Partnership disputes – Mediating Business Conflicts

Running any business is hard. It is especially hard if you are trying to do it by yourself.  After all, a sole proprietor has to do everything, from choosing where and when to open, to provide a profitable product or service, to paying the bills, to bringing in new business. If he or she is out of the office, the money stops flowing. Employees can help perform some functions, but they must be paid and supervised. It is very difficult for one person to be good at all of the activities that go into running a business successfully, and still more difficult to pay for every aspect of operations. 

One way of lessening the burdens of entrepreneurship is to share them with a partner or partners. A partner is someone who participates jointly in the operation of a trade or business, contributing capital, labor or both in return for a share of the profits.  However, like those in other relationships, partners engage in disputes with one another.  These disputes and their resolution are necessarily affected by the peculiar legal and social characteristics of the relationship. These characteristics and their effects are discussed next.

General legal principles of partnership 

General Partnerships, Limited Partnerships, and LLPs

It is important to distinguish between general partners and limited or “silent” partners. While general partners have a voice in the management of the firm and are responsible for partnership liabilities to the full extent of their assets, limited partners only invest money in the business in return for a share of the profits. A limited partner is only responsible for partnership debts to the extent of his or her investment.  A limited partner who becomes involved in operations risks losing this protection and being re-characterized as a general partner with full exposure for partnership liabilities, including the wrongdoing of one’s partners in the conduct of partnership business.

A related business structure is the limited liability partnership (LLP), in which members are not responsible for one another’s wrongdoing. Also, their non-partnership assets are not at risk. Unlike limited partnerships, each member of an LLP has an equal right to management. An LLP is a kind of general partnership.

Fiduciary duties

Each general partner owes fiduciary duties to his or her general and limited partners.  In California, the duties are called:

* The duty of care: A duty to avoid negligence, recklessness, or violation of the law.

* The duty of loyalty: A duty not to compete with the partnership or divert opportunities that should have come to it to oneself; a duty not to act adversely to the partnership on behalf of another; and a duty to account to the partnership for all benefits received on its behalf.

* The duty of obedience: A duty to comply with applicable law, any partnership agreement and the partnership’s purpose and mission.

* The duty of good faith and fair dealing: Partners must treat each other fairly and deal honestly with one another.

Similarities between a marriage and a general partnership 

Though some jurisdictions call a partnership a legal entity, others adhere to the common-law rule that a partnership is merely an aggregation of individuals who have agreed to support and be responsible for one another in pursuit of common business goals.  

In many ways, a general partnership is like a marriage:  They have many of the same powers and liabilities with regard to partnership property that spouses have concerning the marital property. For example, general partners are financially liable for one another’s partnership-related torts, have the authority to incur debt and bind each other to legal obligations, and are entitled to manage partnership assets. Spouses and partners both owe mutual fiduciary duties.   We typically choose a spouse more carefully than we choose a partner (who may be brought on simply because he or she does something better than we do, or has resources we lack). But we owe greater fiduciary duties to our partners than to our spouses. We also risk more. Our separate property is not reachable to pay most of our spouse’s debts. But all we have is at risk for general partnership debts.  Choosing our partners should be done with utmost care. And like a marriage, disagreements in a partnership can have serious consequences..

What happens when partners disagree?

Unless a partnership agreement specifies otherwise, each partner has equal decision-making power, and the majority rule applies. (A few matters statutorily require unanimity.) The majority rule means that where partners are equally divided, nothing happens.  Since there are situations in which the status quo is untenable, the partners must learn to work together if the partnership is to thrive. Even when the majority is given effect, the dissenting partner or partners may feel excluded, disrespected, frustrated, and angry.

A dissenting partner may act on his or her own, with full authority to bind business partners.  As long as the acts are done with due care and for the benefit of all, there is probably no breach of fiduciary duty. If the partnership agreement specifically provides that a partner must abide by the decision of the majority, the unilateral action will be a violation of the fiduciary duty of obedience. But all business partners will still be bound by the unauthorized actions of the dissenting partner unless the contracting third parties knew there was no authority.

