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This Document Contains Chapters 29 to 30 Chapter 29 BANK DEPOSITS, COLLECTIONS, AND FUNDS TRANSFERS Bank Deposits and Collections Collection of Items [29-1] Collecting Banks [29-1a] Duty of Care Duty to Act Timely Indorsements Warranties Final Payment Payor Banks [29-1b] Relationship Between Payor Bank and Its Customer [29-2] Payment of an Item [29-2a] Substitute Check [29-2b] Stop Payment Orders [29-2c] Bank's Right to Subrogation on Improper Payment [29-2d] Disclosure Requirements [29-2e] Customer's Death or Incompetence [29-2f] Customer's Duties [29-2g] Electronic Funds Transfers Types of Electronic Funds Transfers [29-3] Automated Teller Machines [29-3a] Point-of-Sale Systems [29-3b] Direct Deposits and Withdrawals [29-3c] Pay-By-Phone Systems [29-3d] Personal Computer (Online) Banking [29-3e] Wholesale Electronic Funds Transfers [29-3f] Consumer Funds Transfers [29-4] Disclosure [29-4a] Documentation and Periodic Statements [29-4b] Preauthorized Transfers [29-4c] Error Resolution [29-4d] Consumer Liability [29-4e] Liability of Financial Institution [29-4f] Wholesale Funds Transfers [29-5] Scope of Article 4A [29-5a] Payment Order Parties Excluded Transactions Acceptance [29-5b] Erroneous Execution of Payment Orders [29-5c] Unauthorized Payment Orders [29-5d] Cases in This Chapter Dixon, Laukitis and Downing v. Busey Bank Leibling, P.C. v. Mellon PSFS National Association Union Planters Bank National Association v. Rogers Chapter Outcomes After reading and studying this chapter, the student should be able to: • Identify and explain the various stages of and parties to the collection of a check. • Identify and explain the duties of collecting banks. • Explain the relationship between a payor bank and its customers. • Define a consumer electronic funds transfer, identify the various types of electronic funds transfers, and outline the major provisions of the Electronic Funds Transfer Act. • Explain wholesale fund transfers and discuss how they operate. TEACHING NOTES Credit cards, charge accounts, and various deferred payment plans have made cash sales increasingly rare. Credit sales are usually settled by check rather than cash. In some sales, credit is extended by the seller or a third party. In other sales, a noncash payment is made either by paper (checks and drafts) or electronically (debit cards, credit cards, automated clearinghouse [ACH], and prepaid cards).Generally, the buyer’s check must journey from the seller-payee’s bank, where the check is deposited by the seller for credit to his account, to the buyer-drawer’s bank for payment. In the collection process, checks can also pass through one or more banks so that it may be collected and the appropriate entries recorded. BANK DEPOSITS AND COLLECTIONS Article 4 of the UCC, entitled “Bank Deposits and Collections,” provides the principal rules governing the bank collection process. In 2002, the American Law Institute and the Uniform Law Commission completed updates to Article 4. At least ten States have adopted the 2002 version. This part of the text will discuss the pre-2002 Article 4. The end result of the collection process is either the payment of the check or the dishonor (refusal to pay) of the check by the drawee bank. As items in the bank collection process are essentially those covered by Article 3, “Commercial Paper,” and to a lesser extent by Article 8, “Investment Securities,” these Articles often apply to a bank collection problem. In addition, Articles 3 and 4 are supplemented and, at times, preempted by Federal law: the Expedited Funds Availability Act and its implementing Federal Reserve Regulation (Regulation CC). This section will cover the collection of an item through the banking system and the relationship between the payor bank and its customer. The principal rules governing the bank collection process are in Article 4 of the UCC, but some parts of the process are covered by Article 3, “Commercial Paper,” and to a lesser extent by Article 8, “Investment Securities.” *** Chapter Outcome *** Identify and explain the various stages and parties to the collection of a check. 29-1 COLLECTION OF ITEMS When a check is deposited (in the depositary bank), the bank credits the account for that amount. This is provisional credit and, normally, a bank does not permit a customer to draw funds against a provisional credit. If the bank does permit its customer to draw against the provisional credit, it has given value and may qualify to be a holder in due course. Under the customer’s contract with her bank, the bank must make a reasonable effort to obtain payment of all checks deposited for collection. When the amount of the check has been collected from the payor bank (the drawee), the credit becomes final. The Expedited Funds Availability Act has established maximum time periods for which a bank may hold (and thereby deny a customer access to the funds represented by) various types of instruments. Where the depositary and payor banks are different, a check must pass from one bank to the other, either through one or more intermediary banks or through a clearinghouse — an association, composed of banks or other payors, whose purpose is to settle its members’ accounts on a daily basis. NOTE: See Figure 29-1. *** Chapter Outcome *** Identify and explain the duties of collecting banks. 29-1a Collecting Banks A collecting bank is one that handles an instrument for payment, excluding the payor bank. Typically, the depositary bank gives a provisional credit to its customer and then transfers the item to the next bank in the chain, receiving a provisional credit or “settlement” from it, and so on to the payor bank, which then debits the drawer’s account. When the check is paid, all the provisional settlements become final; the transaction is completed. If the payor bank does not pay the check, however, it returns the check, and each intermediary or collecting bank reverses the provisional settlement or credit it previously gave to its forwarding bank. Ultimately, the depositary bank will charge the account of its customer who deposited the item, and the customer must seek recovery from the indorsers or the drawer. Duty of Care — Collecting banks are required to exercise ordinary care in the handling of checks and must act with reasonable care and within a reasonable time to forward them for presentment. They must also use care in routing items and selection of intermediary banks and agents. CASE 29-1 Dixon, Laukitis and Downing v. Busey Bank Appellate Court of Illinois, Third District, 2013 2013 IL App 3d 120832, 993 N.E.2d 580, 373 Ill.Dec. 274 O'Brien, J. [Plaintiff Dixon, Laukitis & Downing, P.C. (DLD) is a law firm that maintained its client trust account at defendant Busey Bank. On May 25, 2011, DLD deposited into its trust account a check from one of its clients in the amount of $350,000. The check was drawn on the account of Intact Insurance Company at Royal Bank of Canada in Toronto, Ontario. The check was marked, “US Funds.” On June 6, 2011, DLD transferred $210,000 from its trust account to the client who provided the $350,000 check. On June 8, 2011, DLD transferred $60,000 from the trust account to the client. On June 10, 2011, the check was returned to Busey uncollected, and Busey notified DLD and charged back $350,000 to DLD's account the same day. DLD filed a negligence action against Busey, alleging that Busey breached a duty of ordinary care the bank owed DLD regarding a fraudulent check DLD deposited and drew against, which was later determined to be uncollectible. The trial court dismissed the complaint, and DLD appealed.] According to DLD, Busey owed it a duty of ordinary care under the common law and the UCC, breached its duty, and caused DLD damages. *** *** Article 4 of the UCC governs bank deposits and collections. It sets forth a bank's general duty to exercise ordinary care and states that “action or non-action approved by this Article *** is the exercise of ordinary care and, in the absence of special instructions, action or non-action consistent *** with a general banking usage not disapproved by this Article, is prima facie the exercise of ordinary care.” Section 4–103(c). A bank that takes an item is a “Depository Bank” and a bank that handles an item for collection and is not a drawee of the draft is a “Collecting Bank.” 4–105. A collecting bank acts as an agent of an item's owner until final settlement of the item and “any settlement given for the item is provisional.” 4–201(a). In addition, a collecting bank has a superior right over the item's owner to a setoff if an item does not settle. 4–201(a). The UCC does not enumerate duties for a depository bank but section 4–202 sets forth the responsibilities for a collecting bank as follows: (a) A collecting bank must exercise ordinary care in: (1) presenting an item or sending it for presentment; (2) sending notice of dishonor or nonpayment or returning an item other than a documentary draft to the bank's transferor after learning that the item has not been paid or accepted, as the case may be; (3) settling for an item when the bank receives final settlement; and (4) notifying its transferor of any loss or delay in transit within a reasonable time after discovery thereof. (b) A collecting bank exercises ordinary care under subsection (a) by taking proper action before its midnight deadline following receipt of an item, notice, or settlement. 4202(a), (b). Section 4–214(a) provides that a collecting bank may charge back a customer's account when the bank makes provisional settlement but does not receive final payment on an item if the collecting bank gives notice to its customer by midnight of the next banking day. 4–214(a). *** The account agreement [and the UCC] placed the risk of loss on DLD until final settlement of the $350,000 check. This provision applied whether Busey acted as a depository bank or a collecting bank. *** *** Under section 4–202, a collecting bank exercises ordinary care when it presents an item, sends notice of dishonor, finally settles an item, or timely notifies the transferor of any delay by performing such actions before midnight following receipt, notice or settlement of an item. DLD seeks to add an additional duty of ordinary care under the common law to supplement these specific standards. Contrary to DLD's claims, the UCC displaces common law duties for a collecting bank. As the trial court noted, the UCC provides a comprehensive plan for the processing of checks. Where, like here, its specific provisions set forth standards regarding particular banking practices, they displace the ordinary care standard under the common law. In the amended complaint, DLD does not assert that Busey failed to timely perform any section 4–202 duties of a collecting bank, including notifying DLD before the midnight deadline that the check was dishonored. *** As discussed above, the account holder agreement between DLD and Busey formed a contract, which incorporated the applicable UCC provisions and defined the parties' responsibilities. *** Where, as here, the account agreement and UCC set forth Busey's duties and define ordinary care, there is no extracontractual relationship. We find that the trial court properly dismissed the complaint *** . Affirmed. Duty to Act Timely — The midnight deadline refers to the midnight of the next banking day subsequent to the day on which an instrument was received. A collecting bank is considered to have acted timely if it forwards or presents an item by this deadline. Indorsements — A restrictive indorsement such as “Pay any bank” locks the check into the bank collection process, and protects the collecting bank by making it impossible for the item to stray from regular collection channels. A depository bank that receives an item without indorsement becomes a holder if the customer was a holder. Warranties — Customers and collecting banks give the same transfer warranties as parties, including: 1) he is entitled to enforce the item, 2) all signatures are authentic and authorized, 3) there are no alterations, 4) he is not subject to any defense or claim in recoupment; and 5) he has no knowledge of any insolvency proceeding involving the maker or the drawer of an unaccepted draft. The presenter’s warranties to a drawee on a draft are 1) she is a person entitled to enforce, 2) the item has not been altered, and 3) she has no knowledge that the signature of the drawer is unauthorized. Additionally, Revised Article 4 provides that the encoding (depositing) bank or a customer who encodes her own checks warrants that the check can be read by the Magnetic Ink Character Recognition system. Final Payment — The UCC states that a payor bank has made final payment when it first does one of these: 1) the item is paid in cash, 2) it settles without the right to revoke the settlement through statute, agreement, or clearing house rule, or 3) enters into a provisional settlement that is not timely revoked. 