Question: Can two or more persons create a partnership even though they did not intend to do so?
Answer: Yes, under certain circumstances.
Generally, under Texas law an association of two or more persons to carry on a business for profit as owners creates a partnership, regardless of whether (1) the persons intend to create a partnership, or (2) the association is called a “partnership”, “joint venture”, or other name. Partnerships are governed by Chapter 152 of the Texas Business Organizations Code.
What this means is that two or more people could in fact cause the creation of a partnership even though they did not intend on doing so. The consequences of being partners is the fiduciary duty which arises between partners. The Texas Business Organizations Code also sets forth factors indicating that persons have created a partnership. These factors include:
(1) Receipt or right to receive a share of profits of the business;
(2) Expression of an intent to be partners in the business;
(3) Participation or right to participate in control of the business;
(4) Agreement to share or sharing:
(A) losses of the business; or
(B) liability for claims by third parties against the business; and
(5) Agreement to contribute or contributing money or property to the business.
Interestingly, an agreement by the owners of a business to share losses is not necessary to create a partnership.
On January 31, 2020, the Texas Supreme Court held that parties can conclusively negate the formation of a partnership under Chapter 152 of the Texas Business Organizations Code through contractual conditions precedent. The condition precedent was that the “venture” would not come into effect until the respective parties’ board of directors approved the deal. The boards of the companies never approved the venture and thus that one provision saved one of the parties almost half a billion dollars:
Texas Supreme Court upholds Court of Appeals reversal of FIVE-HUNDRED-MILLION-DOLLAR trial court verdict. In Energy Transfer v. Enterprise, the high court dealt with a clause that contained conditions precedent to forming a partnership. Enterprise and Energy Transfer, two of the top ten largest energy companies in the United States, sought to re-purpose an existing pipeline or build a new one to transfer crude oil south as opposed to north. The two companies expressly rejected creating a partnership until two conditions precedent were met: 1) execution of definitive agreements memorializing the terms and conditions of the pipeline transaction that 2) received approval from each party’s board of directors. Subsequently, when the companies failed to get shipping commitments to cover the potential costs of the pipeline, Enterprise ended talks with Energy Transfer. Enterprise would eventually go into business with ConocoPhillips. Energy Transfer, believing Enterprise and Energy Transfer entered into a partnership agreement, sued Enterprise claiming breach of fiduciary duty. (Fiduciary duty is putting the wellbeing and interest of the person for whom they are responsible above their individual interests; the duty commands exceptional loyalty of the party owing a fiduciary duty.) The trial court awarded Energy Transfer damages totaling $535,794,777.40. Enterprise appealed, and the Court of Appeals reversed the trial court’s ruling and found for Enterprise. As a result, Energy Transfer filed for review with the Texas Supreme Court. Enterprise continued to argue no fiduciary duty existed because no partnership was entered into between the parties. The Texas Supreme Court agreed. The Court, applying long-standing freedom to contract law, held that parties could require conditions precedent to the formation of a partnership notwithstanding the Texas Business Organizations Code’s five factor partnership test.
It is the general rule that when an agreement provides a condition precedent to the formation of a partnership, it will not come into existence until the condition has been met. However, such condition precedent may be waived and, if the parties actually proceed with the business, they may be held as partners even though the condition precedent has not been satisfied.
Chapter 152 is not the sole source of rules for determining partnership formation. The determination of formation of a partnership should “include” the five factors listed in the section. Those factors are not exclusive. Principles of law and equity supplement the statutory partnership provisions unless otherwise provided by this chapter or the other partnership provisions.
What should persons do when looking into a business venture?
First, the parties should enter into a written agreement, which can be informal, clearly stating that the parties are contemplating a business venture, or exploring the feasibility of a business venture; and that despite negotiations with third parties, expenditures of funds towards investigating the venture, reimbursement or sharing of expenses between the parties, no partnership shall be created “unless …….” (clearly and specifically stated).
That “unless” is the condition precedent. The condition can be approval of a formal agreement by the board of directors of corporations, by the manager or managers of an LLC, or the signed agreement for the formation of a partnership. The condition could be the enactment of a trade agreement with another country, or even a minimum price making up the subject matter of the venture, such as the price per bushel of corn must be “$$$” before any business venture shall be formed, or as simple as requiring the respective wives of the parties to approve the venture in writing.
Make sure oral agreements are disclaimed and a provision that the parties disclaim any reliance upon any representation made by, or information supplied by, the other party, and waives any claims for fraudulent inducement.
Should you need help understanding the laws surrounding General Partnerships, please contact one of our Murray-Lobb Attorneys.