Archive for the ‘Partnerships’ Category

Loftium Unwittingly Forms Partnerships with Homebuyers

Wednesday, September 20th, 2017

Yesterday, the New York Times trumpeted a new internet company, Loftium, and its interesting, new-economy business model (which, for the time being, operates only in Seattle):

Loftium will provide prospective homebuyers with up to $50,000 for a down payment, as long as they are willing to continuously list an extra bedroom on Airbnb for one to three years and share most of the income with Loftium over that time.

At first glance, the arrangement between Loftium and participating homebuyers might sound like a loan.  (Indeed, the Times even describes it as such in an infographic.)  But upon a closer look, the arrangement that Loftium contemplates with homebuyers clearly is not a loan.  First of all, Loftium says it is not a loan; rather, according to Loftium, the down payment assistance it provides to homebuyers is “a part of a services agreement” lasting 12-36 months.  Second, and more important, the arrangement between Loftium and homebuyers has none of the characteristics of a traditional (term) loan.  There is no “principal” amount that the homebuyer is required to repay in a set period of time, and Loftium does not charge the homeowner any “interest.”  In fact, the homebuyer is not required to make any payments to Loftium in return for the company’s cash (unless the homeowner breaches the parties’ agreement and stops renting on Airbnb before the term expires).

All the homebuyer must do in exchange for Loftium’s money is (1) list her spare room on Airbnb continuously through the term of her agreement with Loftium, (2) be a decent host (i.e., “not be[] rude to guests”) and (3) split her Airbnb  rental revenue with Loftium (with two-thirds going to the company.)  If, at the end of the term, Loftium has not been repaid its initial investment, the homeowner is not required to repay Loftium’s initial contribution. Hence, if renting out the homeowner’s spare room is not profitable during the term of the parties’ agreement, “Loftium takes full responsibility for that loss.”

Of course, Loftium expects that the total income from renting out a homeowner’s spare room will greatly exceed the amount that it originally provided to the homebuyer, so that both will profit.  If Loftium makes more in rental income than it pays towards the homeowner’s down payment, Loftium will make a profit.

Further, by all appearances, there is no cap on Loftium’s potential profit is its business arrangement with homebuyers.  In fact, Loftium makes clear that it wants to maximize the income that it splits with homebuyers:  Loftium promises that it will work with them “to increase monthly bookings as much as possible, so both sides can benefit from the additional income.”  To that end, Loftium provides homebuyers with some start-up supplies for their spare bedroom (and a keyless entry lock), access to advice and know-how regarding how to rent an Airbnb room, and online tools to help maximize their rental income.

So, if the business arrangement between Loftium and homeowners is not a loan, what is it?  It is almost certainly a general partnership for a term (i.e., a “joint venture”).

What is a Partnership?

Both the original Uniform Partnership Act (UPA) (adopted uniformly by almost every state, but now in effect in only around 13 states) and its successor, the revised Uniform Partnership Act (RUPA) (variations of which have been adopted by perhaps 37 states) define a partnership as an “association of two or more persons to carry on as co-owners a business for profit.”  UPA § 6(a); RUPA § 202.

Hence, creation of a partnership has four elements: (1) an association of two or more (2) persons; (3) who carry on as co-owners; a (4) for-profit business.

The Easy Elements

There can be no doubt that Loftium and the homebuyer are legal persons under the statute.  See UPA § 2 (defining “person” to include corporations like Loftium).  Further, it is clear that leasing an Airbnb apartment year-round is a for-profit business. (Indeed, Loftium advises homebuyers that they must obtain a business license from the city of Seattle.)

As a result, the only elements in question are (1) whether the parties have voluntarily “associated” and (2) whether they are “co-owners” of the for-profit business of renting out the homeowner’s spare room on Airbnb.

The Element of “Co-Ownership”

It might seem, since the homebuyer owns the spare room and Loftium does not, that the two are not “co-owners.”  However, the relevant question is not whether the two are co-owners of the property used to operate the business, but rather, whether the two are co-owners of the Airbnb business.  It is quite common for a partnership to operate a business using the real property of only one partner.  See, e.g., Lupien v. Malsbenden, 477 A.2d 746 (Me. 1984); Peed v. Peed, 325 S.E.2d 275 (N.C. Ct. App. 1985). Indeed, absent express contrary intention, RUPA presumes that personal property of a partner which she allows the partnership to use for the business remains her own property, and is not contributed to the partnership.  See RUPA § 204(d).