29-1b Payor Banks A payor (drawee) bank is obligated to pay on a drawer's check assuming no stop payment order has been filed and adequate funds are available in the account. In most cases, a payor bank must give its transferor a provisional settlement; otherwise it may become liable to its transferor for the amount of the item unless it has a valid defense, such as breach of a presentment warranty. The payor bank has until the midnight deadline to return the item or, if the item is held for protest or is otherwise unavailable for return, to send written notice of dishonor or nonpayment, and then revoke the provisional settlement and recover any payment it has made. The bank may dishonor an item because: the drawer has no account or the account has insufficient funds, a signature may be forged, or the drawer may have stopped payment on the item. *** Chapter Outcome *** Explain the relationship between a payor bank and its customers. 29-2 RELATIONSHIP BETWEEN PAYOR BANK AND ITS CUSTOMER A bank may not validly (1) disclaim responsibility for its lack of good faith, (2) disclaim responsibility for its lack of ordinary care, or (3) limit its damages for a breach constituting such lack or failure. The parties may by agreement, however, determine the standards by which such responsibility is to be measured, as long as these standards are not clearly unreasonable. 29-2a Payment of an Item A payor bank owes a duty to its customer, the drawer, to pay checks properly drawn by the customer on an account that has funds sufficient to cover the items, although the holder of a check has no right to require the drawee bank to pay it. However, if an item which is less than six months old is presented to a payor bank and the bank improperly refuses payment, it will incur a liability to the customer from whose account the item should have been paid. Checks over six months old are considered “stale” but may be paid at the bank’s option if done in good faith. When a payor bank receives an item properly payable from a customer’s account, but the funds in the account are insufficient to pay it, the bank may (1) dishonor the item and return it, or (2) pay the item and charge its customer’s account, even though an overdraft results. The customer may be liable to the bank to pay a service charge for the bank’s handling of the overdraft or may be liable to pay interest on the amount of the overdraft. 29-2b Substitute Check The Check Clearing for the 21st Century Act (also called Check 21 or the Check Truncation Act), which went into effect in late 2004, permits banks to remove an original paper check from the check collection or return process and sending (1) a substitute check or, (2) by agreement, information relating to the original check (including data taken from the MICR line of the original check or an electronic image of the original check). The substitute check is the legal equivalent of an original check for all purposes, if the substitute check: (1) accurately represents all of the information on the front and back of the original check as of the time the original check was truncated; and (2) bears the legend: “This is a legal copy of your check. You can use it the same way you would use the original check.” A substitute check is a paper reproduction of the original check that: (1) contains an image of the front and back of the original; (2) bears a MICR (magnetic ink character recognition line) containing all the information appearing on the MICR line of the original check; (3) conforms, in paper stock, dimension, and otherwise, with generally applicable industry standards for substitute checks; and (4) is suitable for automated processing in the same manner as the original check. The law does not require banks to accept checks in electronic form nor does it require banks to use the new authority granted by the act to create substitute checks. On the other hand, parties cannot refuse to accept a substitute check that meets the Act’s requirements. The ultimate objective of the Act is to make the collection process more efficient and much faster (transferring digital files within seconds rather than days) and to enhance fraud detection by accelerating return of dishonored checks. 29-2c Stop Payment Orders A customer may revoke the order to pay a sum of money (as contained in a check) with a stop payment order. If the order does not come too late, the bank is bound by it. CASE 29-2 LEIBLING, P.C. v. MELLON PSFS (NJ) NATIONAL ASSOCIATION Superior Court of New Jersey, Law Division, Special Civil Part, Camden County, 1998 710 A.2d 1067, 311 N.J. Super. 651, 35 UCC Rep.Serv.2d 590 Rand, J. Mr. Scott D. Liebling, P.C. (hereinafter “Plaintiff”) is an attorney at law. Plaintiff maintains an attorney trust account (“Account”) at Mellon Bank (NJ) National Association (“Mellon”) ***. Mellon uses a computerized system to process checks for payment. Plaintiff represented defendant Fredy Winda Ramos (“Ramos”) in a personal injury action which resulted in a settlement. On or about May 19, 1995, plaintiff issued Check No. 1031 in the amount of $8,483.06 to Ramos representing her net proceeds from the settlement. Mellon honored that check on May 26, 1995. On or about May 24, 1995, plaintiff mistakenly issued another check, Check No. 1043, to Ramos in the same amount of $8,483.06. Realizing his error, on or about May 30, 1995, Plaintiff called Ramos in Puerto Rico and advised her that the Check No. 1043 was issued by mistake and instructed her to destroy the check. Thereafter, Plaintiff called Mellon and ordered an oral stop payment on the check. On December 21, 1996, some nineteen months after plaintiff issued the Check No. 1043, Ramos cashed the check from Puerto Rico. Plaintiff filed this complaint against both Ramos and Mellon. Ramos was served and defaulted. Plaintiff’s complaint against Mellon alleges breach of duty of good faith, negligence, breach of fiduciary duty, payment of a stale check, and breach of contract as a result of Mellon honoring the second check, Check No. 1043. *** * * * [T]he issue in the present case turns on whether Mellon acted in good faith when it honored plaintiff’s check. Good faith under N.J. Uniform Commercial Code has been defined in [UCC] 3-103(a)(4) as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” * * * *** * * * [P]laintiff’s argument centers on the proposition that the bank’s duty of good faith required it to inquire or consult with plaintiff before honoring a stale check that had a previous oral stop payment order on it. * * * However, * * * “[t]he duty [of inquiry] is inconsistent with the provisions of subsection 4-403(2) on the expiration of the ‘effectiveness’ of stop orders. Such a duty is hardly practical today.” Moreover: “[t]o require that a payor bank check the date of every check received via the collection process would unreasonably increase the cost of processing every check written today.” *** Thus, in determining whether the defendant bank in the present action acted in good faith, the above cited material must be analyzed and applied. First, it appears clear that the Uniform Commercial Code acknowledges that computerized check processing systems are common and accepted banking procedures in the United States. [Citation.] Therefore, it cannot be said that defendant bank acted in bad faith by using a computerized system when it honored plaintiff’s “stale” check. Furthermore, it appears that the test for good faith is a subjective test. Thus, based on all of the foregoing material, as long as the defendant bank used an adequate computer system for processing checks (here there is no proof to the contrary), it appears to have acted in good faith even though it did not consult the Plaintiff before it honored the “stale” check that had an expired oral stop-payment order on it * * * . [T]he obligation of a bank to stop payment on a check does not continue in perpetuity once the stop payment order expires. The bank’s conduct was fair and in accordance with reasonable commercial standards. Accordingly, it appears that the defendant bank is not liable and should prevail. A finding of no liability is entered for the defendant bank. 29-2d Bank's Right to Subrogation on Improper Payment If a payor bank pays an item over a stop payment order or otherwise in violation of its contract with the drawer, the bank is subrogated to (obtains) the rights of (a) any holder in due course on the item against the drawer or maker; (b) the payee or any other holder against the drawer or maker; and (c) the drawer or maker against the payee or any other holder. 29-2e Disclosure Requirements The Truth in Savings Act, passed in 1992, requires all depositary institutions to disclose details of customers’ accounts, including fees, interest rates, and regulations. 29-2f Customer's Death or Incompetence Death or incompetence revokes all agency agreements. Adjudication of incompentency by a court is regarded as notice to the world of that fact. Actual notice is not required. 29-2g Customer's Duties A bank customer must exercise reasonable promptness in examining account statements and canceled checks to detect unauthorized signatures or alterations. Failure to notify the bank of any false signatures within the maximum thirty days (less in some cases) will render the drawer liable for checks subse-quently forged by the same person if the bank has been using reasonable care in the collection process. Even if the bank doesn't use reasonable care, the customer must notify the bank within one year. *** Chapter Outcome *** Define a consumer electronic funds transfer, identify the various types of electronic funds transfers and outline the major provisions of the Electronic Funds Transfer Act. CASE 29-3 UNION PLANTERS BANK, NATIONAL ASSOCIATION v. ROGERS Supreme Court of Mississippi, 2005 912 So.2d 116 Waller, J. This appeal involves an issue of first impression in Mississippi—the interpretation of [UCC] 4-406 (Rev. 2002), which imposes duties on banks and their customers insofar as forgeries are concerned. The case arises from a series of forgeries made by one person on four checking accounts maintained by Helen Rogers at the Union Planters Bank. * * * Facts Neal D. and Helen K. Rogers maintained four checking accounts with the Union Planters Bank in Greenville, Washington County, Mississippi. * * * The Rogers were both in their eighties when the events which gave rise to this lawsuit took place. After Neal became bedridden, Helen hired Jackie Reese to help her take care of Neal and to do chores and errands. In September of 2000, Reese began writing checks on the Rogerses’ four accounts and forged Helen’s name on the signature line. Some of the checks were made out to “cash,” some to “Helen K. Rogers,” and some to “Jackie Reese.” The following chart summarizes the forgeries to each account: ACCOUNT NUMBER BEGINNING ENDING NUMBER OF CHECKS AMOUNT OF CHECKS 54282309 11/27/2000 6/18/2001 46 $ 16,635.00 0039289441 9/27/2000 1/25/2001 10 $ 2,701.00 6100110922 11/29/2000 8/13/2001 29 $ 9,297.00 6404000343 11/20/2000 8/16/2001 83 $ 29,765.00 total 168 $58,398.00 Neal died in late May of 2001. Shortly thereafter, the Rogerses’ son, Neal, Jr., began helping Helen with financial matters. Together they discovered that many bank statements were missing and that there was not as much money in the accounts as they had thought. In June of 2001, they contacted Union Planters and asked for copies of the missing bank statements. In September of 2001, Helen was advised by Union Planters to contact the police due to forgeries made on her accounts. * * * Subsequently, criminal charges were brought against Reese. In the meantime, Helen filed suit against Union Planters, alleging conversion (unlawful payment of forged checks) and negligence. After a trial, the jury awarded Helen $29,595 in damages, and the circuit court entered judgment accordingly. From this judgment, Union Planters appeals. Discussion *** The relationship between Rogers and Union Planters is governed by Article 4 of the Uniform Commercial Code, [citation]. [UCC] Section 4-406(a) & (c) provide that a bank customer has a duty to discover and report “unauthorized signatures”; i.e., forgeries. Section 4-406 of the UCC reflects an underlying policy decision that furthers the UCC’s “objective of promoting certainty and predictability in commercial transactions.” The UCC facilitates financial transactions, benefitting both consumers and financial institutions, by allocating responsibility among the parties according to whomever is best able to prevent a loss. Because the customer is more familiar with his own signature, and should know whether or not he authorized a particular withdrawal or check, he can prevent further unauthorized activity better than a financial institution which may process thousands of transactions in a single day. Section 4-406 acknowledges that the customer is best situated to detect unauthorized transactions on his own account by placing the burden on the customer to exercise reasonable care to discover and report such transactions. The customer’s duty to exercise this care is triggered when the bank satisfies its burden to provide sufficient information to the customer. As a result, if the bank provides sufficient information, the customer bears the loss when he fails to detect and notify the bank about unauthorized transactions. [Citation.] Union Planters’ Duty to Provide Information under §4-406(a). The court admitted into evidence copies of all Union Planters statements sent to Rogers during the relevant time period. Enclosed with the bank