03 / 07 / 2017

Partnership Disputes in Small Businesses: What to Do When a Partner Leaves

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They said it wouldn’t last, and they were right. You or a business partner decides to leave your business partnership for some reason, good or bad. How does the partnership handle things when a partner leaves?

Begin with the End in Mind

If you were smart, you and your partner(s) drafted a partnership agreement at the beginning of the partnership that included clauses that governed what would happen if a partner should leave, die, or become incapacitated.

A well-drafted partnership agreement signed by all partners prevents disputes and financial problems in the future. At a minimum the agreement should:

  • Address the transfer or discontinuation of business licenses and name registrations
  • Include a statement that the partner(s) leaving are no longer responsible for financial obligations to the remaining partners
  • Provide guidelines for each partner to assume assets and liabilities according to their ownership interest

You also need a strong Separation Agreement documenting everything and it should be executed properly by the Company and the Partner(s).

The departing partner should have his or her name removed from all formation documents including:

  • Operating agreement or Bylaws/Corporate Register
  • Articles of Formation
  • With the IRS if the partner’s name was used as a “Responsible Party” when the FEIN was procured

If the partner was a personal guarantor of surety, he or she must also be removed as:

  • Borrower on a line of credit
  • Tenant on a commercial lease
  • Guarantor for the company’s Merchant Account

In some cases, the remaining Partners must renegotiate a new contract and dissolve the old one. If the Partner cannot be removed from a document, that Partner (or you, if you are the one leaving) should retain a business attorney to negotiate with the Company to create an escrow account to pay off the obligation. The remaining Partners may be required to indemnify the one departing. 

Dallas business attorneys at Vethan Law, Charles Vethan and Joseph Colvin, talk about the importance of shareholder and partnership agreements in this video.

Why Do Partners Leave?

There are several reasons for a partner to leave a business. It may be to better balance work and family obligations or that the partner developed new interests. People change over time and may not maintain the same level of enthusiasm for the business as they had at the outset.

Uncontested departures

The best kind of departure is an uncontested departure. These include:

  • Retirement
  • Divorce
  • Death of a family member
  • Change of career
  • Disability or incapacitation

Uncontested departures generally remain cordial and the partners can collaborate on the transition, plan ahead, and negotiate a friendly agreement.

Contested departures

Then there are the contested departures, which are not as pain-free. During a contested departure, the partners typically communicate through attorneys. There may be partnership disputes due to:

  • Differences of opinion or management style
  • Loss of faith or open hostility between partners
  • Terms of departure
  • Outstanding assets
  • Liabilities
  • The operating agreement or bylaws permitting the departure desired

With all this going on, it may be difficult to reach a Separation Agreement. If you are the party that is leaving, you may need to go to court to dissolve the partnership. You could take the risk of leaving the business without a Separation Agreement but you may be sued by the remaining partner(s), have your credit ruined, or go bankrupt.

The dispute could come back to bite you years later, after you thought everything was settled.

Partner Termination According to Business Structure

Different requirements apply depending on how you have structured your business. Business structures include different types of formation documents. For example:

  • LLCs are controlled by the Articles of Organization and an Operating Agreement
  • C-Corps and S-Corps are controlled by Articles of Formation and Bylaws
General Partners

If you are in a General Partnership

In a General Partnership, all partners are financially obligated to any debts incurred by the partnership. When a partner leaves, the partnership dissolves and the partners equally split debts and assets.

  • Have full responsibility for management decisions for the business
  • Have complete obligation for the debts of the partnership
  • Are able to leave the partnership at any time
Limited Partners

If you are in a Limited Partnership…

A Limited Partnership functions with both general partners and limited partners.

  • Only have limited management authority
  • Are protected from debt obligations
  • Must leave the partnership on terms specified in the partnership agreement

The business remains regardless of whether a Limited Partner or a General Partner leaves unless all partners agree to dissolve the partnership.

Additional documentation and contractual agreements

If any partners wish to remain in business after a partner leaves, they can establish a buy-sell agreement so the remaining partners can buy the ownership rights of the departing partner.

Other types of documentation and contractual agreements include:

  • Partnership agreements
  • Restriction agreements
  • Investor Rights agreements

During a contested departure, the appropriate regulatory documents must be followed unless they create an inequitable relationship. In that case, the departing partner or the remainder of the partnership may decide to litigate.

When people go into business together, it is very much like getting married. There are shared financial obligations and management responsibilities, and both parties tend to think the business will go on forever.

Unfortunately, even when a business is successful, life happens and sometimes a partner needs to leave. At that time, all the requirements of the governing documents of the partnership must be honored except in specific circumstances. The best departure is an uncontested one.

For uncontested departures or when partnership dissolution was not planned for, you should contact an experienced Dallas business attorney to help you and your partner(s) through the transition.

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