UPA and RUPA also provide some guidance for courts in assessing whether persons who operate a business are “owners” of that business.  First, both statutes effectively presume that anyone who shares the profits of a business is an owner of—and thus, a partner in—the business.  See UPA § 7(4) & RUPA § 202(c).  However, that presumption has an important caveat: Receiving a share of the profits of a business is not presumed to make one a partner in that business if “the profits were received in payment … of a debt by installments or otherwise … or of interest … on a loan, even if the amount of payment varies with the profits of the business.” RUPA § 202(c)(1)(i) & (v); accord UPA § 7(4)(a) & (d).  Hence, if Loftium shared the profits of each homeowner’s Airbnb rental business as repayment of a loan to the homeowner, the law would not presume that Loftium was a co-owner of (and partner in) the homeowner’s business.

Yet here, not only has Loftium explicitly denied that it is lending money to homebuyers, its arrangement with homebuyers looks nothing like a traditional loan.  Accordingly, if Loftium were to argue that it was not a homebuyer’s partner because it simply loaned the homebuyer money for the homebuyer’s business, a court would probably reject that argument.  See, e.g., Lupien, supra (holding that an alleged “banker” who took over the business of his “borrower,” and whose “loan” to the business “carried no interest and no fixed payments, but was to be repaid only” out of revenues from the business, was in fact a partner).

Admittedly, Loftium and a homeowner do not exactly split “profits” of their Airbnb rental business; rather, they each contribute different things to the partnership and then split the revenues.  The homeowner contributes some labor, plus the use of her spare room, furnishings and bathroom; Loftium puts in cash, some supplies, its know-how about renting on Airbnb, and other online resources.  Yet, it is not uncommon for one partner to contribute property (or the use thereof) to the partnership while another partner contributes something else to the partnership—and both partners split the partnership’s revenues.  For example, it is common for one partner (the “money partner”) to provide capital (and sometimes, agree to accept all capital losses) and the other partner (the “service partner”) to provide labor and/or expertise.  Accordingly, Loftium and each homebuyer are undoubtedly sharing “profits” of the partnership, not the “gross” (which does not lead to a presumption of partnership, see UPA §7(3)).  Although they do not share the profits (or the losses) from the business equally, that is not required of partners (although it is the default rule in the absence of a contrary agreement).  See RUPA § 401 cmt. 3.

In addition, if one stops to consider why the statutes deem sharing profits as a critical gauge of co-ownership, one realizes that sharing profits—i.e., revenues net expenses—means sharing fully in the risks and rewards of the business.  Unlike a lender, who is paid “off the top,” an equity owner who is paid from the “net” shares the risk that the business’s expenses will exceed its revenues.  However, also unlike a lender, an equity owner shares in any profit that occurs if revenues exceed expenses.

Hence, in assessing whether one co-owns a business and therefore is a partner in it, courts often consider whether she shares fully or only superficially in the risks of the business. See In re KeyTronics, 274 Neb. 936 (2008) (describing co-ownership as whether the parties “share the benefits, risks…of the enterprise” such that they “subjectively view themselves as members of the business rather than as outsiders contracting with it”).  Here, there can be no doubt that Loftium is a co-owner of each homeowner’s Airbnb rental business because—as Loftium freely admits—it takes on all of the risks. If, upon expiration of the term, the Airbnb rental has made no money, the owner owes nothing to Loftium and gets her spare room back; Loftium, by contrast, loses its entire investment.  Further, Loftium’s marketing materials make clear that the company  intends to maximize the Airbnb revenues that it shares with the homeowner  This stands in stark contrast to a lender who only cares whether the business makes enough money to repay its principal with interest (which come “off the top”).

