The Uniform Partnership Act defines a partnership as two or more persons who join together in business for a profit. This joining together is a voluntary association with an agreement to share in the profits and losses. When these individuals join together they contribute money, goods, labor and skills to carry on a trade as a commercial enterprise. A necessary element of partnership is an intent to create a relationship to further profit. The idea being the whole is greater than the sum of the individuals separately.
Tenancy in partnership is an important principle in understanding an individual partner’s ownership right as it relates to the partnership and the law of partnership. Does he own the assets jointly or as tenants in common? Can he claim special partnership property as his alone? What happens to his property upon death or the more common occurrence of bankruptcy? What about his spouse or children; what are their rights?
The principle of tenancy in partnership answers these questions and is instrumental in how a partnership agreement is construed and drafted. It is also a basis in court decisions as this principle is often used to resolve misunderstandings between parties; partners and third parties; and the partnership itself and third parties.
To fully appreciate the tenancy in partnership concept the reader must first reacquaint himself with tenancy and the various meanings and court interpretations. As these definitions have a bearing on tenancy in partnership. Next tenancy in partnership is defined in comparison to the respective definitions of tenancy. Finally, tenancy in partnership has many legal implications for all parties and some court cases are reviewed to explain the legal interpretation and foundation of this important right of possession.
- 1 Various Forms of Tenancy
- 2 Tenancy in Partnership – Legal Background
- 3 Legal Interpretation of Tenancy in Partnership
- 4 Summary – Legal and Business Points
Various Forms of Tenancy
There are several commonly used forms of tenancy and they are most often found in real estate title. The basic premise with the modification of tenancy is the number of individuals involved. Two or more individuals requires a modified form of tenancy. There are three basic forms involving two or more individuals.
Tenancy in Common
A tenancy in common is an equal right to possess, control and own an undivided part of survivorship for the other tenant(s). This means that upon death, the remaining cotenant(s) do not inherit the property of the deceased’s share. This deceased tenant may will or sell his share to a third-party. Each tenant in cotillion owns a right to the whole and may freely (if there are no restrictions) convey his share. His share may be encumbered and subject to liens or claims. Any new tenant buying an existing share becomes a tenant in common with the other cotenants.
Other names used for this form include cotenancy, tenants in common, common tenancy and estate in common.
Joint tenancy is very similar to tenancy in common.
1) Two or more tenants
2) All tenants have an equal right to possess, control and own an undivided part of the entire property.
3) A joint tenant may convey his share contingent on a partition of property.
The difference is with the right of survivorship. The deceased tenant has no right to transfer to his heirs his share of the ownership in property. The property is automatically transferred to the remaining joint tenants or single tenant. This form of ownership is ideal with marriage as the surviving spouse will automatically inherit the property without the need for a will or document to convey the property.
This is how bank accounts can be easily transferred upon death on one of the tenants. A joint bank account automatically has a built-in transfer upon the death of one of the owners.
Tenancy by the Entirety
Joint tenancy is quite common for a married couple. Except that there are two problems. First, a tenant may partition the property. This is like the comical scene from the ‘I Love Lucy’ series whereby Lucy painted a white line down the middle of the apartment due to a spat with Ricky. It isn’t realistic with property of a married couple. In effect, tenancy by the entirety makes the property inseparable.
Secondly is the issue of attachment due to a judgement against one of tenants. With joint tenancy, a creditor may request and be granted partition of property to collect on a judgement. Whereas with tenancy by the entirety, the creditor follows a process and places a lien on the property for one of the tenant’s debt. Therefore tenancy by the entirety is not totally exempt under the bankruptcy code 11 U.S.C. §522(b)(2). However, the creditor cannot enforce a process to partition the property. This means if the debtor dies, the remaining spouse automatically owns the property outright clear of any liens associated with the deceased debtor.
This form of title is only available to married couples and only for real state. Some states have two versions of this title ownership. Prior to the 80’s it was referred to as tenancy by the entireties whereby the spouse had no right to the income interest or profits from the real estate. In the 80’s, many states modified this to tenancy by the entirety and granted equal rights to both partners of the marriage.
