Are you a sole proprietor simply conducting business with another person? Or, is that “person” actually your partner in a legally recognized partnership? While you may not believe you are a partner in a partnership with that “person,” surprise, a court may find you are indeed partners. And as partners, albeit unknowingly and/or inadvertently, you may owe additional duties to that partner; including, fiduciary duties (click here to learn more about fiduciary duties).
On December 21, 2011, the Iowa Court of Appeals published an opinion that addresses such partnership issues and how individuals may inadvertently become partners. In Hillman v. Cannon (click for opinion), the plaintiffs, who were injured in a motorcycle accident, sought to establish the defendants, two different parties conducting business together, had formed a partnership. Defendants responded to plaintiffs’ position and argued they (defendants) were not partners in a partnership. The trial court agreed with the defendants and concluded a partnership did not exist; finding instead, that defendants were two distinct sole proprietorships. The plaintiffs appealed.
On appeal, the Iowa Court of Appeals held that in order to establish a partnership, the plaintiffs were “required to show: (1) an intent by the parties to associate as partners; (2) a business; (3) earning of profits; and (4) co-ownership of profits, property, and control.” In Hillman, the court of appeals stated the second and third elements were uncontested; therefore, the court simply addressed the first and fourth elements.
Addressing the first element (intent), the Iowa Court of Appeals acknowledged:
- Iowa Code Section 486A.202(1) states that a partnership is formed when “two or more persons … carry on as co-owners of a business for profit … whether or not the persons intend to form a partnership.” The court, citing the Uniform Partnership Act Section 202, cmt. 1, acknowledged that the italicized language demonstrates a partnership may exist “regardless of the subjective intention to be ‘partners.’ Indeed, [persons] may inadvertently create a partnership despite their expressed subjective intention not to do so.” Consequently, the defendants in Hillman may be partners despite a possible subjective understanding that they were not partners.
- The court further stated that Iowa case law on partnership formation demonstrates “an intent to associate is the crucial test of partnership.” The Iowa Court of Appeals did not state an intent to associate as partners is the crucial test of partnership, just that an “intent to associate” is the test. To this end, the court of appeals acknowledged, “[t]he ‘focus is not on whether individuals subjectively intended to form a partnership, but on whether the individuals intended to jointly carry on a business for profit.’”
- Finally, the court also acknowledged that the requisite intent may be gleaned from the conduct of the parties and the circumstances surrounding the transactions.
Addressing the fourth and final element (co-ownership), the Iowa Court of Appeals acknowledged:
- When parties share “gross receipts, rather than profits,” a partnership may not be formed. And “[t]he distinction between ‘a contemplated sharing of gross receipts and a sharing of profits is commonly drawn and recognized as valid.’”
- “The ‘sharing of excess receipts over disbursements, without proof of separate individual operating expenses attributable to either partner, in effect constitutes a sharing of profits,” which is consistent with the formation of a partnership.
- Citing the Iowa Supreme Court opinion in Chariton Feed & Grain, 369 N.W.2d at 786, the court of appeals stated: “[c]o-ownership of control, or a community of interest in the administration of the business, is a key element in determining the existence of a partnership.” When determining whether co-ownership exists, the court recognized that objective evidence of co-ownership “usually focuses on acts such as holding licenses, assuming a firm name, keeping books that show a capital account for each party, or filing federal partnership tax returns.”
The Hillman opinion provides colorful insight on two (2) of the factors that an Iowa Court may consider when determine whether a partnership exists. While the Hillman court concluded a partnership did not exist, it is clear that if the facts had differed slightly, a different outcome may have likely occurred. If you are curious or have concern as to whether you are a partner in an inadvertently created partnership, an attorney with experience in this area of the law should be able to provide guidance based upon the unique facts of your business arrangement(s).
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