Finally, in assessing whether one is co-owner a business—and as such, is a partner in that business—courts also consider whether the person in question has a right to manage the business.  Cf. UPA § 6 cmt. (“To state that partners are co-owners of a business is to state that they each have the power of ultimate control.”). Loftium satisfies this requirement in spades.  While the owner furnishes and takes care of the premises (and can, if she decides, clean it herself), Loftium plays a critical role in managing the business by setting (and constantly adjusting, to suit market conditions) the price for the homeowner’s spare room on Airbnb.  Further, as described above, Loftium provides some supplies (like the keyless entry lock) and advice for hosting on Airbnb; Loftium also requires homeowners to provide its guests with certain amenities.  Moreover, while the homeowner sets rules for the apartment on Airbnb, Loftium can veto the rules if it considers them “overly restrictive.”

Yet, even if Loftium had no role in managing the Airbnb business, that would not prevent it from being a partner.   The history of “silent” partners in a real estate ventures who merely provide funds (and share profits), but allow another partner to manage the business is a venerable one.  See, e.g., Meinhard v. Salmon, 249 N.Y. 458 (1928) (Cardozo, J.) (perhaps the most famous case in partnership law) (silent partner in New York’s Hotel Bristol provided cash; managing partner operated the business and functioned as its sole public “face”). Donald Trump himself has been involved in similar partnerships (albeit a limited partnership): Back when he actually built buildings, but after he nearly went bankrupt, he sold 70% of his interest in Riverside South to partners from Hong Kong; while The Donald built, operated and was the public face of these buildings, his partners put in the real money.  (Ironically, while he oversaw development, he left himself with no control over key important aspects of the business, including its sale. But I digress.) 

In sum, since Loftium and the homebuyers to whom it provides down payment cash are co-owners of a for-profit business, they undoubtedly are partners.

The Element of “Association”

Yet, what of the final element, “association”?  It means that the parties must partner voluntarily.  See Gangl v. Gangl, 281 N.W.2d 574 (N.D., 1979) (explaining that “association” element “connotes…voluntariness.”).

At first glance, this element seems easily satisfied, because on its website, Loftium repeatedly describes itself as “partnering” with homebuyers to rent out their spare room on Airbnb.  This is a red herring, though. Business people often use the term “partner” colloquially, so labeling oneself a partner in a business does not automatically make one a partner in that business.  See, e.g., Gangl, supra.  Or, as one Texas court famously put it when holding that two people were not partners simply because they described themselves as such: “a duck which is called a horse does not become a horse; a duck is a duck.” City of Corpus Christi v. Bayfront Assocs., Ltd., 814 S.W.2d 98  (Tex. App.—Corpus Christi 1991).

Digging deeper, one discovers that, contrary to Loftium’s careless use of the word “partner” on its website, the company actually has attempted to protect itself from being deemed a partner with homebuyers by contract.  According to the “terms of service” that governs the arrangement between Loftium and homebuyers:

No agency, partnership, joint venture, or employment relationship is created…, and neither party has any authority of any kind to bind the other in any respect.

In short, Loftium and homebuyers will agree by contract that their arrangement is not a partnership.  Although judges often write that the parties’ “intent” is critical to the formation of a partnership, this language is misleading because it does not specify the precise subject of the parties’ intent.  That is to say, this language fails to state exactly what the parties must intend in order to be partners.

Disclaimers of Partnership

According to the settled law, the relevant question is whether the parties intended to be coowners of a for-profit business, not whether they intended to form a relationship known as a “partnership.”  See Byker v. Mannes, 641 N.W.2d 210 (Mich. 2002) (explaining that, if the parties “associated to ‘carry on’ as co-owners a business for profit, they will be deemed to have formed a partnership relationship regardless of their subjective intent to form such a legal relationship”; and that “the statute does not require partners to be aware of their status as ‘partners’ in order to have a legal partnership …. [In ascertaining the existence of a partnership, the proper focus is on whether the parties intended to…’carry on as co-owners a business for profit’ and not on whether the parties subjectively intended to form a partnership.”); Heck & Paetow Claim Service, Inc. v. Heck, 93 Wis.2d 349 (1980)(“The ultimate and controlling test as to the existence of a partnership is the parties’ intention of carrying on a definite business as coowners.”); Bass v. Bass, 814 S.W.2d 38, 41 (Tenn. 1991) (“It is the intent to do the things which constitute a partnership that determines whether individuals are partners, regardless if it is their purpose to create or avoid the relationship.“)  

In short, not only is it possible for two people to form a partnership without any intent to do so, it is possible for two people to form a partnership despite that they intend not to do so.  See RUPA § 202, cmt. 1 (“[A] partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be “partners.” Indeed, they may inadvertently create a partnership despite their expressed subjective intention not to do so.”).

