CH-29-31 Bank Deposits, Collections, and Funds Transfers – Smith and Robersons Business Law : Book Guide

This Document Contains Chapters 29 to 31 Chapter 29 BANK DEPOSITS, COLLECTIONS, AND FUNDS TRANSFERS ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. On November 9, Jane Jones writes a check for $5,000 payable to Ralph Rodgers in payment for goods to be received later in the month. Before the close of business on November 9, Jane notifies the bank by telephone to stop payment on the check. On December 19, Ralph gives the check to Bill Briggs for value and without notice. On December 20, Bill deposits the check in his account at Bank A. On December 21, Bank A sends the check to its correspondent, Bank B. On December 22, Bank B presents the check through the clearinghouse to Bank C. On December 23, Bank C presents the check to Bank P, the payor bank. On December 28, the payor bank makes payment of the check final. Is Jane Jones’ stop payment order effective against the payor bank? Explain. Answer: Stop Payment Orders. Decision for Bank P, the payor bank. Section 4-403(b) of the U.C.C. provides that an oral stop payment order is binding upon the bank only for 14 days unless confirmed in writing within that period. There was no confirmatory writing by Jones. 2. Howard Harrison, a longtime customer of Western Bank, operates a small department store, Harrison’s Store. Because his store has few experienced employees, Harrison frequently travels throughout the United States on buying trips, although he also runs the financial operations of the business. On one of his buying trips, Harrison purchased two hundred sport shirts from Well-Made Shirt Company and paid for the transaction with a check on his store account with Western Bank in the amount of $3,000. Adams, an employee of Well-Made who deposits its checks in Security Bank, sloppily raised the amount of the check to $30,000 and indorsed the check, “Pay to the order of Adams from Pension Plan Benefits, Well-Made Shirt Company by Adams.” He cashed the check and cannot be found. Western Bank processed the check, paid it, and sent it to Harrison’s Store with the monthly statement. After briefly examining the statement, Harrison left on another buying trip for three weeks. (a) Assuming the bank acted in good faith and the alteration is not discovered and reported to the bank until an audit conducted thirteen months after the statement was received by Harrison’s Store, who must bear the loss on the raised check? (b) Assume that Harrison, who was unable to examine his statement promptly because of his buying trips, left instructions with the bank to carefully examine and to notify him of any item over $5,000 to be charged to his account; assume further that the bank nevertheless paid the item in his absence. Who bears the loss if the alteration is discovered one month after the statement was received by Harrison’s Store? If the alteration is discovered thirteen months later? Answer: Customer's Duties. (a) Harrison’s Store must bear the loss. Section 4-406(f) of the U.C.C. provides: "Without regard to care or lack of care of either the customer or the bank a customer who does not within one year after the statement or items are made available to the customer (subsection (a)) discover and report the customer’s unauthorized signature on or alteration on the item is precluded from asserting against the bank the unauthorized signature***or alteration." (b) Security Bank must bear the loss. Section 4-406(e) of the U.C.C. provides: if the “customer proves that the bank failed to exercise ordinary care. . . and that the failure substantially contributed to the loss, the loss is allocated” on a comparative negligence basis. Here, Security Bank did not follow Harrison's explicit instruction and hence did not exercise ordinary care when it paid the item without contacting Harrison. The jury will have to allocate the loss based on comparative negligence. Security Bank would also be liable if the alteration was discovered thirteen months later because it failed to exercise ordinary care pursuant to Harrison's instructions. 3. Tom Jones owed Bank of Cleveland $10,000 on a note due November 17, with 1 percent interest due the bank for each day delinquent in payment. Jones issued a $10,000 check to Bank of Cleveland and deposited it in the night vault the evening of November 17. Several days later, he received a letter saying he owed one day’s interest on the payment because of a one-day delinquency in payment. Jones refused because he said he had put the payment in the vault on November 17. Who is correct? Why? Answer: Duty to Act Timely. The Bank of Cleveland is correct. Assuming that the interest rate is within the state's legal limits, Jones will have to pay the one per cent per day or one day's delinquent payment. The bank may use Nov. 18 as the day of receipt, pursuant to Section 4-108(a) “For the purpose of allowing time to process items, prove balance and make the necessary entries on its books to determine its position for the day, a bank may fix an afternoon hour of two p.m. or later as a cutoff hour for the handling of money and items and the making of entries on its books. (2) An item or deposit of money received on any day after a cutoff hour so fixed or after the close of the banking day must be treated as being received at the opening of the next banking day." 4. Assume that Davis draws a check on Dallas Bank, payable to the order of Perkins; that Perkins indorses it to Cooper; that Cooper deposits it to her account in Houston Bank; that Houston Bank presents it to Dallas Bank, the drawee; and that Dallas Bank dishonors it because of insufficient funds. Houston Bank receives notification of the dishonor on Monday but, because of an interruption of communication facilities, fails to notify Cooper until Wednesday. What result? Answer: Duty to Act Timely. Houston Bank is a collecting bank. As such it has a duty to act timely. A collecting bank acts timely in any event if it takes proper action before its "midnight deadline" following receipt of the item, notice or payment. If the bank adheres to this standard, the timeliness of its action cannot be challenged. Although a reasonably longer time may be timely, the bank bears the burden of proof in such cases. Section 4-202 (b). The midnight deadline means midnight of the next banking day following the banking day on which the bank receives the item or notice. Section 4-104(a)(10). Thus Houston Bank has until midnight of the day after receipt of notification of dishonor or midnight on Tuesday to act under the midnight deadline. Houston bank fails to notify Cooper until Wednesday. Thus Houston bears the burden of proving that its failure to act until Wednesday was not in violation of its duty to act timely. 5. Jones, a food wholesaler whose company has an account with City Bank in New York City, is traveling in California on business. He finds a particularly attractive offer and decides to buy a carload of oranges for delivery in New York. He gives Saltin, the seller, his company’s check for $25,000 to pay for the purchase. Saltin deposits the check, with others he received that day, with his bank, the Carrboro Bank. Carrboro Bank sends the check to Downs Bank in Los Angeles, which in turn deposits it with the Los Angeles Federal Reserve Bank (L.A. Fed). The L.A. Fed sends the check, with others, to the New York Federal Reserve Bank (N.Y. Fed), which forwards the check to City Bank, Jones’s bank, for collection. (a) Is City Bank a depositary bank? A collecting bank? A payor bank? (b) Is Carrboro Bank a depositary bank? A collecting bank? (c) Is the N.Y. Fed. an intermediary bank? (d) Is Downs Bank a collecting bank? Answer: Collecting Banks. (a) City Bank is not a depositary bank. §4-105(2), U.C.C. City Bank is not a collecting bank. §4-105(5). City Bank is a payor bank. §4-105(3). (b) Carrboro Bank is a depositary bank. §4-105(2). Carrboro Bank is a collecting bank. §4-105(5). (c) The N.Y. Fed. is an intermediary bank. §4-105(4). (d) Downs Bank is a collecting bank. Section 4-105(5). 6. On April 1, Moore gave Pipkin a check properly drawn by Moore on Zebra Bank for $5,000 in payment of a painting to be framed and delivered the next day. Pipkin immediately indorsed the check and gave it to Yeager Bank as payment in full of his indebtedness to the bank on a note he previously had signed. Yeager Bank canceled the note and returned it to Pipkin. On April 2, upon learning that the painting had been destroyed in a fire at Pipkin’s studio, Moore promptly went to Zebra Bank, signed a printed form of stop payment order, and gave it to the cashier. Zebra Bank refused payment on the check upon proper presentment by Yeager Bank. (a) What are the rights of Yeager Bank against Zebra Bank? (b) What are the rights of Yeager Bank against Moore? (c) Assuming that Zebra Bank inadvertently paid the amount of the check to Yeager Bank and debited Moore's account, what are the rights of Moore against Zebra Bank? Answer: Payment of an Item. (a) Yaeger Bank cannot recover anything from Zebra Bank. In the absence of certification, a drawee bank is not liable to the holder of a check for failure to honor it, despite the fact that the action of the bank in refusing to pay the check was unjustified, and even despite that the holder sustained a loss as a result thereof. This is because the holder of a check is a stranger to the bank with whom the bank has no direct contractual relationship. Furthermore, the holder of a check ordinarily has no right to enforce the duty which the bank owes to its depositor on any theory that the check operated as an assignment of the depositor's rights. (b) Yaeger Bank can recover $5,000 from Moore. Yeager Bank is a holder in due course as it gave value in good faith, without reason to question its authenticity, and without notice that the instrument was overdue or had been dishonored or of any defenses against it. Taking for value includes taking the check in payment of an antecedent claim. Section 3-303. The failure of the payee to carry out the contract is not a defense to a holder in due course. Section 3-305. The drawer of a check, like an indorser, makes a contract to pay any holder who takes it up. Normally, the liability of the drawer of a check is similar to that of an indorser. The drawer engages that upon dishonor of the check and any necessary notice of dishonor will pay the amount of the check to the holder or to any indorser who takes it up. Section 3-413(2), U.C.C. (c) Moore cannot recover anything from Zebra Bank if, by inadvertence, Zebra Bank paid the check contrary to Moore's stop payment order. The failure of the drawee bank to honor a timely stop payment order is a breach of its contract of deposit. Section 4-403 requires that the stop payment order be received at such time and in such manner as to afford the bank a reasonable opportunity to act on it prior to any other action with respect to the check. The position taken by this section is that stopping payment is a service which depositors expect and are entitled to receive from banks notwithstanding its difficulty, inconvenience and expense. The inevitable occasional losses through failure to stop should be borne by the banks as a cost of the business of banking. Since the stop payment order was timely received, Zebra Bank breached its contract of deposit by failure to honor it. However, a depositor cannot compel the drawee bank to restore a deposit to his account unless he can establish not only that the payment was improper, but also that he sustained a loss by reason of the improper payment. Section 4-403(c) places the burden upon the customer to establish the amount of the loss and Section 4-407 provides for the drawee bank's right to subrogation on improper payment. To summarize, the stop payment order is binding on Zebra Bank. When Zebra Bank pays a check over such a stop order it is prima facie liable, but the burden of establishing the fact and amount of loss from such payment is on Moore. Moreover, Zebra Bank's defense in the problem is that Moore suffered no loss because he would have been liable to a holder in due course (Yaeger Bank) in any event. Payment can be stopped but if it is, Moore is liable and the sound rule is that Zebra Bank is subrogated to the rights of Yaeger Bank. Section 4-403, Comment 1. Since Yaeger Bank is a holder in due course, Moore is unable to sustain a loss and cannot recover anything from Zebra Bank. 7. As payment in advance for services to be performed, Acton signed and delivered the following instrument: Owen requested and received Last National Bank’s certification of the check even though Acton had only $9,000 on deposit. Owen indorsed the check in blank and delivered it to Dan Doty in payment of a preexisting debt. When Owen failed to appear for work, Acton issued a written stop payment order ordering the bank not to pay the check. Doty presented the check to Last National Bank for payment. The bank refused payment. What are the bank's rights and liabilities relating to the transactions described? Answer: Payment of an Item. The instrument is negotiable. The fact that there is a statement on the check of the consideration for which it was issued does not affect its negotiable character. The fact that the consideration for which the check was given is executory in nature, that it is for work to be performed in the future, does not make the order conditional. Although a bank is under not duty to certify a check, if it does certify a check this amounts to an acceptance of the instrument by the drawee bank. Section 3-409(d) states that certification of a check is acceptance. The drawer and all prior indorsers are discharged. Sections 3-414 (c), 3-415 (d). Section 3-401 (a) states that acceptance is the drawee's signed engagement to honor the draft as presented. It must be written on the draft. When the drawee bank certified the check this amounted to an acceptance which resulted in the drawee-acceptor becoming primarily liable for the payment on the instrument. The acceptor has contractually obligated itself to pay the $10,500 irrespective of the drawer's account. The fact that the drawer had only $9,000 on deposit does not affect the liability of the acceptor to third parties. There is no right to stop payment after certification of a check or other acceptance of a draft. The check payable to the order of Owen was order paper. When Owen indorsed a check in blank and delivered it to Doty such acts constituted a negotiation of the instrument. When Doty presented the check to the bank for payment he fulfilled the requirements of a holder in due course. Doty gave value for the instrument in accordance with the provisions of Section 3-303 which states that a holder takes the instrument for value when he takes it in payment of an antecedent claim against any person whether or not the claim is due. The fact that Doty knew the instrument had been given for executory consideration does not put him on notice of any defense or right of others in the instrument. Neither Doty nor Owen breached any warranty to the drawee bank. The acceptance by the bank by way of certification was final and not subject to rescission under Section 3-418. The acceptor may not rescind the acceptance on the theory of mutual mistake of fact in leading to the acceptance. A bank which pays an overdraft or becomes obligated to pay an overdraft by an acceptance or certification has the legal right to look to the drawer for reimbursement. A payment on an overdraft or the acceptance of an overdraft results into a loan so far as the relationship between the bank and drawer are concerned. The bank has the right to debit the drawer's account to the extent of the balance in his account ($9,000) and to proceed by way of the creditor against the drawer for the balance of $1,500. If the bank has in fact paid the $1,500 the bank is entitled to interest at the legal rate on this amount until the drawer pays the bank $1,500. 