statements were either the cancelled checks themselves or copies of the checks relating to the period of time of each statement. The evidence shows that all bank statements and cancelled checks were sent, via United States Mail, postage prepaid, to all customers at their “designated address” each month. Rogers introduced no evidence to the contrary. We therefore find that the bank fulfilled its duty of making the statements available to Rogers and that the remaining provisions of §4-406 are applicable to the case at bar. * * * In defense of her failure to inspect the bank statements, Rogers claims that she never received the bank statements and cancelled checks. Even if this allegation is true, it does not excuse Rogers from failing to fulfill her duties under §4-406(a) & (c) because the statute clearly states a bank discharges its duty in providing the necessary information to a customer when it “sends... to a customer a statement of account showing payment of items.” §4-406(a) (emphasis added). [Citation.] The word “receive” is absent. The customer’s duty to inspect and report does not arise when the statement is received, as Rogers claims; the customer’s duty to inspect and report arises when the bank sends the statement to the customer’s address. A reasonable person who has not received a monthly statement from the bank would promptly ask the bank for a copy of the statement. Here, Rogers claims that she did not receive numerous statements. We find that she failed to act reasonably when she failed to take any action to replace the missing statements. Rogers’ Duty to Report the Forgeries under §4-406(d). A customer who has not promptly notified a bank of an irregularity may be precluded from bringing certain claims against the bank: (d) If the bank proves that the customer failed, with respect to an item, to comply with the duties imposed on the customer by subsection (c), the customer is precluded from asserting against the bank: The customer’s unauthorized signature . . . on the item, if the bank also proves that it suffered a loss by reason of the failure; . . . [UCC] §4-406(d)(1). Also, when there is a series of forgeries, §4-406(d)(2) places additional duties on the customer: The customer’s unauthorized signature . . . by the same wrongdoer on any other item paid in good faith by the bank if the payment was made before the bank received notice from the customer of the unauthorized signature . . . and after the customer had been afforded a reasonable period of time, not exceeding thirty (30) days, in which to examine the item or statement of account and notify the bank. A bank may shorten the customer’s thirty-day period for notifying the bank of a series of forgeries, and here, Union Planters shortened the thirty-day period to fifteen days. The statute states that a customer must report a series of forgeries within “a reasonable period of time, not exceeding thirty (30) days.” “The 30-day period is an outside limit only. However 30 days is presumed to be reasonable and the bank bears the burden of proving otherwise.” [Citation.] *** Rogers is therefore precluded from making claims against Union Planters because (1) under §4-406(a), Union Planters provided the statements to Rogers, and (2) under §4-406(d)(2), Rogers failed to notify Union Planters of the forgeries within 15 and/or 30 days of the date she should have reasonably discovered the forgeries. *** * * * [U]nder §4-406, Rogers is precluded from recovering amounts paid by Union Planters on any of the forged checks because she failed to timely detect and notify the bank of the unauthorized transactions and because she failed to show that Union Planters failed to use ordinary care in its processing of the forged checks. Therefore, we reverse the circuit court’s judgment and render judgment here that Rogers take nothing and that the complaint and this action are finally dismissed with prejudice. ELECTRONIC FUNDS TRANSFERS The use of commercial paper for payment has already made the United States a virtually cashless society; technological advances of computers may bring about a virtually checkless society through electronic funds transfer systems (EFTs). An electronic funds transfer has been defined as “any transfer of funds, other than a transaction originated by check, draft, or similar paper instrument, which is initiated through an electronic terminal, telephonic instrument, or computer or magnetic tape so as to order, instruct, or authorize a financial institution to debit or credit an account.” To address the legal issues of EFTs, Congress enacted the Electronic Fund Transfer Act in 1978, and the Permanent Editorial Board of the UCC has promulgated Article 4A—Funds Transfers. 29-3 TYPES OF ELECTRONIC FUNDS TRANSFERS 29-3a Automated Teller Machines (ATM) Permit customers to conduct various banking transactions through the use of electronic terminals. After activating an ATM with a plastic identification card and a personal identification number (PIN) a customer can deposit and withdraw funds from her account, transfer funds between accounts, obtain cash advances from bank credit card accounts, and make payments on loans. 29-3b Point-of-Sale Systems (POS) Allow consumers to automatically transfer funds from their bank accounts to a merchant, using a machine located within the merchant’s store, activated by the consumer’s identification card and code. The computer will then instantaneously debit the consumer’s account and credit the merchant’s account. 29-3c Direct Deposits and Withdrawals Customer-preauthorized direct deposits (such as direct payroll deposits, deposits of Social Security payments, and deposits of pension payments) may be made to the customer’s account through an electronic terminal. Automatic withdrawals are preauthorized electronic funds transfers from the customer’s account for regular payments to some other party (such as insurance companies, utility companies or automobile finance companies). 29-3d Pay-By-Phone Systems Some financial institutions permit customers to pay bills by telephoning the bank’s computer system and directing the transfer of funds. Customers may also transfer funds between personal accounts. 29-3e Personal Computer (Online) Banking Online banking enables the customer to execute many banking transactions via an Internet-connected computer. For instance, customers may view account balances, request transfers between accounts, and pay bills electronically. *** Chapter Outcome *** Explain wholesale funds transfers and discuss how they operate. 29-3f Wholesale Electronic Funds Transfers Over one trillion dollars of wholesale electronic funds transfer occur each business day between financial institutions, between financial institutions and businesses, and between businesses, under the auspices of the Federal Reserve wire transfer network system (Fedwire) and the New York Clearing House Interbank Payment System (CHIPS), and a number of private wholesale wire systems which exist among large banks. 29-4 CONSUMER FUNDS TRANSFERS The Electronic Funds Transfer Act was passed in 1978 and administered by the Board of Governors of the Federal Reserve System, the act requires disclosure of terms and conditions regarding electronic funds transfers in language the customer will understand. The act is similar in many respects to the Fair Credit Billing Act which applies to credit card transactions. 29-4a Disclosure The act is primarily a disclosure statute, which requires the terms and conditions of electronic funds transfers involving a consumer's account be disclosed in readily understandable language at the time a consumer contracts for services. Required disclosures include liabilities, charges, rights, and procedures. 29-4b Documentation and Periodic Statements Consumers must be provided with written documentation of each transfer made from an electronic terminal at the time of the transfer. The documentation must clearly state the amount involved, the date, the type of transfer, the identity of the consumer's accounts involved, the identity of any third party, and the location of the terminal. Periodic statements must be provided to the customer, describing amount, date, and location for each transfer; the fee for the transaction; and an address and phone number for questions and information. 29-4c Preauthorized Transfers A preauthorized transfer from a consumer's account must be authorized in advance by the consumer in writing. A copy must be provided to the consumer when made. 29-4d Error Resolution From the date a bank sends a periodic statement a customer has sixty days to provide notice of any errors, and upon such notice the institution must respond within ten business days. Failure to investigate in good faith makes the financial institution liable for treble damages. 29-4e Consumer Liability Consumer liability is limited to $50 if notification of unauthorized transfers is provided within two days after the consumer learns of the theft, and $500 if notice is made subsequently. Customer liability is unlimited if notice is not given within sixty days after receipt of a periodic statement, and the bank can demonstrate that the loss would not have occurred absent the customer's failure to report. If the financial institution fails to investigate in good faith, it is liable to the consumer for treble damages. 29-4f Liability of Financial Institution The financial institution is liable for damages proximately caused by a failure to make an EFT within the terms of the customer's account contract. There is no liability if the consumer's account has insufficient funds, the funds are subject to legal process, the transfer would exceed an established credit limit, the terminal has insufficient case, or circumstances beyond the control of the institution to prevent the transfer. 29-5 WHOLESALE FUNDS TRANSFERS Article 4A, Funds Transfers is designed to provide a statutory framework for an electric payment system that is not covered by existing U.C.C. provisions or the Electronic Fund Transfer Act; provides that the rights and obligations of the parties to a funds transfer covered by the article are subject to the contrary agreement of the parties or the funds transfer system rules governing banks. 29-5a Scope of Article 4A Article 4A covers the transfers of credit that move from an originator to a beneficiary through the banking system. However, if any step is governed by the Electronic Fund Transfer Act, the entire transaction is excluded from Article 4A coverage. Payment order — A sender’s instruction to a receiving bank to pay, or to cause another bank to pay, a fixed or determinable amount of money to a beneficiary; may be oral, electronic, or in writing. Parties — These include the originator, sender, receiving bank, originator's bank, beneficiary's bank, beneficiary, and intermediary bank. NOTE: See Fig. 29-2: Parties to a Funds Transfer for an example. Excluded Transactions — Article 4A provides that if any part of a funds transfer is governed by the Electronic Fund Transfer Act, the transfer is excluded from Article 4A coverage. NOTE: See Figure 29-2. 29-5b Acceptance If the beneficiary's bank accepts a payment order, the bank is obligated to pay the beneficiary the amount of the order. 29-5c Erroneous Execution of Payment Orders If a receiving bank mistakenly executes a payment order for an amount greater than that authorized by the sender, the bank is only entitled to the correct ordered amount. 29-5d Unauthorized Payment Orders If a bank establishes commercially reasonable security precautions, its customer may have to pay the payment order even if it proved to be unauthorized. Part Six: Unincorporated Business Associations CONTENTS Chapter 30 Formation and Internal Relations of General Partnerships Chapter 31 Operation and Dissolution of General Partnerships Chapter 32 Limited Partnerships and Limited Liability Companies ETHICS QUESTIONS RAISED IN THIS PART 1. From an ethical perspective what obligations does one partner have toward her fellow partners? Are the ethical obligations of a partner to her fellow partners the same as her legal obligations? What moral obligations does a partner have to her fellow partners in dealing with third parties? 2. A partnership is defined as "an association of two or more persons to carry on as co-owners a business for profit." Are there any kinds or types of businesses that it would be unethical to carry on for profit? If so, what businesses are they? Would these same businesses be unethical if carried on in some other form of business organization? 3. In a limited partnership, are there any moral or ethical obligations that the general partner(s) have to the limited partner(s)? Are there any moral or ethical obligations that the limited partner(s) have to the general partner(s)? 4. What ethical obligations should managers in a limited liability company have towards the members? ACTIVITIES AND RESEARCH PROBLEMS 1. Have students get together with one or more other students and draft the necessary papers to create (a) a general partnership (b) a limited partnership and (c) a limited liability company to carry on a business of some type. 2. Have students find the relative number of new business entities that are formed as partnerships, limited partnerships, limited liability companies, limited liability partnerships, limited liability limited partnerships, and corporations. 