What Obligations and Duties to Partners Have to one Another?
By Dan Frith
Many business men and women form “partnerships” and “limited liability partnerships” to own and run their various business operations. Why? One of the primary reasons is to avoid personal liability for the businesses’ debts and obligations and that is a good reason to form a partnership.
However, while using the partnership model to run your business and, hopefully, protect your personal assets and wealth, the use of this form of business entity is not without potential problems and issues. Our firm was recently involved in a dispute over the dissolution of a professional medical practice which operated as a limited liability partnership. The professional practice began as two doctor operation but continued to grow, expand, and hire additional doctors, all of whom eventually became partners. The doctor who started the practice ran it as a King might run his Kingdom. He did not look to his partners for input or decisions. Most importantly (and disastrously for the King) he made all financial decisions affecting the partners and the partnership, sharing little information with his fellow partners except his final decision on financial issues. As an important aside, he also used the partnership’s checking account as his own personal check book.
Needless to say, the King did not remain King for long. As soon as his partners learned of his financial self-dealings, lawyers got involved for each separate physician/partner and it got messy very quickly. I share this background as a foundation for what follows, a brief discussion of the duties and obligations partners have to one another under Virginia law.
In Virginia a partnership is governed by the Virginia Uniform Partnership Act (the “Virginia Act”), Va. Code Ann. §§ 50-73.79 to .150. The Virginia Act is closely modeled after the Revised Uniform Partnership Act (“RUPA”). RUPA has been adopted in some form by at least 36 states, including Virginia, as well as the District of Columbia.
Addressing the general standards of a partner’s conduct, the Virginia Act provides that “[t]he only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections B and C.” Subsections B and C of § 50-73.102 of the Virginia Act define the fiduciary duties of loyalty and care owed by a partner as follows:
- A partner’s duty of loyalty to the partnership and the other partners is limited to the following:
- To account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;
- To refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and
- To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.
- A partner’s duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
In order to prevail on a claim for breach of fiduciary duty against one of its partners, a partnership must show not only that the partner benefited from the challenged transaction, but that the partnership was harmed by the transaction.
The fiduciary duties of loyalty and care are not the only duties owed by partners to each other and to the partnership itself. Va. Code Ann. §50-73.102(D) provides as follows:
- A partner shall discharge the duties to the partnership and the other partners under this chapter or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.
Unfortunately, the Virginia Act does not define what is meant by “good faith and fair dealing.” The official comments to RUPA do, however, indicate that “‘good faith” clearly suggests a subjective element, while “fair dealing’ implies an objective component.” In addition, “good faith,” as judges generally use the term in contract disputes, is best understood as an ‘excluder,’ a phrase with no general meaning or meanings of its own. Instead, it functions to rule out many different forms of “bad faith.” The drafters of RUPA “intended the characterization of good faith and fair dealing as a non-fiduciary obligation,” as opposed to the fiduciary duties of loyalty and care.
The Virginia Act prohibits the enforcement of a partnership agreement which eliminates the obligation of good faith and fair dealing. In other words, despite the language the King drafted into the medical group’s partnership agreement which limited his obligations and duties to treat his partners fairly, Virginia law would look past such self-serving language and impose the obligation of good faith and fair dealing.
In our case the King/doctor/partner designated himself as the “managing partner” in the partnership documents. A managing partner’s obligations to his partners are even greater and he owes the highest possible fiduciary duty to his partners. Several courts have held that managing partners owe their partners the highest fiduciary duty recognized in the law. A managing partner has a duty to administer the partnership affairs solely for the benefit of the partnership and may not place himself in a position where it benefits him to violate this duty.”
In short, if you are a partner in a partnership or limited liability partnership (and not the King) you have rights and you can hold your partners accountable if you are treated unfairly.