A California Partnership Agreement Explained
A California partnership agreement is a legal document that outlines the relationship between two or more individuals who share ownership and responsibilities in a business partnership. In California, a partnership accrues any time two or more persons agree to carry on a business for profit as co-owners under California Corporations Code Section 16100. A partnership agreement provides clarity and direction to the partnership so operations can run smoothly.
The agreement is also important because it provides flexibility to the business owners. Under Business Corporations Code Section 16103, unless there is a partnership agreement establishing otherwise, the partnership agreement governs relations between the partners , and between the partners and third parties, as well as the rights and obligations of the partnerships.
A California partnership agreement can be complex, depending on the details of the business, the number of partners, the nature of the work or service the partnership provides, and many other factors. The partnership agreement can be as specific or as broad as the partners choose, and can be broken down into multiple agreements to address different areas of the business. Important components of the agreement should be the purpose, the capital contributions, the allocation of profits and losses, voting rights, decision-making authority, and exit strategies for the partnership, among other details.
What’s in a Sample California Partnership Agreement?
A California partnership agreement should clearly articulate the following five areas related to the partners and their contributions to the partnership:
Control & Management
A California partnership agreement should address how the partnership will be managed and who will assume control over the day-to-day operations. The controlling partners typically have the full authority to operate the business without consent of the non-controlling partners. The California Uniform Partnership Act specifies that all aspects of managing the business are subject to the unanimous consent of the partners unless specifically stated otherwise in the partnership agreement.
Compensation of Partners
It is important for the partnership agreement to define the compensation arrangement between the partners before the partnership commences. Many times, the contribution of certain partners may be made in the form of services rather than capital. Likewise, certain partners may be identified as "silent" partners who either contribute capital or defer their capital contributions in exchange for a percentage of the profits and losses of the partnership. When defining compensation between the partners, the partnership agreement should indicate how the profits and losses will be shared and how much the partners will be compensated for their services to the partnership.
Loan Provisions
Without a proper written agreement to the contrary, any funds that the partners contribute to the partnership, such as an initial capital contribution, shall be considered a capital contribution and part of their ownership interest in the partnership. However, if the funds are loaned to the partnership, this will allow the lending partner to receive a return on his/her contribution in the form of interest payments. To accomplish this goal, the partnership agreement must clearly outline this form of contribution as a loan and include the terms for repayment and a specific rate of interest paid. Moreover, the document should state whether the loan(s) to or from the partnership will be unsecured.
The distribution of profits among the partners should address the following:
Termination
The partnership agreement should address what events will cause the partnership to terminate, how early termination rights are exercised and how a withdrawing partner is compensated upon termination. Also the partnership agreement should establish procedures to value the partnership in order to determine the amount of reasonable compensation for the withdrawing partner.
Requirements for Creating a Partnership in California
There are no formal requirements for the creation of a partnership in California. If two or more persons carry on a business as co-owners with intent to make a profit, then a partnership exists even in the absence of an express agreement. Where the parties’ actions indicate the existence of a partnership, there is a presumption that a partnership exists, which must be rebutted. Cal. Corp. Code § 16200. There is no requirement that a partnership be formalized in writing, nor is there a "writing requirement" for a valid and enforceable partnership agreement.
If two or more persons plan to form a general partnership, it is best to document their intent by way of a written partnership agreement. Written agreements are not required by California law, but they are necessary if the partners wish their orally agreed-upon terms to serve as the basis of their partnership agreement.
A partnership agreement does not have to be filed with any agency, although California provides for the registration of partnerships under the California Uniform Partnership Act. If the partnership is conducted in a fictitious name, or "doing business as," the partnership will be required to be registered with the county where the principal place of business is located. Filing fictitious business name statements is discussed in California Fictitious Business Name Statement: A Practical Overview.
Common Types of Partnerships in California
The State of California recognizes three types of partnerships: General Partnerships, Limited Partnerships, and Limited Liability Partnerships ("LLPs"). These are somewhat misleading names and imply that each provides more protection than it really does. More on that later. Through this article, we will briefly describe the three types and delve into the most prevalent of them all here in California – the general partnership.
General Partnerships. A general partnership is the simplest type of partnership available. It requires very few formalities to create a partnership (which we’ll talk more about below) and generally imposes unlimited liability on each partner, which we will also discuss further below. The partners have the authority to bind the partnership to third parties and, assuming they do not spend the money of the partnership for personal reasons, are entitled to an equal share of the profits. General partners maintain the right to manage the everyday operations of the business.
Limited Partnerships. A limited partnership must have at least one general partner and at least one limited partner. Generally, the general partner will be a corporation or LLC and the limited partner will be a natural person. The limited partners do not generally have a say in the management of the business and their liability is limited to their capital contribution. If they exceed their authority as a limited partner, their liability will be expanded to include any amount over their capital contribution. As noted above, more about this type of partnership below. Limited Liability Partnerships. LLPs are akin to corporations in that they provide the partners shield from liability for the acts of the partnership. They are generally designed for professionals who are offering "professional" services, namely, accountants, doctors, lawyers, etc. Each type of partnership has its advantages and disadvantages. Generally, the most advantageous is the general partnership.