4. Have students interview partners in law or accounting partnerships to discover why they chose partnerships and whether they have registered as an LLP. 5. Have students interview members of limited liability companies to find out why they chose to form an LLC. Chapter 30 FORMATION & INTERNAL RELATIONS OF GENERAL PARTNERSHIPS NOTE: the following outline reflects the contents of the student’s textbook. This instructor’s manual is in a slightly different order because it presents a side-by-side comparison of UPA and RUPA where appropriate. Cases in This Chapter In Re KeyTronics Thomas v. Lloyd Enea v. The Superior Court of Monterey County Chapter Outcomes After reading and studying this chapter, the student should be able to: • Identify the various types of business associations and explain the factors relevant to deciding which form to use. • Distinguish between a legal entity and a legal aggregate and identify those purposes for which a partnership is treated as a legal entity and those purposes for which it is treated as a legal aggregate. • Distinguish between a partner’s rights in specific partnership property and a partner’s interest in the partnership. • Identify and explain the duties owed by a partner to her copartners. • Identify and describe the rights of partners. • TEACHING NOTES Various factors such as ease of formation, type of control, and taxation are considered when the owners of a business enterprise decide what type of entity they wish to become. Choices include sole proprietorship, an unincorporated entity (such as a general partnership, limited partnership, or a limited liability company), or a corporation. After a brief introduction to these forms of business, this chapter and Chapter 31will cover general partnerships. Chapter 32 will cover other types of unincorporated business associations; Chapters 33-36 will address corporations. NOTE See Figure 30-1 for a comparison of several of these business forms. CHOOSING A BUSINESS ASSOCIATION *** Chapter Objective*** Identify various types of business associations & explain the factors relevant to deciding which to use. 30-1 FACTORS AFFECTING THE CHOICE 30-1a Ease of Formation Some business associations are created with no formalities, some require filing of documents with the state. 30-1b Taxation Some business associations are considered separate taxable entities; others are not. Income from a business which is not a taxable entity is “credited” to the owners and taxed on their personal returns. Separate taxable entitles, such as corporations, are directly taxed. Funds distributed to the owners are then also taxed on the owners’ personal returns. All businesses that have publicly traded ownership interests must be taxed as a corporation. 30-1c External Liability The most common types of external liability are tort and contract liability. In some business, owners have unlimited liability, meaning their entire estate may be liable for some or all of the business’ debts. In other businesses, the owner’s liability is limited to the capital he or she has contributed to the business. An owner of any type of business does not have limited liability for his own tortious conduct. 30-1d Management and Control Owners may share fully in the control of the business or their right to control may be restricted. 30-1e Transferability In some businesses, owners may transfer their financial interest, but not their managerial interest; in other businesses, ownership is freely transferable. 30-1f Continuity Low continuity in a business means that the death or withdrawal of an owner will dissolve the business. High continuity ensures that the business will continue through an ownership change. Note: See Figure 30-1: General Partnership, Limited Partnership, Limited Liability Company and Corporation 30-2 FORMS OF BUSINESS ASSOCIATIONS 30-2a Sole Proprietorship An unincorporated business owned by just one person; formed with no formality and no documents to be filed. If one person conducts a business and does not file with the state to form an LLC or corporation, a sole proprietorship will result by default. It is not a separate taxable entity. Owners have unlimited liability for all debts. Ownership is freely transferable, but the business dissolves upon the owner’s death. 30-2b General Partnership An unincorporated business formed for profit, owned by two or more persons; formed with no formality and no documents to be filed. If two or more people conduct a business and do not file with the state to form another type of business organization, a general partnership will result by default. It is not a separate taxable entity. Owners have unlimited liability for all debts. Each partner has equal rights to control. Financial interest is freely assignable, but the assignee may become a partner only upon consent of other partners. The business dissolves upon any partner’s death or withdrawal. 30-2c Joint Venture An unincorporated business established by two or more persons, usually for a short time period and for a specific purpose. In most cases, joint ventures are governed by the law of partnerships. 30-2d Limited Partnership An unincorporated business formed for profit, owned by at least one general partner and at least one limited partner; requires filing of certificate of limited partnership with the state. A limited partnership may elect not to be a separate taxable entity, in which case only the partners are taxed. Publicly traded limited partnerships, however, are subject to corporate income taxation. General partners have unlimited liability for all debts; limited partners have limited liability. Each general partner has equal rights to control, but limited partners have no right to participate in control. Financial interest is freely assignable, but the assignee may become a limited partner only upon consent of other partners. The business dissolves upon any general (but not limited) partner’s death or withdrawal. 30-2e Limited Liability Company A limited liability company (LLC) is an unincorporated business association that provides limited liability to all of its owners and permits all of its members to participate in management. It may elect not to be a separate taxable entity. As noted previously, publicly traded LLCs are subject to corporate income taxation. If an LLC has only one member, then it will be taxed as a sole proprietorship, unless separate entity tax treatment is elected. The LLC provides many of the advantages of a general partnership plus limited liability. In most States members may assign their financial interest in the LLC, but the assignee may become a member of the LLC only if all of the members consent or the LLC’s operating agreement provides otherwise. In some States the death, bankruptcy, or withdrawal of a member dissolves an LLC; in others they do not. Every State has adopted an LLC statute. 30-2f Limited Liability Partnership A general partnership that, by making the statutorily required filing, limits the liability of its partners for some or all of the partnership's obligations. To become an LLP, a general partnership must file with the state an application containing specified information. All of the States have enacted LLP statutes. 30-2g Limited Liability Limited Partnership An unincorporated business similar to a limited partnership, except that the general partners have limited liability as in an LLP. An existing limited partnership may be able to register as an LLLP without having to form a new organization, as would be required to form an LLC. 30-2h Corporation A legal entity distinct and separate from its owners. Formed by filing its articles of incorporation with the state. A corporation is taxed on its earnings and the shareholders are taxed on distributions they receive from the corporation. (Some corporations qualify to organize as “Subchapter S” corporations and are exempt from the corporate-level taxing.) Shareholders have limited liability; management is controlled by elected Board of Directors. Shares are freely transferable; the business does not dissolve upon a shareholder’s death or withdrawal. 30-2i Business Trusts Created by voluntary agreement between parties, with no state consent required. Has three distinguishing characteristics: 1) is devoted to the conduct of a business, 2) each beneficiary is entitled to a certificate evidencing ownership of an interest in the trust, 3) trustees have the exclusive right to control the business, free from control by the beneficiaries. The trustees are personally liable, unless expressly stated otherwise; in most jurisdictions, beneficiaries have no liability for trust obligations. FORMATION OF A GENERAL PARTNERSHIP Partnerships as a form of business can be traced as far back in time as ancient Babylonia, classical Greece and the Roman Empire. Partnerships are important because they allow people with different expertise, backgrounds, resources, and interests to combine their skills to form a more competitive enterprise. It should be recalled that except for the filing requirements and the partners’ liability shield, the law governing LLPs is identical to the law governing general partnerships. 30-3 NATURE OF PARTNERSHIP The National Conference of Commissioners on Uniform State Laws promulgated the Uniform Partnership Act (UPA) in 1914. In August 1986, the UPA Revision Subcommittee of the Committee on Partnerships and Unincorporated Business Organizations of the American Bar Association's Section of Corporation, Banking and Business Law and the National Conference of Commissioners on Uniform State Laws decided to undertake a complete revision of the UPA. The revision was approved in 1997 and was amended in 2011 and 2013. At least 37 States have adopted the Revised Act (RUPA). This Instructor’s Manual will discuss both UPA and RUPA, with a side-by-side comparison when appropriate. Note that the chapter in the text discusses the RUPA but, where the RUPA has made significant changes, the UPA is also discussed. The chapter summary in the text reflects only the RUPA. Though fairly comprehensive, the RUPA and UPA do not cover all legal issues concerning partnerships. Accordingly, both the RUPA (Section 104) and the UPA (Section 5) provide that unless displaced by particular provisions of this Act, the principles of law and equity supplement this Act. 30-3a Definition RUPA and UPA both define a partnership as “an association of two or more persons to carry on as co-owners a business for profit.” Section 101(6). The RUPA broadly defines “person” to include individuals, partnerships, corporations, joint ventures, business trusts, estates, trusts, and any other legal or commercial entity.” Section 101(10). The comments indicate that this definition would include a limited liability company. Also defined by Section 101, a business includes every trade, occupation, and profession. [UPA Sections 2, 6] *** Chapter Objective*** Distinguish between a legal entity and a legal aggregate. Identify those purposes for which a partnership is treated as a legal entity and those purposes for which it is treated as a legal aggregate. 30-3b Entity Theory Partnership as a Legal Entity — A legal entity is a unit capable of possessing legal rights and of being subject to legal duties. A legal entity may acquire, own, and dispose of property. It may enter into contracts, commit wrongs, sue, and be sued. A partnership is an entity distinct from its partners, but what this means exactly depends on whether UPA or RUPA is ruling. UPA RUPA Under UPA, a partnership is a legal entity with regard to (1) holding title to real estate, (2) assets of partnership are distinct from assets of members, (3) partner is a fiduciary to partnership, (4) partner is an agent of partnership, and (5) marshaling of assets. Under the Revised Act a partnership is a legal entity in these ways: (1) The assets of the firm are treated as those of the business and are considered to be distinct from the individual assets of the members. (2) A partner is accountable as a fiduciary to the partnership. (3) Every partner is considered an agent of the partnership. (4) A partnership may sue and be sued in the name of the partnership. Partnership as a Legal Aggregate — The common law regarded a partnership as a legal aggregate, a group having no legal existence apart from that of its individual members. The Internal Revenue Code treats a partnership as an aggregate. The partnership does not pay federal income tax; but the partners are taxed on the income each derives from the partnership. UPA RUPA The UPA partially rejected the common law view and treats partnerships as legal aggregates for some purposes but as legal entities for others. The UPA continues aggregate treatment of partnerships: (1) partners have unlimited liability for partnership debts, (2) partnerships lack continuity of existence, and (3) an assignee cannot become a member without the consent of all members. The Revised Act has greatly increased the extent to which partnerships are treated as entities. It applies aggregate treatment to very few aspects of partnerships, the most significant of which is that partners still have unlimited liability for the partnership’s obligations, unless the partnership has filed a statement of qualification to become a limited liability partnership (LLP). 