For this reason, courts have long held—particularly in cases involving claims by third parties against one or more partners (but, as I intend to argue in a subsequent article, also in claims between partners)—disclaimers of partnership are not dispositive if contrary to the facts.  As the New York Court of Appeals explained, in a celebrated case:

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

Martin v. Peyton, 246 N.Y. 213, 217-18 (1927) (Andrews, J.)

Although some cases hold (wrongly, I believe) that parties may define their own relationship by contract, there is little doubt that Martin (which involved a claim made by a creditor against alleged partners) is the rule in lawsuits by third parties.

In sum, even if a court were to decide, in a lawsuit by the homeowner, that the disclaimer of partnership in Loftium’s terms of service precludes formation of a partnership between Loftium and the homeowner, a court would nonetheless be likely to deem the disclaimer ineffective in a lawsuit by a third party. So, for example, if an Airbnb renter who slips and falls in a homebuyer’s spare room (and whose claim exceeds Airbnb’s $1 million liability insurance policy for its subscribers) could probably obtain damages from Loftium.  See UPA § 13(a) & 15(a) (partners are liable for the negligence of another).

A Simple Solution

Although this possibility of liability to third parties (and, if my interpretation of partnership law is correct, to homebuyers) may come as a shock to Loftium, the problem actually has an easy solution.  With respect to third parties, Loftium could substantially limit its potential liability by forming a limited liability company (LLC) with each homebuyer.  A member of (i.e., one with an ownership interest in) an LLC is not liable to third parties for debts of the LLC.  See, e.g., Tex. Bus. Orgs. Code § 101.114.  While this would not allow Loftium to escape liability for its own misconduct (or, if its disclaimers of partnership are ineffective as to homeowners, for lawsuits by homeowners), it would substantially reduce Loftium’s risk of being held liable to a third party for a homeowner’s torts or contractual debts.

Posted by Joe Leahy

When You’re Alone, You’re Alone: Hillman and Weidner on Partners without Partners

Friday, August 19th, 2011

In a partnership at will, unless the partners otherwise agree, the voluntary withdrawal of a partner (a much nicer word than “dissociation”) automatically causes dissolution of the partnership.  RUPA § 801(1).  For partnerships for a definite term or particular undertaking, after the voluntary withdrawal of a partner only results in dissolution of the partnership by the express will of at least half of the remaining partners.  RUPA § 801(2)(i). If the withdrawal of a partner does not result in dissolution of the partnership, the partnership must purchase the interest of the withdrawn partner.  RUPA §§ 603(a), 701(a).

But what if the partnership had only two partners?  does the remaining partner have the right to buyout the other partner? Robert Hillman (Cal-Davis) and Donald Weidner address this question in an article forthcoming in The Fordham Journal of Corporate and Financial Law, Partners without Partners:  The Legal Status of Single Person Partnerships (SSRN, draft dated Aug. 1, 2011).  Prof. Hillman is of the view that, under RUPA § 101(6),  the partnership dissolves by operation of law:

The core of RUPA’s definition is that a partnership is “an association of two or more persons to carry on as co-owners a business for profit.” If one partner leaves, the predicate association of two or more persons no longer exists, which means a partnership is constituted only for the limited purpose of winding up the business. In other words, the partnership that existed prior to the dissociation is no more.

Id. at 3 (footnotes omitted).  Dean Weidner, who was the Reporter for the RUPA, disagrees:

I obviously think you are asking the definition of partnership to do too much by effectively operating as a special dissolution rule whenever partnerships no longer meet the language of the definition. RUPA contains three separate articles on partnership breakups, defining when and how liquidations versus buyouts are to take place. To attach to the definition substantive breakup consequences would create yet another set of dissolution rules and certainly was not considered in the drafting of the RUPA.

