General partnerships, and their “joint venture” cousins, are composed of partners seeking to make a profit in a business venture. But things don’t always work out. Often, a once promising endeavor breaks down due to mismanagement and miscommunication. In these situations, partners may feel the urge to get out with whatever equity they can. Usually, it isn’t that easy.
The Revised Uniform Partnership Act allows partners to dissociate from their partnerships whenever they want. Yet this withdrawal can sometimes cause serious damage, especially when the partner trying to leave was a major source of capital. For that reason, the California Corporations Code provides for penalties when the dissociation is “wrongful.” In the end, getting out of a partnership isn’t so much about doing it the “right” way as it is about avoiding the “wrong” way to dissociate.
What is dissociation?
A “dissociation” is a legal way of saying that a partner is leaving the partnership. But the process is not as simple as outright declaring that one is withdrawing from the business venture. Instead, dissociation is governed by its own set of rules of regulations under the California Corporations Code.
Additionally, where the previous version of the Uniform Partnership Act mandated a dissolution and winding up of the partnership, now the concept of dissociation merely describes a change in the relationship caused by a partner ceasing to be associated with the partnership business.
How does a partner dissociate?
The Corporations Code sets out events that will lead to a partner’s dissociation in section 16601. While the list is expansive, the main ways a partner can dissociate are as follows:
(1) The partner gives notice to the partnership of their express intent to withdraw from the venture at a specified date, (2) the partnership agreement contains a provision setting out how a partner dissociates, (3) the partner is expelled from the venture according to the partnership agreement, (4) the partner is expelled via a unanimous vote of all the other partners, (5) the court system expels the partner through a judicial determination, and (6) the partner dies. (Corp. Code § 16601.)
Some of these situations require additional actions. For instance, a partner cannot go to the courts to dissociate another partner without cause. By code, it is mandatory for that partner to have engaged in wrongful conduct, willfully breached the partnership agreement, or engaged in conduct that makes carrying on the partnership not reasonably practicable. (Corp. Code § 16601(5).)
When is a dissociation wrongful?
While the Corporations Code does not provide a definition of a “rightful” dissociation, it does explicitly provide for what constitutes a wrongful dissociation in section 16602.
There are two ways a dissociation can be wrongful. The first is if the dissociation is in breach of an express provision of the partnership agreement. Partnership agreements are incredibly powerful. In fact, the “terms of a partnership are controlled by the partnership agreement, or by [RUPA] if the agreement is silent on an issue.” (Jones v. Goodman (2020) 57 Cal.App.5th 521, 531.
Thus, if the partnership agreement dictates that dissociation can only proceed according to certain procedures, then a failure to comply with those procedures results in a wrongful dissociation.
The second way dissociation can be wrongful concerns only partnerships for definite terms and particular undertakings. Usually, partnerships will set out that they are to last a definite amount of time, following which the partnership will terminate. Alternatively, some partnerships will set out in their agreement that their purpose is to accomplish an undertaking, whatever it may be. Upon completion of the goal, the partnership dissolves.
If the partnership is for a definite term or particular undertaking, then a partner’s decision to dissociate prior to that date/goal is considered wrongful only if any of the following apply: (1) the partner chooses to withdraw by their express will, (2) they are judicially expelled, (3) they become a debtor in bankruptcy, or (4) the partner is some type of business association, and that association itself dissolves.
By means of example, in Bustamante v. Intuit, Inc. (2006) 141 Cal.App.4th 199, Bustamante entered a joint venture with Intuit to introduce their wildly popular “QuickBooks” technology to Mexico.
But their written agreement was woefully lacking. It provided only that they would “form and launch” a company in Mexico. When it was clear the venture would not work out, Intuit terminated the relationship. Bustamante sued for wrongful dissociation.
The court found that the dissociation was not wrongful because the terms were unclear, and there was no “meeting of the minds” on several key provisions, such as investor funding commitments. This case is an important reminder that partnership agreements are still contracts and are subject to scrutiny in lawsuits.
What is the effect of a “rightful” dissociation?
Once a partner dissociates from a partnership, a few things happen.
First, their right to participate in the management and conduct of the partnership terminates. (Corp. Code § 16603.) Along with this comes the termination of any duty of loyalty or care the former partner had to the partnership.
Then, under section 16701, the partnership must buy out the dissociated partner’s interest in the partnership. This way, the partners have the ability to continue the partnership if they so choose.
Yet, this is not as cut and dry as it appears. While the code does provide for a method of determining the buy-out price, inter-partnership squabbles inevitably lead to lawsuits and court action. But-out disputes are incredibly common.
What is the effect of wrongful dissociation?
Wrongfully dissociating from a partnership can carry heavy penalties. Usually, it will lead to some type of lawsuit.
This is because a partner who wrongfully dissociates is liable to the partnership for damages caused by the dissociation. This liability is in addition to any other obligation of the partner to the partnership or to the other partners. (Corp. Code § 16602 (c).)
Yet, under RUPA and California law, liability for damages is the extent of the punishment. Some partnership agreements will attempt to include a clause that strips a wrongfully dissociating partner of their partnership capital account, but California cases have held such clauses unenforceable. “California case law does not support a forfeiture of a capital account.” (O’Flaherty v. Belgum (2004) 115 Cal.App.4th 1044, 1058.)
While wrongful dissociation still mandates a buy-out, the damages from the dissociation are subtracted from the distribution of funds. Moreover, if the wrongful dissociation is related to a premature withdrawal, the dissociating partner is not entitled to any portion of the buy-out price until the term or undertaking is complete. (Corp. Code § 16701 (h).)
How can the attorneys at the Underwood Law Firm, P.C. assist you?
Partnership law can be incredibly tricky, despite its heavy reliance on statutes and codes. Because of the penalties associated with wrongfully dissociating, partners need to understand their agreements to ensure that when they leave the venture, they are doing it the right way and unencumbered by the possibility of a lawsuit.
As each case is unique, members of partnerships would be well-served to seek experienced counsel familiar with contract interpretation and partnership law. At the Underwood Law Firm, P.C., our knowledgeable attorneys are here to help. If you are concerned about dissociating from a partnership, worried that one of your fellow partners is trying to wrongfully dissociate or if you just have questions, please do not hesitate to contact our office.
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