8. Jones drew a check for $1,000 on The First Bank and mailed it to the payee, Thrift, Inc. Caldwell stole the check from Thrift, Inc., chemically erased the name of the payee, and inserted the name of Henderson as payee. Caldwell also increased the amount of the check to $10,000 and, by using the name of Henderson, negotiated the check to Willis. Willis then took the check to The First Bank, obtained its certification on the check, and negotiated the check to Griffin, who deposited the check in The Second National Bank for collection. The Second National forwarded the check to the Detroit Trust Company for collection from The First Bank, which honored the check. Griffin exhausted her account in The Second National Bank, and the account was closed. Shortly thereafter, The First Bank learned that it had paid an altered check. What are the rights of each of the parties? Answer: Payor Bank and Its Customer. Jones may compel the First Bank to re-credit his account for the entire amount of the certified check, or, in alternative, Thrift Inc. may recover the original amount of the check from the payor-bank in an action for conversion, and Jones may then compel the payor-bank to recredit his account for the difference between the original amount of the check and the altered amount. The payor-bank may not maintain an action for breach of warranty against Griffin, the Second National Bank, and the Detroit Trust Company. However, the payor-bank has a valid cause of action against Willis and Caldwell for breach of warranty of entitlement to enforce and that the check was altered. First, it is the general rule that the payor bank may charge against the account of its depositor only those items which are properly payable, i.e., the payor bank must comply with Jones' command to pay Thrift Inc., and any payment to Henderson is not consistent with this command and renders the payor-bank liable for breach of contract. Section 4-401, U.C.C. If the real payee, Thrift Inc., had altered the check by increasing the amount and had then indorsed to Griffin, Griffin as a holder in due course, would be entitled to keep the original amount of the check and the First Bank would have correctly paid the original amount. Section 4-401(d)(1). Jones may sue only the payor-bank and may not sue the depository and other collecting banks. Second, the payee who received the check and had a property right in it may sue the payor-bank on a conversion cause of action because it paid on a forged indorsement of the payee. Although it is true that no one signed the name of the payee as in the typical forgery case, the unauthorized erasure of the payee's name and the substitution of another name as a payee constitutes a forgery. The payee may sue the payor bank because it paid on a forged indorsement of the payee, and the measure of recovery against the payor banks is the original amount of the check. Section 3-420. Section 3-420 (c) also provides that the true owner of the check may sue the depository or collecting bank for conversion when it makes collection of a check bearing a forged indorsement. However, the depository bank is liable for only the amount of any proceeds of the check which it still has in its possession. Under the facts, Griffin withdrew all of the funds from his account and it was closed, hence the Second National Bank would not be liable to Thrift, Inc. Finally, under the U.C.C., a party receiving payment on an accepted draft does not warrant that it is without alteration. In addition, the U.C.C. also provides that the acceptor engages that he will pay the instrument according to its tenor at the time of his engagement and that the acceptor admits as against all subsequent parties the existence of the payee and his then capacity to indorse. Thus we have the following result: The First Bank certified the check when it was presented by Willis. This certification constituted a promise that the bank would pay the amount then appearing on the check and that Henderson existed and had capacity to indorse. Griffin took the check after it was certified and consequently when he presented it for payment through the depository bank, he made no warranties regarding alterations to the payor-bank. The U.C.C. provides that each collecting bank (here the Second National Bank and the Detroit Trust Company) warrants to the payor-bank that it has the right to enforce the item, and this could appear to make both of them liable because of the forged indorsement. However, this general rule is subservient to the rule that when a check has been altered and then certified, the certifying bank becomes bound according to the tenor of its acceptance. Further, when the collecting banks are operating in good faith and they have taken the check after the acceptance, they do not warrant to the payor-bank that the check has not been altered. Article 4 places the collecting banks in the same position as an individual holder who has taken the check after certification, and as a result neither bank would be liable to the First Bank. Assuming that the payor-bank is unable to recover the proceeds of the certified check from Griffin and the banks, it may recover the proceeds on a breach of warranty theory from Willis and from Caldwell, assuming that Caldwell is solvent and can be found. Caldwell will be liable to the First Bank and to Willis if he is forced to pay the payor-bank. Caldwell, even though he used a fictitious name, is liable because the U.C.C. provides that the signature may be made by use of any name. Accordingly, Caldwell is liable under the assumed name of Henderson. Caldwell's liability is predicated on the theory of breach of warranty. Under U.C.C., Caldwell warrants to the payor-bank that he was entitled to enforce the check and, of course, he did not. He also warrants that the check has not been altered, and since he altered the check he has breached this warranty to the payor-bank. Similarly, Caldwell is deemed by the U.C.C. to have warranted to Willis that he (Caldwell) had good title to the check, that all signatures are genuine and that it had not been altered. Since all three warranties were breached, Caldwell is liable to Willis. 9. Jason, who has extremely poor vision, went to an automated teller machine (ATM) to withdraw $200 on February 1. Joshua saw that Jason was having great difficulty reading the computer screen and offered to help. Joshua obtained Jason’s personal identification number and secretly exchanged one of his old credit cards for Jason’s ATM card. Between February 1 and February 15, Joshua withdrew $1,600 from Jason’s account. On February 15, Jason discovered that his ATM card was missing and immediately notified his bank. The bank closed Jason’s ATM account on February 16, by which time Joshua had withdrawn another $150. What is Jason’s liability, if any, for the unauthorized use of his account? Answer: Electronic Funds Transfer: Consumer Liability. Jason’s liability is only $50. The EFTA provides that a consumer's liability for an unauthorized electronic funds transfer is limited to a maximum of $50 if the consumer notifies the bank within two days after he learns of the loss or theft. In this case Jason informed bank the day that he discovered the card was missing. 10. On July 21, Boehmer, a customer of Birmingham Trust, secured a loan from that bank for the principal sum of $5,500 in order to purchase a boat allegedly being built for him by A. C. Manufacturing Company, Inc. After Boehmer signed a promissory note, Birmingham Trust issued a cashier’s check to Boehmer and A. C. Manufacturing Company as payees. The check was given to Boehmer, who then forged A. C. Manufacturing Company’s indorsement and deposited the check in his own account at Central Bank. Central Bank credited Boehmer’s account and then placed the legend “P.I.G.,” meaning “Prior Indorsements Guaranteed,” on the check. The check was presented to and paid by Birmingham Trust on July 22. When the loan became delinquent in March of the following year, Birmingham Trust contacted A. C. Manufacturing Company to learn the location of the boat. They were informed that it had never been purchased, and they soon after learned that Boehmer had died on January 24 of that year. Can Birmingham Trust obtain reimbursement from Central Bank under Central’s warranty of prior indorsements? Explain. Answer: Warranties. Decision for Birmingham Trust based upon breach of the guarantee of prior indorsements. If Central Bank had not guaranteed the indorsements with the "PIG" stamp, however, it would probably not be liable under the presenting bank's warranties, because a presenting bank only warrants on presentment that (1) it has good title or is authorized to obtain payment; (2) it has no knowledge that the signature of the maker or drawer is unauthorized; and (3) that the item has not been materially altered. These warranties are not as extensive as the transferor's warranties. Birmingham Bank has no knowledge that the signature of A.C. Manufacturing is unauthorized and thus would not be in breach of the warranties on presentment were it not for the "PIG" stamp it placed on the instrument. Unlike the presenter, the transferor warrants that all signatures are genuine and authorized. If the transfer warranties applied, the warranty would have been breached even without the "PIG" stamp. Birmingham Trust Nat'l Bank v. Central Bank & Trust Co., 44 Ala. App. 630, 275 So.2d 148 (1973). [Revised warranties are covered in Sections 4-207 and 4-208.] 11. Advanced Alloys, Inc., issued a check in the amount of $2,500 to Sergeant Steel Corporation. The check was presented for payment fourteen months later to the Chase Manhattan Bank, which made payment on the check and charged Advanced Alloys’s account. Can Advanced Alloys recover the payment made on the check? Why? Answer: Payment of an Item. No, Advanced Alloys cannot recover from Chase Manhattan. A bank is under no obligation to a customer having a checking account to pay a check, other than a certified check, which is presented more than six months after its date, but it may charge its customer's account for a payment made thereafter in good faith. Good faith is defined as honesty in fact in the conduct or transaction concerned. Chase Manhattan acted in good faith when it paid the check presented fourteen months after its issuance without inquiry of the depositor Advanced Alloys because it did not actually know that Advanced Alloys did not want the check paid. Advanced Alloys, Inc. v. Sergeant Steel Corp., 72 Misc.2d 614, 340 N.Y.S.2d 266 (1973). 12. Laboratory Management deposited into its account at Pulaski Bank a check issued by Fairway Farms in the amount of $150,000. The date of deposit was February 5. Pulaski, the depositary bank, initiated the collection process immediately by forwarding the check to Worthen Bank on the sixth. Worthen sent the check on for collection to M Bank Dallas, and M Bank Dallas, still on February 6, delivered the check to M Bank Fort Worth. That same day, M Bank Fort Worth delivered the check to the Fort Worth Clearinghouse. Because TAB/West Side, the drawee/payor bank, was not a clearinghouse member, it had to rely on TAB/Fort Worth for further transmittal of the check. TASI, a processing center used by both TAB/Fort Worth and TAB/West Side, received the check on the sixth and processed it as a reject item because of insufficient funds. On the seventh, TAB/West Side determined to return the check unpaid. TASI gave M Bank Dallas telephone notice of the return on February 7, but physically misrouted the check. Because of this, M Bank Dallas did not physically receive the check until February 19. However, M Bank notified Worthen by telephone on the fifteenth of the dishonor and return of the check. Worthen received the check on the twenty-first and notified Pulaski by telephone on the twenty-second. Pulaski actually received the check from Worthen on the twenty-third. On February 22 and 23, Laboratory Management’s checking account with Pulaski was $46,000. Pulaski did not freeze the account because it considered the return to be too late. The Laboratory Management account was finally frozen on April 30, when it had a balance of $1,400. Pulaski brings this suit against TAB/Fort Worth, Tab/Dallas, and TASI, alleging their notice of dishonor was not timely relayed to Pulaski. Explain whether Pulaski is correct in its assertion. Answer: Collection of Items. Decision for Pulaski Bank & Trust. A payor bank's liability is for the full amount of a check, whereas the collecting bank's liability is for the full amount minus the loss that would not have occurred if the collecting bank had used ordinary care. TAB Ft. Worth was acting as TAB West Side's transferor bank, and not its agent. TASI, acting as an agent for both TAB Ft. Worth and TAB West Side, made the appropriate ledger entries between West Side and Ft. Worth, reversing the transaction before midnight on February 7. TAB West Side had timely given notice of dishonor to its transferor/collecting bank prior to its midnight deadline. Pulaski Bank & Trust v. Texas American Bank, 759 S.W.2d 723 (Tex. App. 1988). 