* * *

RUPA’s breakup provisions are much more detailed than the UPA on how a departing partner is to be cashed out. * * *

* * * Section 801, by its terms, lists the “only” events that cause dissolution and winding up, and a departure from a term partnership is not on the list. Both Sections 603(a) and 801, therefore, require a buyout in this situation.

Id. at 6-7 (footnotes omitted).

In a recent opinion, the Third Division of the Fourth District of the California Court of Appeals reasoned that, by definition, a partnership requires at least two partners, and ruled that the withdrawal of one partner in a two-partner partnership automatically caused dissolution.  Corrales v. Corrales, G043598 (Cal. Ct. App. Aug. 10, 2011).

In many ways, this conundrum is a self-inflicted wound, in that it is an artifact of the RUPA generally embracing the “entity” concept.  Under the UPA, the withdrawal of a partner automatically dissolved the partnership, and usually gave each partner the right to liquidation.  But, in a partnership for a term or undertaking, UPA § 38(2)(a) gave the other partners the right to continue the business, either alone, or with others.

In any event, the problem of the partner-less partner under the RUPA illustrates how the entity approach can be a snare; you begin to believe that all partnership-related problems can be solved by the ritual invocation of the entity.  Even the RUPA retains aggregate elements, such as liability of the partners. Partnerships and sole proprietorships are the only business forms that can be formed without filing with the state.  The difference between the two has always been the partnerships were aggregates; it takes at least two to partner.  As Bruce Springsteen sang in When You’re Alone:

When you’re alone you’re alone
When you’re alone you ain’t nothing but alone

Hat tip:  Eric C. Chaffee (Dayton), Jay Adkisson.

Gary Rosin

The Joint Venture Fable

Monday, June 28th, 2010

Robert Flannigan (Saskatchewan) has an interesting article,  The Joint Venture Fable, 50 Am. J. Legal Hist. 200 (2010)(SSRN).  The article is a survey of, and a commentary on, the development of the concept that “joint ventures” are distinct from partnerships:

It recurrently is assumed that a joint venture is a distinct legal form. That is not a valid assumption. The joint venture claim materialised only aberrantly in the nineteenth century. A remedial distinction within partnership law led to, or was the springboard for, the assertion that the “joint venture” had a legal identity different from every other form of commercial association. That claim was confronted and rejected by most judges and commentators. Others were opposed to equating the joint venture with the partnership, or were hesitant to do so, insisting (or worrying) that there were basic differences. That thin wedge of dissent and hesitation allowed the claim to persist. It did not, however, prosper. Additional arguments offered in justification were easily repelled. Today there remains a stale deadlock between the majority and minority views. The minority claim now appears to be that the joint venture has a legal character that, while largely defined by the law of partnership, differs in certain substantive respects and therefore exists as a distinct form of association. The claim, however, remains fabulous. It is a fabrication or concoction that rightlyhas failed to secure the imprimatur of uniform judicial approbation. There is no historical basis for a distinct law of joint venture.

Id. at 200.

Posted by Gary Rosin

Partnership Property & Continuation. Faegre & Benson, LLP v. R & R Investors (Minn. Ct. App. 2009)

Friday, October 9th, 2009

Faegre & Benson, LLP v. R & R Investors, No. A08-1899 (Minn. Ct. App. Sept. 29, 2009) involves the same issue as Putnam v. Shoaf, 620 S.W.2d 510 (Tenn. App. 1981):  a dispute over a partnership claim against a third person after the sale of an interest in the partnership.  Putnam involved an unknown claim, while R & R Investors involved claims against the federal government related to a pending lawsuit in which the trial court had found in favor of the government. 

The partnership, R & R Investors, which owned and operated an apartment complex.  Over the years, several groups of partners came and went.  The “appellants” sold their interest in the business via several documents:

  1. a Purchase Agreement for the sale of the apartments and related personal property;
  2. an amendment to the partnership agreement transferring the selling partners’ interests in the partnership; and
  3. an indemnity agreement under which the purchasers assumed, and indemnified sellers against the obligations of the partnership.

