or she has no meaningful decision-making rights as an owner (eg, as in large, multi-partner medical or law practices) may be entitled to certain employment rights.
Partners’ dutiesIs there a statutory or common law concept of good faith among partners, and what are its implications? What are typical contractual duties between partners or owed by partners to their firms?
Partners and LLC members are contractually bound to the duties outlined in their organising documents (partnership agreement or operating agreement).
Partners’ and members’ fiduciary duties are recognised in state and federal common law. In addition, state statutes governing partnerships and LLCs may explicitly impose fiduciary duties, including the duties of:
- loyalty to act in the best interests of the organisation;
- care to act reasonably with all material information and resources reasonably available;
- obedience to follow governing documents; and
- good faith and fair dealing, to interact honestly, fairly and in good faith when performing as a partner or LLC member.
Entering and leaving the partnership
Joining the partnershipHow do prospective partners typically enter the partnership? Are there any formalities?
Prospective partners may join - or be legally deemed to have joined - a general partnership by transacting business in conjunction with one another. No other formality is necessary.
Joining a partnership or LLC is otherwise controlled by governing documents. Prospective partners joining an existing partnership or LLC will typically ‘purchase’ a partnership interest or make a capital contribution to the partnership or LLC in exchange for the other partners’ or LLC members’ agreement to admit them as a partner or member.
Depending on the value and nature of the interest acquired, the partnership or LLC may need to update its documentation with appropriate government agencies.
Leaving the partnershipCan partners leave a firm without the agreement of the other partners, and must they serve a notice period? Will a partner receive back any capital invested, a share of the value of the partnership or any other payments on leaving? In what circumstances can a partner be required to leave a firm?
The process of ‘dissociating’ or leaving a partnership or LLC is determined by the partnership agreement or LLC operating agreement. This process will also determine when and by how much a dissociating partner or LLC member may withdraw his or her capital investment or proportionate share.
When a natural person dies, he or she is usually deemed as dissociated and the value of his or her interest will belong to his or her estate.
Statutes governing partnerships and LLCs include a general process by which a partnership or LLC may involuntarily expel a partner. This process may be modified or elaborated on in the partnership agreement or LLC operating agreement.
Non-profit organisations will not typically allow dissociating members or partners to withdraw any investment into the organisation.
Disputes and redress
Recovering losses caused by partnersMay partners sue for loss caused by another partner?
If a partner or LLC member causes loss to another partner or member, or the partnership or LLC, by violating a duty or exceeding his or her authorisation under the partnership agreement or LLC operating agreement, the harmed partners or LLC members may seek some remedy for breach of the partnership or operating agreement. Applicable state laws and the partnership or operating agreement may provide for relief through litigation or through alternative dispute resolution. Typically, parties will seek binding arbitration as a more cost-effective dispute resolution method than litigation.
DisputesHow are disputes among partners and between individual partners and the partnership itself typically handled?
The partnership agreement or LLC operating agreement should specify how internal disputes are handled. Such agreements commonly require mediation or arbitration prior to, or in lieu of, civil suits. Applicable state statutes may define the rights of individual partners or LLC members, if any, to bring claims before a court on behalf of the partnership or LLC, or against other partners or members.
Disputes between partners most frequently arise in the allocation of profits and losses, particularly when the partnership agreement or LLC operating agreement does not provide clear guidance or dispute resolution processes.
Dissolving the partnership
DissolutionHow are partnerships voluntarily dissolved?
The process of dissolution is governed by statute, and to a lesser extent, determined by the partnership agreement or LLC operating agreement. Dissolution may be triggered by any number of events specified by statute or agreement. Upon a decision to dissolve, the partnership or LLC must give notice to its actual or potential creditors of the decision, either directly or through publication. The time frame in which a creditor may bring a claim is determined by applicable statute.
After the ‘wind down’ process of satisfying debts and ending all business is complete, the partnership or LLC may file a formal notice to applicable government agencies of termination of all business. Any remaining assets are distributed in accordance with the partnership agreement or LLC operating agreement, or where silent, in accordance with applicable state law.
Statutes governing partnerships and LLCs typically include a process by which a court or governing agency may also involuntarily dissolve a partnership or LLC.
Upon dissolution, non-profit organisations must transfer their assets to the public or to another non-profit organisation. States may require authorisation from a government entity to proceed with a plan of dissolution.
Update and trends
Emerging trendsAre there any emerging trends or hot topics in your jurisdiction?
Emerging trends18 Are there any emerging trends or hot topics in your jurisdiction?A number of US state jurisdictions have adopted statutory frameworks for ‘benefit corporations’ and cooperative organisations to encourage community investment and economic development. These organisations are intended to take advantage of both economic drivers and public benefit obligations.
Similarly, public-private partnerships (PPPs) are statutory or contractual arrangements between government and private entities to encourage development. PPPs are typically used for large-scale public works, often in transportation, and are intended to take advantage of private sector expertise with public sector safeguards.