30-4 FORMATION OF A PARTNERSHIP Forming a partnership is simple. A partnership may result from an oral or written agreement between the parties or simply from the conduct of the parties. Persons become partners by agreeing to associate themselves in a business as co-owners. If two or more individuals share the control and profits of a business, the law may deem them partners regardless of how they themselves characterize their relationship. 30-4a Partnership Agreement A “partnership agreement” is “the agreement, whether written, oral, or implied, among the partners concerning the partnership, including amendments to the partnership agreement.” This definition does not include other agreements between some or all of the partners, such as a lease or a loan agreement. Partners should put their agreement to associate as partners in writing, although they are not usually required to do so by law. UPA RUPA Any partnership agreement (sometimes called articles of partnership) should include: 1. the firm name and identity of the partners, 2. the nature and scope of the partnership business, 3. the duration of the partnership, 4. the capital contributions of each partner, 5. the division of profits and sharing of losses, 6. the management duties of each partner, 7. a provision for salaries, if desired, 8. the restrictions, if any, on the authority of particular partners to bind the firm, 9. the right, if desired, of a partner to withdraw from the firm, and the terms, conditions, and notice such withdrawal would require, and 10. a provision for continuation of the business by the remaining partners, if desired, in the event of the death of a partner or other dissolution, and a statement of the method or formula for appraising and paying the interest of the deceased or former partner. Any partnership agreement should include 1. The firm name and the identity of the partners; 2. The nature and scope of the partnership business; 3. The duration of the partnership; 4. The capital contributions of each partner; 5. The division of profits and sharing of losses; 6. The managerial duties of each partner; 7. A provision for salaries, if desired; 8. Restrictions, if any, upon the authority of particular partners to bind the firm; 9. Any desired variations from the partnership statute’s default provisions governing dissolution; and 10. A statement of the method or formula for determining the value of a partner’s interest in the partnership Statute of Frauds – Partnership agreements required to be in writing are: a contract to form a partnership to exist longer than one year; a contract for the transfer of an interest in real estate to or by a partnership. Firm Name – A partnership should have a firm name, which may not be identical with or deceptively similar to the name of any other existing business concern; it may be the name of the partners or of any one of them, or a fictitious or assumed name. In most states, statutes require anyone conducting business under an assumed or fictitious name to file in a designated public office a certificate with the business name and the real names and addresses of all persons conducting the business. The name must not be likely to indicate to the public that it is a corporation. 30-4b Tests of Partnership Existence Because partnerships can be formed without the slightest formality, it is important that the law establish a test for determining whether a partnership has been formed. Under both UPA and RUPA, the definition of a partnership contains three components. Association — A partnership is formed by the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the parties intend to form a partnership Business for Profit — The partners must co-own a business for profit. Not a partnership because not for profit are: social clubs, charitable organizations, fraternal orders and civic societies. Also not a partnership: an association of people for financial gain on a temporary basis or for relatively few isolated transactions, although they may have formed a joint venture. Co-ownership — The co-ownership of a business is essential for the existence of a partnership; the co-ownership of property used in a business is not necessary. The two most important factors in business ownership are (a) sharing of profits and (b) right to manage and control the business. Sharing profits is prima facie evidence that a person is a partner in a business. But the sharing of gross returns does not in itself establish a partnership — thus, two brokers who share commissions are not necessarily partners, and an author who receives royalties is not a partner with her publisher. An agreement to share in the losses of a business gives strong evidence of a partnership interest. Also, evidence of participation in management and control is persuasive evidence of a partnership relationship, when taken together with other factors, particularly profit sharing. NOTE: See Figure 30-2. CASE 30-1 IN RE KEYTRONICS Supreme Court of Nebraska, 2008 274 Neb. 936, 744 N.W.2d 425 http://scholar.google.com/scholar_case?case=18315123236442947796&q=744+N.W.2d+425&hl=en&as_sdt=2,34 McCormack, J. [In 1999 King was doing business under the name of “Washco” as a sole proprietorship engaged in selling, installing, and servicing carwash systems and accessories. King offered to his customers the “QuikPay” system, a cashless vending system for carwashes that used a memory chip key that interacted with a controller at the carwash. Either a cash value can be placed on the key or the carwash usage recorded on the key is billed monthly. Washco purchased QuikPay systems for resale from Datakey Electronics Inc. (Datakey) but it was becoming unprofitable for Datakey, partly because the keys for QuikPay could only be obtained from an attendant. According to Glen Jennings, president of Datakey, since most carwashes are unattended, this reliance on the presence of the carwash owner or employee was limiting the product’s market. As QuikPay’s largest distributor, King was aware that QuikPay’s limitations made the product unattractive to many of his customers. King contacted Willson, an electronics technician and computer programmer, to see if Willson could develop a combined “key dispenser” and “revalue station” for the QuikPay system that would make the system self-service. King also asked Willson if he would design and install an interface between the QuikPay system and the carwash of one of King’s customers. Designing such an interface was beyond King’s technical expertise. Willson individually designed and installed at least four specific customer interfaces that allowed King to sell the QuikPay system to those customers, but Willson was never paid for his work. According to King there was an oral agreement among himself, Willson, and Scott Gardeen (an employee of Datakey who was an original designer of QuikPay) to form a corporation whenever Willson developed the key dispenser-revalue station. The three parties met in the spring of 2002 to discuss the venture in which they would design and build the key dispenser-revalue station and sell it to Datakey. It was agreed that Willson would write the software and do the firmware, hardware, and any other electrical or software work; Gardeen would contribute his knowledge of the system and his contact with Datakey; and King would contribute financial resources and his experience and contacts as QuikPay’s largest distributor. Together, Willson, King, and Gardeen came up with the name “Secure Data Systems” for their business. They discussed the fact that the entity’s initials, “SDS,” were also the initials of their first names, Scott, Don, and Scott. By the summer, Willson had built a handheld revalue station for a meeting with Jennings. Jennings indicated that if a final, marketable key dispenser-revalue station were developed, Datakey would be interested in a business relationship with Secure Data Systems. Around October 2002, Datakey decided to discontinue its QuikPay line and referred all of its customers to King for continued support of the system. By the beginning of 2003, King had deliberately separated his QuikPay sales, maintenance, and its future development from his Washco carwash business and had moved all QuikPay business to Secure Data Systems. Around the same time, Willson developed a website for Secure Data Systems with e-mail accounts for King and Willson. By the spring of 2003, Willson’s work for Secure Data Systems consisted primarily of dealing with QuikPay maintenance and repair issues, although he continued to try to finish the key dispenser-revalue station whenever he had time. Willson made changes in the QuikPay software to fix problems that customers wanted fixed. In May 2003, King and Willson went together to an international carwash convention in Las Vegas, Nevada. King suggested to Willson that he make up Secure Data Systems business cards for King and Willson. The cards presented Willson as “System Designer & Engineer” and King as “Sales.” The cards described Secure Data Systems as carrying the “QuikPay Product Line.” In correspondence with clients, King often referred to Willson as the person doing technical work for QuikPay. Willson also sent e-mails communicating directly with QuikPay clients on various issues. In an e-mail dated August 12, 2003, Willson described himself as the software and hardware designer with Secure Data Systems and he referred to King as his “partner.” In October 2003, King sent an e-mail to a potential customer in which King referred to Willson as “the other half of Secure Data Systems.” Willson estimated that he had put at least 2,000 hours into QuikPay sales and maintenance and in developing the key dispenser-revalue station. When Willson was asked why he invested his time and expertise into QuikPay without any remuneration, he explained, “That was my contribution to the company. I mean that was my piece.” Willson contacted a law firm to draw up papers to formalize the partnership. These papers were never drafted. According to Willson, when he told King he was looking into creating a written agreement for their relationship, King “assured [him] that he was having his attorneys look at it.” King and Willson had another meeting around the end of December and agreed to end their relationship and any joint QuikPay or key dispenser-revalue station activities. Approximately two weeks after this meeting, King called Willson and offered to compensate him for the time he had spent in maintaining or repairing QuikPay. Willson refused. Willson brought an action for winding up and an accounting, alleging formation of a partnership. King denied they had formed a partnership. The trial court found that King and Willson had “pooled resources, money and labor,” but found no partnership existed because there was no “specific agreement.” Alternatively, the trial court found that because King did not commit his preexisting business to any specifically formed partnership, the scope of the partnership did not encompass any activity garnering profits. Willson appealed the trial court’s order.] This case is governed by the * * * revised Uniform Partnership Act. Section [202(a)] of the Act defines that a partnership is formed by “the association of two or more persons to carry on as co-owners a business for profit” and explains that this is true “whether or not the persons intend to form a partnership.” [Citation.] * * * [W]hether the business of QuikPay maintenance, or even the development of the never-produced key dispenser-revalue station, qualifies as a business “for profit” is not in issue. It is not essential that the business for which the association was formed ever actually be carried on, let alone that it earn a profit. Rather, a business qualifies under the “business for profit” element of [Section 202(a)] so long as the parties intended to carry on a business with the expectation of profits. [Citations.] * * * We first consider whether King and Willson formed an association. King correctly points out that inherent to the term “association” is the idea that the relationship between the “two or more persons” be intentional. [Citation.] King argues that no partnership was formed because he never intended to form a partnership relationship with Willson. * * * But, as [Section 202(a)] explicitly states, the intent necessary to form an association does not refer to the intent to form a partnership per se. There is no requirement that the parties have a “specific agreement” in order to form a partnership. People do not become partners when they attain co-ownership of a business for profit through an involuntary act. [Citation.] But, if the parties’ voluntary actions form a relationship in which they carry on as co-owners of a business for profit, then “they may inadvertently create a partnership despite their expressed subjective intention not to do so.” [Citation.] Intent, in such cases, is still of prime concern, but it will be ascertained objectively, rather than subjectively, from all the evidence and circumstances. [Citation.] * * * In considering the parties’ intent to form an association, it is generally considered relevant how the parties characterize their relationship