Slip Op., at 5-6.  Unlike an earlier sale (id. at 4), no deeds or bills of sale seemed to have been used.  It is clear that the Purchase Agreement for the purchase and sale of the property was the primary document.  The Purchase Agreement provided that the purchase of the partnership was “[t]o facilitate the sale of this property”.  Id. at 5.

In Putnam, the Court rejected a claim that, because an existing, but unknown, claim was not included in the list of property being sold, the selling partner retained ownership of it.  The selling partners in R & R Investors took a different approach.  The sellers argued that

  • changes in partners dissolved the partnership,
  • the business was continued, but by a new partnership, and
  • the disputed claim was an undistributed asset of the earlier partnership.

Id. at 13-14.  The Minnesota Court of Appeals held that, under the Minnesota version of the UPA

we conclude that, absent agreement to the contrary, the partnership property of a dissolved partnership became the property of the partnership continuing the business without need for separate devise. We base our conclusion primarily on the former UPA’s treatment of partnership property and allowance for continuation of partnership businesses. Appellants’ reading of the former UPA would frustrate the purposes of these provisions.

Id. at 15-16.  Although the Court cited (Slip Op., at 16 n.6) only one portion of my article, The Entity-Aggregate Dispute:  Conceptualism and Formalism in Partnership Law,42 Ark. L. Rev. 395 (1989), its reasoning largely parallels my discussion of the treatment of partnership property in a continuation (id. at 427-43).

Gary Rosin

On Joint Ventures

Tuesday, September 22nd, 2009

Robert Flannigan (Saskatchewan), has an article, The Legal Status of the Joint Venture, 46 Alberta L. Rev. 713 (2009) (SSRN), that criticizes the use of the term “joint ventures” in opinions (elegantly referred to as the “judicial lexicon”) and the mistaken impression by courts that a joint venture is a”a distinct legal form”.

Gary Rosin

Twist on Pre-Formation Contracts. Baltimore Street Builders v. Stewart (Md. Ct. Spec. App 2009)

Monday, August 24th, 2009

Baltimore Street Builders v. Stewart, 186 Md.App. 684, 975 A.2d 271(Md. Ct. Spec. App 2009), involves an interesting twist on pre-formation contracts.  Lenkey and Kunkel were contractors, with separate businesses, each conducted through separate LLCs.  Apparently, Lenkey and Kunkel also conducted business as partners under the name Baltimore Street Builders.  Lenkey signed a construction contract in the name of Baltimore Street Builders, LLC.  Work under the contract began in January 2006.  The LLC was not organized until March 2007, shortly before the completion of the work in June 2007.  When the homeowner refused to pay for the work as performed, the LLC sued to establish and enforce a mechanic’s lien on the property.  The problem?  Neither Lenky, who signed the conttract, nor the LLC, nor its predecessor partnership, had a home improvement license, either at the time of contracting, or before starting or completing work.  No license, no lien.

The Court rejected the argument that the licensing requirement was met because work under the contract was done by Kunkel’s LLC, which did have a home improvement license.  The court reasoned that the statute required “persons” acting as contractors to be licensed, and defined person to include any “partnership, firm, association, corporation, or other entity.”  Slip Op., at 8-9. 

Inasmuch as neither Robert Lenkey or BSB [the LLC?]  of the informal partnership known as BSB ever had a home improvement contractor’s license, it cannot be said that the “person” with whom appellee contracted complied with [the licensing statute]. (sic).

Slip Op., at 9.  The Court also rejected a substantial compliance argument

Because BSB’s counsel admitted at oral argument before us that it was Mr. Kunkel’s company … that had the license, we interpret the appellant’s argument to be that BSB substantially complied with the statute because at the time the contract … was signed, BSB was a partnership and Mr. Kunkel was one of BSB’s partners, and an entity controlled by Mr. Kunkel had a license.  Such an attenuated relationship with a license holder can scarcely be considered “substantial compliance” in light of the requirement that the partnership [BSB] that contracts to do the home improvement work must be licensed.

Slip Op., at 12-13.

And, the mere fact that [Kunkel’s LLC], a sub contractor, was licensed does not fulfill the purpose of the Home Improvement Law insofar as [the homeowner] s concerned. After all, [the homeowner] never contracted with that entity and thus could not have successfully brought a breach contract action against [it.]