13. On Tuesday, June 11, Siniscalchi issued a $200 check on the drawee, Valley Bank. On Saturday morning, June 15, the check was cashed. This transaction, as well as others taking place on that Saturday morning, was not recorded or processed through the bank’s bookkeeping system until Monday, June 17. On that date, Siniscalchi arrived at the bank at 9:00 A.M. and asked to place a stop payment order on the check. A bank employee checked the bank records, which at that time indicated the instrument had not cleared the bank. At 9:45 A.M., she gave him a printed notice confirming his request to stop payment. May Siniscalchi recover the $200 paid on the check? Explain. Answer: Stop Payment Order. No, Siniscalchi may not recover on the check; judgment for Valley Bank. A customer has a right to stop payment on a check, but the stop payment order must be received at such time and in such manner as to afford the bank a reasonable opportunity to act on the stop payment. Here, the check was cashed before the stop payment order was issued, and hence the stop payment order did not effectively bind Valley Bank. 14. Morvarid Kashanchi and her sister, Firoyeh Paydar, held a savings account with Texas Commerce Medical Bank. An unauthorized withdrawal of $4,900 from the account was allegedly made by means of a telephone conversation between some other unidentified individual and a bank employee. Paydar learned of the transfer of funds when she received her bank statement and notified the bank that the withdrawal was unauthorized. The bank, however, declined to recredit the account for the $4,900 transfer. Kashanchi brought an action against the bank, claiming that the bank had violated the Electronic Funds Transfer Act (EFTA) The bank defended by arguing that the Act did not apply. Does the EFTA govern the transaction? Explain. Answer: Electronic Fund Transfer. The act defines an "electronic funds transfer" to include "transfers initiated by telephone," with the exception of "any transfer of funds which is initiated by a telephone conversation between a consumer and an officer or employee of a financial institution which is not pursuant to a prearranged plan and under which periodic or recurring transfers are not contemplated . . ." The unauthorized withdrawal of $4,900 from the Kashanchi account falls under this exception and is therefore not covered by the act. Although the act does not explicitly address informal personal phone transfers, the lack of such discussion suggests an intent not to include these under the act's protection. Moreover, the act was passed to fill gaps in existing legislation in the consumer protection area. For example, a consumer previously might have had no action against a financial institution if an individual had made an unauthorized withdrawal from the consumer's account at an automatic teller machine. In such instances, the bank has no way of knowing that the transfer is unauthorized. The act was passed to protect consumers in these cases. Kashanchi, however, may have a negligence or breach of contract action against the Texas bank, for the bank employee made no attempt to obtain a positive identification of the phone caller who requested the unauthorized withdrawal. 15. Tally held a savings account with American Security Bank. On seven occasions, Tally’s personal secretary, who received his bank statements and had custody of his passbook, forged Tally’s name on withdrawal slips that she then presented to the bank. The secretary obtained $52,825 in this manner. Three years after the secretary’s last fraudulent withdrawal she confessed to Tally who promptly notified the bank of the issue. Can Tally recover the funds from American Security Bank? Answer: Customer’s Duties. Partial summary judgment for American Security Bank granted. The U.C.C. imposes a duty upon a bank customer to inspect promptly statements and items either sent to the customer or reasonably made available to him. A customer must report any unauthorized signature on an item within one year from the time the item is made available. Tally first notified the bank of the irregularities some three years after his secretary's last withdrawal. Tally claims, however, that the one-year time limit only holds when the periodic account statement is accompanied by the items supporting it. In this case, the savings withdrawal slips were retained on file by the bank. They were, however, effectively made available to Tally when the statement was sent. Tally should have reviewed the statement and reported any problems to the bank. Since he did not do so within the specified one-year time period, he cannot recover for the allegedly forged withdrawal orders paid by the bank. 16. During a period of sixteen months, Great Lakes Higher Education Corp. (Great Lakes), a not-for-profit student loan servicer, issued 224 student loan checks totaling $273,152.88. The checks were drawn against Great Lakes’s account at First Wisconsin National Bank of Milwaukee (First Wisconsin). Each of the 224 checks was presented to Austin Bank of Chicago (Austin) without indorsement of the named payee. Austin Bank accepted each check for purposes of collection and without delay forwarded each check to First Wisconsin for that purpose. First Wisconsin paid Austin Bank the face amount of each check even though the indorsement signature of the payee was not on any of the checks. Has Austin Bank breached its warranty to First Wisconsin and Great Lakes due to the absence of proper indorsements? Explain. Answer: Bank’s Duties. Negligence claims and breach of warranty to a third party are dismissed with prejudice. [Author’s Note: This case applies Revised Article 3 and 4.] Plaintiffs have claimed negligence in the presentment of checks as a theory of recovery. Presentment under the U.C.C. means “a demand made by or on behalf of a person entitled to enforce an instrument . . . .” U.C.C. § 3-501. Under U.C.C. § 4-202, a collecting bank such as Austin is required to use ordinary care in the presentment of checks or the sending of checks for presentment. Comment Two to this section indicates that where the collecting bank is itself presenting the check for payment, it must use ordinary care with respect to the time and manner of the presentment. However, where the collecting bank is merely sending the check for presentment, it must exercise ordinary care in the routing of the check and the selection of intermediary banks. In this case, Austin was merely sending the checks for presentment. Therefore, since, Austin used ordinary care with respect to routing and choosing intermediaries, it is not liable under § 4-202. Great Lakes also alleges that it is the third party beneficiary of a transfer warranty owed by Austin to First Wisconsin under U.C.C. § 4-207. Section 4-207 provides, in relevant part, “a customer or collecting bank . . . warrants to the transferee and to any subsequent collecting bank that . . . all signatures on the item are authentic and authorized.” However, the majority of courts do not allow a drawer to maintain an action under § 4-207 as a third party beneficiary. Comment 2 to U.C.C. § 3-417, the minority position that a drawer may maintain such an action is specifically rejected. Therefore, Great Lakes’ claim that it is entitled to relief as a third party beneficiary of Austin’s § 4-207 warranty to First Wisconsin is dismissed. ANSWERS TO “TAKING SIDES” PROBLEMS Mary Mansi claims that eighteen checks on her account contain forgeries but were nevertheless paid by her bank, Sterling National Bank. The checks bore signatures that, according to the Mansi’s handwriting expert, were apparently “written by another person who attempted to simulate her signature” and thus were not considered obvious forgeries. Sterling National Bank acknowledged that it did honor those eighteen checks, but nine of them were returned to the plaintiff more than one year prior to this action. In addition, Mansi had received bank statements and failed to examine them. (a) What are the arguments that the bank is liable to Mansi for wrongfully paying the checks? (b) What are the arguments that the bank is not be liable to Mansi for paying the checks? (c) Who should prevail? Why? Answer: (a) The bank paid the checks even though Mansi never ordered the bank to pay these instruments. The signatures were forgeries, and the bank should not have paid these forged checks. (b) It is the customer’s duty to exercise due care in reviewing checks and bank statements that have been returned to her. Mansi did not do this and therefore cannot recover from the bank for their payment. (c) Summary judgment granted in favor of Sterling National Bank. Mansi did not report the fraud with respect to nine of the checks until more than a year after the checks were made available to her and thus she was barred from recovering on these items. On the remaining nine checks, she was also barred by her failure (1) to exercise reasonable care in examining her bank statements and (2) to submit any evidence that the bank failed to exercise ordinary care in paying the items. Mansi v. Gaines Supreme Court, Appellate Division, Second Department 1995, 216 A.D.2d 536, 628 N.Y.S.2D 804. Chapter 30 FORMATION & INTERNAL RELATIONS OF GENERAL PARTNERSHIPS ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Lynn and Jack jointly own shares of stock of a corporation, have a joint bank account, and have purchased and own as tenants in common a piece of real estate. They share equally the dividends paid on the stock, the interest on the bank account, and the rent from the real estate. Without Lynn’s knowledge, Jack makes a trip to inspect the real estate and on his way runs over Samuel. Samuel sues Lynn and Jack for his personal injuries, joining Lynn as defendant on the theory that Lynn was Jack’s partner. Is Lynn a partner of Jack? Answer: Tests of Partnership Existence. Lynn is not liable. No partnership exists between Lynn and Jack merely by reason of their joint ownership of shares of stock of a corporation, or their joint bank account, or their passive ownership of real estate as tenants in common. If their ownership and renting of the property involved such active participation as to constitute a business, then Lynn and Jack would be considered partners. R.U.P.A. Section 202(c)(1), U.P.A Section 7(2). There is no association to carry on a business for profit. 2. James and Suzanne engaged in the grocery business as partners. In one year they earned considerable money, and at the end of the year they invested a part of the profits in oil land, taking title to the land in their names as tenants in common. The investment was fortunate, for oil was discovered near the land, and its value increased many times. Is the oil land partnership property? Why? Answer: Partnership Capital and Property. The oil land was most likely a partnership asset because it was acquired with partnership funds. R.U.P.A. Section 204(c), U.P.A. Section 8(2). Property is presumed to be partnership property if purchased with partnership assets, even if not acquired in the name (1) of the partnership or (2) of one or more partners with an indication in the instrument transferring title to the property (a) of the person’s capacity as a partner or (b) of the existence of a partnership. 3. Sheila owned an old roadside building that she believed could be easily converted into an antique shop. She talked to her friend Barbara, an antique fancier, and they executed the following written agreement: (a) Sheila would supply the building, all utilities, and $100,000 capital for purchasing antiques. (b) Barbara would supply $30,000 for purchasing antiques, Sheila to repay her when the business terminated. (c) Barbara would manage the shop, make all purchases, and receive a salary of $500 per week plus 5 percent of the gross receipts. (d) Fifty percent of the net profits would go into the purchase of new stock. The balance of the net profits would go to Sheila. (e) The business would operate under the name “Roadside Antiques.” Business went poorly, and after one year a debt of $40,000 is owed to Old Fashioned, Inc., the principal supplier of antiques purchased by Barbara in the name of Roadside Antiques. Old Fashioned sues Roadside Antiques, and Sheila and Barbara as partners. Decision? Answer: Co-ownership. Old Fashioned will clearly recover from Roadside Antiques and Sheila. Recovery from Barbara would be based upon showing that a partnership actually existed between Sheila and Barbara. R.U.P.A. Section 202(c)(2) and U.P.A. Section 7(3) provide that the sharing of gross receipts does not of itself establish a partnership. Barbara can point out that she participated in gross receipts regardless of profits and she may allege that the agreement between Sheila and herself also amounts to an indemnity against losses, since Sheila's obligation to repay her appears to be absolute. On the whole, Barbara appears to have the advantage on this issue. It appears that Sheila is operating as a sole proprietor. Recovery from Barbara, therefore, is not likely. 4. Clark, who owned a vacant lot, and Bird, who was engaged in building houses, entered into an oral agreement by which Bird was to erect a house on the lot. Upon the sale of the house and lot, Bird was to have his money first. Clark was then to have the agreed value of the lot, and the profits were to be equally divided. Did a partnership exist? Answer: Business for Profit. No partnership existed. The agreement is a joint venture. Clark and Bird were not "carrying on" a business but engaged in a single transaction involving contributions by each and an agreement to share profits. 5. Grant, Arthur, and David formed a partnership for the purpose of betting on boxing matches. Grant and Arthur would become friendly with various boxers and offer them bribes to lose certain bouts. David would then place large bets, using money contributed by all three, and would collect the winnings. After David had accumulated a large sum of money, Grant and Arthur demanded their share, but David refused to make any split. Can Grant and Arthur compel David to account for the profits of the partnership? Why? Answer: Nature of Partnership. Grant and Arthur are not entitled to an accounting against David, as the business in which Grant, Arthur and David engaged was illegal. The parties are left without a legal or equitable remedy and the court will leave them in the position in which they find themselves. 