The Case of the "Accidental Partnership"
Some of you may remember being forced to do partner or group projects in high school or college. The instructor randomly tossed you into a group with other students, under the assumption that workload would be divided equally. Inevitably, you were probably in at least one group in which this didn’t happen. One to two members ended up completing virtually all of the work, but everyone in the group getting to share the good grade at the end (no matter how helpful or unhelpful they were).
What does this have to do with business?
Under the law in most states (including Iowa), a partnership can exist without drafting or filing any documents. The partners don’t even need to sign a written agreement between one another. The law provides “default” terms of an agreement among partners. Most of these default partnership agreement terms can and are changed when a partnership agreement is signed. Without a separate, signed agreement, this can be problematic if partners do not understand what terms the partnership statutes are imposing.
Are you familiar with the makeup company, Urban Decay? That company’s origin story provides an example of a partnership being created without any formal documentation. Patricia Holmes had a knack for creating cosmetics. Her friend, Sandra Kruger Lerner, was a seasoned entrepreneur. Lerner proposed they start a company and hire employees so they could be free to focus on the creative side (and do some horseback riding). Lerner told Holmes, “It’s going to be our baby, and we’re going to work on it together,” and they would do everything. They did not set out who would do what for the business. Next thing they knew, Urban Decay was taking off. Lerner was serving in an executive capacity, even bringing in some people to help make management decisions. Holmes, on the other hand, worked in the warehouse. Unknown to Holmes, Lerner and the people she brought in had filed the paperwork formally organizing the company as an LLC. Some time later, Lerner offered Holmes a measly 1% stake in Urban Decay. Holmes, eventually filed a lawsuit claiming Lerner breached a partnership agreement. Lerner, of course, argued there was no partnership agreement (after all, they never signed anything in writing), and stated Holmes had never engaged in decision-making or attended board meetings - though she received notice of the meetings. Ultimately, the court decided the oral discussions between Holmes and Lerner were enough to create a partnership between Holmes and Lerner. This is despite the fact that there were no terms in writing, that Holmes didn’t actually make big picture management decisions (or even attend the meetings where such decisions were made), and that Lerner filed the LLC documents without Holmes being named an owner.
Like the example of group work back in our school days, the amount of work someone performs for the business is not what determines who is entitled to credit - so long as there is some agreement beforehand that everyone would operate as “partners,” even if those exact words are not used. In the context of partnerships, the credit or grades received amounts to a partner’s share of the profits. If there was an agreement that two or more people would operate as partners, and one or more of them didn’t pull their weight, those people have to be dealt with in a specific way in order to keep them from sharing in everybody else’s “A+”. This illustrates something mentioned in another article on this website: If a business will have more than one owner, consult with a lawyer.
If you are a Patricia Holmes, and are wrongfully being denied your fair share of profits, or were unjustly kicked out of your own business, call a lawyer immediately to discuss your options. Likewise, if you are considering kicking out another business owner, do not make the mistakes of Sandra Kruger Lerner. Contact a lawyer to assess your options so you can minimize the risk of prolonged business litigation down the road.