The Basics of Unwritten Partnerships
An informal partnership typically arises by way of a handshake and even though an informal partnership may not be a legal entity, participants still have rights and responsibilities. Each of the partners assume all liabilities and obligations with respect to their activities as a partnership. Under state partnership laws, each partner is considered an agent of the other partners and is obligated to act in accordance with the agreement and the understanding that the partner will act for the common benefit of the partnership. The partners can bind the partnership by their actions and can obligate the partnership without the need for the signature or consent of the remaining partners. In addition, the partners are liable for the partial or full extent of torts, negligence or other misconduct of each partner and the partnership can be held liable for negligent or criminal acts of a partner. Informal partnerships often arise in circumstances in which two or more people sit at a bar, discuss an idea, and immediately decide to acquire some restaurants based upon their love of cooking . The basic difference between a general partnership and an LLC, for example, is that in an LLC the limited liability characteristics of the entity separate assets and liabilities from those of the individuals that are members of the LLC, i.e., liability to satisfy claims against the LLC is limited to the assets of the LLC. In most cases, owners of an informal partnership must be mindful of doing the necessary due diligence regarding any liability or credit issues that could affect each of the partners in the partnership and since partners have been adjudged personally liable for corporate debt, restrictive covenants, etc., full disclosure and discussion among all partners must occur before becoming partners. In addition, all of the partners must also recognize that they are bound by the acts of the others, and that a single act of any of the partners could create liability for all of the partners.
When there’s No Contract Between Business Owners
Navigating Partnerships Without Formal Agreements
For all the good that can come from partners working together, there can be a lot of bad as well. In some cases, this bad can be disastrous. No matter how well two partners seem to work together or how amicably they might part, having a legal document in place is critical to protecting yourself and your business.
In theory, you would expect a verbal partnership to be generally no different than a written one. In practice, however, things rarely play out that way. When there is no explicit terms of a partnership, it is sometimes up to the courts to determine what is and is not acceptable. The absence of a partnership agreement does not, however, make you a sole proprietor. You will still be held responsible for all the action and inactions of your partners. Even an agreement lacking formalities is likely to be recognized by the courts, as long as those terms are followed by both partners. Even if the courts do eventually side with you, in the interim you may find yourself responsible for liabilities that your partner causes.
The answer to the question of why it matters is simple: Liability. If you enter into a business arrangement with someone without a written account of intentions, terms, signatures, etc., you and the other individual act as one entity under the eyes of the law. Therefore, if one of you acts irresponsibly, it can cause issues for both of you. While you should generally be able to approximate the terms of your arrangement verbally, no two agreements are presumably the same. Still, it’d be safe to say that if something bad happens, the fault will rest with the person responsible for the issue.
Liability and Risk of an Oral Partnership Agreement
In the shifting landscape of business, the absence of a formal, written agreement with a business partner can lead to a domino effect of complications. While the initial formation of a partnership may be born out of shared ideas, goals, or simply a sense of mutual trust, the unraveling of that partnership is a different story altogether. Verbal agreements, even if they seem to have been straightforward, can quickly become ambiguous. Misunderstandings can arise as partners interpret the terms differently, or as one partner claims that an initial condition has been violated. If a verbal agreement has been breached, litigation usually ensues. And once the court gets involved, it follows its own procedures concerning written agreements, because the lack of a written document is not an excuse for shirking the facts and circumstances from the Court. Therefore it is the non-breaching partner that must prove the existence and scope of the verbal agreement. So before investing too much effort into a business relationship, consider the risk that follows a verbal agreement with a business associate. Even if you believe that everything is going well, without a verification of the deal in writing, you are straddling a 50% risk of loss at all times. A written agreement that is properly drafted with a qualified attorney and signed by both parties, can establish respective rights and duties consistent with the terms of the transaction. Following the terms of an agreement can help a person stay out of court, and keep the costs of an agreement reasonable.
How to Protect Yourself Informally
When formal agreements are not in place, partners can still take steps to protect themselves. Careful attention to detail, documenting informal understandings, and having a plan to resolve disputes offer some protection in the absence of a written partnership agreement.
Partnerships require clear communication between the partners. Although an oral agreement may be legally enforceable, it is far less secure than a written agreement because oral agreements are vague and vague agreements often lead to misunderstanding and suspicion.
Written terms that outline the understanding(s) of the partners should be created . These terms may include what assets have been purchased and how they are to be divided, how the partnership will be dissolved, how an inadequate or unfit partner can be removed, how assets are to be protected, and any other issue that partners need to come to a consensus on. This record can provide a precious basis for a legal action if a dispute arises.
Partnerships often come to an end as a result of conflict between the partners. The ability to peacefully dissolve a partnership therefore greatly increases the likelihood of its success. A viable plan for resolving a conflict might include a neutral third-party mediator to oversee the negotiations and/or an impartial accountant to review the partnership records.
Starting a Partnership Without a Contract
While written agreements are almost always the recommended choice for memorializing relationships, they’re not the only option available. Agreements less formal than a contract may also provide some degree of certainty to companies brokering partnerships at various levels.
Memorandum of Understanding (MOU) An MOU typically spells out all key points of a prospective business relationship. An MOU is usually signed by both parties but lacks the exchange of anything of value in return — other than a promise of good faith in the collaborative process. A signed MOU may be viewed as binding by a court. However, if the agreement includes terms such as "subject to contract", "not legally binding", or "in principle only", it may be interpreted as nonbinding by a court.
Letter Agreement A letter agreement lays the foundation for a future deal, often in the context of an agreement in principle. Like an MOU, it is generally not binding but may be looked upon as binding by a court if its terms are detailed enough to rise to the level of a contract.
Handshake Deal During dynamic negotiations, not every commitment can or should be documented. In some instances, a mere handshake may be sufficient. For example, for a small project, previous relationship with the company may lead you to trust that it will deliver as promised. Handshake deals are quick, flexible and inexpensive but they have serious drawbacks. If the parties’ understandings are different, litigation may ensue. The lack of clear commitment as to each party’s obligations also leaves the parties exposed to unanticipated risk.
Formalizing the Relationship Selecting the right alternative to a formal written agreement depends on the complexity and size of a project, cultural norms, industry standards, and the willingness of the parties to invest in a binding agreement.
When You May Need a Lawyer
When entering into an informal partnership, it is always better to consult a legal professional. Even when you think that your partnership is operating smoothly, it is helpful to consult with an attorney. The professional can give you insight into the rules and regulations of a partnership and explain how the law will perceive certain actions. This becomes more crucial when there is a change in the partnership . Changes in ownership or management can affect how the partnership operates and how the law will come into play. Also, when there is a dispute it is important to consult with an attorney to learn about your legal standing and options in a case. If the dispute is internal, having a professional help you resolve the matter is beneficial. If the issue with the partners, however; is external to your partnership, the legal professional can advise you to get your matter resolved quickly and properly for all involved.