or how they have previously referred to one another. [Citation.] The joint use of a business name is evidence of an association. [Citations.] This is especially true when the business name is composed of the parties’ names or initials. [Citations.] It is undisputed that King and Willson discussed the fact that Secure Data Systems had the initials of Scott, Don, and Scott. Granted, at its inception, Secure Data Systems was an association among three parties focused on the limited task of creating a key dispenser-revalue station. * * * King removed any QuikPay operations from his Washco business. He instead began to conduct all QuikPay business exclusively through Secure Data Systems. Willson was clearly associated with King in that venture. * * * Business cards were created for King and Willson describing their respective positions in Secure Data Systems. King and Willson went as joint representatives of Secure Data Systems to a Las Vegas carwash convention. King and Willson worked together both in servicing the QuikPay line, assembling and repairing Datakey’s old inventory, and developing the key dispenser-revalue station. Various e-mails to customers and to Datakey evidence their joint efforts in this regard. To King and to others, Willson referred to himself and King as partners. Specifically in regard to ventures involving the regular QuikPay system, King referred to Willson as “the other half of Secure Data Systems.” We believe the evidence is clear that King and Willson formally associated to develop a key dispenser-revalue station and that further, this association expanded in scope to encompass all QuikPay operations. * * * King claims that he started selling and maintaining QuikPay by himself and asserts that he maintained full control of that business line. According to King, Willson simply did what King asked him to—apparently for free. Being “co-owners” of a business for profit does not refer to the co-ownership of property, [RUPA Section 202(c)(3)] but to the co-ownership of the business intended to garner profits. It is co-ownership that distinguishes partnerships from other commercial relationships such as creditor and debtor, employer and employee, franchisor and franchisee, and landlord and tenant. [Citation.] Co-ownership generally addresses whether the parties share the benefits, risks, and management of the enterprise such that (1) they subjectively view themselves as members of the business rather than as outsiders contracting with it and (2) they are in a better position than others dealing with the firm to monitor and obtain information about the business. [Citation.] The objective indicia of co-ownership are commonly considered to be: (1) profit sharing, (2) control sharing, (3) loss sharing, (4) contribution, and (5) co-ownership of property. [Citation.] The five indicia of co-ownership are only that; they are not all necessary to establish a partnership relationship, and no single indicium of co-ownership is either necessary or sufficient to prove co-ownership. [Citation.] * * * The record demonstrates that Willson contributed his time and expertise not only to the business of developing the key dispenser-revalue station, but also to the continued operations of the regular QuikPay product line. * * * The continuing investment of one’s labor without pay is generally considered a strong indicator of co-ownership. [Citations.] * * * Valid consideration for an ownership interest in a partnership may take the form of either property, capital, labor, or skill, and the law does not exalt one type of contribution over another. [Citations.] In this case, Willson contributed his time and expertise without any compensation for approximately 1 year. Conservatively, Willson estimated his contribution as totaling over 2,000 hours. * * * that without Willson’s technical assistance, King would have been unable to continue QuikPay’s viability after Datakey abandoned the product. That King could have dealt with certain issues by hiring contractors or employees is irrelevant. He chose not to do so—presumably because the promise of the key dispenser-revalue station made a partnership relationship more worthwhile—and saved himself the expense of paying for this labor. We also find that despite King’s protestations to the contrary, the evidence shows that King and Willson shared control over QuikPay business. * * * * * * Willson also testified that he had an agreement with King to share profits, although King denies this. Of the five indicia of co-ownership, profit sharing is possibly the most important, and the presence of profit sharing is singled out in [Section 202(c)(3)] as creating a rebuttable presumption of a partnership. [Citations.] However, what is essential to a partnership is not that profits actually be distributed, but, instead, that there be an interest in the profits. [Citations.] Willson’s testimony that they agreed to share in the profits of the business is, in light of all the evidence, simply more credible than King’s statement that compensation “was never discussed.” And even King vaguely admits that they had an understanding to share profits of the key dispenser-revalue station, if that were developed. * * * We do not find any evidence that King and Willson had an agreement for loss sharing. But we find this of little import, since purported partners, expecting profits, often do not have any explicit understanding regarding loss sharing. [Citation.] Likewise, although King and Willson admittedly do not own any joint property, in an informal relationship, the parties may intend co-ownership of property but fail to attend to the formalities of title. [Citation.] Moreover, in this case, it is unclear that there is much QuikPay “property” at all. * * * We conclude that the objective, as well as subjective, indicia are sufficient to prove co-ownership of the business of selling, maintaining, and developing QuikPay. Having already concluded that there was an association for the same, we conclude that Willson proved that he and King had formed a partnership for the business of selling, maintaining, and developing QuikPay. Reversed and remanded for further proceedings. 30-4c Partnership Capital and Property Partnership capital is the total money and property the partners contribute and dedicate to use in the enterprise. All property brought into the partnership or later acquired by it is partnership property. Questions arise over whether property owned by a partner before formation of the partnership and that is used in partnership business is a capital contribution and thus an asset of the partnership. Ultimately, the partners’ intention controls whether property belongs to the partnership or to one or more of the partners in their individual capacities. The intention to consider property as partnership property may be inferred from any of the following: • property was improved with partnership funds, • property was carried on the books of the partnership as an asset, • taxes, liens, or expenses were paid by the partnership, • income or proceeds of the property were treated as partnership funds, or • the partners have admitted or declared that it is partnership property. UPA RUPA The RUPA sets forth two rebuttable presumptions that apply when the partners have failed to express their intent. First, property purchased with partnership funds (cash or credit) is presumed to be partnership property, without regard to the name in which title is held. Second, property acquired in the name of one or more of the partners, without an indication of their capacity as partners and without use of partnership funds or credit, is presumed to be the partners’ separate property, even if used for partnership purposes. CASE 30-2 THOMAS v. LLOYD Missouri Court of Appeals, Southern District, Division One, 2000 17 S.W.3d 177 http://scholar.google.com/scholar_case?case=17595001908950706244&q=17+S.W.3d+177&hl=en&as_sdt=2,34 Shrum, J. Plaintiff’s husband of thirty years died in February 1988. In February 1989, Plaintiff met Defendant in Mobile, Alabama, while traveling. Their chance meeting quickly blossomed into a romantic relationship. When Plaintiff returned to her home in Maryland in late February 1989, Defendant accompanied her and they began living together. Initially, Defendant told Plaintiff he worked for a major oil company, had been outside the country for the past three years, was independently wealthy, and was not married. As Plaintiff later learned, none of these statements was true. In truth, Defendant had recently been released from prison. He had multiple criminal convictions, including convictions for counterfeiting and stealing. Further, Defendant’s assets at the time were no more than $2,000, and he was legally married to Patricia Lloyd. Evidence as to when Plaintiff learned of Defendant’s deceptions was contradictory. The trial court found that Plaintiff first learned of Defendant’s criminal history and lack of wealth soon after she returned to Maryland in February 1989. It found that Plaintiff discovered Defendant was not single “soon after her void marriage to Defendant.” The parties’ “void marriage” occurred July 10, 1989, in Canada. Except for occasional vacations, Plaintiff and Defendant resided in Plaintiff’s home in Maryland from late February 1989 through October 1990. During that period, Defendant made repairs and renovations to Plaintiffs house. In October 1990, Plaintiff sold her Maryland home in an “owner-finance” arrangement. The parties then moved to Missouri. After looking at several farm properties, they bought a 600-acre farm in Crawford County, Missouri, for $150,000. The deed was dated March 8, 1991. The grantees named in the deed and the type of tenancy created were as follows: Plaintiff, a single person, and Defendant, a single person, as joint tenants with right of survivorship. The $150,000 purchase price was paid as follows: $100,000 cash down- payment and a $50,000 purchase money note that called for 120 monthly installments of $633.38. After buying the farm, Plaintiff and Defendant bought cattle and farm machinery, then began operating a cattle business on the property. The parties also made improvements to the farm, including remodeling an old farm house in which they lived. In June 1992, they began construction on a 4,200 square-foot house. Later, the house was expanded to 6,500 square feet. By the time of trial, Plaintiff s expenditures for labor and materials on the home exceeded $201,000. A progressive deterioration in the parties’ relationship led to the filing of this multiple-count lawsuit in October 1995. [The trial court found that the subject real estate was not a partnership asset and ordered it be sold at public auction and the net sale proceeds to be distributed ninety-eight percent to Plaintiff and two percent to Defendant. The Defendant appealed the trial court’s refusal to classify farm real estate as a partnership asset.] “The true method of determining whether, as between partners themselves, land standing in the names of individuals is to be treated as partnership property is to ascertain from the conduct of the parties and their course of dealing, the understanding and intention of the partners themselves, which, when ascertained, unquestionably should control.” [Citations.] Whether real estate titled in the names of individual partners is partnership property is a question of fact and the burden of proof is on the one alleging that the ownership does not accord with the legal title. [Citation.] In attempting to demonstrate that the parties intended for the real estate to be a partnership asset, Defendant points to the joint ownership of the farm and the fact that the parties operated the partnership cattle business on the farm as evidence that the two understood and intended for the farm to be a partnership asset. His reliance on those facts is misplaced, however. A joint purchase of real estate by two individuals does not, in and of itself, prove the land is a partnership asset. [Citation.] On the contrary, when land is conveyed to partnership members without any statement in the deed that the grantees hold the land as property of the firm, there is a presumption that title is in the individual grantees. [Citation.] * * * The mere use of land by a partnership does little to show the land is owned by the partnership. [Citation.] * * * Defendant points to evidence that some real estate taxes and promissory note payments for the farm came from partnership funds. He argues such evidence indicates the parties intended the farm to be a partnership asset. We agree that such evidence is a factor to be considered, but it is not determinative of the issue, especially, when, as here, the partnership payment evidence is viewed in context. For instance, none of the $100,000 downpayment for the farm came from partnership funds. Instead, it all came from Plaintiff’s separate funds. Plaintiff was never reimbursed by either the partnership or Defendant for her downpayment. Of eighty-four monthly farm note payments, only three were paid from the parties’ joint account. Seventy-seven of the monthly farm note payments, a total of $48,770.26, were paid from Plaintiffs separate funds. Plaintiff also spent $201,927.87 of her separate money to build a new house on the