01 Oct Stop the Presses! A Partnership Must Have At Least Two Partners!
More often than might be imagined, clients ask whether they can have a partnership with only one partner. A recent case from the California Court of Appeal has held, for the first time, that a partnership (not surprisingly) must have at least two partners.
In Corrales v. Corrales, decided on August 10, 2011, one of two brothers who had formed a partnership withdrew as a partner, and there followed a dispute about the value of his partnership interest. Although the brothers disagreed about the value, they both assumed that the value would be determined under a provision of the California Revised Uniform Partnership Act dealing with “dissociation,” which requires the partnership to buy out the interest of the withdrawing partner. The trial judge, with no one arguing otherwise, agreed with the brothers on that point, and assigned a value.
However, the Court of Appeal refused to address the valuation issues raised by the parties, focusing instead on a preliminary question: Did the partnership survive the withdrawal of one of its partners?
The Court noted that a partnership is, by statutory definition, “an association of two or more persons to carry on as co-owners a business for profit….” Thus, the Court concluded that withdrawal of one partner automatically resulted in dissolution of the partnership, because it left only one “partner.” This meant that there had been no dissociation,” and therefore no buy-out requirement. Instead, the partnership was required under the dissolution provisions of the partnership law to pay off its creditors first, and then to distribute anything that was left over to the two former partners.
How could this problem have been avoided? Fairly easily — at least on paper. The non-withdrawing partner could simply have formed a separate entity, under his complete control, to purchase the interest of the withdrawing partner. That way, there would have been two partners at all times. Of course, this plan would have required cooperation between the two brothers, at a time when cooperation was apparently in short supply.
This case illustrates one of the many advantages of a limited liability company (an “LLC”) over a general partnership. Unlike a partnership, an LLC can have a single member, so it does not have to dissolve if one member withdraws. But the primary advantage of an LLC over a general partnership is that an LLC can afford the partners the same protection against personal liability for liabilities of the business that a corporation can — while still being treated as a partnership for tax purposes.
Despite the advantages of the LLC form, there are still many general partnerships in existence. Some were formed before the LLC structure became available in the 1990’s, while others continue to be formed because the partners try to save on legal expenses at the time the business is started, and (frankly) don’t consider the options. In either case, it is often wise, and usually quite simple, to convert a general partnership to an LLC before a liability or dissolution crisis arises.