6. Teresa, Peter, and Walker were partners under a written agreement made in January that the partnership should continue for ten years. During the same year, Walker, being indebted to Smith, sold and conveyed his interest in the partnership to Smith. Teresa and Peter paid Smith $50,000 as Walker’s share of the profits for that year but refused Smith permission to inspect the books or to come into the managing office of the partnership. Smith brings an action setting forth the above facts and asks for an account of partnership transactions and an order to inspect the books and to participate in the management of the partnership business. (a) Does Walker's action dissolve the partnership? (b) To what is Smith entitled with respect to (1) partnership profits, (2) inspection of partnership books, (3) an account of partnership transactions, and (4) participation in the partnership management? Answer: Transfer of Partnership Interest. (a) No. Walker's action does not dissolve the partnership. R.U.P.A. Section 503(a)(2), U.P.A. Section 27(1). (b) (1) Smith is entitled to receive Walker's share of the partnership profits. R.U.P.A. Section 503(b)(1), U.P.A. Section 27(1). (2) Smith is not entitled to inspect the partnership books. R.U.P.A. Section 503(a)(3), U.P.A. Section 27(1). (3) Smith is not entitled to an account of the partnership's transactions. R.U.P.A. Section 503(a)(3), U.P.A. Section 27(1). (4) Smith is not entitled to participate in the management or administration of the partnership business or affairs. R.U.P.A. Section 503(a)(3), U.P.A. Section 27(1). 7. Horn’s Crane Service furnished supplies and services under a written contract to a partnership engaged in operating a quarry and rock-crushing business. Horn brought this action against Prior and Cook, the individual members of the partnership, to recover a personal judgment against them for the partnership’s liability under that contract. Horn has not sued the partnership itself, nor does he claim that the partnership property is insufficient to satisfy its debts. What result? Explain. Answer: Entity Theory. Judgment for Prior and Cook. A partnership is a legal entity distinct and apart from the members composing it. Therefore, in order to hold the individual partners liable, it is necessary for a creditor to show that the partnership property is insufficient to satisfy the debts of the partnership. The partnership relation is such that the separate property of a partner cannot be subjected to the payment of partnership debts until the property of the firm is exhausted. There are two reasons for this rule. First, since credit was extended to the partnership, the partnership property should be exhausted first. Second, to allow a partnership creditor to bypass the partnership's assets and exhaust the assets of an individual member would allow the other partners to profit unjustly at his expense. Horn's Crane Service v. Prior, 182 Neb. 94, 152 N.W. 2d 421 (1967). The outcome would be the same under the Revised Act. 8. Cutler worked as a bartender for Bowen until they orally agreed that Bowen would have the authority and responsibility for the entire active management and operation of the tavern business known as the Havana Club. Each was to receive $300 per week plus half of the net profits. The business continued under this arrangement for four years until the building was taken over by the Salt Lake City Redevelopment Agency. The agency paid $30,000 to Bowen as compensation for disruption. The business, however, was terminated after Bowen and Cutler failed to find a new, suitable location. Cutler, alleging a partnership with Bowen, then brought this action against him to recover one-half of the $30,000. Bowen contends that he is entitled to the entire $30,000 because he was the sole owner of the business and that Cutler was merely his employee. Cutler argues that although Bowen owned the physical assets of the business, she, as a partner in the business, is entitled to one-half of the compensation that was paid for the business’s goodwill and going-concern value. Who is correct? Explain. Answer: Tests of Partnership Existence. Judgment for Cutler. The appellate court upheld the trial court's determination that a partnership had been formed. One of the primary matters to consider in determining whether a partnership exists is the nature of the contribution each party makes to the enterprise. It need not be in the form of tangible assets or capital, but, as is frequently done, one partner may make such a contribution, and this may be balanced by the other's performance of services and the shouldering of responsibility. On the question of whether profits shared should be regarded simply as wages, it is important to consider the degree to which a party participates in the management of the enterprise and whether the relationship is such that the party shares generally in the potential profits or advantages and thus should be held responsible for losses or liability incurred therein. Cutler v. Bowen, 543 P.2d 1349 (Utah Supreme Court, 1975). The outcome would be the same under the Revised Act. 9. In 2007, Gauldin and Corn entered into a partnership for the purpose of raising cattle and hogs. The two men were to share equally all costs, labor, losses, and profits. The business was started on land owned initially by Corn’s parents but later acquired by Corn and his wife. No rent was ever requested or paid for use of the land. Partnership funds were used to bulldoze and clear the land, to repair and build fences, and to seed and fertilize the land. In 2011, at a cost of $2,487.50, a machine shed was built on the land. In 2016, a Cargill unit was built on the land at a cost of $8,000. When the partnership dissolved in 2017, Gauldin paid Corn $7,500 for the “removable” assets; however, the two had no agreement regarding the distribution of the barn and the Cargill unit. Is Gauldin entitled to one-half of the value of the two buildings? Explain. Answer: Partnership Property. Yes, judgment for Gauldin. The well-established rule is that improvements made upon lands owned by one partner, if made with partnership funds for purposes of the partnership business, are the property of the partnership. The non-land owning partner is then entitled to his proportionate share of the value of the improvements. This general rule only applies, however, where there is no agreement between the partners controlling the disposition of the improvements. Here, Gauldin and Corn had no agreement regarding the disposition of the fixed assets upon the partnership's dissolution. The barn and Cargill unit, acquired with partnership funds for the purpose of raising cattle and hogs, are such fixed assets. Therefore, Gauldin is entitled to his proportionate share (one-half) of the value of the two buildings at the time of the partnership's dissolution. Gauldin v. Corn, 595 S.W.2d 329 (Mo. So. Dist. Div. 1 1980). The outcome would be the same under the Revised Act. 10. Anita and Duncan had been partners for many years in a mercantile business. Their relationship deteriorated to the point at which Anita threatened to bring an action for an accounting and dissolution of the firm. Duncan then offered to buy Anita’s interest in the partnership for $250,000. Anita refused the offer and told Duncan that she would take no less than $360,000. A short time later, James approached Duncan and informed him he had inside information that a proposed street change would greatly benefit the business and that he, James, would buy the entire business for $1,000,000 or buy a one-half interest for $500,000. Duncan made a final offer of $350,000 to Anita for her interest. Anita accepted this offer, and the transaction was completed. Duncan then sold the one-half interest to James for $500,000. Several months later, Anita learned for the first time of the transaction between Duncan and James. What rights, if any, does Anita have against Duncan? Answer: Right to an Account. Anita has a right against Duncan for an accounting of the $150,000 difference in the sale price, and Anita may bring a suit in equity to impress a trust thereon. R.U.P.A. Section 404(b)(1) provides that a partner’s duty of loyalty to the partnership and the other partners includes the duty “to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity.” U.P.A. Section 21 provides: (1) Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property. One partner will not be permitted directly or indirectly to purchase the interest of the other or reap any benefit therefrom without making a full and fair disclosure of all facts within his knowledge relative thereto. This relationship exists until a dissolution or termination of the partnership and it is immaterial that the partners' relationship is strained or that a suit for an accounting and dissolution is threatened. Here, Duncan did not make a full disclosure, which failure resulted in a $150,000 loss to Anita, his partner. 11. ABCD Company is a general partnership. It consists of Dianne, Greg, Knox, and Laura, whose capital contributions were as follows: Dianne, $5,000; Greg, $7,500; Knox, $10,000; and Laura, $5,000. The partnership agreement provided that the partnership would continue for three years and that no withdrawals of capital were to be made without the consent of all the partners. The agreement also provided that all advances would be entitled to interest at 10 percent per year. Six months after the partnership was formed, Dianne advanced $10,000 to the partnership. At the end of the first year, net profits totaled $11,000 before any moneys had been distributed to partners. How should the $11,000 be allocated to Dianne, Greg, Knox, and Laura? Explain. Answer: Rights Among Partners: Right to Share in Distributions. RUPA: Dianne would receive the entire $11,000. When a partner makes an advance to the firm above and beyond her capital contribution she is entitled to repayment of this advance plus interest. R.U.P.A. Section 401(c). Comment 4 to that section states: “Although the right to indemnification is usually enforced in the settlement of accounts among partners upon dissolution and winding up of the partnership business, the right accrues when the liability is incurred and thus may be enforced during the term of the partnership in an appropriate case.” This partner's position is on the same footing as firm creditors and is superior to the partners' claims for return of capital or distribution of profits. R.U.P.A. Section 404(f). In this case the $11,000 represents the total of Dianne's advance plus one year of interest at 10%. UPA: The same outcome except this partner's position as a firm creditor is subordinate to other firm creditors, but is superior to the partners' claims for return of capital or distribution of profits. U.P.A. Section 18(c). 12. Donald Petersen joined his father, William Petersen, in a chicken hatchery business William had previously operated as a sole proprietorship. When the partnership was formed, William contributed the assets of the proprietorship, which included cash, equipment, and inventory having a total value of $41,000. Donald contributed nothing. They agreed to share the profits equally. For fifteen years Donald took over the operation of the hatchery with very little help from his father. When the business was terminated William contended that he was entitled to the return of his capital investment of $41,000 before Donald could recover anything. Donald asserted that he is entitled to one-half the value of the business. Explain who is correct in his contention. Answer: Distribution of Assets. Judgment for Donald. According to the Uniform Partnership Act, the right of a partner to receive back the capital he contributed is subject to a contrary agreement among the partners. Such an agreement need not be written but may be implied from the conduct of the partners. Here, although Donald contributed no substantial capital to the business, he operated it with very little help from his father. Meanwhile, William continued to receive half of the income. The conduct of the parties makes it reasonable to infer that William put up the capital and Donald provided the labor under an agreement by which each was to own half of the business, including capital and profits. Donald's estate is therefore entitled to half of the value of the business. Petersen v. Petersen, 284 Minn. 61, 169 N.W.2d 228 (1969). 13. Smith, Jones, and Brown were creditors of White, who operated a grain elevator known as White’s Elevator. Heavily in debt, White was about to fail when the three creditors agreed to take title to his elevator property and pay all the debts. It was also agreed that White should continue as manager of the business at a salary of $1,500 per month and that all profits of the business were to be paid to Smith, Jones, and Brown. It was further agreed that they could dispense with White’s services at any time and that he was free to quit when he pleased. White accepted the proposition and continued to operate the business as before. The agreement worked successfully and for several years paid substantial profits, enough so that Smith, Jones, and Brown had received nearly all that they had originally advanced. Were Smith, Jones, and Brown partners? Explain. Answer: Tests of Partnership Existence. Yes. Smith, Jones, and Brown purchased White's business for themselves and White thereafter had no further interest in it. Moreover, they have agreed to share all profits from the business and could discharge White at any time. Consequently, they are partners. 14. Virginia, Georgia, Carolina, and Louis were partners doing business under the trade name of Morning Glory Nursery. Virginia owned a one-third interest, and Georgia, Carolina, and Louis owned two-ninths each. The partners acquired three tracts of land for the purpose of the partnership. Two of the tracts were acquired in the names of the four partners, “trading and doing business as Morning Glory Nursery.” The third tract was acquired in the names of the individuals, the trade name not appearing in the deed. This third tract was acquired by the partnership out of partnership funds and for partnership purposes. Who owns each of the three tracts? Why? Answer: Partnership Property. The partnership. (a) The first two tracts were acquired for the purpose of the partnership and title included the name of the partnership. RUPA Sections 204 (a) and 204(b), UPA Section 8(3). (b) The third tract was acquired with partnership funds. Even if the instrument transferring title to one or more of the partners does not indicate their capacity as a partner or the existence of a partnership, the property nevertheless may be partnership property. Ultimately, the partners’ intention controls whether property belongs to the partnership or to one or more of the partners in their individual capacities. When the partners have failed to express their intent, property purchased with partnership funds is presumed to be partnership property, without regard to the name in which title is held. RUPA Section 204(c). The result would be the same under the UPA. Unless the contrary intention appears, property acquired with partnership funds is partnership property. U.P.A. Section 8(2). 