farm. None of the house construction costs came from partnership funds. Of the seven years’ worth of state and county real estate taxes that had been paid on the farm property, only one year was paid out of partnership funds. On the whole, the evidence is that Plaintiff invested over $350,000 of her own funds in this farm while less than $2,400 of partnership funds were used to pay the farm note and real estate taxes. Such minimal partnership expenditures is more indicative of the tendency of people—particularly in family or quasi-family businesses—to intermingle personal and partnership affairs, than it is an indication of the parties’ intent to include the farm as a partnership asset. [Citation.] Other evidence from which the parties’ intent can be gleaned includes the following: (A) Plaintiff and Defendant signed as individuals on the $50,000 purchase money note and deed of trust securing the same, without a recital of partnership status; (B) neither party filed a partnership income tax return; (C) Plaintiff filed income tax returns as an individual; (D) Defendant never filed an income tax return after the farm was purchased; (E) Plaintiff wrote checks on her individual account for materials and labor for farm improvements; and (F) Plaintiff repeatedly testified she never intended nor agreed to a partnership with Defendant. We find these circumstances sufficient to support the implicit finding and judgment of the trial court that a partnership agreement did not exist regarding the land and it was not a partnership asset. * * * The judgment of the trial court is affirmed. RELATIONSHIPS AMONG PARTNERS The operation and management of a partnership involves interactions among the partners as well as their interactions with third persons. This chapter will consider both of these relationships. The first part of the chapter focuses on the rights and duties of the partners among themselves and to the partnership, which are determined by the partnership agreement, the partnership statute, and the common law. The second part of the chapter focuses on the relations among the partnership, the partners and third persons who deal with the partnership. These relations are governed by the laws of agency, contracts, and torts as well as by the partnership statute. 30-5 DUTIES AMONG PARTNERS Most legal rights and duties of partners may be established by agreement of the partners, so long as they maintain standards of fairness and do not affect the rights of third parties. Nevertheless, the RUPA makes some duties mandatory; these cannot be waived or varied by the partnership agreement. The legal duties of partners among themselves are the duties of loyalty, of obedience, and of care; also, the duties to inform their co-partners and to account to the partnership. All of these duties correspond precisely with the duties owed by an agent to his principal. *** Chapter Objective*** Identify and explain the duties owed by a partner to his or her copartners. 30-5a Fiduciary Duty Each partner owes a fiduciary duty of utmost good faith, fairness, and loyalty to his partners. His duty is one of continuous and undivided loyalty to them. UPA RUPA The UPA touches only sparingly on a partner’s duty of loyalty and leaves any further development of the fiduciary duties of partners to the common law of agency. In general, this fiduciary duty means that a partner may not (1) make a profit other than his agreed compensation, (2) compete with the partnership, (3) profit at the partnership’s expense, (4) put himself before the firm, (5) deal at arm’s length with his partners, and (6) acquire for himself a partnership asset or opportunity without consent of all the partners. The fiduciary duty under the UPA differs in some respects from that of the RUPA. First, the partner’s fiduciary duty under the UPA applies to the formation of the partnership. Second, it applies to the winding up of the partnership. The UPA states that every partner must account to the partnership for any benefit he receives and must hold as trustee for it any profits he derives without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use he makes of its property. UPA Section 21. A partner may not prefer himself over the firm, nor may he even deal at arm's length with his partners, to whom his duty is one of undivided and continuous loyalty. The fiduciary duty also applies to the purchase of a partner's interest from another partner. Each partner owes the highest duty of honesty and fair dealing to the other partners, including the obligation to disclose fully and accurately all material facts. The RUPA completely and exclusively states the components of the duty of loyalty by specifying that a partner has a duty not to appropriate partnership benefits without the consent of her partners, to refrain from self dealing, and to refrain from competing with the partnership. Section 404(b). More specifically, Section 404(b) of the RUPA provides that a partner’s duty of loyalty to the partnership and the other partners is limited to the following: • 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; • to refrain from dealing with the partnership in the conduct or winding up of the partnership business as, or on behalf of, a party having an interest adverse to the partnership; and • to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. In addition, the Revised Act provides that a partner does not violate the duty of loyalty merely because the partner's conduct furthers his own interest. The fiduciary duty does not extend to the formation of the partnership, when, according to the comments to RUPA Section 404, the parties are really negotiating at arm's length. The duty not to compete terminates upon dissociation, and the dissociated partner may immediately engage in a competitive business, without any further consent. The Revised Act imposes a duty of good faith and fair dealing when a partner discharges duties to the partnership and the other partners under the RUPA or under the partnership agreement and exercises any rights. Section 404(d). CASE 30-3 ENEA v. THE SUPERIOR COURT OF MONTEREY COUNTY Court of Appeal of California, Sixth Appellate District, 2005 132 Cal.App.4th 1559, 34 Cal.Rptr. 3d 513 http://scholar.google.com/scholar_case?q=34+Cal.Rptr.3d+513&hl=en&as_sdt=2,34&case=5283361880886275530&scilh=0 Rushing, P. J. Defendants [William and Claudia Daniels] state that in 1980, they and other family members formed a general partnership known as 3-D. The partnership’s sole asset was a building that had been converted from a residence into offices. Some portion of the property—apparently the greater part—has been rented since 1981 on a month-to-month basis by a law practice of which William Daniels is apparently the sole member. From time to time the property was rented on similar arrangements to others, including defendant Claudia Daniels. Plaintiff’s counsel stipulated in the court below that “the partnership agreement has as its principal purpose the ownership, leasing and sale of the only partnership assets, which is the building.” He also stipulated that the partnership agreement contained no provision that the property “[would] be leased for fair market value.” Defendants also assert, as the trial court ultimately found, that there was no evidence of any agreement to maximize rental profits. In 1993, plaintiff [Benny Enea], a client of William Daniels, purchased a one-third interest in the partnership from the latter’s brother, John P. Daniels. * * * In 2001, however, plaintiff questioned William Daniels about the rents being paid for the property * * * “and in 2003, Plaintiff was ‘dissociated’ from the partnership.” On August 6, 2003, plaintiff brought this action “to determine partner’s buyout price and for damages.” Alleg[ing] that defendants had occupied the partnership property * * * [while] paying significantly less than fair rental value, “in breach of their fiduciary duty to plaintiff.” In their answer, defendants denied all of these allegations except to admit that defendant Claudia Daniels had occupied a portion of the premises at one time. * * * [The court granted defendants’ motion for summary judgment, and plaintiff appealed.] * * * Despite the numerous diversions offered by defendants, the case presents a very simple set of facts and issues. For present purposes it must be assumed that defendants in fact leased the property to themselves, or associated entities, at below-market rents. * * * Therefore the sole question presented is whether defendants were categorically entitled to lease partnership property to themselves, or associated entities (or for that matter, to anyone) at less than it could yield in the open market. Remarkably, we have found no case squarely addressing this precise question. We are satisfied, however, that the answer is a resounding “No.” The defining characteristic of a partnership is the combination of two or more persons to jointly conduct business. [Citation.] It is hornbook law that in forming such an arrangement the partners obligate themselves to share risks and benefits and to carry out the enterprise with the highest good faith toward one another—in short, with the loyalty and care of a fiduciary. “Partnership is a fiduciary relationship, and partners are held to the standards and duties of a trustee in their dealings with each other.” “‘… [I]n all proceedings connected with the conduct of the partnership every partner is bound to act in the highest good faith to his copartner and may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation, concealment, threat or adverse pressure of any kind.’ [Citations.]” [Citation.] Or to put the point more succinctly, “Partnership is a fiduciary relationship, and partners may not take advantages for themselves at the expense of the partnership.” [Citations.] Here the facts as assumed by the parties and the trial court plainly depict defendants taking advantages for themselves from partnership property at the expense of the partnership. The advantage consisted of occupying partnership property at below-market rates, i.e., less than they would be required to pay to an independent landlord for equivalent premises. * * * Defendants * * * persuaded the trial court that they had no duty to collect market rents in the absence of a contract expressly requiring them to do so. This argument turns partnership law on its head. Nowhere does the law declare that partners owe each other only those duties they explicitly assume by contract. On the contrary, the fiduciary duties at issue here are imposed by law, and their breach sounds in tort. * * * * * * [Accordingly, we direct the trial court to set aside its order and deny the motion.] 30-5b Duty of Obedience The partner’s duty of obedience means that he is to act in accordance with the partnership agreement and any business decisions properly made by the partnership. 30-5c Duty of Care UPA RUPA A partner owes a duty of care to manage partnership affairs without culpable, or blameworthy, negligence. Culpable negligence is something more than ordinary negligence, yet short of gross negligence. Thus, a partner who makes honest errors of judgment or who fails to use ordinary skill in transacting partnership business certainly made a mistake, but she does not breach her duty of care so long as she is not culpably negligent. Each partner owes the partnership a duty of faithful service to the best of his ability. Nonetheless, he need not possess the degree of knowledge and skill of an ordinary paid agent. Under the Revised Act a partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. *** Chapter Objective*** Identify and describe the rights of partners. 30-6 RIGHTS AMONG PARTNERS UPA RUPA The law provides partners with certain rights, including their: • rights in specific partnership property under a tenancy in partnership, • interest in the partnership, • right to share in distributions, • right to participate in management, • right to choose associates, and • right of enforcement. The law provides partners with certain rights, which include their: • right to use and possess partnership property for partnership purposes, • transferable interest in the partnership, • right to share in distributions (part of their transferable interest), • right to participate in management, • right to choose associates, and • enforcement rights. *** Chapter Objective*** Distinguish between a partner’s rights in specific partnership property and a partner’s interest in the partnership. 30-6a Rights in Specific Partnership Property UPA RUPA A partner’s ownership interest in any specific item of partnership property is by tenancy in partnership, a type of ownership that exists only in partnership and has the following characteristics: 1. Each partner has an equal right to possess partnership property for partnership purposes, but he has no right to possess it for any other purpose without his copartners’ consent. 2. A partner may not make an individual assignment of his right in specific partnership property. 3. A partner’s interest in specific partnership property is not subject to attachment or execution by his individual creditors — only by creditors with a claim against the partnership. 