Contracting Out of Partnership.

• Author: Moll, Douglas K.

1. INTRODUCTION 754 II. PARTNERSHIP FORMATION: AN OVERVIEW 756 III. THE ENTERPRISE DECISION 758 A. Summary 758 B. Implications 762 1. Partnership Formation as a "Default Test" 762 2. The Legality of Partnership Disclaimers 763 IV. CONTRACTING OUT OF PARTNERSHIP: COSTS AND BENEFITS 766 A. Costs of Allowing Parties to Contract Out of Partnership 766 1. Undermining Mandatory Fiduciary Duties 766 a. Fiduciary Duty Modifications and Information 768 b. Fiduciary Duty Modifications and Cognitive Biases 770 2. Creating Uncertainty About the Operating Rules for the Business 773 3. Denying the Rights of Third Parties 776 a. The Doctrine of Partnership as to Third Persons 778 b. Limiting the Effect of RUPA [section] 308(e) 782 V. BENEFITS OF ALLOWING PARTIES TO CONTRACT OUT OF PARTNERSHIP 784 A. Promoting Freedom of Contract 784 B. Providing Certainty on the Partnership Formation Question 786 VI. WEIGHING THE COSTS AND BENEFITS 788 A. Within the General Partnership 788 B. Beyond the General Partnership 792 VII. CONCLUSION 795 I. INTRODUCTION

   "Mere words will not blind us to realities. Statements that no partnership is intended are not conclusive. If as a whole a contract contemplates an association of two or more persons to carry on as co-owners a business for profit, a partnership there is." (1)

   "In other words, a duck which is called a horse does not become a horse; a duck is a duck." (2)

   The general partnership serves as the "default" or "residual" form of co-owned, for-profit business organization in this country. (3) If two or more persons associate to carry on as co-owners a business for profit, and if they choose not to organize as a corporation, limited liability company, or other entity that requires a state filing for its creation, a general partnership has been formed. (4) This state of affairs existed under the 1914 Uniform Partnership Act, and it has been carried forward in the uniform partnership statutes that are prevalent today. (5)

   In determining whether two or more persons have associated to carry on as co-owners a business for profit--i.e., in determining whether a general partnership has been formed--the parties' conduct is of paramount importance. (6) By contrast, the parties' subjective intent to be characterized (or not characterized) as partners is of little relevance. (7) Indeed, modern partnership statutes state that "the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership." (8) If the parties' actions demonstrate that they have, in fact, associated as co-owners in a for-profit business, a partnership is formed, even if the parties expressly deny that they are partners. (9) Stated differently, denying that a conduct-based partnership is a partnership is just as ineffective as denying that a duck is a duck.

   Or so it seemed. In the 2020 decision of Energy Transfer Partners, L.P. v. Enterprise Products Partners, L.P., (10) the Supreme Court of Texas effectively concluded that, as between themselves, parties could avoid a partnership characterization by simply agreeing not to be partners, even if their conduct would otherwise meet the statutory definition. (11) Moreover, because the court relied primarily on general freedom of contract concepts, its holding could easily be replicated in other jurisdictions. (12) As a consequence, the issue raised by the Enterprise court--whether disclaimers of partnership should be dispositive in disputes between the parties themselves--is far more than a Texas issue. It is a critical matter of national partnership law that has the potential to upend well-accepted doctrinal and policy principles.

   This Article argues that allowing parties to contract out of partnership is inconsistent with modern statutes. More importantly, the Article concludes that the costs of permitting parties to contract out of partnership outweigh the benefits, particularly when much of the benefit of allowing dispositive disclaimers of partnership can be captured without the need to alter established principles of partnership formation.

   Part II of this Article presents an overview of partnership formation and its totality-of the-circumstances focus on the parties' conduct rather than subjective intent. Part III provides more detail on the Enterprise decision and its uneasy fit with the uniform partnership statutes that are prevalent today. Part IV examines the costs and benefits of allowing parties to contract out of partnership. With respect to costs, permitting parties to enter into dispositive disclaimers of partnership undermines the protections of fiduciary duty and creates uncertainty about the operating rules for the business. In addition, although the Enterprise court purported to limit its holding to disputes between the alleged partners themselves, the decision nevertheless threatens the rights of third persons who did not agree to any disclaimer. With respect to benefits, allowing parties to contract out of partnership promotes freedom of contract and brings more certainty to the partnership formation inquiry.