15. Charles and L. W. Clement were brothers who had formed a partnership that lasted forty years until Charles discovered that his brother, who kept the partnership’s books, had made several substantial personal investments with funds improperly withdrawn from the partnership. He then brought an action seeking dissolution of the partnership, appointment of a receiver, and an accounting. Should Charles succeed? Explain. Answer: Fiduciary Duty/Duty to Disclose Material Facts. Yes. There is a fiduciary relationship between partners such that a person does not have to deal with his partner as though he were the opposite party in an arm’s length transaction. Where a partner commingles partnership funds with his own and generally deals loosely with partnership assets, he has the burden of proving that he did not breach his fiduciary duty. Here, L.W. dealt loosely with partnership funds. At various times he made substantial investments in his own name with partnership funds. Charles is entitled to recover even if he cannot trace the money invested by his brother dollar for dollar from the diverted partnership funds. 16. Michael, his mother, and his four siblings orally agreed that they would all play the lottery and that if any one of them should purchase a lottery ticket which would win a substantial prize, all of them would share the money equally. Michael's mother purchased the sole winning ticket for the six million dollar lottery prize and informed the lottery commission that, per the family agreement, a six-person partnership had won the prize. Each of the six family members took an equal one-sixth share of the lottery proceeds. Explain whether Michael’s share of the lottery proceeds was income resulting from a partnership or a gift from Michael’s mother. Answer: Tests of Partnership Existence. Michael’s share of the lottery proceeds was income resulting from a partnership. This case problem is based on the case of Weinig v. Weinig, 674 N.E.2d 991, Indiana Court of Appeals (1996). Existence of a partnership is generally a question of fact. To establish a partnership relation between parties, there must be: (1) a voluntary contract of association for the purpose of sharing profits and losses which may arise from the use of capital, labor, or skill in a common enterprise; and (2) an intention on the part of the parties to form a partnership. The six family members agreed that they would continue to play the lottery, and would evenly divide any major winnings. The agreement is a voluntary joining together to share winnings that may result from expenditures of money on lottery tickets. The second element essential to establishing a partnership, that there be an intention on the part of the parties to form a partnership, was established by the parties conduct subsequent to forming the oral agreement. There was evidence from which the trial court could conclude that Michael continued to play the lottery regularly, along with the other parties to the oral agreement. After Michael's mother discovered that she possessed the winning ticket, the family stated to the Lottery Commission and federal taxing authorities that the Lottery was won by a six person partnership. No gift tax was paid on the lottery proceeds disbursed to Michael since Michael declared the money to be earned income resulting from his one sixth interest in a partnership to play the lottery. Finally, the lottery jackpot was in fact divided equally among all six family members as contemplated by their oral agreement. The facts of this case reveal a wholly completed partnership. 17. Anderson and Tallstrom are partners in Rancho Murieta Investors (RMI). Anderson owns 80 percent of RMI; Tallstrom owns the other 20 percent and is the managing partner of RMI. Hellman obtained judgments against Anderson in his individual capacity for more than $440,000. After various unsuccessful attempts to enforce the judgments, Hellman obtained an "Order Charging Debtor John B. Anderson's Partnership Interest" in RMI. Despite the charging order, Hellman has not received any monies in satisfaction of the judgments because RMI had not generated profits and was not expected to do so in the near future. Explain what Hellman’s rights are with respect to the unsatisfied charging order. Answer: Creditors’ Rights. Hellman may seek a court-ordered foreclosure of Anderson’s transferable partnership interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee. This case problem is based on Hellman v. Anderson, 233 Cal. App. 3d 840, 284 Cal. Rptr. 830, California Court of Appeal, 3rd Appellate Dist. 1991, decided under the 1914 UPA. Section 15028 authorizes a charging order on the debtor partner's partnership interest and further allows the trial court to "make all other orders ... which the circumstances of the case may require." (§ 15028, subd. (1); see also 6 West's U.Laws Ann. (1969) Uniform Partnership Act, § 28.) The statute clearly implies judicial authority to order foreclosure and sale of the charged interest because it further says the interest charged may be redeemed "at any time before foreclosure, or in case of a sale being directed by the court" may be purchased by nondebtor partners without causing a dissolution of the partnership. Foreclosure sales of charged partnership interests are also implicitly recognized in section 15032 which deals with partnership dissolutions and makes reference to "the purchaser" of a partner's interest under section 15028. ANSWERS TO “TAKING SIDES” PROBLEMS Chaiken entered into separate but nearly identical agreements with Strazella and Spitzer to operate a barber shop. Under the terms of the “partnership” agreements, Chaiken would provide barber chairs, supplies, and licenses, while the other two would provide tools of the trade. The agreements also stated that gross returns from the partnership were to be divided on a percentage basis among the three men and that Chaiken would decide all matters of partnership policy. Finally, the agreements stated hours of work and holidays for Strazella and Spitzer and required Chaiken to hold and distribute all receipts. (a) What are the arguments that Strazella and Spitzer are partners with Chaiken? (b) What are the arguments that Strazella and Spitzer are employees of Chaiken? (c) Explain which arguments should prevail. Answer: (a) Arguments that Strazella and Spitzer are partners with Chaiken include (1) they had entered into a partnership agreement, (ii) they contributed their tools and labor, and (2) they shared gross returns generated by the business. (b) Arguments that Strazella and Spitzer are not partners with Chaiken but are employees of Chaiken include (1) having separate agreements with each barber, (2) sharing gross receipts rather than sharing profits, (3) lack of control by Strazella and Spitzer, and (4) Chaiken setting working hours for Strazella and Spitzer. (c) Strazella and Spitzer are employees of Chaiken. Chaiken v. Employment Security Commission, 274 A.2d 707 (Delaware Superior Court, 1971), http://scholar.google.com/scholar_case?case=9812582210779482634&q=274+A.2d+707&hl=en&as_sdt=2,34. A partnership is an association of two or more persons to carry on as co-owners a business for profit. The mere existence of a writing labeled “partnership agreement” and the characterization of its signatories as “partners” does not conclusively establish the existence of a partnership. Rather, the intention of the parties, as explained by the wording of the agreement, is controlling. Here, several aspects of the agreements between Chaiken and the two barbers, when considered as a whole, negate the finding of a partnership arrangement. First, Chaiken reserved the exclusive right to determine partnership policy. Second, distribution of assets upon dissolution of a partnership is to occur only after all partnership liabilities have been satisfied. Here, however, there was no such condition placed on such distributions to Strazella and Spitzer. Third, the agreements set forth holidays and hours of work for the two barbers, subjects not commonly found in partnership agreements. Finally, and of most importance, the agreements provided for a division of gross returns, not of net profits. The intent to divide profits is an indispensable requisite of a partnership. All of these factors taken together negate a finding of partnership intent here. Rather, Strazella and Spitzer are employees of Chaiken. Chapter 31 OPERATION AND DISSOLUTION OF GENERAL PARTNERSHIPS ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Albert, Betty, and Carol own and operate the Roy Lumber Company. Each contributed one-third of the capital, and they share equally in the profits and losses. Their partnership agreement provides that two partners must authorize all purchases over $2,500 in advance and that only Albert is authorized to draw checks. Unknown to Albert or Carol, Betty purchases on the firm’s account a $5,500 diamond bracelet and a $5,000 forklift and orders $5,000 worth of logs, all from Doug, who operates a jewelry store and is engaged in various activities connected with the lumber business. Before Betty made these purchases, Albert told Doug that Betty is not the log buyer. Albert refuses to pay Doug for Betty’s purchases. Doug calls at the mill to collect, and Albert again refuses to pay him. Doug calls Albert an unprintable name, and Albert then punches Doug in the nose, knocking him out. While Doug is lying unconscious on the ground, an employee of Roy Lumber Company negligently drops a log on Doug’s leg, breaking three bones. The firm and the three partners are completely solvent. What are the rights of Doug against Roy Lumber Company, Albert, Betty, and Carol? Answer: Authority to Bind Partnership/Liability of Partners. (a) The Roy Lumber Company Partnership is not liable for the logs; Betty is personally liable for the price of the logs. No act of a partner in contravention of a restriction on authority shall bind the partnership to persons having knowledge of the restriction. R.U.P.A. Section 301(1), U.P.A. Section 9(4). Thus, the partnership will not be bound as to the logs because Doug had knowledge of the lack of authority. Betty is liable for breach of warranty of authority. (b) The Roy Lumber Company Partnership is liable for the forklift truck. Since Doug was unaware of the $2,500 restriction upon partners' purchases and the purchase of a forklift was within the apparent authority of Betty, the partnership is bound. R.U.P.A. Section 301(1), U.P.A. Section 9(1). The partners are personally and unlimitedly liable for this obligation. Under the RUPA, their liability is joint and several. R.U.P.A. Section 306(a). Under the UPA, their liability is joint. U.P.A. Section 15(b). (c) Partnership is not liable for the diamond bracelet; Betty is personally liable for the bracelet. R.U.P.A. Section 301(2) provides: An act of a partner which is not apparently for carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership only if the act was authorized by the other partners. U.P.A. Section 9(2) is similar: "An act of a partner which is not apparently for the carrying on of the business of the partnership in the usual way does not bind the partnership unless authorized by the other partners." (d) Partnership is liable for the injured leg; the employee is liable for injured leg. A partnership, as are all principals, is liable under the doctrine of respondeat superior for torts committed by employees within the scope of their employment. The partners are personally and unlimitedly liable for this obligation. Under the RUPA, their liability is joint and several. R.U.P.A. Section 306(a). Under the UPA, their liability is also joint and several. U.P.A. Section 15(a). 2. Paula, Fred, and Stephanie agree that Paula and Fred will form and conduct a partnership business and that Stephanie will become a partner in two years. Stephanie agrees to lend the firm $50,000 and take 10 percent of the profits in lieu of interest. Without Stephanie’s knowledge, Paula and Fred tell Harold that Stephanie is a partner, and Harold, relying on Stephanie’s sound financial status, gives the firm credit. The firm later becomes insolvent, and Harold seeks to hold Stephanie liable as a partner. Should Harold succeed? Answer: Partnership by Estoppel. Harold should not succeed in holding Stephanie liable as a partner. The agreement to become a partner in two years did not create a present partnership. Neither does the receipt by a creditor of a share of the profits rather than interest on the loan. R.U.P.A. Section 202(c)(3), U.P.A. Section 7(4). Stephanie is not liable as a partner by estoppel as she had no knowledge of the representation made by Paula and Fred to Harold. R.U.P.A. Section 308(a), U.P.A. Section 16. 3. Simmons, Hoffman, and Murray were partners doing business under the firm name of Simmons & Co. The firm borrowed money from a bank and gave the bank the firm’s note for the loan. In addition, each partner guaranteed the note individually. The firm became insolvent, and a receiver was appointed. The bank claims that it has a right to file its claim as a firm debt and also that it has a right to participate in the distribution of the assets of the individual partners before partnership creditors receive any payment from such assets. (a) Explain the principle involved in this case. (b) Is the bank correct? Answer: Marshaling of Assets. Under the UPA the principle involved is that of marshaling of assets. U.P.A. Section 40(g). The Revised Act has abolished the marshaling of assets doctrine. Under the UPA the bank is correct, and may file its claim against and participate in the assets of the partnership and also in the separate non-partnership assets of the estate of each individual partner, as the guaranty is the individual and separate liability of each partner. This is sometimes referred to as "doubling proofing." Under the UPA the bank would have a priority over partnership creditors in the assets of the individual partners. Under the Revised Act the bank would not have a priority over partnership creditors in the assets of the individual partners. 