Slip Op., at 20.

Gary Rosin

Unfinished Business & Law Firms

Wednesday, August 12th, 2009

As noted earlier, In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), involves the concept of unfinished business.  That concept grows out of UPA Section 34(1)(a), which provides that, after dissolution,  partners have the power to bind the partnership “[b]y any act appropriate for . . . completing transactions unfinished at dissolution.”  

In a law firm, the primary unfinished business would include the representation of clients in matters already begun, but not yet completed.  We often associate law-firm unfinished business with contingent-fee litigation, but even matters billed on an hourly basis could have substantial remaining work–consider a major acquisition or commercial litigation, for example.  Unfinished business in no different from unbilled hourly matters or unpaid receivable; all must be finished, billed and collected for the benefit of the old firm. 

The Brobeck waiver of the firm’s interest in unfinished business amounted to a distribution in kind of that business.  It is well-settled that partners may agree to distributions in kind, rather than liquidations by sale and distributions of cash.  As noted by the Brobeck court, completing unfinished business of a law firm “can be protracted”.  Slip Op. at *8.  Given that, the court concluded that

an agreement that immediately disposes of unfinished business and minimizes the disruptive impact of a dissolution is appropriate, and the court will not fault them for complying with this aspect of California law.


The problem was that the Brobeck firm was not only insolvent, but also an LLP; its partners were not liable for the obligations that the firm could not cover.  There is a very real difference between the interests of the firm and those of its partners.  In that context, partner consent should not be sufficient to avoid a breach of the duty of loyalty to the partnership.  Yet the court treated the duty to account as operating only as among the partners. 

The court gestured towards the principle that agreements solely among partners cannot override the rights of creditors.  Slip. *10.  That said, the court incorrectly viewed the insolvency of the partnership as relating only to the general creditors’ remedy of the fraudulent transfer laws.  The duty to act for the benefit of the partnership cannot allow partners to strip assets from an insolvent firm.  any assertion otherwise is “manifestly unreasonable.”

Gary Rosin

Law-Firm Dissolutions & Fiduciary Duties. In re Brobeck, Pheleger & Harrison, LLP (Bankr. N. D. Cal 2009)

Wednesday, August 12th, 2009

Prior to filing bankruptcy, in order to facilitate an orderly liquidation and movement of attorneys to other firms, the law firm of Brobeck, Phleger & Harrison, LLP (“Brobeck”) amended its partnership agreement to include a waiver of the rights of the firm and its partners to any “unfinished business” of the firm, as that term is defined in Jewel v. Boxer. 

In In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), the bankruptcy court held that the provision was valid as a matter of California partnership law but was a fraudulent transfer because it was a transfer of interests in Brobeck’s property that was made while Brobeck was insolvent and without the receipt by Brobeck of any value in return.

In Jewel v. Boxer, 156 Cal.App.3d 171, 203 Cal.Rptr. 13 (1984), a California court of appeals held that, in the absence of an agreement otherwise, when a partnership dissolves, the partners have a duty to account to the dissolved firm and their former partners for profits earned on the dissolved firm’s unfinished business after deducting for overhead and reasonable compensation.  The Jewel case involved contingency fee matters, but later cases made clear that the rule also applies to hourly rate matters.  Many Brobeck partners were familiar with the Jewel duty to account because a law firm had recently sued Brobeck for an accounting of profits earned on unfinished business completed by former partners of that firm who went to Brobeck.  As the dissolution of Brobeck loomed, the Brobeck policy committee thus recommended that the  partnership agreement be amended to include a provision waiving Jewel claims that Brobeck would have against its former partners or their new firms except for two specified matters.  The amendment received the requisite approval of the partners, and Brobeck proceeded to dissolve.  After Brobeck entered involuntary bankruptcy, the trustee asserted various claims against the Brobeck partners and several firms who had hired Brobeck partners.  The trustee settled with most of the partners and the two firms to which most Brobeck partners moved, but certain Jewel claims were not settled, and the trustee asserted these claims against two firms and ten former Brobeck partners who moved to those firms.