Let’s assume that the action of the dissenting partner is not destructive to the partnership and that it isn’t clear that a fiduciary duty was breached. Even in this scenario, conduct in opposition to the majority, or even the presence of an insistent minority, is likely to lead to an ongoing dispute between the partners. Whatever time, energy, and money are expended disputing is a drain on the business.  

Too much conflict will erode the trust necessary for a successful partnership.  Important decisions may not be made or maybe delayed while partners bicker.  Work may suffer as anger and frustration cloud judgment and distract critical personnel from the work at hand. Employees or junior partners will lack direction and may not know whose instructions to follow. Clients may not get consistent service or feedback.

Mediating Partnership disputes requires a broad skillset

An underlying assumption of partnership law is that partners will make decisions jointly and cooperatively, each acting with full authority for the benefit of all.  In return, each general partner risks everything, counting on the success of the business for his or her livelihood.  The degree of risk and dependence amplifies emotions when things go wrong or expectations of cooperation are violated, in much the same way that marital disharmony leads to heightened emotions.  Like spouses, partners count on one another’s support and depend on the success of the collective endeavor. Threats to success generate anger and fear, leaving partners impulsive, jealous and suspicious of those they need to trust most. So mediating partnership disputes requires the ability to deal effectively with strong negative emotions.

A good partnership mediator also needs to excel at promoting communication.  Partnership formation need not be a formal process. Too often, partners don’t openly discuss their vision for the business to be sure their goals are compatible, or inventory their joint skills to decide who should perform what functions. The author is aware of one law firm in which the management tasks fell to the partner who lost a drinking game.  Mediators need to draw out unspoken expectations, unsatisfied goals and hopes for the future. Where there is dissent, alternatives need to be explored. A good question for dissenters, after the obvious “Why don’t you want to do X?,” is “What can be done to make you more comfortable with X?” To a partner afraid the business will become overextended, reaching certain financial goals before taking costly action might be the answer. To one with a new wife or baby, fewer hours may be the key to consensus. If the volume of work requires his or her constant presence, it may be time to discuss adding an employee or partner to take some of the strain.  

This example brings up an important point. Like the partners themselves, businesses change. The former workaholic may become a homebody after marriage; the managing partner may want to stop managing in favor of more time practicing her profession. The risk-taker might become risk-averse as personal circumstances or market conditions change.  Businesses that depended on personal contact for years or decades may need to adapt and provide services virtually. Advertising on the internet is becoming more important as we lessen face-to-face interactions. So is social media.  Having someone design a website or Facebook page might not be enough anymore. Perhaps it is time to find a tech-savvy partner or employee.  Industries, even whole societies, change. To remain viable, partnerships and their businesses must also change.  We are currently living in a time of accelerated change.  Good partnership mediators need to be alive to these realities, and ideally will be familiar with current conditions in the business partner’s relevant industry. This will help them assist the partners in discovering mutually beneficial alternatives to the current conflict.

Lastly, if the partners are or may soon be involved in a legal dispute and desire an evaluation or prevention using legal knowledge, a good mediator must be familiar with the intricacies of partnership law.  Many partnership disputes spring from flaws in the partnership agreement, or the failure to have one at all. In the early stages of a business, planning for the withdrawal, death, or bankruptcy of a partner may seem unnecessary and even defeatist. But if a partnership agreement does not address these issues adequately, any of these events will automatically cause the dissolution of a partnership. This is only an example. The point is that a mediator can, without becoming a draftsman, suggest the need for legal assistance to ameliorate or prevent a dispute that could end in litigation.

Conclusion

Because of the high degree of liability, trust, and interdependence between business partners, partnership disputes are often more intense and emotional than those in sole proprietorships, corporations, or other business structures.  A nonproductive or even misbehaving partner can’t be fired like an employee. Usually, unless they break the law, they cannot be forced out. Even if they can, costly litigation will probably be required. Meanwhile, every partner’s assets remain at risk. Less dramatic disputes still can weaken the business everyone depends on. A good partnership mediator should be able to facilitate communication, adept at dealing with intense emotions, familiar with how partnerships work day-to-day, and ideally with the industry involved. Integrative solutions are critical to partners, who may have no realistic choice but to find a way forward together if their business is to succeed.

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