4. Anthony and Karen were partners doing business as the Petite Garment Company. Leroy owned a dye plant that did much of the processing for the company. Anthony and Karen decided to offer Leroy an interest in their company, in consideration for which Leroy would contribute his dye plant to the partnership. Leroy accepted the offer and was duly admitted as a partner. At the time he was admitted as a partner, Leroy did not know that the partnership was on the verge of insolvency. About three months after Leroy was admitted to the partnership, a textile firm obtained a judgment against the partnership in the amount of $50,000. This debt represented an unpaid balance that had existed before Leroy was admitted as a partner. The textile firm brought an action to subject the partnership property, including the dye plant, to the satisfaction of its judgment. The complaint also requested that, in the event the judgment was unsatisfied by sale of the partnership property, Leroy’s home be sold and the proceeds applied to the balance of the judgment. Anthony and Karen own nothing but their interest in the partnership property. What should be the result (a) with regard to the dye plant and (b) with regard to Leroy's home? Answer: Liability of Incoming Partner. (a) The dye plant may be sold. (b) Leroy's home cannot be sold. A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person’s admission as a partner. R.U.P.A. Section 306(b). The UPA is very similar. A person admitted as a partner into an existing partnership is liable for all the obligations of the partnership arising before his admission as though he had been a partner when such obligations were incurred, except that his liability shall be satisfied only out of partnership property. U.P.A. Section 17. 5. Jones and Ray formed a partnership on January 1, known as JR Construction Co., to engage in the construction business, each partner owning a one-half interest. On February 10, while conducting partnership business, Jones negligently injured Ware, who brought an action against Jones, Ray, and JR Construction Co. and obtained judgment for $250,000 against them on March 1. On April 15, Muir joined the partnership by contributing $100,000 cash, and by agreement each partner was entitled to a one-third interest. In July, the partners agreed to purchase new construction equipment for the partnership, and Muir was authorized to obtain a loan from XYZ Bank in the partnership name for $200,000 to finance the purchase. On July 10, Muir signed a $200,000 note on behalf of the partnership, and the equipment was purchased. In November, the partnership was in financial difficulty, its total assets amounting to $50,000. The note was in default, with a balance of $150,000 owing to XYZ Bank. Muir has substantial resources, while Jones and Ray each individually have assets of $20,000. What is the extent of Muir's personal liability and the personal liability of Jones and Ray as to (a) the judgment obtained by Ware and (b) the debt owing to XYZ Bank? Answer: Liability of Incoming Partner. (a) Muir is not personally liable for the Ware judgment. . A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person’s admission as a partner. R.U.P.A. Section 306(b), U.P.A. Section 17. Jones and Ray are jointly and severally liable for the judgment obtained by Ware since he was injured by a wrongful act of a partner acting in the ordinary course of business. R.U.P.A. Section 306(a), U.P.A. Sections 13 and 15. (b) Under the RUPA, Muir, Jones and Ray are jointly and severally liable for the debt owing to XYZ Bank but not collected from partnership assets. Since Muir executed the note as an agent of the partnership, the partnership is bound for the debt as Muir had authority to do this, and the liability for this obligation would be joint and several for all partners. R.U.P.A. Section 306(a). Under the UPA the result would be the same except the liability would be joint. U.P.A. Sections 9 and 15. 6. Lauren, Matthew, and Susan form a partnership, Lauren contributing $100,000; Matthew contributing $50,000; and Susan contributing her time and skill. Nothing is said regarding the division of profits. The firm later dissolves. No distributions to partners have been made since the partnership was formed. The partnership sells its assets for a loss of $90,000. After payment of all firm debts, $60,000 is left. Lauren claims that she is entitled to the entire $60,000. Matthew contends that the distribution should be $40,000 to Lauren and $20,000 to Matthew. Susan claims the $60,000 should be divided equally among the partners. Who is correct? Explain. Answer: Distribution of Assets. Neither Lauren, nor Matthew, nor Susan, is correct. Under the Revised Act, where the agreement is silent as to sharing profits, the partners share the profits equally. The instant agreement is silent as to both profits and losses. Hence, Lauren, Matthew, and Susan bear the $90,000 loss equally or in the amount of $30,000 each. This results in the partners’ accounts as follows: Lauren = $70,000, Matthew = $20,000, and Susan = ($30,000). Accordingly, Lauren will receive $70,000, Matthew will receive $20,000, and Susan must contribute $30,000. Under the UPA, the total capital contributions are $150,000. After payment of all partnership debts, the remaining assets are $60,000. The loss is therefore $90,000. Where the partnership agreement is silent as to bearing losses, the partners bear the loss in the same proportion as they share profits. Where the agreement is silent as to sharing profits, the partners share the profits equally. The instant agreement is silent as to both profits and losses. Hence, Lauren, Matthew, and Susan bear the $90,000 loss equally or in the amount of $30,000 each. Lauren is entitled to the return of her $100,000 capital contribution, less her $30,000 share of the loss, or $70,000. Matthew is entitled to the return of his $50,000 capital contribution, less his $30,000 share of the loss, or $20,000. Susan must pay her share of the loss, $30,000, which sum added to the $60,000 on hand would be paid to Lauren and Matthew in the amount above stated. 7. Adams, a consulting engineer, entered into a partnership with three others for the practice of their profession. The only written partnership agreement is a brief document specifying that Adams is entitled to 55 percent of the profits and the others to 15 percent each. The venture is a total failure. Creditors are pressing for payment, and some have filed suit. The partners cannot agree on a course of action. How many of the partners must agree to achieve each of the following objectives? (a) To add Jones, also an engineer, as a partner, Jones being willing to contribute a substantial amount of new capital. (b) To sell a vacant lot held in the partnership name, which had been acquired as a future office site for the partnership. (c) To move the partnership's offices to less expensive quarters. (d) To demand a formal accounting. (e) To dissolve the partnership. (f) To agree to submit certain disputed claims to arbitration, which Adams believes will prove less expensive than litigation. (g) To sell all of the partnership's personal property, Adams having what he believes to be a good offer for the property from a newly formed engineering firm. (h) To alter the respective interests of the parties in the profits and losses by decreasing Adams's share to 40 percent and increasing the others' shares accordingly. (i) To assign all the partnership's assets to a bank in trust for the benefit of creditors, hoping to work out satisfactory arrangements without filing for bankruptcy. Answer: Rights Among Partners. In the absence of an agreement to the contrary, all four partners stand on an equal footing in the management of the firm notwithstanding their unequal shares in the profits. R.U.P.A Section 401(b), U.P.A. Section 18(e). (a) The admission of a new partner requires unanimous consent of all partners. R.U.P.A Section 401(i), U.P.A. Section 18(g). (b) A majority of the partners may decide to sell partnership property. R.U.P.A Section 401(j), U.P.A. Section 18(h). (c) A majority of the partners may decide upon relocation of the offices, that being an ordinary matter connected with the partnership business. R.U.P.A Section 401(j), U.P.A. Section 18(h). (d) One. Under the Revised Act a partner may maintain a direct suit against the partnership or another partner for legal or equitable relief, with or without an accounting as to partnership business, to enforce the partner's rights under the partnership agreement and the Act. Section 405(b). Under the UPA any partner may demand an accounting since the present circumstances of the business would appear to render the demand just and reasonable. U.P.A. Section 22. (e) RUPA: Any partner may rightfully dissociate by withdrawing and thereby cause the partnership to dissolve, since the partnership agreement is not for a definite term or a particular undertaking. R.U.P.A Sections 601, 602, and 801(1). UPA: any partner may rightfully cause the partnership to dissolve, since the partnership agreement is not for a definite term or a particular undertaking. U.P.A. Section 31. (f) RUPA: This probably would require a majority of the partners. Comment 4 to Section 301 states: “UPA Section 9(3) contains a list of five extraordinary acts that require unanimous consent of the partners before the partnership is bound. RUPA omits that section. That leaves it to the courts to decide the outer limits of the agency power of a partner. Most of the acts listed in UPA Section 9(3) probably remain outside the apparent authority of a partner under RUPA, such as disposing of the goodwill of the business, but elimination of a statutory rule will afford more flexibility in some situations specified in UPA Section 9(3). In particular, it seems archaic that the submission of a partnership claim to arbitration always requires unanimous consent.” UPA: Only all partners acting together may submit a partnership claim or liability to arbitration. U.P.A. Section 9(3). (g) If the disposition of all the personal property would make it impossible to carry on the ordinary business of the partnership, it requires unanimous action of all partners. Otherwise, a majority may act. R.U.P.A. Section 301(2), U.P.A. Section 9. (h) Since the interests of the partners in profits and losses is fixed by the written partnership agreement, they can only be altered with the consent of all the partners. R.U.P.A. Section 401(j), U.P.A. Section 18(h). (i) RUPA: Uncertain. See (f) above. UPA: An assignment in trust for the benefit of creditors requires unanimous consent of the partners. U.P.A. Section 9(3). 8. Charles and Jack orally agreed to become partners in a tool and die business. Charles, who had experience in tool and die work, was to operate the business. Jack was to take no active part but was to contribute the entire $500,000 capitalization. Charles worked ten hours a day at the plant, for which he was paid nothing. Nevertheless, despite Charles’s best efforts, the business failed. The $500,000 capital was depleted, and the partnership owed $500,000 in debts. Prior to the failure of the partnership business, Jack became personally insolvent; consequently, the creditors of the partnership collected the entire $500,000 indebtedness from Charles, who was forced to sell his home and farm to satisfy the indebtedness. Jack later regained his financial responsibility, and Charles brought an appropriate action against Jack for (a) one-half of the $500,000 he had paid to partnership creditors and (b) one-half of $80,000, the reasonable value of Charles’s services during the operation of the partnership. Who will prevail and why? Answer: Right to Share in Profits. Charles cannot recover for (a) or (b). (a) Since Charles and Jack had no specific agreement regarding the division of profits and losses, profits were to be divided equally and, hence, losses were to be shared equally. Losses include "capital or otherwise" so the partnership lost $1,000,000. Jack had already contributed his half of the loss so Charles could not force further contribution from Jack. R.U.P.A. Section 401 and Comment 3, U.P.A. Section 18(a). (b) The RUPA provides that unless otherwise agreed a partner is not entitled to remuneration for services performed for the partnership. R.U.P.A. Section 401(h). Since Charles and Jack had no specific agreement regarding remuneration, Charles is entitled to none. U.P.A. Section 18(f) is similar. 9. Glenn refuses an invitation to become a partner of Dorothy and Cynthia in a retail grocery business. Nevertheless, Dorothy inserts an advertisement in the local newspaper representing Glenn as their partner. Glenn takes no steps to deny the existence of a partnership between them. Ron, who extended credit to the firm, seeks to hold Glenn liable as a partner. Is Glenn liable? Explain. Answer: Partnership by Estoppel. Glenn is not liable as a partner by estoppel because he took no part in placing the advertisement in the newspaper nor is he under a duty to have a retraction published. The comment to RUPA Section 308 states: “As under the UPA, there is no duty of denial, and thus a person held out by another as a partner is not liable unless he actually consents to the representation.” Under the UPA, a few courts, however, have held that Glenn is under a duty to have a retraction published. 10. Hanover leased a portion of his farm to Brown and Black, doing business as the Colorite Hatchery. Brown went upon the premises to remove certain chicken sheds that he and Black had placed there for hatchery purposes. Thinking that Brown intended to remove certain other sheds, which were Hanover’s property, Hanover accosted Brown, who willfully struck Hanover and knocked him down. Brown then ran to the Colorite truck, which he had previously loaded with chicken coops, and drove back to the hatchery. On the way, he picked up George, who was hitchhiking to the city to look for a job. Brown was driving at seventy miles an hour down the highway. At an open intersection with another highway, Brown in his hurry ran a stop sign, striking another vehicle. The collision caused severe injuries to George. Immediately thereafter, the partnership was dissolved, and Brown was insolvent. Hanover and George each bring separate actions against Black as copartner for the alleged tort committed by Brown against each. What judgments as to each? Answer: Torts of Partnership. (a) Hanover may recover against Black as the assault and battery committed by Brown was in connection with a dispute which concerned property of the partnership and was, therefore, a tort committed by a partner in the course of the partnership business. (b) George may not recover against Black as the act of Brown in picking up George as a hitchhiker was not connected with the carrying on of the partnership business or for the benefit of the partnership. 