4. On the death of a partner, his right in specific partnership property vests in the surviving partners. On the death of the last surviving partner, that partner’s right in the property vests in his legal representative. In either case, the partnership property may be used only for partnership purposes. In adopting the entity theory, the Revised Act abolishes the UPA’s concept of tenants in partnership. Partnership property is owned by the partnership entity and not by the individual partners. Section 203. Moreover, RUPA Section 501 provides, “A partner is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily.” A partner may use or possess partnership property only on behalf of the partnership. Section 401(g). 30-6b Partner’s Transferable Interest in the Partnership UPA RUPA Besides owning every specific item of partnership property as a tenant in partnership, each partner has an interest in the partnership, defined as her share of the profits and surplus. This interest is personal property and, on the partner’s death, passes to her estate. Each partner has an interest in the partnership, which is defined as “all of a partner’s interests in the partnership, including the partner’s transferable interest and all management and other rights.” Section 101(9). A partner’s “transferable interest” is a more limited concept; it is the partner's share of the profits and losses of the partnership and the partner's right to receive distributions. This interest is personal property. Assignability — A partner may sell or assign her transferable interest in the partnership, but the transfer does not by itself cause the partner’s dissociation or a dissolution and winding up of the partnership business. The new owner is not entitled to (1) participate in the management or conduct of the partnership business, (2) require access to any information concerning partnership transactions, or (3) inspect or copy the partnership books or records. A new owner is merely entitled to receive the share of profits to which the original partner would otherwise be entitled, including a share of distributions upon dissolution and winding up. UPA RUPA The other partners by a unanimous vote may expel a partner who has transferred substantially all of his transferable partnership interest, other than as security for a loan. The partner may be expelled, also, upon foreclosure of the security interest. Under Section 103(a), the partners may agree among themselves to restrict the right to transfer their partnership interests. Creditors’ Rights — A partner’s interest in the partnership is subject to the claims of the partner’s individual creditors, who may obtain a charging order (type of judicial lien) against the partner’s interest. UPA RUPA The creditor who has charged the interest of a partner may apply for a court-appointed receiver to receive and hold for the creditor’s benefit the share of profits ordinarily paid to the partner. Neither the creditor nor the receiver becomes a partner. And neither the charging order nor its sale upon foreclosure causes a dissolution of the partnership. A court may charge the transferable interest of the partner to satisfy a partner’s debt. A charging order is also available to the judgment creditor of a transferee of a partnership interest. The court may appoint a receiver of the debtor’s share of the distributions. The court may order a foreclosure of the interest subject to the charging order. At any time before foreclosure, an interest charged may be redeemed by (1) the partner who is the judgment debtor; (2) other partners with non-partnership property; or (3) other partners with partnership property but only with the consent of all of the remaining partners. Neither the judgment creditor, the receiver, nor the purchaser at foreclosure becomes a partner. Neither the charging order nor its sale upon foreclosure causes a dissolution. Section 601(4)(ii) provides that a partner may be expelled by a unanimous vote of the other partners upon foreclosure of a judicial lien charging a partner’s interest. NOTE: See Figure 30-3: Partnership Property Compared with Partner's Interest 30-6c Right to Share in Distributions A distribution is a transfer of money or other partnership property from the partnership to a partner in the partner’s capacity as a partner. UPA RUPA Right to Share in Profits — Each partner is entitled, unless otherwise agreed, to a share of the profits. Conversely, unless otherwise agreed, each partner must contribute toward any losses of the partnership. If the partners have no agreement regarding profits, they share them equally, regardless of the ratio of their financial contributions or their degree of participation in management. And unless the partnership agreement provides otherwise, partners bear losses in the same proportion as they share profits. Right to Return of Capital — After all partnership creditors have been paid, each partner is entitled to repayment of his capital contribution during the winding up of the firm. Unless otherwise agreed, a partner is not entitled to interest on his capital contribution; however, a delay in the return of his capital contribution entitles the partner to interest at the legal rate from the date when it should have been repaid. Right to Indemnification — A partner who makes an advance to (loan to) the partnership over and above his agreed capital contribution is entitled to repayment of the advance plus interest on it. His position as a creditor of the firm is subordinate to the claims of nonpartner creditors but superior to the partners’ rights to return of capital. In addition, a partner who has reasonably and necessarily incurred personal liabilities in the ordinary and proper conduct of the firm's business or who has made payments on behalf of the partnership is entitled to indemnification or repayment on footing equal to that of partners who make advances. Right to Compensation — The UPA provides that, unless otherwise agreed, no partner is entitled to payment for acting in the partnership business. Nevertheless, all of the partners may agree to allow a partner to receive a salary or a disproportionate percentage of the profits. A partner is entitled to reasonable com-pensation for services rendered in winding up. The RUPA’s rules regarding distribution are subject to contrary agreement of the partners. A partner has no right to receive, and may not be required to accept, a distribution in kind. The RUPA provides that each partner is deemed to have an account that is credited with the partner’s contributions and share of the partnership profits and charged with distributions to the partner and the partner’s share of partnership losses. Right to Share in Profits — In the absence of an agreement regarding the division of profits, the partners share the profits equally. Absent an agreement to the contrary, however, a partner does not have a right to receive a current distribution of the profits credited to his account, the timing of the distribution of profits being a matter arising in the ordinary course of business to be decided by majority vote of the partners. Conversely, each partner is chargeable with a share of any losses the partnership sustains. A partner, however, is not obligated to contribute to partnership losses before his withdrawal or the liquidation of the partnership, unless the partners agree otherwise. Right to Return of Capital — Absent an agreement to the contrary, a partner does not have a right to receive a distribution of the capital contributions in his account before his withdrawal or the liquidation of the partnership. Right to Indemnification — A partner who makes an advance beyond his agreed capital contribution is entitled to reimbursement. An advance is treated as a loan that accrues interest. In addition, the partnership must reimburse a partner for payments made and indemnify a partner for liabilities incurred in the ordinary course of the business or for the protection of the partnership business or property. Under the RUPA a loan from a partner to the partnership is treated the same as loans of a person not a partner, subject to the fraudulent transfer law, the law of avoidable preferences under the Bankruptcy Act, and general debtor-creditor law. Right to Compensation — The RUPA provides that, unless otherwise agreed, no partner is entitled to payment for services performed for the partnership. A partner may, however, by agreement among all of the partners, receive a salary, and is entitled to reasonable compensation for services rendered in winding up. 30-6d Right to Participate in Management Under both the UPA and the RUPA, each of the partners, unless otherwise agreed, has equal rights in the management and conduct of the partnership business. The majority generally governs the decisions of the partnership, with the principal exception that all the partners must consent to any actions that are contrary to the partnership agreement. In other words, partners may override their original partnership agreement, but they must agree unanimously to do so. In their partnership agreement, the partners may provide for unequal voting rights. Large partnerships often concentrate most or all management authority in a committee of a few partners or even in just one partner. Classes of partners with different management rights may also be created. This is a common practice in accounting and law firms, which may have two or three classes of partners (e.g. junior, senior, and managing partners). 30-6e Right to Choose Associates No partner may be forced to accept as a partner any person of whom she does not approve. This is partly because of the fiduciary relationship between the partners and partly because each partner has a right to participate in the management of the business, handle the partnership assets for partnership purposes, and act as an agent of the partnership. The expression delectus personae literally means “choice of the person” and indicates the right one has to select her partners. When a partner sells her interest, the purchaser does not become a partner and is not entitled to participate in management. But partners may provide in their partnership agreement for admission of a new partner by a less-than-unanimous vote — a provision that is not uncommon in very large partnerships. 30-6f Enforcement Rights Because the partnership relationship creates rights and duties among partners, the law provides partners and the partnership with the means to enforce these rights and duties. UPA RUPA Right to Information and Inspection of the Books — Each partner may demand full information about all partnership matters and, in turn, must supply other partners with full and accurate information about all things that affect the partnership. Unless agreed otherwise, each partner has a right to inspect the firm’s books and copy any part of them. (This right may also be exercised by a duly authorized agent on behalf of a partner.) Right to Information and Inspection of the Books — If a partnership maintains books and records, they must be kept at its chief executive office. A partnership must provide partners access to its books and records to inspect and copy them during ordinary business hours. Former partners are given a similar right, limited to the records from the period during which they were partners. A duly authorized agent may also exercise this right. Each partner and the partnership must affirmatively disclose to a partner, without demand, any information concerning the partnership’s business and affairs reasonably required for the proper exercise of the partner’s rights and duties under the partnership agreement or the Act. Moreover, on demand, each partner and the partnership must furnish to a partner any other reasonable information concerning the partnership’s business and affairs. The rights to receive and demand information extend also to the legal representative of a deceased partner. Legal Action — UPA RUPA A formal account is a complete review of all financial transactions of the partnership, including financial statements. The UPA grants each partner the right to an account whenever (1) his copartners wrongfully exclude him from the partnership business or possession of its property, (2) the partnership agreement so provides, (3) a partner makes a profit in violation of his fiduciary duty, or (4) other circumstances render it just and reasonable. If a partner does not receive a requested account or is dissatisfied with it, she may bring an enforcement action called an accounting, an equitable proceeding for a complete settlement of all partnership affairs. Under RUPA 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 Revised Act. Section 405(b). Thus, under the RUPA, an accounting is not a prerequisite to the availability of the other remedies a partner may have against the partnership or the other partners. Since general partners are not passive investors, the RUPA does not authorize derivative actions. Reflecting the entity theory of partnership, the RUPA provides that the partnership itself may maintain an action against a partner for any breach of the partnership agreement or for the violation of any duty owed to the partnership, such as a breach of fiduciary duty. Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637

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