If a divorce occurs, the property is automatically tenancy in common unless noted in the divorce decree as joint tenants.
From the above three forms of title among two or more owners, only joint and common tenancy can be applicable to a partnership. The non partitioning element of tenants by the entirety is also applicable with the tenancy in partnership. The attachment element can only exist in one form as will be explained below. The tenancy by the entireties only exists with married couples and with their real estate. It was included to make the reader aware of creditor attachment issues related to tenancy. This attachment issue is significant in partnership law as partners often incur debt personally and sometimes for the partnership. Therefore title formation for a partnership plays a key role in the overall business economics of this form of ownership. This title format is known as tenancy in partnership.
Tenancy in Partnership – Legal Background
As stated in the introduction paragraphs, a partnership is an association of two or more persons to carry on as a business for a profit. It is composed of partners and the partnership itself. A partner has an interest in the partnership assets and in the going concern of the partnership, i.e. his share of profits and surplus. Remember, this partnership existence is greater than the value of the respective individual assets/partners.
For a partner there are four key questions related to ownership.
1) What exactly does a partner own?
2) Can a partner assign his rights?
3) Can a creditor attach and then execute on his ownership right in the partnership?
4) What happens to a partner’s ownership upon death?
The following four sub-sections address these one at a time.
Ownership of a Partnership’s Property
This ownership ties to a fundamental understanding of what a partnership truly represents. A partnership encompasses a whole that is greater than the sum of the individual partners. This sum entails a partner’s economic interest, i.e. his share of profits exceeding what he can do on his own. The partnership’s economy of scale is not a tangible asset but an intangible asset.
A second interest is tied to the assets of the partnership. The assets are titled to the partnership and not to the individual partners as joint tenants. Remember joint tenancy provides a right of survivorship to the remaining partners. This precludes heirs of the deceased partner from laying claim to the physical property. This is achieved via the wording of the partnership agreement. In effect, upon the death of a partner, his right in specific property vests in the surviving partner(s).
A third ownership right is the power to manage the partnership. This includes voting rights. This power is completely dictated by the partnership agreement.
In summation, a partner has three separate and distinct ownership interests in a partnership:
1) Economic – a right to participate and share in the profits and surplus
2) Management – granted with voting rights
3) Ownership – similar to personal property
Ability to Assign Rights
Before answering this question, a reminder of the structure is important. The partnership owns all physical property; the partners own a right to participate in the partnership; an equal right with his partners to possess the property (but only for partnership purposes); enjoy his ownership and ultimately dispose of his interest in the partnership.
Since partnerships are a voluntary association, partners are selective of who may be a partner in the business. Therefore, partnership agreements forbid an existing partner from assigning his rights to a third-party. In effect he can’t use his partnership interest or assign partnership property as collateral without the full consent of all partners.
This is a fundamental principle of partnership law as stated in the Uniform Partnership Act and many court battles. See Costello v. Costello, 1913, 109 N.Y. 252, 103 N.E. 148; Kraus v. Kraus, 1928, 150 N.Y. 63, 164 N.E. 743.
Attachment and Execution
Earlier in the ownership subsection it states that a partner has a joint ownership in the property of the partnership. However, his interest in the partnership is actually a tenant in common with his partners. This tenancy means that a creditor can attach due to a judgement on a debtor. New York Law, §54, Subsection 1 states ‘On due application to a competent court by any judgement creditor of a partner, the court … may charge the interest of the debtor partner with payment of the unsatisfied amount of such judgement debt with interest thereon … and make all other orders … which the circumstance of the case may require’.
What courts can’t do is force the partnership to sell partnership assets to satisfy the judgement. A prudent businessman as a partner in an ongoing operation wants no obligation to pay the personal debts of his associate. Therefore many partnership agreements have articles in them addressing this issue. Solutions include payment plans as a percentage of draws and in some cases dissolution of the partnership.
The Uniform Partnership Act requires dissolution of a partnership upon the filing of bankruptcy of a partner. This actually makes sense for two reasons:
1) The remaining partners will desire to exclude and distant themselves from the debtor partner and any ongoing concern value of the partnership will pass to the new partnership.
2) The existing partners are together as a voluntary association, the addition of a trustee in bankruptcy defeats this voluntary association.