11. Martin, Mark, and Marvin formed a retail clothing partnership named M Clothiers and conducted a business for many years, buying most of their clothing from Hill, a wholesaler. On January 15, Marvin retired from the business, but Martin and Mark decided to continue it. As part of the retirement agreement, Martin and Mark agreed in writing with Marvin that Marvin would not be responsible for any of the partnership debts, either past or future. On January 15 the partnership published a notice of Marvin’s retirement in a newspaper of general circulation where the partnership carried on its business. Before January 15, Hill was a creditor of M Clothiers to the extent of $10,000, and on January 30, he extended additional credit of $5,000. Hill was not advised and did not in fact know of Marvin’s retirement and the change of the partnership. On January 30, Ray, a competitor of Hill, extended credit for the first time to M Clothiers in the amount of $3,000. Ray also was not advised and did not in fact know of Marvin’s retirement and the change of the partnership. On February 1, Martin and Mark departed for parts unknown, leaving no partnership assets with which to pay the described debts. What is Marvin’s liability, if any, (a) to Hill and (b) to Ray? Answer: Rights of Creditors Under the Revised Act: (a) Marvin is liable to Hill for $15,000; (b) Marvin is liable to Ray for $3,000. A partner’s dissociation does not of itself discharge the partner’s liability for a partnership obligation incurred before dissociation. Section 703(a). An agreement as to continuing liability of a retiring partner, though binding on the parties making it, is not binding on an existing creditor unless such creditor assents to it, and Marvin, therefore, remains liable on the pre-existing $10,000 debt to Hill. For partnership obligations incurred within two years after a partner dissociates without resulting in a dissolution of the partnership business, a dissociated partner is liable for a partnership obligation if at the time of entering into the transaction the other party: (1) reasonably believed that the dissociated partner was then a partner; (2) did not have notice of the partner's dissociation; and (3) is not deemed to have had constructive notice from a filed statement of dissociation. Section 703(b). On the facts it appears most likely that both Hill and Ray satisfy all of the conditions of Section 703(b) and could hold Marvin liable. Under the UPA: (a) Marvin is liable to Hill for $15,000; (b) Marvin is not liable to Ray for any amount. An agreement as to continuing liability of a retiring partner, though binding on the parties making it, is not binding on an existing creditor unless such creditor assents to it, and Marvin, therefore, remains liable on the pre-existing $10,000 debt to Hill. There is a distinction in regard to continued liability of a retiring partner to persons who had extended credit to the firm before dissolution as opposed to those who have not; as to the former, actual notice is necessary of the withdrawal or retirement of the partner and must be given in some form to such creditor unless the creditor, in fact, knows of the change. Therefore, Marvin would be liable to Hill for the $5,000 credit extended in Hill's continued dealings but before he knew of the retirement. Ray, the new creditor, having extended credit to the new partnership only after the retirement of Marvin and after the news item was published, can look only to such partnership, and therefore, Marvin is not liable to Ray. 12. Ben, Dan, and Lilli were partners sharing profits in proportions of one-fourth, one-third, and five-twelfths, respectively. Their business failed, and the firm was dissolved. At the time of dissolution, no financial adjustments between the partners were necessary with reference to their respective partners’ accounts, but the firm’s liabilities to creditors exceeded its assets by $24,000. Without contributing any amount toward the payment of the liabilities, Dan moved to a destination unknown. Ben and Lilli are financially responsible. How much must each contribute? Answer: Contribution of Partners. Ben must contribute $9,000; Lilli, $15,000. Section 807(c) of the Revised Act provides that if a partner fails to contribute the full amount required, all of the other partners must contribute, in the proportions in which those partners share partnership losses, the additional amount necessary to satisfy the partnership obligations for which they are personally liable. Section 40 of the Uniform Partnership Act is similar and provides, in part: If any, but not all, partners are insolvent, or not being subject to process, refuse to contribute, the other partners shall contribute their share of the liabilities and in the proportions in which they share the profits, the additional amount necessary to pay the liabilities. The partners’ required contribution is as follows: Ben, $6,000; Dan, $8,000; and Lilli, $10,000. Since Dan failed to contribute, Ben and Lilli must contribute to Dan's share of the liability. As between themselves Ben and Lilli share profits in the proportion of three to five (1/4 divided by 5/12 = 3/5). Accordingly, Ben must contribute 3/8ths of the $24,000 required to pay creditors or $9,000; and Lilli must contribute 5/8ths of the $24,000, or $15,000. 13. Ames, Bell, and Cole were equal partners in the ABC Construction Company. Their written partnership agreement provided that the partnership would dissolve upon the death of any partner. Cole died on June 30, and his widow, Cora Cole, qualified as executor of his will. Ames and Bell wound up the business of the partnership and on December 31 they completed the sale of all of the partnership’s assets. After paying all partnership debts, they distributed the balance equally among themselves and Mrs. Cole as executor. Subsequently, Mrs. Cole learned that Ames and Bell had made and withdrawn a net profit of $200,000 from July 1 to December 31. The profit was made through new contracts using the partnership name and assets. Ames and Bell had concealed such contracts and profit from Mrs. Cole, and she learned about them from other sources. Immediately after acquiring this information, Mrs. Cole made demand upon Ames and Bell for one-third of the profit of $200,000. They rejected her demand. What are the rights and remedies, if any, of Cora Cole as executor? Answer: Winding Up. Mrs. Cole as executor is entitled to one-third of the dissolution net profits. The surviving partners have the right to continue possession of the firm's assets and business for the purpose of winding up. The surviving partners have no right to bind the partnership by new contracts. If the new contracts are within their apparent authority the partnership is bound. The continuing partners must account to the personal representative of the deceased partner for any profit from the new contracts. They are liable to the partnership for any loss from the new contracts. Mrs. Cole, as executor, is entitled to one-third of the net profits of $200,000. 14. The articles of partnership of the firm of Wilson and Company provide William Smith to contribute $50,000; to receive interest thereon at 13 percent per annum and to devote such time as he may be able to give; to receive 30 percent of the profits. John Jones to contribute $50,000; to receive interest on same at 13 percent per annum; to give all of his time to the business and to receive 30 percent of the profits. Henry Wilson to contribute all of his time to the business and to receive 20 percent of the profits. James Brown to contribute all of his time to the business and to receive 20 percent of the profits. There is no provision for sharing losses. After six years of operation, the firm is dissolved and wound up. No distributions to partners have been made since the partnership was formed. The partnership assets are sold for $400,000 with a loss of $198,000. Liabilities to creditors total $420,000. What are the rights and liabilities of the respective parties? Answer: Distribution of Assets. RUPA: Smith and Jones are entitled to have their partners’ accounts credited with interest of $39,000, as the partnership agreement expressly provides. Each of the partners’ accounts is charged with each partner’s share of the $198,000 loss. These losses are borne in the same ratio as profits are shared. Smith and Jones are each charged with 30 per cent or $59,400. Wilson and Brown are each charged with $39,600, their share of the losses. The partner’s account for Smith and Jones each equals $29,600 ($50,000 plus $39,000 in interest minus his share of the loss of $59,400). The partner’s account for Wilson and Brown each equals a negative $39,600, which each must contribute to the partnership. This sum added to the $400,000 assets on hand makes a total of $479,200. The creditors' claims of $420,000 are paid first, leaving a balance of $59,200. Of this amount, $29,600 is paid to Smith, and $29,600 is paid to Jones. UPA: The total capital contributions are $100,000. In addition, interest of $39,000 is due to Smith and Jones each on their respective capital contributions, as the partnership agreement expressly provides. Liabilities to creditors are $420,000, assets are $400,000, and the total losses are $198,000. These losses are borne in the same ratio as profits are shared. Smith is entitled to $50,000 in capital plus $39,000 in interest minus his share of the loss (30 per cent or $59,400), which equals $29,600. On the same basis, Jones is entitled to receive $29,600. Wilson and Brown should each pay $39,600, their share of the losses, for a total of $79,200. This sum added to the $400,000 assets on hand makes a total of $479,200. The creditors' claims of $420,000 are paid first, leaving a balance of $59,200. Of this amount, $29,600 is paid to Smith, and $29,600 is paid to Jones. 15. Adam, Stanley, and Rosalind formed a partnership in State X to distribute beer and wine. Their agreement provided that the partnership would continue until Decem¬ber 31, 2020. Which of the following events would cause the ABC partnership to dissolve? If so, when would the partnership be dissolved? a) Rosalind assigns her interest in the partnership to Mary on April 1, 2018. b) Stanley dies on June 1, 2020. c) Adam withdraws from the partnership on September 15, 2019. d) A creditor of Stanley obtains a charging order against Stanley’s interest on October 9, 2017. e) In 2018, the legislature of State X enacts a statute making the sale or distribution of alcoholic beverages illegal. f) Stanley has a formal accounting of partnership affairs on September 19, 2019. Answer: Causes of Dissolution. RUPA a. No dissociation and no dissolution. A partner can transfer her transferable interest in a partnership to another. The assignee does not become a partner. b. Death of a partner in a term partnership will not cause dissolution of a partnership if within 90 days fewer than half of the remaining partners vote to wind up the partnership. c. Withdrawal of a partner in a term partnership in violation of the partnership agreement will not cause dissolution of a partnership if within 90 days fewer than half of the remaining partners vote to wind up the partnership. d. No dissociation and no dissolution. The charging order will not cause dissociation or dissolution. At the expiration of the specified term, the holder of the charging order may seek to obtain a court-ordered dissolution. e. Dissolution upon the action by the legislature making the business illegal; this dissolves the partnership by operation of law. f. No dissolution. Any partner is entitled to request an accounting, and this will not cause a dissolution. UPA a. No dissolution. A partner can assign her interest in a partnership to another. The assignee does not become a partner. b. Dissolution upon the death of a partner; this causes the dissolution of a partnership by operation of law. c. Dissolution. Because Adam has withdrawn prior to the expiration of the partnership agreement, he is liable to his partners for damages and they have the right to continue the partnership until the agreed expiration date. d. No dissolution. The charging order will not effect a dissolution. At the expiration of the specified term, the holder of the charging order may obtain a court ordered dissolution. e. Dissolution upon the action by the legislature making the business illegal; this dissolves the partnership by operation of law. f. No dissolution. Any partner is entitled to request an accounting, and this will not cause a dissolution. 16. Phillips and Harris are partners in a used car business. Under their oral partnership, each has an equal voice in the conduct and management of the business. Because of their irregular business hours, the two further agreed that they could use any partnership vehicle as desired. This use includes transportation to and from work, even though the vehicles are for sale at all times. Harris conducted partnership business both at the used car lot and from his home. He was on call by Phillips or customers at his home and he went back to the lot two or three times after going home. While driving a partnership vehicle home from the used car lot, Harris negligently hit a car driven by Cook, who brought this action against Harris and Phillips individually and as copartners for his injuries. Who is liable? Answer: Torts of Partnership. Both the partnership and the individual partners are liable. The test of the liability of the partnership and of its members for the torts of any one partner is whether the wrongful act was done within what may reasonably be found to be the scope of the business of the partnership and for its benefit. Phillips v. Cook, 239 Md. 215, 210 A.2d 743 (1965). 17. Voeller, the managing partner of the Pay-Out Drive-In Theater, signed a contract to sell to Hodgea small parcel of land belonging to the partnership. Except for the last twenty feet, which was necessary for the theater’s driveway, the parcel was not used in theater operations. The agreement stated that it was between Hodge and the partnership, with Voeller signing for the partnership. Voeller claims that he told Hodge before signing that a plat plan would have to be approved by the other partners before the sale. Hodge denies this and sues for specific performance, claiming that Voeller had actual and apparent authority to bind the partnership. The partners argue that Voeller had no such authority and that Hodge knew this. Who is correct? Explain. Answer: Authority to Bind Partnership. Judgment for the partners. Under the UPA a partner may convey legal title to property held in the partnership name. The partnership, however, may recover the property (except from a good faith purchaser) if (1) the conveying partner did not have apparent authority, or (2) he did not have any authority and the purchaser knew this fact. Here, although Voeller was managing partner, selling the land adjacent to the theater is not in the usual course of the business of operating a theater. Therefore, Voeller did not have apparent authority to sell the land. Furthermore, there is no evidence that Voeller had sold property before on behalf of the partnership, nor was the partnership engaged in the business of buying and selling real estate. Thus, there was no actual authority to sell real property belonging to the partnership. In the absence of both apparent and actual authority, the contract is not binding on the partnership. Hodge v. Garrett, 614 P.2d 420 (Idaho 1980). The RUPA appears consistent with this decision. 