   Part V weighs the costs and benefits of permitting parties to contract out of partnership. It argues that the benefits of freedom of contract and certainty on partnership formation mainly boil down to the parties' desire to control their fiduciary duty exposure--a desire that can largely be accommodated within the existing general partnership setting. That desire can also be accommodated to an even greater degree beyond the general partnership setting, if the parties so choose, by forming a limited liability company in a jurisdiction that permits the elimination of fiduciary duties. Under either option, what the parties really want can be accomplished without having to incur the substantial costs of permitting dispositive disclaimers of partnership.

2. PARTNERSHIP FORMATION: AN OVERVIEW

   The law governing general partnerships is largely derived from statute. The National Conference of Commissioners on Uniform State Laws (NCCUSL) (13) promulgated the Uniform Partnership Act (UPA) in 1914. (14) With the exception of Louisiana, UPA was adopted in every state. (15) In 1997, NCCUSL concluded a process of revising UPA, and the final act became known as the Revised Uniform Partnership Act (RUPA). (16) From 2009-2013, NCCUSL worked to harmonize, to the extent possible, all of the uniform acts that addressed unincorporated business organizations. That effort resulted in the promulgation of an amended version of RUPA (RUPA (2013)). (17) As of this writing, thirty-five states have adopted RUPA, and four states (and the District of Columbia) have adopted RUPA (2013). (18) Thus, some version of RUPA governs partnerships in most of the jurisdictions in this country. (19)

   The general partnership is unique among business organizations with two or more owners because its formation does not require a public filing with the state. (20) RUPA [section] 202(a) indicates that "the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership." (21) Partnership, therefore, has a legal definition (provided by statute), and a partnership is formed when the parties' actions meet this definition. Although other business organizations, such as corporations and limited liability companies, could also be described as co-owned businesses for profit, (22) such "filing entities" are explicitly excluded from the partnership definition. (23) Thus, the general partnership has been characterized as the "default" or "residual" form of co-owned, for-profit business organization. (24) If such a business does not organize as a filing entity, it is a general partnership and will be governed by the jurisdiction's general partnership statute.

   Traditionally, the most important factors in determining whether the legal definition of partnership has been met--i.e., in determining whether parties have "associate[ed] . . . to carry on as co-owners a business for profit"--are the sharing of profits and control. As explained by the comment to RUPA (2013) [section] 202(a):

   Consistent with the common law and UPA (1914), under this act "co-ownership" is a key concept. Ownership involves the power of ultimate control (albeit a power that can be substantially diminished by agreement) and a right to share in the profits of the co-owned business. To state that partners are co-owners of a business is to state that: (i) they share in the profits (if any) of the enterprise; and (ii) ab initio at least, they collectively have the power of ultimate control. (25)

   Other factors that courts have found relevant to the partnership determination include sharing losses of the business, contributing money or property to the business, and any other evidence that is typically associated with ownership. (26) Partnership formation is considered to be a totality-of-the-circumstances inquiry; thus, if a court concludes that sufficient evidence exists of these factual predicates, the legal definition of partnership is met. (27)

   Significantly, so long as the parties' conduct falls within the statutory definition, a general partnership is created, even if the partners do not realize that they are forming such an enterprise, and even if they specifically disclaim that they are partners. (28) Put differently, while it is often stated that the intent of the parties is critical to the question of whether a partnership has been formed, the intent that matters is the intent to do the things that meet the legal definition of partnership--not the parties' subjective intent to be characterized (or not characterized) as "partners." (29) As one court explained:

   The statutory language is devoid of any requirement that the individuals have the subjective intent to create a partnership. Stated more plainly, the statute does not require partners to be aware...