Typically, the partnership agreement mandates dissolution upon bankruptcy of a partner. The costs of dissolution and winding up are charged against the bankrupt partner’s capital account prior to disbursements made during the winding up phase.
Death of a Partner
The primary goal of a partnership is to generate profits. Often these profits are retained in the partnership allowing for growth and accumulation of wealth. The tenancy in partnership grants the partner a right similar to tenancy in common to transfer that wealth to the deceased heirs.
To achieve this, the partnership agreements have sections devoted to addressing death including permanent disability. What the remaining partners don’t want is for an heir to become a partner with them. Therefore death of a partner requires dissolution of the existing partnership and a corresponding winding up of affairs.
This means a partner can will his ownership interest including his existing economic interest (notice no management interest) to his heirs. The management interest evaporates upon death of a partner.
Legal Interpretation of Tenancy in Partnership
All the federal cases researched for this article concentrated on the ability of non partners to access the rights or assets of the partnership via a partner. In United States v. Silverstein, 210 F. Supp. 401; October 30, 1962 the Internal Revenue Service sought access to the books and records of several partnerships where Mr. Silverstein was a general partner. Mr. Silverstein denied access claiming Fifth Amendment rights not to self incriminate. Mr. Silverstein stated he had a personal right as a partner to prevent access (similar to attachment) to records (property).
The court responded by stating that although he does have a property interest in the records or dominion over them as a tenant in partnership, he does not have an exclusive right to control them. The court focused in on the substance over form and stated that Mr. Silverstein’s:
As explained earlier, a partner owns three distinct rights in a partnership, 1) management, 2) economic and 3) an ownership position. There are situations whereby one or two of theses rights can be sold without selling the other(s).
In Magers v. Thomas, a partner in a real estate venture unknowingly only sold one of his three rights. Because the partnership failed to formalize the relationship, there were no safeguards in place to ensure the proper replacement of a partner. With the tenancy in partnership, a partner’s right in specific partnership property is not assignable except in connection with the assignment of the rights of all the partners in the same property – Section 51 of the New York Uniform Partnership Act.
In this case, a Mr. Vanoy borrowed money from Mr. Thomas. Mr. Thomas conditioned the loan on a title via a deed of trust to Mr. Vanoy’s specific interest of the real estate asset of the partnership. The other partners not understanding the three interests of tenancy in partnership agreed to the transaction.
The transaction did not grant Mr. Vanoy’s economic or management interest in the partnership. Therefore Mr. Thomas had no rights to access the economic return of the partnership to service the debt. See Magers v. Thomas, 176 B.R. 758; August 15, 1994.
The final case is the most common form of partnership issue. It addresses bankruptcy of a partner. When bankruptcy is declared the bankruptcy court assigns a trustee to liquidate the assets. Naturally a partner has an economic and ownership interest in the partnership. The trustee will want to liquidate this value. The tenancy in partnership protects the remaining partners by legally separating the partner from the fact that the partnership owns the property; not the individual partners.
As explained in Karancy v. Pelican Island Groves, 1989 Bankr. Lexis 500, March 30, 1989 the trustee may attach to the partnership interest of the partner but cannot force the partnership to execute. This is why the Uniform Partnership Act requires a partnership to dissolve upon the bankruptcy of a partner.
Summary – Legal and Business Points
A tenancy in partnership is a form of tenancy creating a unique legal relationship. It is essentially a two tier ownership relationship. The partnership owns the property used in business as one tier (the inner tier); the outer tier consists of the partners owning a three-part interest in the partnership. This ownership comprises an economic interest in the profits, a management interest in the operations and an ownership of a right to possess and dispose of his share of the partnership.
From the business perspective, the tenancy in partnership is a basis to create any entity that is greater than the sum of its individual partners. By using economies of scale and the business principle of a going concern, this tenancy in partnership provides a unique opportunity to take advantage of the legal process and create a highly proficient business model to generate cash. Act On Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.
If you found this article helpful, please consider a donation to the site. The donation button is just to the right. Even if you don’t make a contribution, I encourage you to read more articles on the website to help you become a better business entrepreneur.