18. L. G. and S. L. Patel, husband and wife, owned and operated the City Center Motel in Eureka. On April 16, Rajeshkumar, the son of L. G. and S. L., formed a partnership with his parents and became owner of 35 percent of the City Center Motel. The partnership agreement required that Rajeshkumar approve any sale of the motel. Record title to the motel was not changed, however, to reflect his interest. On April 21, L. G. and S. L. listed their motel for sale with a real estate broker. On May 2, P. V. and Kirit Patel made an offer on the motel, which L. G. and S. L. accepted. Neither the broker nor the purchasers knew of the son’s interest in the motel. When L. G. and S. L. notified Rajeshkumar of their plans, to their surprise, he refused to sell his 35 percent of the motel. On May 4, L. G. and S. L. notified P. V. and Kirit that they wished to withdraw their acceptance. They offered to pay $10,000 in damages and to give the purchasers a right of first refusal for five years. Rather than accept the offer, on May 29, P. V. and Kirit filed an action for specific performance and incidental damages. L. G., S. L., and Rajeshkumar responded that the contract could not lawfully be enforced. Discuss who will prevail and why. Answer: Authority to Bind Partnership. Judgment for the partnership selling the motel. The trial court found the provisions of U.P.A. section 9 (3)(c) to prevail over those of subdivision (3) of section 10. To enforce the contract of sale without Rajeshkumar's approval would frustrate the purpose of subdivision (3)(c) of section 9 by making it impossible for the partnership to continue. (See U.P.A. § 9 (3)(c).) Because the purpose of the partnership is to operate a motel, rather than to hold it for eventual sale, the better result would be to preserve the partnership and hold the contract unenforceable. Patel v. Patel, 212 Cal.App.3d, 260 Cal.Rptr 255 (California 1989). The RUPA appears consistent with this decision. 19. Davis and Shipman founded a partnership under the name of Shipman & Davis Lumber Company. Seven years later, the partnership was dissolved by written agreement. Notice of the dissolution was published in a newspaper of general circulation in Merced County, where the business was conducted. No actual notice of dissolution was given to firms that previously had extended credit to the partnership. By the dissolution agreement, Shipman, who was to continue the business, was to pay all of the partnership’s debts. He continued the business as a sole proprietorship for a short time until he formed a successor corporation, Shipman Lumber Servaes Co. After the partnership’s dissolution, two firms that previously had done business with the partnership extended credit to Shipman for certain repair work and merchandise. The partnership also had a balance due to Valley Company for prior purchases. Five months later, two checks were drawn by Shipman Lumber Servaes Co. and accepted by Valley as partial payment on this debt. Credit Bureaus of Merced County, as assignee of these three accounts, sued the partnership as well as Shipman and Davis individually. Does the dissolution of the partnership relieve Davis of personal liability for the accounts? Explain. Answer: Rights of Creditors. Judgment for the Credit Bureaus affirmed. A retired partner may be relieved of liability for partnership debts incurred after his retirement if creditors receive appropriate notice of the partnership's dissolution. As to the firms having prior credit dealing with the partnership, actual notice is required. Here, all three creditors had previously extended credit to the partnership. The publication of notice of the partnership's dissolution, by itself, is insufficient to show that these prior creditors received actual notice. Furthermore, the two checks do not, in themselves, prove that Valley Company entered into a novation to relieve Davis of liability for the account. Again, actual knowledge of the partnership's dissolution is required. Therefore, Davis remains liable for these debts. Credit Bureaus of Merced County, Inc. v. Shipman, 167 Cal. App.2d 673, 334 P.2d 1036 (1959). The outcome under the Revised Act is uncertain. The Revised Act has changed the UPA’s rule distinguishing between creditors who extend credit before dissociation and those who first do so after dissociation. Under the RUPA, for partnership obligations incurred within two years after a partner dissociates without resulting in a dissolution of the partnership business, a dissociated partner is liable for a partnership obligation if at the time of entering into the transaction the other party: (1) reasonably believed that the dissociated partner was then a partner; (2) did not have notice of the partner's dissociation; and (3) is not deemed to have had constructive notice from a filed statement of dissociation. Section 703(b). It is not clear whether all these creditors have satisfied all of these requirements. Moreover, if any of the new obligations arose after two years following dissociation, there would be no liability. 20. In August, Victoria Air Conditioning, Inc. (VAC) entered into a subcontract for insulation services with Southwest Texas Mechanical Insulation Company (SWT), a partnership composed of Charlie Jupe and Tommy Nabors. In February of the following year, Jupe and Nabors dissolved the partnership, but VAC did not receive notice of the dissolution at that time. Sometime later, insulation was removed from Nabors’s premises to Jupe’s possession and Jupe continued the insulation project with VAC. From then on, Nabors had no more involvement with SWT. One month later, Nabors informed VAC’s project manager, Von Behrenfeld, that Nabors was no longer associated with SWT, had formed his own insulation company, and was interested in bidding on new jobs. Subsequently, SWT failed to perform the subcontract and Jupe could not be found. VAC brought suit for breach of contract against SWT, Jupe, and Nabors. Nabors claims that several letters and change orders introduced by both parties show that VAC knew of the dissolution and impliedly agreed to discharge Nabors from liability. These documents indicated that VAC had dealt with Jupe, but had not dealt with Nabors, after the dissolution. VAC denies that the course of dealings between VAC and Jupe was the type from which an agreement to discharge Nabors could be inferred. Who is correct? Explain. Answer: Rights of Creditors. The general rule is that the dissolution of a partnership does not of itself discharge any existing liabilities of a partner. U.P.A. § 36(1). (R.U.P.A. § 703(a) is similar.) However, an exception to the general rule exists when the retired partner, the person continuing the partnership’s business, and the partnership creditor agree that the retired partner will be discharged from liability. U.P.A. § 36(2). (R.U.P.A. § 703(c) continues this rule.) Furthermore, such an agreement may be inferred from the course of dealing between the creditor having knowledge of the dissolution and the person continuing the partnership’s business. U.P.A. § 36(2). (R.U.P.A. § 703(c) omits the language regarding inferring an agreement from the course of dealing.) It must be determined whether the evidence is factually sufficient to show that there was an agreement between VAC, Jupe, and Nabors to discharge Nabors from liability. First, the evidence supports that VAC knew of the dissolution of the SWT partnership. Also, the letters and change orders subsequent to dissolution support the contention that VAC was aware of SWT’s change of address. Second, the course of dealing between Jupe and VAC after the dissolution shows that there was an implied agreement between the parties to discharge Nabors from liability. Therefore sufficient evidence of a course of dealing exists in the record from which it could have inferred that an agreement existed between VAC, Jupe, and Nabors to discharge Nabors from liability. Victoria Air Conditioning, Inc. v. Southwest Texas Mechanical Insulation Co., Court of Appeals of Texas, 850 S.W.2d 720 (1993). 21. Horizon—a large, publicly traded provider of both nursing homes and management for nursing homes—wanted to expand into Osceola County, Florida. Southern Oaks was already operating in Osceola County; it owned the Southern Oaks Health Care Center and had a Certificate of Need issued by the Florida Agency for Health Care Administration for a new one-hundred-and-twenty-bed facility in Kissimmee. Horizon and Southern Oaks decided to form a partnership to own the proposed Kissimmee facility, which was ultimately named Royal Oaks, and agreed that Horizon would manage both the Southern Oaks facility and the new Royal Oaks facility. To that end, Southern Oaks and Horizon entered into twenty-year partnership and management contracts. The partnership agreements provided that “irreconcilable differences” was a permissible reason for dissolving the partnership. Three years later, Southern Oaks filed suit alleging that Horizon breached its obligations under two different partnership agreements and that Horizon had breached the various management contracts. The court ordered that the partnerships be dissolved, finding that they were incapable of continuing to operate in business together. Explain whether Southern Oaks is entitled to receive a damage award for the loss of the partnerships’ seventeen remaining years’ worth of future profits. Answer: Dissolution by Court Order. Southern Oaks is not entitled to future damages. A court-ordered dissolution for good cause is not wrongful and does not entitle either party to damages from the other. Horizon/CMS Healthcare Corporation v. Southern Oaks Health Care, Inc., Court of Appeal of Florida, Fifth District, 732 So.2d 1156; review denied, 744 So.2d 454 (1999). First, the trial court's finding that the parties are incapable of continuing to operate together is a finding of “irreconcilable differences,” a permissible reason for dissolving the partnerships under the express terms of the partnership agreements. One of the reasons the Revised Uniform Partnership Act (RUPA) gives for dissolution is “It is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement.” While “reasonably practicable” is not defined in RUPA, the term is broad enough to encompass the inability of partners to continue working together, which is what the court found. Thus, dissolution was not “wrongful,” and Southern Oaks was not entitled to damages for lost future profits. Additionally, the partnership contracts also permit dissolution by “judicial decree.” Second, even assuming the partnership was dissolved for a reason not provided for in the partnership agreements, damages were properly denied. Under RUPA, it is clear that wrongful dissociation triggers liability for lost future profits. However, RUPA does not contain a similar provision for dissolution. RUPA does not refer to the dissolutions as rightful or wrongful. Under RUPA only when a partner dissociates and the dissociation is wrongful can the remaining partners sue for damages. Southern Oaks' attempt to bring the instant dissolution under the statutory provision applicable to dissociation is rejected. The trial court ordered dissolution of the partnership, not the dissociation of Horizon for wrongful conduct. There no longer appears to be “wrongful” dissolution—either dissolution is provided for by contract or statute or the dissolution was improper and the dissolution order should be reversed. In the instant case, because the dissolution either came within the terms of the partnership agreements or judicial dissolution in which case it is not reasonably practicable to carry on the partnership business, Southern Oaks' claim for lost future profits is without merit. ANSWERS TO “TAKING SIDES” PROBLEMS Stroud and Freeman are general partners in Stroud’s Food Center, a grocery store. Nothing in the articles of partnership restricts the power or authority of either partner to act in respect to the ordinary business of the Food Center. In November, however, Stroud informed National Biscuit that he would not be personally responsible for any more bread sold to the partnership. Then, in the following February, at the request of Freeman, National Biscuit sold and delivered more bread to the Food Center. a. What are the arguments that Stroud is not liable to National Biscuit for the value of the bread delivered to the Food Center? b. What are the arguments that Stroud is liable to National Biscuit for the value of the bread delivered to the Food Center? c. Explain which arguments should prevail. Answer: a. Stroud would argue that because he had informed National Biscuit of a restriction on Freeman’s authority the contract was not binding on the partnership and thus not binding on Stroud. b. National Biscuit would argue that each partner is an agent of the partnership for the purpose of its business. An act of a partner for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership and thus binds Stroud. c. National Biscuit should prevail. National Biscuit v. C. N. Stroud, 249 N.C. 467, 106 S.E.2d 692 (1959). (The Revised Uniform Partnership Act [RUPA] appears consistent with this decision.) Freeman’s purchase bound both the partnership and his partner Stroud. Freeman is a general partner with no restrictions on his authority to act within the scope of partnership business. Under the Uniform Partnership Act (UPA), then, he had “equal rights in the management and conduct of the partnership business.” Stroud could not restrict the power and authority of Freeman to buy bread for the partnership as a going concern, for such a purchase was an “ordinary matter connected with the partnership business,” for the purpose of its business and within its scope. Such a restriction on Freeman’s powers could only be implemented by a majority of the partners, which Stroud was not. According to Crane on Partnership: In cases of an even division of the partners as to whether or not an act within the scope of the business should be done, of which disagreement a third person has knowledge, it seems that logically no restriction can be placed upon the power to act. The partnership being a going concern, activities within the scope of the business should not be limited, save by the expressed will of the majority deciding a disputed question; half of the members are not a majority. Solution Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637