Our weekly columns frequently focus on the virtues of formally organized business entities, such as limited partnerships, limited liability companies and corporations. However, the largest number of all entities in the United States don’t fall within any of these categories. They are either sole proprietorships or general partnerships. The sole proprietorship and general partnership are the default entities for those who have begun to conduct a business, provide a service, perform a trade or sell a product on their own, but have not elected another form of entity.

Last week’s article focused on the mechanics of the sole proprietorship, which is analogous to a one man show. For review, although the sole proprietor may employ agents to aid with the operation of the business, the business’s identity is one and the same as the owner for both income tax and legal purposes.

A general partnership is very similar to sole proprietorship in many respects, with the main distinction being that there is more than one owner. A partnership, by its nature, must have at least two partners and can have as many more than that as the existing partners agree to accept. The statutory definition of an Oklahoma partnership also dictates that the association of these two or more persons must be for the purpose of carrying on a business for profit. There are no initial filing requirements to form a partnership. The partnership may simply carry the name of the members or may elect to conduct business under a trade name. Again, if a trade name is used, it is advisable to register it as a tradename with the Oklahoma Secretary of State.

No formal partnership agreement is required to form a general partnership, however, it is highly recommended. If the partners elect not to sign a partnership agreement, the "Oklahoma Revised Uniform Partnership Act" will supply the basic terms that govern the operation of the partnership. Most of the rules provided by the partnership act are default rules, which the partners may choose to override in their formal agreement.

Because the default rules provided by state statute may or may not be the rules by which you would want to operate and because the laws can change over time, it is in the best interest of a new partnership for all partners to sit down together and determine what the parameters should be and to reduce those terms to writing. When it comes to reducing your partnership agreement to writing, remember that an ounce of prevention is worth a pound of cure. Never assume that all partners are in agreement on matters that have not been discussed. Once you have discussed your arrangement, for the protection of all partners be bold in taking the next step and put it in writing!

Some of the issues the partners should discuss, agree upon and include in the partnership agreement are as follows: How long will the partnership last? A partnership can be for a short time, such as the undertaking of a particular project, or for much longer. What will each new partner contribute and what proportion of ownership will each partner receive for his contributions? While partners may bring very different assets into the partnership, such as money, equipment, skills or labor, the law presumes that all partners have an equal ownership interest, and consequently, unless the partnership agreement dictates otherwise, all will equally share in profits and losses. Who will have authority to bind the partnership when dealing with third parties? If you intend for certain partners to handle the business’s management and for others to be silent, your agreement should say so. Also consider defining what matters should be subject to approval by a majority or unanimous vote and what matters are routine and may be handled by one or more designated members without group authorization. Also consider what should be grounds for permitting the termination of the partnership, and on what conditions new partners may be admitted or existing partners may be expelled. Please keep in mind that this list is not comprehensive, just a starting point for thinking ahead of the issues that will confront your business over time.

All earnings and losses of the partnership will be taxable directly to the partners according to their ownership interests. While a partnership avoids the double taxation associated with a corporation, partnerships present another potential tax problem because all of the earnings (or losses) are taxed to the partners regardless of whether or not the partnership has made distributions. Consequently, if the partnership generates large amounts of taxable income, and reinvests all net earnings without paying any distributions to the partners, the partners will be responsible for paying the taxes on the partnership income out of their own pockets.

The primary drawback of conducting business as a general partnership is the unlimited liability of the partnership for potential personal claims against each partner and the individual partners’ potentially unlimited liability for claims of creditors of the business. Like the sole proprietorship, the assets of any individual partner may be required to satisfy claims or debts of any partner incurred in the scope of the partnership’s activities. While insurance can minimize exposure to some kinds of liability, a wiser choice would be to consider converting the general partnership into a limited liability entity, such as a limited partnership, limited liability company, or corporation.

Although the simplicity of startup may appeal to the small group who have recently undertaken a new business activity, many business owners quickly realize they need liability protection both for their business enterprise and for their personal assets. For these reasons, most general partnerships are eventually converted into an entity that provides the desired liability protection. These entities have quite different organizational and operational requirements, many of which have been discussed in prior articles, which are archived on our website at www.brownlaw-ok.com.

If you would like help drafting a general partnership agreement or if you have questions regarding a general partnership or the steps necessary to convert a partnership to another form of entity, be sure to consult with an attorney knowledgeable in business transactional law.

© Sarah J. Lane 2004

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