The court first analyzed whether the Jewel waiver was valid under California partnership law.  The court concluded that the partners were not only free to adopt such a provision, but were, in fact, encouraged by the case law in this area to adopt an agreement as to how to handle unfinished business in a way that immediately disposes of unfinished business and minimizes the disruptive impact of the dissolution.  The court rejected the trustee’s arguments that the waiver ran afoul of the RUPA provision permitting modification of the duty of loyalty by identifying “specific types or categories of activities that do not violate the duty of loyalty” so long as the modification is not  “manifestly unreasonable.”  The trustee argued that the provision was not specific enough because it did not refer to the partners’ duty of loyalty, but the court stated that specific reference to the duty of loyalty, while “it may be a prudent exercise,” is not required for a valid modification of the duty under RUPA.  The court also rejected the trustee’s argument that the provision was “manifestly unreasonable.”  The court stated that it was left to rely on its common sense in the absence of case law defining the term, and the court concluded that the Jewel waiver was not “manifestly unreasonable.”  The court reasoned that the waiver did not eliminate the duty of loyalty, but merely modified the duty to account, which is just one of the three duties of loyalty set forth in RUPA.  The court stated that Brobeck’s insolvency at the time of adoption of the waiver did not affect its validity under RUPA because RUPA does not govern the relationship of the partnership or its partners to third parties, such as creditors.

While the court determined that the Jewel waiver was lawful and valid under RUPA, the court ultimately determined that the waiver was avoidable as a fraudulent transfer.  The court held that profits from unfinished business amounted to property of Brobeck and that the waiver effected a transfer of that property to the partners.  Although the court concluded that the trustee failed to meet his summary judgment burden with respect to actual intent to hinder, delay, or defraud a creditor, the court concluded that the trustee was entitled to summary judgment that the Jewel waiver was a constructively fraudulent transfer.  The parties did not dispute that Brobeck was insolvent when the waiver was approved, and the court concluded that there was no evidence that Brobeck received anything of value in exchange for the waiver.  Thus, the waiver was avoidable as a fraudulent transfer, and the partners, as initial transferees, and their new firms, as immediate transferees, were liable to the extent of profits received on Brobeck’s unfinished business.

Elizabeth Miller

Care in Contracting. BASF v. POSM II Properties Partnership LP (Del. Ch. 2009)

Sunday, March 8th, 2009

BASF Corp. v. POSM II Properties Partnership LP, C.A. No. 3608-VCS, (Del. Ch. March 3, 2009) (for opinion, see Delaware Corporate and Commercial Litigation blog), involved tiered limited partnerships.  BASF was a limited partner in POSM II Properties Partnership, LP formed to build and lease a facility to Lyondell’s predecessor-in-interest, ARCO.  The partnership’s general partner was POSM II Properties, the initial general partner of which was ARCO (later, Lyondell Chemical Company).  BASF’s predecessor-in-interest, Mobil, had negotiated for a right to withdraw from the partnership if ARCO (or, now, Lyondell) or its affiliates no longer operated the facility.  After Basel AF S.C.A.acquired Lyondell, Lyondell became a wholly-owned subsidiary of LyondellBasel.  BASF claimed that, even though Lyondell was still operating the facility, the change in control of Lyondell triggered the withdrawal right.  Slip Op. at 3-4.

Vice Chancellor Strine, noted that the parties’ agreement tied the withdrawal right to Lyondell’s operation of the facility, and not to a change in control of Lyondell itself.  Id. at 4-7.  He declined to find a de facto change in control:

If the parties t… had reached a bargain to give [BASF] a right to walk away and be bought out upon a change of control of [Lyondell], one would have expected them to use the common technique and do that explicitly. In this regard, it is notable that change of control provisions often detail the precise scenarios that qualify, whereas, under BASF’s approach, the parties would either have to reach an after-the-fact accord on what corporate events qualified as an implied change in the operator or have a court do so. 

Delaware law does not invest judicial officers with the power to creatively rewrite unambiguous contracts in this manner.

Id. at 13  (footnote omitted).

Certainly, it’s hard to imagine that major oil companies didn’t know about acquisitions and mergers, and the effect of various structures used in acquisitions on the rights of the parties.

Hat tip, Francis G.X. Pileggi.

posted by Gary Rosin