Articles Posted in Partnerships

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The recent court case of Scafidi v. Hille No. 2014-CA-01261-SCT offers countless reminders for small business owners both experienced and novice about the importance of planning and documenting no matter what the relationship is between the parties involved. While there may be certain factors that may make it seem unnecessary to plan or develop managerial and operational strategies, this case highlights just how messy things can become no matter what the relationship is between the individuals. The overall message is to always plan ahead, document finances and other important information, and remember that when it comes to business, relationships should be set aside.

A Breakdown of the Case

Scafidi v. Hille centers on issues between a brother and sister who inherited a total of three family businesses. Due to the lack of proper planning, the funds were comingled, at one point one or both individuals were kept out of big decision-making processes, funds were not split properly and in the end this led to a huge upset between siblings and a lengthy court battle. The lack of formality in the operation of the business made the case complex and a battle that could have been completely avoided. In the end, each party was awarded a single business each and the third business was sold and funds were split. However, with some planning, not only could they both have been spared legal expenses and the stress associated with such a process, but they could have had three thriving businesses that each one could have benefited from. This case highlights the exact reasons why any business should hire a knowledgeable business attorney to assist with the process.

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In the recent ruling of DKN Holdings, LLC v. Wade Faerber (decided on July 13, 2015) the California Supreme Court helped clarify the meaning of joint and several liability holding. Parties that are jointly and severally liable on the same obligation can be sued in separate actions which are not barred by the doctrines of claim preclusion or issue preclusion.

The cause of action for this case arose from Caputo, Faerber, and Neel, three individuals who each signed a ten-year lease to operate a gym in a shopping center. Caputo later sued DKN, the landlord, for damages and rescission of the lease based on fraud, breach of contract, and other claims. DKN cross-complained for rent and other monies due under the lease. DKN won at a bench trial and was awarded over $2.8 million in damages. DKN then sued Faerber and Neel for breach of the lease.

Faerber demurred, arguing that, because the landlord’s rights under the lease was adjudicated in the first action, suit against him was barred by the rule against splitting a cause of action. In opposition, the landlord argued that separate actions are permitted against parties who are jointly and severally liable. The trial court sustained the demurrer without leave to amend and entered judgment for Faerber.

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What are the consequences of an improperly formed partnership? The case of Utnehmer v. Crull (In re Utnehmer), 2013 WL 5573198 (B.A.P. 9th Cir October 10, 2013), recently decided by the Bankruptcy Appellate Panel of the 9th Circuit here in California, may shed some light on this question.

The Facts

In 2005, real estate developer William Utnehmer, the debtor and defendant in this case, undertook to develop a luxury property in Venice, California. Mary and Patrick Crull, the judgment creditors and plaintiffs in this case, were offered an opportunity to participate in the project, which they accepted. Utnehmer sent the Crulls a packet of documents, which included a cover letter, a loan agreement for $100,000, a promissory note, and a private offering memo. The loan agreement provided that $50,000 of the initial $100,000 was intended to be superseded by execution of a formal operating agreement which would recharacterize the $50,000 of the Crull’s interest as an investor’s equity interest in a limited liability company to be formed, with an annual preferred return, and a percentage participation in profits on a prorated basis. At the time these documents were exchanged, the documents for formation of the limited liability company and the operating agreement were allegedly being drafted. The parties subsequently executed a promissory note, which was consistent with the loan agreement but made no reference to the expected recharacterization of the $50,000 as an equity interest.

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When starting a business, one thing that you need to think about is the type of business you would like to create. The most commonly known type of business is a called a corporations, but there are also other other types of businesses such as partnerships. And within each type of business, there are subsets, such general partnerships versus limited partnerships. Each title comes with a different set of responsibilities and liabilities. That is why it is important to look at each business options and figure out which options are best for your needs. Once you decide on a business type, you need to register it properly. An improper registration, can cause problems such as making you personally liable for your business transactions when that was not your intent or it can allow clients and vendors to cancel contracts. While there are some mistakes that are minor and fairly easy to fix, it will still be time consuming and often costly.

Take, for example, this California case where an improper registration almost cancelled the partial sale of a company. In this case, Howard and Jane Farnsworth bought John and Velma Dawson’s interests as limited partners in Nevada-Cal Management, Ltd. (“Nevada-Cal”). Nevada-Cal is a limited copartnership made up of bother limited and general partners. The Farnsworthes sued Nevada-Cal because after they purchased the Dawsons’ shares, they learned the limited partnership was not properly formed. Because the partnership was improperly formed, the Farnsworthes believed that the sale of the limited partnership interests were invalid, and therefore wanted their money back.

Under California law, at the time of this case, all companies were required to have a permit before they could sell security, which included partnership interests, without a permit. There were exceptions in place, but specifically for properly formed general and limited partnerships. In deciding this case, the judge not only looked to the relevant laws in place, but also to the intent of the writers of the law. The judge found that the purpose of the law was to protect the general public against scheming companies, not an individual in a private sale. In small sales, individuals have the ability to ask questions directly to the seller, or its representatives. When companies make securities available to the public, the public only has the public filings from the previous year and whatever the company divulges in the investment packet. If someone has a specific question, it is not guaranteed it will be answered. Requiring permits is one more way for the public to find out more information about a company on its own. Because of this, the judge decided in favor of the Dawsons, finding a permit unnecessary and making the sale valid.