How to Draft an Effective Partnership Agreement
An essential part of forming any business entity is drafting the appropriate governing document. In the case of a California partnership, that document is called a partnership agreement. A partnership agreement should be written in clear language and organized in a manner that is logical and easy to follow. Partnerships are often founded on trust. A perceived lack of transparency may undermine this. An uncertainly drafted California partnership agreement may result in subsequent fees and costs and/or lost profits from a failure to comply with the agency statutes and regulations. Given this, it is prudent to spend the proper time, attention and resources on drafting a quality agreement from the onset.
A partnership agreement for your specific situation does not have to be drafted from scratch. The contents of a California partnership agreement must include all matters that the California Corporations Code requires for all general partnerships. But it can also contain just about any provision that the partners wish to have included that is not inconsistent with the law (much like a corporation’s bylaws).
Business templates for nearly every type of partnership exist. Further, there is plenty of sample partnership agreement language , even for industry specific types of partnerships. In fact, a host of templates and forms will give you the ability to customize your California partnership agreement for a specific kind of partnership, such as a limited liability partnership (LLP), an insurance partnership, a foreclosure partnership, a joint venture, a health care partnership, a renewable energy partnership, an investment partnership, a franchisee, a franchise partnership, an equipment rental partnership, a restaurant partnership, a medical partnership, a dentist partnership or any partnership that engages in the many types of California entertainment and media activities.
But we always recommend that you consult an attorney who is experienced in the area of corporation and California business law. An attorney can review existing templates and forms to help you see if there are variations that you want to make to any of these templates. An experienced corporate attorney may even have created their own California partnership document that contains the right provisions for your situation. These attorneys also know how to draft and organize your specific California partnership agreement to best suit your needs and avoid potential pitfalls.
Resolving Partnership Disputes and Dissolution
Unless a California partnership agreement provides otherwise, an ordinary partnership terminates by any of the following events: 1. The partnership is dissolved and its business is wound up; 2. The partnership is dissolved by unanimous will or consent of the partners; 3. In a term partnership, by the termination of the partnership term or the happening of a specified event; 4. In a partnership at will, without violation of the partnership agreement, by the express will of any partner when no definite term or particular undertaking is specified; or, 5. When a specific event, including the death of a partner, makes the partnership unlawful to continue. (Cal. Corp. Code § 16801(1) and § 16801(5)).
Without a partnership agreement to the contrary, a partnership may terminate and be wound up either voluntarily by the partners or involuntarily by a court. (Cal. Corp. Code § 16801(2)). When a partnership agreement provides for its winding up upon the occurrence of any of the events noted above, a partner may seek a court order for winding up and for the appointment of a receiver if the partnership is insolvent or if all the partners, except the partner seeking the order, consent to the appointment. (Cal. Corp. Code § 16801(4)).
When a partnership is wound up, the partners must discharge the partnership obligations to third parties. When the liabilities are satisfied to the full extent of the partnership assets, the partners shall then receive the balance of the partnership assets in equal shares. If there are creditors of different classes, assets of the partnership shall be applied to claims in the following order: 1. To creditors in the order in which they became due; 2. To creditors holding nonrecourse claims against the partnership; 3. To partners in satisfaction of liabilities as partners; and, 4. To partners, individually, in the proportion in which partners share in distributions. (Cal. Corp. Code § 16801(5)).
Advantages and Disadvantages of Partnerships
As with any type of business arrangement, there are advantages to forming a partnership and drawbacks as well. Here are some of the key factors that are worth considering: Advantage: They’re easy, cheap and quick to form. In fact, you don’t really even need to draft a formal, written California partnership agreement to create a partnership. The simple act of having conversations with potential partners about going into business can create a de facto partnership in which you and your partners are now co-owners with no formal agreement. Advantage: It’s a pass-through tax entity, so you only pay taxes once, rather than twice if you were operating as a corporation. Again, a pass-through entity means its owners don’t pay taxes on the business income; instead, the taxes "pass through" to the individual owners, who report their pro rata share of the profits on their individual tax returns. Advantage: Partners can maintain a stable control of the business. As a practical matter, partners are not allowed to transfer their ownership shares without the other partners’ consent. So as long as things stay amicable, the owners can keep the business running pretty consistently – unlike a corporation, where shares can be sold easily. Advantage: Owners have an incentive to work hard. Each partner has a pro rata share of the profits, therefore incentivizing them to exert extra effort for the success of the company . Disadvantage: Partners may not give time or money to the same level. For example, let’s say you have two partners: You’re putting in 20 hours a week, while your partner Chip is only putting in 10. You both own 50 percent of the business. Who gets to make the call over what happens next? Generally, you, with the larger share, but the "equal" footing you both started with has fractured, at least for the time being. Additionally, Chip may want to donate less capital, on occasion. How do you handle that? Disadvantage: As noted above, partners have to work on the same "level." Let’s say you put in 80 hours a week, and Chip puts in 5. In theory, you have the best argument to say you should be a partner with 76 percent of the company’s ownership shares, and he should only have 24 percent. But that’s not how partnerships generally operate; in terms of decision making, 50 percent to 50 percent is what the partnership was built on. Disadvantage: Bad behavior is contagious. One or more partners may begin to make some bad decisions that the others don’t fully support. The more that goes on, the more challenging it is to undo the damage. For example, Chip might begin to take numerous business trips, one after the next. You’re not a big fan of instantaneous trips. Do you get to make the choice with him going against your wishes? What if other partners think the same thing?
